STUDENT EDITION

PowerPoint Presentation by Gail B. Wright

Professor Emeritus of Accounting Bryant University

MANAGEMENT ACCOUNTING
8th EDITION BY

Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license.

HANSEN & MOWEN

15 QUALITY COSTS AND PRODUCTIVITY

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LEARNING OBJECTIVES
1. Identify & describe the 4 types of quality costs. 2. Prepare a quality cost report; differentiate between acceptable quality level & total quality control. 3. Tell why quality cost information is needed & show how it is used. 4. Explain what productivity is; calculate the impact of productivity changes on profits.
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WEIGHING COSTS & BENEFITS

Managers need to know what quality costs are & how they change over time
Costs of quality
Studies suggest that cost of quality production might be as much as 20% 30% of sales

Benefits of quality
Competitive dimension

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DIMENSIONS OF QUALITY: 1
Performance: how consistently a product functions Aesthetics : appearance of tangible products, Aesthetics facilities, communication materials Serviceability: ease of maintaining, repairing product Features of quality design: characteristics that differentiate between similar products
Continued
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DIMENSIONS OF QUALITY: 2
Reliability: probability that product, service will perform intended function for specified length of time Durability: length of time a product functions of conformance conformance : measure of how a Quality Quality of product meets its specifications Fitness for use: suitability of product for advertised functions
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DEFECTIVE PRODUCT:
Definition

Is one that does not conform to specifications. Zero defects is the goal.

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What are costs of quality?

Costs of quality exist because poor quality does or may exist: Control activities to prevent, detect poor quality.

Failure activities are responses to poor quality.

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CATEGORIES OF QUALITY COSTS

1. Prevention costs: incurred to prevent poor quality 2. Appraisal Appraisal costs : incurred to determine whether products, services conform to requirements, customer needs 3. Internal failure costs: incurred when nonconformance is discovered & product, service reworked, scrapped, etc. 4. External failure costs: incurred when products fail to conform after delivery and recalled
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CLASSIFYING QUALITY COSTS

Observable
Costs available in accounting records

Hidden
Significant Not directly available in accounting records Estimated
Multiplier method Market research Taguchi quality loss function
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FORMULA: Multiplier Method

Multiplier method estimates quality costs as some multiple of measured failure costs.

Total external failure cost: = k (Measured external failure costs)

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How does market research estimate hidden quality costs?

Market research uses customer surveys & interviews of sales staff to project future profit losses.

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What assumption does the Taguchi quality loss function make?

Taguchi quality loss function assumes that variations from target value of quality characteristic causes hidden quality costs regardless of specification limits.
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FORMULA: Taguchi Function

Taguchi quality loss function estimates hidden costs of poor quality.

[Quality loss * Actual value of quality characteristic] L(y)

= a proportional constant multiplier of external cost failure structure * (difference between actual and target value squared) L(y) = k(y-T)2
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ACCEPTABLE QUALITY LEVEL (AQL): Definition

Is the optimal balance between control costs & failure costs.

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Is there a problem with the ACL (traditional) view of quality?

AQL encouraged lower quality levels by accepting production of a given number of defective units.

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ZERO DEFECTS MODEL:

Definition

Claims that it is cost beneficial to reduce nonconforming units to zero.

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Is there a problem with the zero defects model?

Zero defects model understates quality costs & the potential for savings from efforts to improve quality.

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REDUCING QUALITY COSTS

Take direct attack on failure costs to drive them to zero Invest in right prevention activities to bring about improvement Reduce appraisal costs according to results achieved Continuously evaluate, redirect prevention efforts to gain further improvement
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What is the strategy for reducing costs based on?

The strategy is based on the premise that a) there is a root cause for each failure, b) causes are preventable, and c) prevention is always cheaper.

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ABM & OPTIMAL QUALITY COSTS

ABM classifies costs as value-added & non-value-added and recommends non-value-added costs be eliminated.
Value-added quality costs
Prevention activities, when performed efficiently

Non-value-added quality costs

Appraisal costs Failure costs (both internal & external)
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TQC COMPONENT GRAPH

Over time, quality costs shift from nonvalue-added to valueadded (prevention) costs.

EXHIBIT 15-8
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LO 3

What are principal objectives of reporting quality costs?

Principal objectives are to improve & facilitate a) managerial planning, b) control, and c) decision making.

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TOTAL PRODUCTIVE EFFICIENCY

When concerned with productive efficiency, 2 conditions must be satisfied:
Technical efficiency: For any mix of inputs that will produce a given output, no more of any 1 input is used than necessary to produce the output Input trade-off efficiency: Given the mixes that satisfy the first condition, the least costly mix is chosen.
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PARTIAL MEASURES: Analysis

Conclusions that can be drawn about partial measures:
Existence of trade-offs mandates total measure of productivity for assessing merits of productivity decisions Because of possibility of trade-offs, financial productivity must be measured

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TOTAL PRODUCTIVITY MEASUREMENT: Definition

Is measuring productivity for all inputs simultaneously.

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PROFIT-LINKED PRODUCTIVITY MEASUREMENT: Definition

Is measuring the amount of profit change attributable to productivity change.

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PROFIT-LINKAGE RULE:
Definition

States that productivity change is the difference between [Cost of inputs without productivity change cost of inputs actually used].
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FORMULA: Profit Recovery

Profit recovery is the change in revenue minus a change in the cost of inputs .

Profit recovery

= Profit change Profit linked productivity change

= ($1,510,000 $450,000) = $1,060,000

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CHAPTER 15

THE END

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