Chapter 3 Operating in a Quality Environment

1. How and by whom is quality defined for products and services? 2.How are companies addressing the demand for product and service quality? 3.What underlying factors support the concept of total quality management? C3 Learning Objectives

4.How do process benchmarking and results benchmarking differ? 5.How can a company’s move along the quality continuum be assessed? 6.How is the cost of quality measured? C3 Continuing... Learning Objectives

7.Why is a strategically based management accounting system needed in addition to a financial accounting system? 8.What recent changes in technology are affecting current business practices? C3 Continuing... Learning Objectives

What is Quality? Quality is the sum total of all characteristics that influence a product’s or service’s ability to meet a customer’s stated or implied needs, within that product’s or service’s grade. Grade refers to the addition or removal of product or service characteristics to satisfy additional needs, especially price.

Total Quality Management Total Quality Management (TQM) is a “management approach of an organization, centered on quality, based on the participation of all its members and aiming at long-term success through customer satisfaction, and benefits to all members of the organization and to society.” ISO 8402, Total Quality Management (1994), definition 3.7, p. 6.

Customer Focus Who are the customers? What do the customers need/want? Consider both external and internal customers!

Continuous Improvement/Innovation Continuous improvement refers to small, ongoing efforts to make positive adjustments in the status quo. Innovation involves dramatic improvements in the status quo caused by radical new ideas, technological breakthroughs, or large investments in new technology.

Decentralization The downward delegation, by top management of decision-making authority Eliminates tier of middle management Empowers employees

Empowered Employees Understand how their jobs fit into the “big picture” Recognize the needs of their customers Have the knowledge, skills, and resources to properly perform their jobs Are educated to make appropriate judgments Are held responsible for the outcomes of their decisions Believe that they are trusted by and can trust management

Activity Analysis and Process Improvement Activity analysis can be used to remove errors, redundancies, and waste from a process. Non-value-added activities are those that increase the time and costs spent on a product or service without increasing its worth to the customer. Value-added activities are those that increase the worth of a product or service to a customer and for which the customer is willing to pay.

Control Charts Control charts can be used to identify and analyze process variations. They graphically present the actual results of a specified activity and indicate upper and lower control limits.

Benchmarking Benchmarking means learning from others. More completely, it is the process of investigating, comparing, and evaluating a company’s products, processes, and/or services against those of organizations (or organizational subunits) believed to be the “best in class.”

Continuing... Benchmarking There are two major types of benchmarking: process and results. Process benchmarking assesses the quality of key internal processes by comparing them with those of other firms. Results benchmarking examines the end product or service of another company, focusing on product/service specifications and performance results.

Malcolm Baldrige Quality Award Malcolm Baldrige Quality Awards are given annually to winners in the manufacturing, service, and small business sectors. The winner must demonstrate quality achievements in the following categories: –Leadership –Information and Analysis –Strategic Planning –Human Resource Focus –Process Management –Business Results –Customer and Market Focus

ISO 9000 Key objectives for a company following the ISO 9000 series are: 1. seeking and achieving continuous improvement of the quality of its products or services in relationship to quality requirements; 2. continuously meeting all customers’ and other stakeholders’ needs by improving operations; and 3. assuring managers and customers that quality requirements are being fulfilled and improved.

Costs of Quality The four types of quality costs are: –Prevention costs –Appraisal costs –Internal failure costs –External failure costs

Continuing... Costs of Quality Prevention costs are intended to improve quality by preventing product defects that might result from dysfunctional processing. Examples: improved production equipment, training, engineering and modeling

Continuing... Costs of Quality Appraisal costs represent quality control costs incurred for monitoring. These costs compensate for mistakes not eliminated through prevention activities.

Continuing... Costs of Quality Internal failure costs represent internal losses created by defective products. Examples: Scrap or rework

Continuing... Costs of Quality External failure costs represent external losses caused by defective products. Example: warranty costs, handling customer complaints, litigation, and recalling defective products

Continuing... Costs of Quality Quality of design reflects how well a product is conceived or designed for its intended use. Quality of conformance is the extent to which a product meets the specifications of its design.

Continuing... Costs of Quality Two types of costs comprise the total quality cost of a firm: 1. Cost of quality compliance or assurance 2. Cost of noncompliance or quality failure

Continuing... Costs of Quality The cost of compliance equals the sum of prevention and appraisal costs. The cost of noncompliance results from production imperfections and equals the sum of internal and external failure costs.

Prevention Costs Employees: –Hiring for quality –Training and awareness –Establishing participation programs

Continuing... Prevention Costs Customers: –Surveying needs –Researching needs –Conducting field trials

Appraisal Costs Before Production: –Inspecting materials Production Process: –Monitoring and inspecting –Keeping the process consistent, stable, and reliable –Using procedure verification –Automating

Continuing... Appraisal Costs During and After Production: –Quality audits Information Process: –Recording and reporting defects –Measuring performance Organization: –Administering quality control department

Internal Failure Product: –Reworking –Waste –Storing and disposing –Reinspecting rework Production Process: –Reprocessing –Having unscheduled interruptions –Experiencing unplanned downtime

External Failure Organization: –Staffing complaint departments –Staffing warranty claims departments Customer: –Losing future sales –Losing reputation –Losing goodwill

Continuing... External Failure Product: –Repairing –Replacing –Reimbursing –Recalling –Litigating Service: –Providing unplanned service –Expediting –Serving after service

Time-Phased Model for Quality Costs Before Production During Production After Production After Sale Prevention Costs Appraisal Costs Internal Failure Costs External Failure Costs Feedback Loop

Numerical Example: Total Cost of Quality Consider the following operating information for the Wing Company: Defective units (D) 800 Profit per good unit (P 1 ) $25 Cost to rework defective unit (r) $5 Cost of return (w) $8 Appraisal cost (A) $5,400 Units reworked (Y) 400 Profit per defective unit (P 2 ) $15 Defective units returned (D r ) 100 Prevention cost (K)$20,000

Calculating Lost Profit Profit Lost by Selling Units as Defects Total Defective Units Number of Units Reworked Profit for Good Unit Profit for Defective Unit = Z = (D - Y) x (P 1 - P 2 ) Z = ( ) x ($25 - $15) Z = $4,000 ===== x

Calculating Rework Cost Rework Cost Number of Units Reworked Cost to Rework Defective Unit =X R = (Y) x (r) R = 400 x $5 R = $2,000 =====

Calculating Cost of Customer Returns Cost of Processing Customer Returns Number of Defective Units Returned Cost of a Return = X W = (D r ) x (w) W = 100 x $8 W = $800 ====

Calculating Total Cost of Failure Total Failure Cost Rework Cost Profit Lost by Selling Units as Defects =++ F = Z + R + W F = $4,000 + $2,000 + $800 F = $6,800 ===== Cost of Processing Customer Returns

Calculating the Total Quality Cost Total Quality Cost = Defect Control Cost + Failure Cost T = K + A + F T = $20,000 + $5,400 + $6,800 T = $32,200 ====== T Prevention Cost Appraisal Cost Failure Cost =++

Electronic Data Interchange (EDI) EDI refers to the almost instantaneous computer-to- computer transfer of information. It diminishes paperwork and speeds up communication with suppliers and customers.

Automation Bar-codes, robotics, and other forms of automation can enhance the quantity and quality of business output and the value-to- price relationship of a company’s goods and services for customers.