Quality and Environmental Cost Management COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license.

Study Objectives Define quality, describe the four types of quality costs, discuss the approaches used for quality cost measurement, and prepare a quality cost report. Explain why quality cost information is needed and how it is used. Describe and prepare three different types of quality performance reports. Explain how environmental costs can be measured and reduced.

Costs of Quality 1. Quality-linked activities Activities performed because poor quality may or does exist Control activities performed by an organization to prevent or detect poor quality Failure activities Performed by an organization or its customers In response to poor quality

Costs of Quality 1. Categories of quality costs Prevention costs: incurred to prevent poor quality in product or services from being produced Appraisal costs: Incurred to determine whether products and services are conforming Product acceptance: sample finished goods Process acceptance: sample goods while in process Internal failure costs: incurred because products or services do not conform; discovered prior to delivery External failure costs: incurred because products or services do not conform; discovered after delivery

Costs of Quality 1.

Costs of Quality 1.

Costs of Quality 1. Quality cost Estimating hidden quality costs Observable Available from the accounting records Hidden Opportunity costs resulting from poor quality Estimating hidden quality costs The multiplier method The market research method

Costs of Quality 1. Multiplier Method Assumes that the total failure cost is simply some multiple of measured failure costs: where k is the multiplier effect If k = 4, and the measured external failure costs are $3 million, then the actual external failure costs are estimated to be $12 million.

Costs of Quality 1. Market Research Method Uses formal market research methods to assess the effect of poor quality on sales and market share. Market research results can be used to project future profit losses attributable to poor quality. Customer surveys and interviews with members of a company’s sales force can provide significant insights into the magnitude of a company’s hidden costs.

Costs of Quality 1. a Actual sales of $5,000,000. b $1,000,000 ÷ $5,000,000 = 20%.

Costs of Quality 1.

Quality Cost Information and Decision Making 2. Strategic Pricing

Quality Cost Information and Decision Making 2. Cost-Volume-Profit Analysis and Strategic Decisions New Product Analysis, Project #675 Projected sales potential: 44,000 units Production capacity: 45,000 units Unit selling price: $60 Break-even: 50,000 units Decision: Reject (breakeven exceeds capacity and potential) Unit variable costs: $40 Fixed costs: Product development $ 500,000 Manufacturing 200,000 Selling 300,000 Total $1,000,000 Includes $5 quality costs Includes $100,000 quality costs

Quality Cost Information and Decision Making 2. Cost-Volume-Profit Analysis and Strategic Decisions New Product Analysis, Project #675, Revised Projected sales potential: 44,000 units Production capacity: 45,000 units Unit selling price: $60 Unit variable costs: $40 $35 Fixed costs: Product development $ 500,000 $500,000 Manufacturing 200,000 100,000 Selling 300,000 300,000 Total $1,000,000 $900,000 Break-even: 50,000 units Decision: Reject (breakeven exceeds capacity and potential) Break-even: 36,000 units Decision: Accept

Quality Cost Information and Decision Making 2.

Controlling Quality Costs 3. Traditional Approach Acceptable quality level (AQL) is the standard Includes a certain number of defective products Ship products if defective units do not exceed AQL Creates a “commitment to deliver” defective products

Controlling Quality Costs 3. Total Quality Approach Zero-defect standards Reflects a philosophy of total quality control Calls for products and services to be produced and delivered that meet the targeted value Implies the elimination of failure costs

Controlling Quality Costs 3. Total Quality Approach Quantify the standard As the costs of quality decrease, higher quality results 2.5% standard is accepted by many QC experts Interim standards Mid-range goals while pursuing the zero-defects level

Controlling Quality Costs 3. Quality Performance Reports Interim Standard Report: Progress with respect to a current-period standard or goal Multiple-Period Trend Report: The progress trend since the inception of the quality-improvement program Long-Range Report: Progress with respect to the long-range standard or goal

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Controlling Quality Costs 3.

Defining, Measuring, and Controlling Environmental Costs 4. Environmental costs: costs that are incurred because poor environmental quality exists or may exist Damage Direct degradation of the environment Indirect degradation (unnecessary usage) Categories prevention costs detection costs internal failure costs external failure costs

Defining, Measuring, and Controlling Environmental Costs 4.

Defining, Measuring, and Controlling Environmental Costs 4.

Defining, Measuring, and Controlling Environmental Costs 4.

Defining, Measuring, and Controlling Environmental Costs 4. continued

Defining, Measuring, and Controlling Environmental Costs 4. Note: “S” = societal costs

Defining, Measuring, and Controlling Environmental Costs 4.

Defining, Measuring, and Controlling Environmental Costs 4.

Defining, Measuring, and Controlling Environmental Costs 4.

End Chapter 14 COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license.