1 PowerPointPresentation by PowerPoint Presentation by Gail B. Wright Professor Emeritus of Accounting Bryant University © Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license. MANAGEMENT ACCOUNTING 8 th EDITION BY HANSEN & MOWEN 15 QUALITY COSTS AND PRODUCTIVITY STUDENT EDITION

2 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. LEARNING OBJECTIVES

3 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 LO 1

4 DIMENSIONS OF QUALITY: 1  Performance: how consistently a product functions  Aesthetics : appearance of tangible products, facilities, communication materials  Serviceability: ease of maintaining, repairing product  Features of quality design: characteristics that differentiate between similar products LO 1 Continued Aesthetics

5 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  Quality of conformance : measure of how a product meets its specifications  Fitness for use: suitability of product for advertised functions LO 1 Quality of conformance

6 DEFECTIVE PRODUCT: Definition Is one that does not conform to specifications. Zero defects is the goal. LO 1

7 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. LO 1 Failure activities

8 CATEGORIES OF QUALITY COSTS 1.Prevention costs: incurred to prevent poor quality 2.Appraisal costs : incurred to determine whether products, services conform to requirements, customer needs 3.Internal failure costs: incurred when non- conformance is discovered & product, service re- worked, scrapped, etc. 4.External failure costs: incurred when products fail to conform after delivery and recalled LO 1 Appraisal costs

9 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 LO 1

10 FORMULA: Multiplier Method Multiplier method estimates quality costs as some multiple of measured failure costs. LO 1 Total external failure cost: = k (Measured external failure costs)

11 How does market research estimate hidden quality costs? Market research uses customer surveys & interviews of sales staff to project future profit losses. LO 1

12 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. LO 1

13 FORMULA: Taguchi Function Taguchi quality loss function estimates hidden costs of poor quality. LO 1 [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

14 ACCEPTABLE QUALITY LEVEL (AQL): Definition Is the optimal balance between control costs & failure costs. LO 2

15 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. LO 2

16 ZERO DEFECTS MODEL: Definition Claims that it is cost beneficial to reduce non- conforming units to zero. LO 2

17 Is there a problem with the zero defects model? Zero defects model understates quality costs & the potential for savings from efforts to improve quality. LO 2 understates

18 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 LO 2

19 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. LO 2

20 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) LO 2

21 TQC COMPONENT GRAPH LO 2 EXHIBIT 15-8 Over time, quality costs shift from non- value-added to value- added (prevention) costs.

22 What are principal objectives of reporting quality costs? Principal objectives are to improve & facilitate a) managerial planning, b) control, and c) decision making. LO 3

23 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. LO 4

24 PARTIAL MEASURES: Analysis LO 4 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

25 TOTAL PRODUCTIVITY MEASUREMENT: Definition Is measuring productivity for all inputs simultaneously. LO 4

26 PROFIT-LINKED PRODUCTIVITY MEASUREMENT: Definition Is measuring the amount of profit change attributable to productivity change. LO 4

27 PROFIT-LINKAGE RULE: Definition States that productivity change is the difference between [Cost of inputs without productivity change – cost of inputs actually used]. LO 4

28 FORMULA: Profit Recovery Profit recovery is the change in revenue minus a change in the cost of inputs. LO 4 Profit recovery = Profit change – Profit linked productivity change = ($1,510,000 – $450,000) = $1,060,000

29 THE END CHAPTER 15