Quality Costs

LOVETTE JAM PRADA JACOSALEM

Quality Cost/Cost of Quality
• the expense of nonconformance –the cost of doing
things wrong. [Crosby, P. 1979, Quality is Free]
• Sum of costs incurred in maintaining acceptable
quality levels plus the cost of failure to maintain
that level (cost of poor quality). [
http://www.businessdictionary.com/definition/cost-of-quality.html]

• Includes any costs in excess of those that would

have been incurred if a good were manufactured or
a service provided exactly right the first time [Anthony,
et. al, 2007, Accounting Texts and Cases].
Categories of Quality Costs

Quality Cost

Non-Conformance Conformance
Cost of Quality
= Cost of conformance + Cost of non-conformance

• Cost of conformance is the cost of providing

products or services as per the required
standards. (Prevention & Appraisal Costs)
• Cost of non-conformance is the failure cost
associated with a process not being operated per
the requirements. (Internal & External Failure
Costs)
Prevention Costs
 Prevention costs are associated with design,
implementation, maintenance, and planning
prior to actual operation in order to avoid
defects from happening.
 The emphasis is on the prevention of defects in
order to reduce the probability of producing
defective products. Prevention activities lead to
reduction of costs in the other three categories.
Activities Associated with Prevention
Costs
 Market research
 Quality training programs
 Contract review
 Design review
 Field trials
 Supplier evaluation
 Process plan review
 Process capability review
 Design and manufacture of jigs and fixtures
 Preventive maintenance
Appraisal Costs
• Detection Costs
• Costs spent to detect defects to assure
conformance to quality standards.
• Appraisal costs include inspection, testing, and
other activities designed to find problems before
a good is delivered.
• The appraisal costs are focused on the discovery
of defects rather than prevention of defects.
Activities Associated with Appraisal Costs
 Prototype testing
 Incoming material inspection
 Process inspection/control
 Final inspection
 Laboratory testing/measurement
 Quality audits
Internal Failure Costs
• Internal failure costs occur when results of work
fail to reach designated quality standards, and
are detected before transfer to the customer
takes place.
• Include scrap, rework, and other activities to
“make things right” before a good is delivered.
Activities Associated with Internal
Failure Costs
 Design changes/corrective action
 Scrap due to design changes
 Excess inventory
 Rectification/reject disposition of purchased
material
 Rework/rejection in manufacturing
 Downgrading of end product
 Downtime of plant & machinery
 Troubleshooting & investigation of defects
External Failure Costs
• External failure costs occur when the product or
service from a process fails to reach designated
quality standards , and is not detected until after
transfer to the customer.
• Costs of “making things right” when a quality
problem has occurred after the product has been
delivered to the customer.
Activities Associated with External Failure
Costs

 Processing/investigation of customer complaint

 Repair/replacement of sold goods
 Warranty claims
 Product liability and litigation costs
 Interest charges on delayed payment due to quality
problems
 Loss of customer goodwill and sales/lost future
business (not readily measurable)
Product Cost vs. Quality Cost
• Unlike product costs, costs of quality often are
estimates based on special studies rather than
the output of routine accounting systems.
Importance:
• Various studies have reported that these costs
range from 25% for manufacturing firms to as
high as 40% for service firms. Thus, quality can
have a large impact on profits.
• Understanding quality costs enables you to
 Understand hidden costs (conformance)
 Reduce and eliminate unnecessary cost
(non-conformance)
 Prevent problems from happening
NON-FINANCIAL QUALITY DATA
•  Principle: to identify the activity that needs
improvement and monitor the nonfinancial
elements of the activity
• Steps:
• identify the appropriate nonfinancial quality measures
to monitor;
• immediately record the measures; and
• use the recorded data to prepare timely quality reports,
including line or bar graphs.
Non-financial Quality Data
• Raw Material and Scrap
• Inventory
• Machinery
• Product Quality
• Production and Delivery
• Productivity
• Innovation and Learning
Raw Materials
• Number of vendors
• Number of unique parts
• Number of common parts
• Raw material as a percentage of total cost
• Lead time for material delivery
• Percentage of orders received on time
• Deviations between actual and budgeted raw-
material prices
• Scrap as a percentage of raw-material cost
• Quality of raw material
Inventory
• Average value of inventory
• Average amount of time various inventory items are held
• Ratio of inventory value to sales revenue
• Number of inventoried parts

Machinery
• Hours/percentage of machine downtime
• Percentage of machine availability
• Detailed machine maintenance
• Percentage of on-time routine maintenance procedures
• Setup time
Product Quality
• Customer acceptance measures
▫ Number of customer complaints
▫ Number of warranty claims
▫ Number of products returned
• In-process quality measures
▫ Number of defects found

Production and Delivery

• Manufacturing cycle time
• Velocity
• Manufacturing cycle efficiency
• Percentage of on-time deliveries
• Percentage of orders filled
• Delivery cycle time
Productivity
• Operational (physical) measures
▫ Express relationships between input and outputs in
physical terms:
 musical instruments produced per day per employee
 square feet of floor space required per instrument
per day;
 electricity required per instrument produced

Innovations and Learning

• New products:
• Percentage of sales from new products
• New products introduced by firm vs. by competitors
• Process improvements
• Number of process improvements made
Sample Nonfinancial Quality Measures