Tutorial 3 Quality Costing

Solutions

Dr Hadiza Said

Cost of quality analysis

What does prevention, appraisal, internal failure
and external failure means?
Rearrange the costs based on the above categories

Quality Costing
Quality Costs
Costs incurred
to eliminate
defective units
before they
are produced

Costs incurred
when a defect is
discovered
before being sent
to the customer

Prevention
Costs

Internal
Failure
Costs

Appraisal
Costs

External
Failure
Costs

Costs incurred
inspecting
products to
make sure they
meet both
internal and
external
customers
requirements
Costs incurred
when a
customer
receives a
defective
product
3

Quality Costing (contd)

Prevention costs - quality engineering, quality training, statistical
process control, supplier certification, research of customer
needs
Appraisal costs - inspection/testing of incoming materials,
maintenance of test equipment, process-control monitoring,
product quality audits.
Internal-failure cost - defects, waste, net cost of scrap, rework
costs

External-failure costs - Product liability lawsuit, repair costs in

the field, product liability recalls, service calls, warranty claims

20.16

Costs of quality analysis, non-financial quality measures

1 and 2
Sales

2012

2011

12,500,000

10,000,000

Percentage

Percentage

of sales

Costs of quality

of sales

Cost

(2) = (1)

Cost

(4) = (3)

(1)

12,500,000

(3)

10,000,000

Prevention costs
Design engineering
Preventive maintenance
Training
Supplier evaluations
Total prevention costs

240,000

100,000

90,000

35,000

120,000

45,000

50,000
500,000

20,000
4.0%

200,000

2.0%

Appraisal costs
Line inspection
Product-testing equipment

85,000

110,000

Incoming materials inspection

50,000

50,000

Product-testing labour

40,000

20,000

75,000

220,000

Total appraisal costs

250,000

2.0%

400,000

4.0%

Internal failure costs

Scrap

200,000

250,000

Rework

135,000

160,000

40,000

90,000

Breakdown maintenance
Total internal failure costs

375,000

500,000
3%

5.0%

External failure costs

Returned goods
Customer support

145,000

60,000

30,000

40,000

Product liability claims

100,000

200,000

Warranty repair

200,000

300,000

Total external failure costs

Total costs of quality

475,000
1,600,000

600,000
3.8%
12.8%

1,700,000

6.0%
17.0%

Comments
Between 2011 and 2012, Alcazarquivirs costs of
quality have declined from 17% of sales to 12.8% .

The analysis of individual costs of quality categories

indicates that Alcazarquivir began allocating more
resources to prevention activities
design engineering, preventive maintenance,
training and supplier evaluations in 2012 relative to
2011. As a result, appraisal costs declined from 4%
of sales to 2%, costs of internal failure fell from 5%
of sales to 2.8% and external failure costs decreased
from 6% of sales to 3.8%.

Examples of non-financial quality measures

that Alcazarquivir could monitor are:
I. Number of defective grinders shipped to
customers as a percentage of total units of
grinders shipped.
II. Ratio of good output to total output at each
production process.
III. Employee turnover.

Hull Ltd Solutions

a) Percentage of sales
Costs
Prevention
Costs
Quality training
Workshop
Process improve
-ment project
Auditing the
quality system
Total
Appraisal
Costs
Clarifying customer
Expectation
Proof reading
Inspecting by
quality control
Total

1,200

0.3

4,800 0.9

9,800

1.6

1,800

0.4

5,900 1.1

10,900

1.8

2,400
5,400

0.5
1.2

6,200 1.2
16,900 3.2

9,100 1.5
29,800 4.9

3,200
11,500

0.7
2.5

8,600 1.7
16,400 3.2

10,900
19,200

4,300
19,000

0.9
4.1

11,800 2.3
36,800 7.2

13,700 2.3
29,800 7.3

1.8
3.2

a). Percentage of sales (cont.)

Internal failure
Costs
Press downtime
Correction of typos
Bindery waste
Total
External failure Costs
Responding to complaints
Investigating claims
Lost sales
Total
Grand total
Sales revenue
Ratio of cost/sales

12,500
10,400
6,300
29,200

2.7
2.3
1.4
6.4

8,900
9,200
3,500
21,600

1.7
1.8
0.7
4.2

11,200 2.4
6,600 1.27
11,600 2.5
6,600 1.27
23,500 5.1
10,900 2.1
46,300 10.0
24,100 4.6
99,900
99,400
460,400
517,700
21.7%
19.2%

5,500
6,700
2,100
14,300

0.9
1.1
0.7
2.7

4,500 0.7
3,900 0.6
2,900 0.4
11,300 1.7
99,200
597,600
16.6%
9

a) Another method; Percentage of total quality cost

Cost category
Prevention
Costs
Quality training
Workshop
Process improve
-ment project
Auditing the
quality system
Total
Appraisal
Costs
Clarifying customer
Expectation
Proof reading
Inspecting by
quality control
Total

First
Qtr

Second
Qtr

Third
Qtr

1,200

4,800

9,800

1,800

5,900

10,900

2,400
5,400

5%

3,200
11,500
4,300
19,000

6,200
16,900

17%

8,600
16,400
19%

11,800
36,800

9,100
29,800

30%

10,900
19,200

37%

13,700
29,800 |

44%

10

a) Another method; Percentage of total quality cost (cont.)

Internal failure
Costs
Press downtime
Correction of typos
Bindery waste
Total
External failure Costs
Responding to complaints
Investigating claims
Lost sales
Total
Grand total
Sales revenue
Ratio of cost/sales

12,500
10,400
6,300
29,200
11,200
11,600
23,500
46,300
99,900
460,400
21.7%

29%

46%

8,900
9,200
3,500
21,600
6,600
6,600
10,900
24,100
99,400
517,700
19.2%

22%

24%

5,500
6,700
2,100
14,300
4,500
3,900
2,900
11,300
99,200
597,600
16.6%

14%

11%

11

a) Interpretation (comparison
between the quarters)

First quarter emphasis was more on fixing

rather than preventing quality problems.
Over-emphasis on correcting rather than
preventing is an expensive way of having
quality
Shifts of emphasis over the quarters to
prevention
Both theory and practice tend to demonstrate
that quality costs are highest when prevention
costs are lowest
Percentage to sales ratio decline over quarters
12

b). Explain why management

might need accounting for
quality

Understanding the types and causes of quality costs can help

managers prioritise improvement projects and provide
feedback to supports and justifies improvement efforts
Management accounting provides information for planning,
decision making and control
Cost accounting has been criticised as not being adequate for
promoting quality improvement
Traditional cost accounting systems reports quality cost
through the use of standards for raw materials, direct labour
and overhead.
The costs of internal failure are normally indirectly measured
through a set of variances, while prevention and appraisal
costs are usually budgeted and allocated as part of overhead.

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b). Explain why management might need

accounting for quality

There is no detailed information to monitor all the

elements of quality costs in traditional costing
systems.
Standards are considered optimal, there is little scope
for encouraging quality reporting systems that show
detailed budgeted and actual figures for prevention,
appraisal, internal failure and external failure.
Discover what causes failures and adjust prevention
activities to close the gaps that allowed the failures to
occur. The aim is to achieve zero-defects, maximum
value, and maximum customer satisfaction.
The cost of quality report helps monitor operational
performance and identify bottlenecks and other
inefficiencies.
Any relevant point
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c). Recommendation
The cost of quality only contains indirect measures of
quality and, therefore, the operational performance
report should also include direct measures (e.g.
number of defective units; quantity of waste, etc.)
Link rewards to the cost of quality performance
Extend the quality training programmes as this
preventive action seems to have produced positive
results in the second and third quarters.
Emphasise the continuous improvement principle
not one-off results.
Encourage employees to submit suggestions for
improvements
Any relevant point
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