COST OF QUALITY (COQ)

EXERCISE 8-29 (20 MINUTES)

SAN MATEO CIRCUITRY

QUALITY-COST REPORT
FOR THE MONTH OF MAY
Costs Percentage
for of
May Total
Prevention costs:
Training of quality-control inspectors............................................ $21,000 22.2
Total........................................................................................ $21,000 22.2
Appraisal costs:
Tests of instruments......................................................................  30,000 31.7
Inspection of purchased electrical components............................ $12,000 12.7
Total........................................................................................ $42,000 44.4
Internal failure costs:
Costs of rework............................................................................. $ 9,000 9.5
Costs of defective parts that cannot be salvaged..........................   6,100 6.5
Total........................................................................................ $15,100 16.0
External failure costs:
Replacement of instruments already sold..................................... $16,500 17.4
Total........................................................................................ $16,500 17.4  
Total quality costs............................................................................ $94,600 100.00

PROBLEM 8-39 (35 MINUTES)

1. Warranty costs: External failure

Reliability engineering: prevention
Rework at AT’s manufacturing plant: internal failure
Manufacturing inspection: appraisal
Transportation costs to customer sites: external failure
Quality training for employees: prevention
PROBLEM 8-39 (CONTINUED)

2&3. Evaluation of quality costs:

No. 165 No. 172

$ % of Sales $ % of Sales
Sales revenue:
$60,000 x 80; $55,000 x 100... $4,800,000 $5,500,000
Prevention:
Reliability engineering
1,600 hours x $150……… $ 240,000
2,000 hours x $150……… $ 300,000
Quality training………………. 35,000 50,000
Total…………………… $ 275,000 5.73% $ 350,000 6.36%
Appraisal (inspection):
300 hours x $50………………. $ 15,000 .31%
500 hours x $50………………. $ 25,000 .45%
Internal failure (rework at AT):
80 units x 35% x $1,900…….. $ 53,200 1.11%
100 units x 25% x $1,600…… $ 40,000 .73%
External failure:
Warranty costs:
80 units x 70% x $1,200… $ 67,200
100 units x 10% x $400…. $ 4,000
Transportation to customers 29,500 15,000
Total…………………… $ 96,700 2.01% $ 19,000 .35%
Total quality costs……………….. $ 439,900 9.16% $ 434,000 7.89%

Individual quality costs as a % of total quality costs:

No. 165 No. 172

$ % of Total $ % of Total

Prevention……….. $275,000 62.51% $350,000 80.65%

Appraisal ………... 15,000 3.41% 25,000 5.76%
Internal failure …. 53,200 12.09% 40,000 9.22%
External failure…. 96,700 21.98% 19,000 4.38%
Total …………. $439,900 $434,000
PROBLEM 8-39 (CONTINUED)

4. Yes, the company is “investing” its quality expenditures differently for the two machines. Advanced
is spending more up-front on no. 172 with respect to prevention and appraisal—over 86% of the total
quality expenditures. (This figure is approximately 66% for no. 165.) The net result is lower internal
and external failure costs and, perhaps more important, lower total quality costs as a percentage of
sales (7.89% for no. 172 and 9.16% for no. 165).

This problem illustrates the essence of total quality management (TQM) systems when compared
with conventional quality control procedures. Overall costs are lower with TQM when compared
against systems that focus on “after-the-fact” detection and rework.

5. Prevention, appraisal, internal failure, and external failure costs are observable in the sense that such
amounts can be measured and reported. When inferior products make it to the marketplace, customer
dissatisfaction will often increase, resulting in lost sales of the defective product and perhaps other
goods as well. The “cost” of these lost sales is an opportunity cost—a “hidden” cost that is very
difficult to measure.

Additional Questions

1. Middle Manufacturing reported sales revenue of $500,000 for year ending March 31, 2007. Due to a
company-wide campaign on improving quality and external competitive pressures, Middle
Manufacturing began to focus on quality costs during 2007. The following costs have been identified
as being quality-related.

lost market share $30,000

design reviews $15,000
inspecting and testing materials $25,000
design changes $15,000
product acceptance (i.e., sampling) $20,000
scrap $10,000

a. Calculate the amount of quality costs classified as Prevention costs.

Ans: Prevention costs include design reviews = $15,000
 b. Calculate the amount of quality costs classified as Appraisal costs.
ANS: Appraisal costs include inspecting and testing materials and product acceptance = $45,000

c. Determine what percentage of sales is made up of internal failure costs.

ANS: Internal failure costs include scrap and design changes totaling $25,000. $25,000/$500,000
= 5%.

d. Determine what percentage of sales is made up of external failure costs.

ANS: External failure costs include lost market share of $30,000. $30,000/$500,000 = 6%.

2. Lacy Company reports the following information relating to quality costs as they relate to sales for
the past five years:

Year Prevention Appraisal Internal Failure External Failure

2000 2% 3% 9% 10%
2001 3% 4% 8% 10%
2003 3% 4% 8% 9%
2004 3% 3% 7% 9%
2005 4% 3% 6% 8%
 Lacy has plotted the data on a multiple-period trend graph as follows:

Required:

1) In which quality cost areas does the company appear to be doing better?

2) List a possible explanation for the improvements suggested in 1) above.

3) What is the potential significance of a decrease in external failure costs?

ANS:
1) The company appears to be doing a better job in controlling appraisal, internal failure
and external failure costs.
2) The company’s focus on prevention costs may have had a positive impact on the
decrease in quality costs in the other three areas.
3) A decrease in external failure costs means less rework, warranty work, product liability
and customer dissatisfaction. Improvements in this area are critical for continued
growth in sales.