Cost Management Accounting & Control, Chapter 14
COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan
Quality and
Environmental Cost
Management
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
1
Study Objectives
1. Define quality, describe the four types of quality
costs, discuss the approaches used for quality
cost measurement, and prepare a quality cost
report.
2. Explain why quality cost information is needed
and how it is used.
3. Describe and prepare three different types of
quality performance reports.
4. Explain how environmental costs can be
measured and reduced.
2
Costs of Quality
• Quality-linked activities
– Activities performed because poor quality may
or does exist
– Control activities
• performed by an organization
• to prevent or detect poor quality
– Failure activities
• Performed by an organization or its customers
• In response to poor quality
3
Costs of Quality
• Categories of quality costs
– Prevention costs: incurred to prevent poor quality in
product or services from being produced
– Appraisal costs: Incurred to determine whether
products and services are conforming
•
•
Product acceptance: sample finished goods
Process acceptance: sample goods while in process
– Internal failure costs: incurred because products or
services do not conform; discovered prior to delivery
– External failure costs: incurred because products or
services do not conform; discovered after delivery
4
Costs of Quality
5
Costs of Quality
6
Costs of Quality
• Quality cost
– Observable
• Available from the accounting records
– Hidden
• Opportunity costs resulting from poor quality
• Estimating hidden quality costs
– The multiplier method
– The market research method
7
Costs of Quality
Multiplier Method
Assumes that the total failure cost is simply some multiple of
measured failure costs:
Total external = k Measured external
failure cost
failure cost
where k is the multiplier effect
If k = 4, and the measured external failure costs are $3
million, then the actual external failure costs are
estimated to be $12 million.
8
Costs of Quality
Market Research Method
Uses formal market research methods to assess the effect of
poor quality on sales and market share.
Market research results can be used to project
future profit losses attributable to poor quality.
Customer surveys and interviews with members of a
company’s sales force can provide significant insights into the
magnitude of a company’s hidden costs.
9
Costs of Quality
a
b
Actual sales of
$5,000,000.
$1,000,000 ÷ $5,000,000
= 20%.
10
Costs of Quality
11
Quality Cost Information and
Decision Making
Strategic Pricing
12
Quality Cost Information and
Decision Making
Cost-Volume-Profit Analysis and Strategic Decisions
New Product Analysis, Project #675
Projected sales potential:44,000 units
Production capacity: 45,000 units
Unit selling price:
$60
Unit variable costs:
Fixed costs:
Product development
Manufacturing
Selling
Total
$40
$ 500,000
200,000
300,000
$1,000,000
Break-even: 50,000 units
Decision:
Reject (breakeven
exceeds capacity and potential)
Includes $5 quality
costs
Includes $100,000
quality costs
13
Quality Cost Information and
Decision Making
Cost-Volume-Profit Analysis and Strategic Decisions
New Product Analysis, Project #675, Revised
Projected sales potential:44,000 units
Production capacity: 45,000 units
Unit selling price:
$60
Unit variable costs:
Fixed costs:
Product development
Manufacturing
Selling
Total
$40
$35
$ 500,000
200,000
300,000
$1,000,000
$500,000
100,000
300,000
$900,000
Break-even: 50,000 units
Decision:
Reject (breakeven
exceeds capacity and potential)
Break-even: 36,000 units
Decision:
Accept
14
Quality Cost Information and
Decision Making
15
Controlling Quality Costs
Traditional Approach
• Acceptable quality level (AQL) is the standard
– Includes a certain number of defective products
– Ship products if defective units do not exceed AQL
• Creates a “commitment to deliver” defective
products
16
Controlling Quality Costs
Total Quality Approach
Zero-defect standards
• Reflects a philosophy of total quality control
• Calls for products and services to be produced
and delivered that meet the targeted value
• Implies the elimination of failure costs
17
Controlling Quality Costs
Total Quality Approach
• Quantify the standard
– As the costs of quality decrease, higher quality
results
– 2.5% standard is accepted by many QC
experts
• Interim standards
– Mid-range goals while pursuing the zerodefects level
18
Controlling Quality Costs
Quality Performance Reports
1. Interim Standard Report: Progress with
respect to a current-period standard or goal
2. Multiple-Period Trend Report: The progress
trend since the inception of the qualityimprovement program
3. Long-Range Report: Progress with respect to
the long-range standard or goal
19
Controlling Quality Costs
20
Controlling Quality Costs
21
Controlling Quality Costs
22
Controlling Quality Costs
23
Controlling Quality Costs
24
Controlling Quality Costs
25
Controlling Quality Costs
26
Controlling Quality Costs
27
Controlling Quality Costs
28
Controlling Quality Costs
29
Controlling Quality Costs
30
Defining, Measuring, and
Controlling Environmental Costs
• Environmental costs: costs that are incurred
because poor environmental quality exists or
may exist
• Damage
– Direct degradation of the environment
– Indirect degradation (unnecessary usage)
• Categories
–
–
–
–
prevention costs
detection costs
internal failure costs
external failure costs
31
Defining, Measuring, and
Controlling Environmental Costs
32
Defining, Measuring, and
Controlling Environmental Costs
33
Defining, Measuring, and
Controlling Environmental Costs
34
Defining, Measuring, and
Controlling Environmental Costs
continued
35
Defining, Measuring, and
Controlling Environmental Costs
Note: “S” = societal costs
36
Defining, Measuring, and
Controlling Environmental Costs
37
Defining, Measuring, and
Controlling Environmental Costs
38
Defining, Measuring, and
Controlling Environmental Costs
39
COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan
End Chapter 14
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
40
Accounting & Control
Hansen▪Mowen▪Guan
Quality and
Environmental Cost
Management
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
1
Study Objectives
1. Define quality, describe the four types of quality
costs, discuss the approaches used for quality
cost measurement, and prepare a quality cost
report.
2. Explain why quality cost information is needed
and how it is used.
3. Describe and prepare three different types of
quality performance reports.
4. Explain how environmental costs can be
measured and reduced.
2
Costs of Quality
• Quality-linked activities
– Activities performed because poor quality may
or does exist
– Control activities
• performed by an organization
• to prevent or detect poor quality
– Failure activities
• Performed by an organization or its customers
• In response to poor quality
3
Costs of Quality
• Categories of quality costs
– Prevention costs: incurred to prevent poor quality in
product or services from being produced
– Appraisal costs: Incurred to determine whether
products and services are conforming
•
•
Product acceptance: sample finished goods
Process acceptance: sample goods while in process
– Internal failure costs: incurred because products or
services do not conform; discovered prior to delivery
– External failure costs: incurred because products or
services do not conform; discovered after delivery
4
Costs of Quality
5
Costs of Quality
6
Costs of Quality
• Quality cost
– Observable
• Available from the accounting records
– Hidden
• Opportunity costs resulting from poor quality
• Estimating hidden quality costs
– The multiplier method
– The market research method
7
Costs of Quality
Multiplier Method
Assumes that the total failure cost is simply some multiple of
measured failure costs:
Total external = k Measured external
failure cost
failure cost
where k is the multiplier effect
If k = 4, and the measured external failure costs are $3
million, then the actual external failure costs are
estimated to be $12 million.
8
Costs of Quality
Market Research Method
Uses formal market research methods to assess the effect of
poor quality on sales and market share.
Market research results can be used to project
future profit losses attributable to poor quality.
Customer surveys and interviews with members of a
company’s sales force can provide significant insights into the
magnitude of a company’s hidden costs.
9
Costs of Quality
a
b
Actual sales of
$5,000,000.
$1,000,000 ÷ $5,000,000
= 20%.
10
Costs of Quality
11
Quality Cost Information and
Decision Making
Strategic Pricing
12
Quality Cost Information and
Decision Making
Cost-Volume-Profit Analysis and Strategic Decisions
New Product Analysis, Project #675
Projected sales potential:44,000 units
Production capacity: 45,000 units
Unit selling price:
$60
Unit variable costs:
Fixed costs:
Product development
Manufacturing
Selling
Total
$40
$ 500,000
200,000
300,000
$1,000,000
Break-even: 50,000 units
Decision:
Reject (breakeven
exceeds capacity and potential)
Includes $5 quality
costs
Includes $100,000
quality costs
13
Quality Cost Information and
Decision Making
Cost-Volume-Profit Analysis and Strategic Decisions
New Product Analysis, Project #675, Revised
Projected sales potential:44,000 units
Production capacity: 45,000 units
Unit selling price:
$60
Unit variable costs:
Fixed costs:
Product development
Manufacturing
Selling
Total
$40
$35
$ 500,000
200,000
300,000
$1,000,000
$500,000
100,000
300,000
$900,000
Break-even: 50,000 units
Decision:
Reject (breakeven
exceeds capacity and potential)
Break-even: 36,000 units
Decision:
Accept
14
Quality Cost Information and
Decision Making
15
Controlling Quality Costs
Traditional Approach
• Acceptable quality level (AQL) is the standard
– Includes a certain number of defective products
– Ship products if defective units do not exceed AQL
• Creates a “commitment to deliver” defective
products
16
Controlling Quality Costs
Total Quality Approach
Zero-defect standards
• Reflects a philosophy of total quality control
• Calls for products and services to be produced
and delivered that meet the targeted value
• Implies the elimination of failure costs
17
Controlling Quality Costs
Total Quality Approach
• Quantify the standard
– As the costs of quality decrease, higher quality
results
– 2.5% standard is accepted by many QC
experts
• Interim standards
– Mid-range goals while pursuing the zerodefects level
18
Controlling Quality Costs
Quality Performance Reports
1. Interim Standard Report: Progress with
respect to a current-period standard or goal
2. Multiple-Period Trend Report: The progress
trend since the inception of the qualityimprovement program
3. Long-Range Report: Progress with respect to
the long-range standard or goal
19
Controlling Quality Costs
20
Controlling Quality Costs
21
Controlling Quality Costs
22
Controlling Quality Costs
23
Controlling Quality Costs
24
Controlling Quality Costs
25
Controlling Quality Costs
26
Controlling Quality Costs
27
Controlling Quality Costs
28
Controlling Quality Costs
29
Controlling Quality Costs
30
Defining, Measuring, and
Controlling Environmental Costs
• Environmental costs: costs that are incurred
because poor environmental quality exists or
may exist
• Damage
– Direct degradation of the environment
– Indirect degradation (unnecessary usage)
• Categories
–
–
–
–
prevention costs
detection costs
internal failure costs
external failure costs
31
Defining, Measuring, and
Controlling Environmental Costs
32
Defining, Measuring, and
Controlling Environmental Costs
33
Defining, Measuring, and
Controlling Environmental Costs
34
Defining, Measuring, and
Controlling Environmental Costs
continued
35
Defining, Measuring, and
Controlling Environmental Costs
Note: “S” = societal costs
36
Defining, Measuring, and
Controlling Environmental Costs
37
Defining, Measuring, and
Controlling Environmental Costs
38
Defining, Measuring, and
Controlling Environmental Costs
39
COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan
End Chapter 14
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
40