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COST MANAGEMENT

Guan ▪ Hansen ▪ Mowen

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.Cengage Learning and South-Western are trademarks used herein under license. 1

Quality and Environmental

Cost Management



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Study Objectives

1. Define quality, describe the four types of qualitycosts, discuss the approaches used for qualitycost measurement, and prepare a quality costreport.

2. Explain why quality cost information is neededand 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.



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Costs of Quality

• Quality-linked activities

– Activities performed because poor quality mayor 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



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• Categories of quality costs

– Prevention costs: incurred to prevent poor quality inproduct or services from being produced

– Appraisal costs: Incurred to determine whetherproducts and services are conforming• Product acceptance: sample finished goods

• Process acceptance: sample goods while in process

– Internal failure costs: incurred because products orservices do not conform; discovered prior to delivery

– External failure costs: incurred because products orservices do not conform; discovered after delivery

Costs of Quality



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Costs of Quality



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Costs of Quality



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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



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Assumes that the total failure cost is simply some multiple ofmeasured failure costs:

Costs of Quality

Multiplier Method

If k = 4, and the measured external failure costs are $3million, then the actual external failure costs areestimated to be $12 million.

Total external Measured external=failure cost failure cost

k

where k is the multiplier effect



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Costs of Quality

Uses formal market research methods to assess the effect ofpoor quality on sales and market share.

Market research results can be used to p rojectfutu re prof i t losses attr ibutable to poor qual ity.

Market Research Method

Customer surveys and interviews with members of acompany’s sales force can provide significant insights into the

magnitude of a company’s hidden costs.



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a Actual sales of$5,000,000.

Costs of Quality

b $1,000,000 ÷ $5,000,000= 20%.





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Quality Cost Information andDecision Making

Strategic Pricing

Revenues (1,000,000 @ $20) 20,000,000$ Quality costs (estimated):

Cost of goods sold (15,000,000) Inspection - materials 200,000$

Operating expenses (3,000,000) Scrap 800,000

Product-line income 2,000,000$ Rejects 500,000

Rework 400,000

Product inspection 300,000

Warranty work 1,000,000

Total Estimate 3,200,000$

Product-line Income Low-Level Instrument Group



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New Product Analysis, Project #675

Projected sales potential: 44,000 unitsProduction capacity: 45,000 unitsUnit selling price: $60


Cost-Volume-Profit Analysis and Strategic Decisions

Break-even: 50,000 unitsDecision: Reject (breakeven

exceeds capacity and potential)

Unit variable costs: $40Fixed costs:

Product development $ 500,000Manufacturing 200,000Selling 300,000

Total $1,000,000

Includes $5 qualitycosts

Includes $100,000quality costs





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Controlling Quality Costs

Zero -defect standards

• Reflects a philosophy of total quality control

• Calls for products and services to be producedand delivered that meet the targeted value

• Implies the elimination of failure costs

Total Quality Approach





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1. In ter im Standard Repo rt : Progress withrespect to a current-period standard or goal

2. Mu lt ip le-Per iod Trend Repor t: The progresstrend since the inception of the quality-improvement program

3. Long-Range Report: Progress with respect tothe long-range standard or goal

Quality Performance Reports



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Defining, Measuring, andControlling Environmental Costs

• Environmental costs: costs that are incurredbecause poor environmental quality exists ormay exist

• Damage

– Direct degradation of the environment – Indirect degradation (unnecessary usage)

• Categories – prevention costs

– detection costs – internal failure costs – external failure costs



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continued



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Note: “S” = societal costs





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COST MANAGEMENT

Guan ▪ Hansen ▪ Mowen

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.

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End Chapter 14

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Ch14 Guan Cm Aise Ppt