Description Amount Percentage of Percentage of Revenues (4)

(1) (2) Total COQ = (2) ÷ $45,000,000

(3) = (2) ÷
$1,820,000
Prevention costs $   350,000             19.2% 0.8%
Appraisal costs     200,000             11.0% 0.4%
Internal failure costs
  Rework     475,000
  Scrap     100,000
    Total internal failure     575,000             31.6% 1.3%
costs
External failure costs
  Customer replacements     450,000
  Lost contr. margin from     245,000
customer returns   1

    Total external failure costs     695,000             38.2% 1.5%

Total COQ $1,820,000           100.0%
1
Lost contribution margin from customer returns = 35% ×  Lost sales from customer returns.
= 35% ×  $700,000
= $245,000

The following table shows the actual COQ at iProtect, as a percentage of total COQ, and
as a percentage of revenues after the change in the production process. Note that as a result of
these changes, lost sales from customer returns decrease by 50% × $700,000 = $350,000, so
sales revenues increase by the same amount. Sales revenues in this case = $45,000,000 +
$350,000 = $45,350,000 

Description Amount Percentage of Total Percentage of

(1) (2) COQ Revenues
(3) = (2) ÷ $1,802,500 (4) = (2) ÷
$45,350,000
Prevention costs 1
$              37.7%         1.5%
680,000
Appraisal costs                11.1%         0.4%
200,000
Internal failure costs
Rework   
475,000
Scrap   
100,000
Total internal failure costs                31.9%         1.3%
575,000
External failure costs
Customer replacement costs 2
  
225,000
 Lost contr. margin from customer   
returns  
3
122,500
Total external failure costs                19.3%         0.8%
347,500
Total COQ $1,802,50           100.0%         
0
1
Prevention costs = Existing prevention costs + CAD design improvement costs + Machine calibration costs
            = $350,000 + $110,000 + $220,000 = $680,000
2
Customer replacement costs = $450,000 ×  (1 – 0.50) = $225,000
3
Lost contribution margin from customer returns = 35%  × Lost sales from customer returns
= 35% ×  $700,000 ×  (1 – 0.50)
= 35%  ×  $350,000 = $122,500

Description % Total COQ % Total COQ % of Revenue % of Revenue

BEFORE AFTER BEFORE AFTER
Prevention 19.2% 37.7% 0.8% 1.5%
Appraisal 11.0% 11.1% 0.4% 0.4%
Internal 31.6% 31.9% 1.3% 1.3%
Failure
External 38.2% 19.3% 1.5% 0.8%
Failure

As a result of implementing changes in the production process, prevention costs, which

are 19.2% of the total COQ and 0.8% of revenues, will become 37.7% of the total COQ and
1.5% of revenues. External failure costs, which are 38.2% of the total COQ and 1.5% of
revenues, will become 19.3% of the total COQ and 0.8% of revenues. The changes also result in
a decrease in the total COQ. 
The preceding calculations assume that overall sales revenues (other than the additional
sales from fewer returns) will be unaffected by the change in the production process. But quality
improvements could well result in an increase in sales, providing further benefit to iProtect. 
Improvements in the production process could also decrease rework costs, resulting in
even more benefits from quality improvement. Better quality could also have other advantages
such as improving employee morale and, therefore, making them proud to work for iProtect.

19-22 Quality improvement, relevant costs, relevant revenues. Pressing Matters

manufactures and sells 18,000 high-technology printing presses each year. The variable and
fixed costs of rework and repair are as follows:

Pressing Matters’ current presses have a quality problem that causes variations in the shade of
some colors. Its engineers suggest changing a key component in each press. The new component
will cost $70 more than the old one. In the next year, however, Pressing Matters expects that
 with the new component it will (1) save 14,000 hours of rework, (2) save 850 hours of customer
support, (3) move 225 fewer loads, (4) save 8,000 hours of warranty repairs, and (5) sell an
additional 140 printing presses, for a total contribution margin of $1,680,000. Pressing Matters
believes that even as it improves quality, it will not be able to save any of the fixed costs of re-
work or repair. Pressing Matters uses a 1-year time horizon for this decision because it plans to
introduce a new press at the end of the year.

Required:
1. Should Pressing Matters change to the new component? Show your calculations.
2. Suppose the estimate of 140 additional printing presses sold is uncertain. What is the minimum
number of additional printing presses that Pressing Matters needs to sell to justify adopting the
new component?
3. What other factors should managers at Pressing Matters consider when making their decision
about changing to a new component?

SOLUTION

(25 min.) Quality improvement, relevant costs, and relevant revenues.

1. Relevant costs over the next year of changing to the new component
= $70 × 18,000 copiers  =  $1,260,000

Relevant Benefits over 

the Next Year of Choosing the New
Component
Costs of quality items
Savings in rework costs
$79 × 14,000 rework hours $1,106,000
Savings in customer-support costs
$35 × 850 customer-support hours 29,750
Savings in transportation costs for parts
$350 × 225 fewer loads 78,750
Savings in warranty repair costs
$89 × 8,000 repair-hours 712,000

Opportunity costs   1,680,000

Contribution margin from increased sales
$3,606,500
Cost savings and additional contribution
margin
s