COST MANAGEMENT
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license. 1
Accounting & Control
Hansen▪Mowen▪Guan
Quality and
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Study Objectives
1. Define quality, describe the four types of quality costs, discuss the approaches used for quality cost measurement, and prepare a quality cost report.
2. Explain why quality cost information is needed and how it is used.
3. Describe and prepare three different types of quality performance reports.
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Costs of Quality
• 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
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• 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
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Costs of Quality
• Quality cost
– Observable
• Available from the accounting records
– Hidden
• Opportunity costs resulting from poor quality
• Estimating hidden quality costs
– The multiplier method
8 Assumes that the total failure cost is simply some multiple of measured failure costs:
Costs of Quality
Multiplier Method
If k = 4, and the measured external failure costs are $3 million, then the actual external failure costs are
estimated to be $12 million.
Total external = Measured external failure cost k failure cost
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Costs of Quality
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.
Market Research Method
Customer surveys and interviews with members of a
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a Actual sales of
$5,000,000.
Costs of Quality
b $1,000,000 ÷ $5,000,000
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Quality Cost Information and
Decision Making
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New Product Analysis, Project #675
Projected sales potential:44,000 units Production capacity: 45,000 units Unit selling price: $60
Quality Cost Information and
Decision Making
Cost-Volume-Profit Analysis and Strategic Decisions
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
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New Product Analysis, Project #675, Revised
Projected sales potential:44,000 units Production capacity: 45,000 units Unit selling price: $60
Quality Cost Information and
Decision Making
Cost-Volume-Profit Analysis and Strategic Decisions
Break-even: 50,000 units
Decision: Reject (breakeven exceeds capacity and potential)
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
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Controlling Quality Costs
• 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
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Controlling Quality Costs
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
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Controlling Quality Costs
• 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
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Controlling Quality Costs
1. Interim Standard Report: Progress with
respect to a current-period standard or goal
2. Multiple-Period Trend Report: The progress
trend since the inception of the quality-improvement program
3. Long-Range Report: Progress with respect to
the long-range standard or goal
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Defining, Measuring, and
Controlling Environmental Costs
• 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
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Defining, Measuring, and
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Defining, Measuring, and
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Defining, Measuring, and
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Defining, Measuring, and
Controlling Environmental Costs
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Defining, Measuring, and
Controlling Environmental Costs
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Defining, Measuring, and
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Defining, Measuring, and
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Defining, Measuring, and
COST MANAGEMENT
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license. 40
