Copyright © 2013 Nelson Education Ltd. PowerPoint Presentations for Cornerstones of Cost Accounting First Canadian Edition Adapted by George Gekas Ryerson University Copyright © 2013 Nelson Education Ltd.

Quality and Environmental Cost Management CHAPTER 16 16-2 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Quality Defined OBJECTIVE 1 Quality Definitions A quality product or service is one that meets or exceeds customer expectations. Quality is customer satisfaction. Quality of conformance is a measure of how a product meets is specifications. Quality means zero defects (all products conform to specifications). 16-3 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Quality Defined OBJECTIVE 1 Costs of Quality These exist because poor quality or potential for poor quality: Control costs (prevention & appraisal costs): For activities performed by an organization to prevent or detect poor quality. Failure costs (internal & external): Costs incurred by an organization because failure activities are performed in response to customer requests/complaints due to poor quality (external failure costs). 16-4 Copyright © 2013 Nelson Education Ltd.

Quality Defined 1 Four Categories of Quality Costs Prevention costs: OBJECTIVE 1 Four Categories of Quality Costs Prevention costs: Incurred to prevent poor quality in the products or services being produced Examples: quality training, quality audits, market research, design reviews, prototype inspection Appraisal costs: Incurred to determine whether products and services are conforming to their requirements or customer needs Examples: inspections, testing, vendor verifications 16-5 Copyright © 2013 Nelson Education Ltd.

Quality Defined 1 Four Categories of Quality Costs OBJECTIVE 1 Four Categories of Quality Costs 3. Internal failure costs: This nonconformance is detected prior to the product being shipped or the service being delivered to outside parties Examples: scrap, re-work down time, repairs, design and process changes 4. External failure: This nonconformance is detected after being delivered to outside parties Examples: recalls, returns and allowances, warranties, discounts due to defects, lost sales Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Quality Defined OBJECTIVE 1 16-7 Copyright © 2013 Nelson Education Ltd.

Quality Defined 1 Quality Cost Measurement Hidden costs of quality: OBJECTIVE 1 Quality Cost Measurement Hidden costs of quality: Lost sales Lost market share Customer dissatisfaction can be measured using three methods: Multiplier method Market research method Taguchi quality loss function 16-8 Copyright © 2013 Nelson Education Ltd.

Quality Defined 1 Multiplier Method Quality Cost Measurement OBJECTIVE 1 Quality Cost Measurement Multiplier Method Assumes that the total failure cost is simply some multiple of measured failure costs: Total external failure cost = k(Measured external failure costs) where k is the multiplier effect 16-9 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Quality Defined OBJECTIVE 1 The Market Research Method Uses formal market research methods to assess the effect of poor quality on sales and market share 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 Market research results can be used to project future profit losses attributable to poor quality 16-10 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Quality Defined OBJECTIVE 1 The Taguchi Loss Function Assumes any variation from the target value of a quality characteristic causes hidden quality costs The hidden quality costs decrease quadratically as the actual value deviates from the target value. 16-11 Copyright © 2013 Nelson Education Ltd.

Quality Defined 1 L(A) = k(A−T)2 The Taguchi Quality Loss Function OBJECTIVE 1 The Taguchi Quality Loss Function L(A) = k(A−T)2 where k = A proportionally constant dependent upon the organization’s external failure cost structure A = Actual value of quality characteristic T = Target value of quality characteristic L = Quality loss 16-12 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Quality Defined OBJECTIVE 1 16-13 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Quality Defined OBJECTIVE 1 16-14 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Reporting Quality Costs OBJECTIVE 2 Strategy to reduce quality costs recommended by the American Society for Quality Control: The strategy for reducing quality costs is quite simple: (1) take direct attack on failure costs in an attempt to drive them to zero; (2) invest in the “right” prevention activities to bring about improvement; (3) reduce appraisal costs according to results achieved; and (4) continuously evaluate and redirect prevention efforts to gain further improvement. This strategy is based on the premise that: For each failure, there is a root cause. Causes are preventable. Prevention is always cheaper.* *Jack Campanella, ed., Principles of Quality Costs (Milwaukee: ASQC Quality Press, 1990):12. 16-15 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Reporting Quality Costs OBJECTIVE 2 16-16 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Reporting Quality Costs OBJECTIVE 2 See Cornerstone 16-1 16-17 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Quality Cost Information and Decision Making OBJECTIVE 3 Reporting quality costs improves: Managerial planning Control Decision making Managers need quality cost information for: Strategic planning Cost-volume-profit analysis Companies may also assess the supplier quality through ISO 9000 (international quality standards) that ensures quality—like testing products, training employees, keeping records, fixing defects. 16-18 Copyright © 2013 Nelson Education Ltd.

Controlling Quality Costs OBJECTIVE 4 The Total Quality Approach Zero-Defects Standards Philosophy of total quality control and calls for products and services to be produced and delivered that meet the targeted value 16-19 Copyright © 2013 Nelson Education Ltd.

Controlling Quality Costs OBJECTIVE 4 The Total Quality Approach Progress with respect to a current-period standard or goal (an interim standard report) Progress trend since the inception of the quality-improvement program (a multiple-period trend report) Progress with respect to the long-range standard or goal (a long-range report) 16-20 Copyright © 2013 Nelson Education Ltd.

Controlling Quality Costs OBJECTIVE 4 Interim Standard Report Compares actual quality costs for the period with the budgeted costs Measures progress achieved within the period relative to the planned level of progress See Cornerstone 16-2 16-21 Copyright © 2013 Nelson Education Ltd.

Controlling Quality Costs OBJECTIVE 4 Multiple-Period Trend See Cornerstone 16-3 16-22 Copyright © 2013 Nelson Education Ltd.

Controlling Quality Costs OBJECTIVE 4 Multiple-Period Trend See Cornerstone 16-3 16-23 Copyright © 2013 Nelson Education Ltd.

Controlling Quality Costs OBJECTIVE 4 Multiple-Period Trend See Cornerstone 16-3 16-24 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Defining, Measuring, and Controlling Environmental Costs OBJECTIVE 5 Ecoefficiency Ability to produce competitively priced goods and services that satisfy needs while simultaneously reducing negative environmental impacts, resource consumption, and costs Producing more goods and services using less materials, energy, water, and land, while minimizing air emissions, water discharges, waste disposal and the dispersion of toxic substances Complementary and supportive to sustainable development Development that meets present needs without compromising the ability of future generations to meet their own needs 16-25 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Defining, Measuring, and Controlling Environmental Costs OBJECTIVE 5 Ecoefficiency Paradigm Reduce the consumption of resources Reduce the environmental impact Increase product value Reduce environmental liability 16-26 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Defining, Measuring, and Controlling Environmental Costs OBJECTIVE 5 16-27 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Defining, Measuring, and Controlling Environmental Costs OBJECTIVE 5 Environmental Costs Costs that are incurred because poor environmental quality exists or may exist Environmental costs, like quality, can be classified in four categories: Prevention costs Detection costs Internal failure costs External failure costs 16-28 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Defining, Measuring, and Controlling Environmental Costs OBJECTIVE 5 16-29 Copyright © 2013 Nelson Education Ltd.

5 Defining, Measuring, and Controlling Environmental Costs OBJECTIVE 5 Environmental Cost Report Reports two outcomes: Impact of environmental costs on firm profitability Relative amounts expended in each category See Cornerstone 16-5 16-30 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Defining, Measuring, and Controlling Environmental Costs OBJECTIVE 5 16-31 Copyright © 2013 Nelson Education Ltd.

5 Defining, Measuring, and Controlling Environmental Costs OBJECTIVE 5 Environmental Financial Report Three types of benefits: Additional revenues: Revenues that flow into the organization due to environmental actions Current savings: Ongoing savings of costs that had been paid in prior years Cost avoidance (ongoing savings): Reductions in environmental costs achieved in the current year 16-32 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Defining, Measuring, and Controlling Environmental Costs OBJECTIVE 5 16-33 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. Assigning Environmental Costs to Products and Processes OBJECTIVE 6 Quality and also environmental costs can be expressed as a percentage of sales Interim or long-term reports focusing on variances in terms of prevention, appraisal, detection, internal & external failure costs ABC activities-variance analysis See Cornerstone 16-6 16-34 Copyright © 2013 Nelson Education Ltd.

Copyright © 2013 Nelson Education Ltd. End of Chapter 16 Copyright © 2013 Nelson Education Ltd.