Quality and environmental cost management

1. Quality and environmental cost management Chapter 14

2. Chapter 14 objectives • Define quality, describe the four types of quality costs, and discuss the approaches used for quality cost measurement • Prepare a quality cost report, and explain its use • Explain why quality cost information is needed and how it is used • Describe and prepare three different types of quality performance reports

3. Chapter 14 objectives • Discuss how environmental costs can be measured, reported, and reduced • Show how environmental costs can be assigned to products and processes

4. 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

5. 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

6. COSTS OF QUALITY The definitions of quality-related activities imply four categories of quality costs • Prevention costs • Appraisal costs • Internal failure costs • External failure costs LO-1

7. 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

8. 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

9. Exhibit 14.1—Examples of Quality Costs by Category LO-1

10. 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 • The multiplier method • The market research method • The taguchi quality loss function LO-1

11. 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

12. 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

13. Exhibit 14.2—The Taguchi Quality Loss Function LO-1

14. Exhibit 14.2—Quality Loss Computation Illustrated LO-1

15. 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

16. REPORTING QUALITY COSTS 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

17. Exhibit 14.4—Quality Cost Categories: Relative Contribution Graphs LO-2

18. Exhibit 14.5—Robust Quality and the Zero-Defects Quality Graph LO-2

19. REPORTING QUALITY COSTS 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

20. QUALITY COST INFORMATIONAND 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

21. QUALITY COST INFORMATIONAND 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

22. 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

23. CONTROLLING QUALITY COSTS 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

24. CONTROLLING QUALITY COSTS 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

25. CONTROLLING QUALITY COSTS 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

26. Exhibit 14.6—Multiple-Period Trend Graph: Total Quality Costs LO-4

27. Exhibit 14.7—Multiple-Period Trend Graph: Individual Quality Cost Categories LO-4

28. Exhibit 14.8—Multiple-Period Trend Graph: Relative Quality Costs LO-4

29. CONTROLLING QUALITY COSTS Incentives for Quality Improvement Nonmonetary incentives Monetary incentives LO-4

30. CONTROLLING QUALITY COSTS 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

31. CONTROLLING QUALITY COSTS 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

32. 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

33. Exhibit 14.9—Ecoefficiency Relationships LO-5

34. DEFINING, MEASURING, AND CONTROLLING ENVIRONMENTAL COSTS Environmental Costs Costs that are incurred because poor environmental quality exists or may exist Four categories • Environmental prevention costs • Environmental detection costs • Environmental internal failure costs • Environmental external failure costs LO-5

35. Exhibit 14.10—Classification of Environmental Costs by Activity Type LO-5

36. DEFINING, MEASURING, AND CONTROLLING ENVIRONMENTAL COSTS 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

37. Exhibit 14.11—Relative Distribution: Environmental Costs LO-5

38. DEFINING, MEASURING, AND CONTROLLING ENVIRONMENTAL COSTS 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

39. DEFINING, MEASURING, AND CONTROLLINGENVIRONMENTAL 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

40. Exhibit 14.12—Environmental Financial Statement LO-5

41. 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

42. 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

43. End of Chapter 14