HMCost3e PPT Ch14

QUALITY AND ENVIRONMENTAL
COST MANAGEMENT
CHAPTER 14
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CHAPTER 14 OBJECTIVES
1. Define quality, describe the four types of

quality costs, and discuss the approaches
used for quality cost measurement
2. Prepare a quality cost report, and explain
its use
3. Explain why quality cost information is
needed and how it is used
4. Describe and prepare three different types
of quality performance reports
CHAPTER 14 OBJECTIVES
5. Discuss how environmental costs can be

measured, reported, and reduced
6. Show how environmental costs can be
assigned to products and processes
COSTS OF QUALITY
• A quality product or service is one that meets or

exceeds customer expectations
• Quality of conformance measure of how a product
meets its specifications
• Defective product is one that does not conform to
specifications
• Zero defects means all products conform to
specifications
• Robustness means exact conformance to the
target value
LO-1
COSTS OF QUALITY
• Costs of quality are the costs that exist because

poor quality may or does exist
• Control activities are performed by an organization
to prevent or detect poor quality
• Failure activities are performed by an organization
or its customers in response to poor quality
• Failure costs are the costs incurred by an
organization because failure activities are
performed
LO-1
COSTS OF QUALITY
• The definitions of quality-related activities

imply four categories of quality costs
1. Prevention costs
2. Appraisal costs
3. Internal failure costs
4. External failure costs
LO-1
COSTS OF QUALITY
• Prevention costs: incurred to prevent poor

quality
• Appraisal costs: incurred to determine

whether products and services are
conforming to their requirements or
customer needs
LO-1
COSTS OF QUALITY
• Internal failure costs: incurred because

products and services do not conform to
specifications or customer needs
• External failure costs: incurred because

products and services fail to conform to
requirements or satisfy customer needs after
being delivered to customers
LO-1
EXHIBIT 14.1—EXAMPLES OF QUALITY
COSTS BY CATEGORY
LO-1
COSTS OF QUALITY
Quality Cost Measurement

• Observable quality costs: available from an
organization’s accounting records
• Hidden quality costs: opportunity costs resulting
from poor quality
• Three methods of estimating hidden quality costs
1. The multiplier method
2. The market research method
3. The taguchi quality loss function
LO-1
COSTS OF QUALITY
• The multiplier method: assumes that the total

failure cost is simply some multiple of
measured failure costs
Total external failure cost = k(Measured external
failure costs)
• The market research method: used to assess
the effect of poor quality on sales and
market share
• Used to project future profit losses attributable to
poor quality
LO-1
COSTS OF QUALITY
• The taguchi quality loss function: assumes that any

variation from the target value of a quality
characteristic causes hidden quality costs
L(y) = k(y-T)2
where
K= A proportionally constant dependent upon the
organization’s external failure cost structure
Y = Actual value of quality characteristic
T = Target value of quality characteristic
L = Quality loss
LO-1
EXHIBIT 14.2—THE TAGUCHI QUALITY
LOSS FUNCTION
LO-1
EXHIBIT 14.2—QUALITY LOSS
COMPUTATION ILLUSTRATED
LO-1
REPORTING QUALITY COSTS
• The first and simplest step in creating a quality

cost reporting system is assessing current actual
quality costs
• A detailed listing of actual quality costs by
category can provide two important insights
• Reveals the magnitude of the quality costs in
each category, allowing managers to assess their
financial impact
• Shows the distribution of quality costs by
category, allowing managers to assess the
relative importance of each category
LO-2
Optimal Distribution of Quality Costs: Zero-Defects

with Robust Quality View
• Strategy for reducing quality costs
• Take direct attack on failure costs in an attempt
to drive them to zero
• Invest in the “right” prevention activities to bring
about improvement
• Reduce appraisal costs according to results
achieved
• Continuously evaluate and redirect prevention
efforts to gain further improvement
LO-2
EXHIBIT 14.4—QUALITY COST CATEGORIES:
RELATIVE CONTRIBUTION GRAPHS
LO-2
EXHIBIT 14.5—ROBUST QUALITY AND
THE ZERO-DEFECTS QUALITY GRAPH
LO-2
Role of Activity-Based Cost Management

• Activity-based costing (ABC) can be used to
calculate the quality costs per unit of a firm’s
products
• Classifies activities as value added and non-value-
added
• Keeps only those activities that add value
• Applies to quality-related activities
LO-2
QUALITY COST INFORMATION
AND DECISION MAKING
• Reporting quality costs improves managerial

planning, control, and decision making
Decision-Making Contexts
• Strategic pricing
• Cost-volume-profit analysis and strategic design
decisions
LO-3
QUALITY COST INFORMATION
AND DECISION MAKING
Certifying Quality Through ISO 9000

• Companies assess the quality of its supplies through
ISO 9000 international quality standards
• Standards are applied to the way in which a
company ensures quality
• For example, testing products, training employees,
keeping records, and fixing defects
LO-3
CONTROLLING QUALITY COSTS
Choosing the Quality Standard

• The total quality approach
• Total quality management standard that will be used
is referred to as the robust zero-defects standard
• Total quality control implies the ultimate elimination of
failure costs
• Quantifying the quality standard
• Quality can be measured by its costs
• As the costs of quality decrease, higher quality results
LO-4
Types of Quality Performance Reports

• Quality performance reports measure the progress
realized by an organization’s quality improvement
program
• Three types of progress measured and reported
• Progress with respect to a current-period standard or
goal (an interim standard report)
• The progress trend since the inception of the quality
improvement program (a multiple-period trend report)
• Progress with respect to the long-range standard or
goal (a long-range report)
LO-4
Interim Standard Report

• Compares the actual quality costs for the period
with the budgeted costs
• Measures the progress achieved within the period
relative to the planned level of progress for that
period
LO-4
Multiple-Period Trend Report

• By plotting quality costs as a percentage of sales
against time, the overall trend in the quality
program can be assessed
Long-Range Report
• Compares the current actual costs with the costs
that would be allowed if the zero-defects standard
were being met
• A variation of the value- and non-value-added cost
report
LO-4
EXHIBIT 14.6—MULTIPLE-PERIOD
TREND GRAPH: TOTAL QUALITY COSTS
LO-4
EXHIBIT 14.7—MULTIPLE-PERIOD TREND GRAPH:
INDIVIDUAL QUALITY COST CATEGORIES
LO-4
EXHIBIT 14.8—MULTIPLE-PERIOD TREND
GRAPH: RELATIVE QUALITY COSTS
LO-4
Incentives for Quality Improvement

• Nonmonetary incentives
• Monetary incentives
LO-4
Nonmonetary Incentives
• Participation helps employees internalize quality
improvement goals as their own
• One approach is the use of error cause
identification forms
• Program in which employees describe problems
that interfere with their ability to do the job right
the first time
LO-4
Monetary Incentives
• Gainsharing provides cash incentives for a
company’s entire workforce that are keyed to
quality or productivity gains
• Gainsharing provides an incentive by offering a
bonus to the employees equal to a percentage of
the cost savings
LO-4
DEFINING, MEASURING, AND
CONTROLLING ENVIRONMENTAL COSTS
The Ecoefficiency Paradigm

• Ecoefficiency: ability to produce competitively
priced goods and services that satisfy customer
needs while simultaneously reducing negative
environmental impacts, resource consumption, and
costs
• Sustainable development: development that meets
the needs of the present without compromising the
ability of future generations to meet their own
needs
LO-5
EXHIBIT 14.9—ECOEFFICIENCY
RELATIONSHIPS
LO-5
Environmental Costs
• Costs that are incurred because poor
environmental quality exists or may exist
• Four categories
1. Environmental prevention costs
2. Environmental detection costs
3. Environmental internal failure costs
4. Environmental external failure costs
LO-5
EXHIBIT 14.10—CLASSIFICATION OF
ENVIRONMENTAL COSTS BY ACTIVITY
TYPE
LO-5
Environmental Cost Report

• Reporting environmental
• Costs by category reveals two important outcomes
• The impact of environmental costs on firm profitability
• The relative amounts expended in each category
LO-5
EXHIBIT 14.11—RELATIVE DISTRIBUTION:
ENVIRONMENTAL COSTS
LO-5
Environmental Cost Reduction

• Investing more in prevention and detection
activities reduces environmental failure costs
• Zero damage is the lowest cost point for
environmental costs
LO-5
DEFINING, MEASURING, AND CONTROLLING
ENVIRONMENTAL COSTS
An Environmental Financial Report

• Ecoefficiency suggests a possible modification to
environmental cost reporting
• Specifically, in addition to reporting environmental
costs, report environmental benefits
• Additional revenues
• Current savings
• Cost avoidance (ongoing savings)
LO-5
EXHIBIT 14.12—ENVIRONMENTAL
FINANCIAL STATEMENT
LO-5
ENVIRONMENTAL COSTING
Environmental Product Costs

• Full environmental costing: assignment of all
environmental costs, both private and societal, to
products
• Full private costing: assignment of only private costs
to individual products
LO-6
ENVIRONMENTAL COSTING
Activity-Based Environmental Cost

Assignments
• Activity-based costing facilitates environmental
costing
• Each environmental activity is assigned costs,
activity rates are computed, and the rates are then
used to assign environmental costs to products
based on usage of the activity
• By assigning environmental cost to products,
management can classify products according to
their degree of “dirtiness”
LO-6
END OF CHAPTER 14

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HMCost3e PPT Ch14

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QUALITY AND ENVIRONMENTAL

1. Define quality, describe the four types of

5. Discuss how environmental costs can be

• A quality product or service is one that meets or

• Costs of quality are the costs that exist because

• The definitions of quality-related activities

• Prevention costs: incurred to prevent poor

• Appraisal costs: incurred to determine

• Internal failure costs: incurred because

• External failure costs: incurred because

Quality Cost Measurement

• The multiplier method: assumes that the total

• The taguchi quality loss function: assumes that any

• The first and simplest step in creating a quality

Optimal Distribution of Quality Costs: Zero-Defects

Role of Activity-Based Cost Management

• Reporting quality costs improves managerial

Certifying Quality Through ISO 9000

Choosing the Quality Standard

Types of Quality Performance Reports

Interim Standard Report

Multiple-Period Trend Report

Incentives for Quality Improvement

The Ecoefficiency Paradigm

Environmental Cost Report

Environmental Cost Reduction

An Environmental Financial Report

Environmental Product Costs

Activity-Based Environmental Cost

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