The Management & Control of Quality

1. Chapter Sixteen The Management & Control of Quality

2. Learning Objectives • Define accounting’s role in the management & control of quality • Define “quality” and the characteristics of total quality management (TQM) • Develop a comprehensive framework for the management & control of quality • Understand two different approaches for setting quality-related goals

3. Learning Objectives (continued) • Prepare and interpret relevant financial information to support TQM initiatives • Discuss the use of nonfinancial information to support TQM initiatives • Describe & understand techniques for detecting & correcting quality problems

4. Strategic Importance of Quality • Baldridge Quality Award • ISO 9000 and ISO 14000 • Conceptual linkage between Quality and Financial Performance (Exhibit 16.1—see next slide) • Empirical evidence regarding the relationship between quality and financial performance—what do the data suggest?

5. Exhibit 16.1 Improved Quality Lower Return Sales Lower Manufacturing Cost Higher Perceived Value Lower Throughput Time Lower Warranty and Service Costs Higher Prices Higher Market Share Faster Delivery Increased Revenue Financial Performance

6. Accounting’s Role in the Management & Control of Quality • Accountants can add value to the organization by providing decision-makers with relevant financial and nonfinancial information related to quality • Such information actively supports the quality initiatives embraced by management

7. Basic Terminology • “Quality”— customer satisfaction with the total experience of a product or service: • Design quality (focuses on the features that customers want) • Performance quality (focuses on product/service performance) • Total quality management (TQM) • Importance of having a good measurement system to support TQM • Limitations of conventional accounting systems?

8. Comprehensive Framework for Managing/Controlling Quality: Exhibit 16.3 • Broad business perspective—knowledge of business processes • Paramount role of the consumer • Relevant financial data • Nonfinancial performance indicators • Feedback loops • Linkage to operations management • Breadth of the system—value-chain approach

9. Setting Quality-Related Expectations • Six-Sigma approach: • Define • Measure • Analyze • Improve • Control • Goalpost vs. Absolute Conformance: • Goalpost conformance • Absolute quality conformance (robust quality approach)

10. Goalpost Conformance Goalpost or absolute conformance assumes that the firm incurs no quality or failure cost or loss if quality measures fall with the specified limits

11. Absolute Conformance Absolute quality conformance requires that all products or services meet exactlythe target value with no variation allowed

12. Financial Measures & COQ Financial information to support TQM initiatives: • Relevant cost information for decision- making (refer to concepts in Chapter 9): • Future costs and revenues that differ between decision alternatives • “Avoidable costs” vs. Sunk costs • Out-of-Pocket costs + Opportunity costs • Cost of Quality (COQ) Reporting

13. COQ Reports • Prevention—expenditures incurred to keep quality defects from occurring • Appraisal—costs incurred in the measurement and analysis of data to find out if products and services conform to specification/customer expectations • Internal failure—costs incurred as a result of poor quality found through appraisal prior to delivery to customers • External failure—costs incurred to rectify quality defects after unacceptable products or services reach the customer

14. Sample Costs of Quality • Prevention: • Quality training costs • Equipment maintenance costs • Appraisal: • Testing & inspection costs • Quality audits • Vendor certification • Test equipment and instruments

15. Sample Costs of Quality (continued) • Internal failure: • Rework costs • Scrap (net of disposal value) • Lost contribution margin because of schedule disruptions • External failure: • Costs to handle customer complaints & returns • Lost sales/market share (customer ill-will) • Field service/repair costs • Product liability lawsuits

16. Example: COQ Report

17. Conformance and Nonconformance Costs • Cost of Conformity: • Prevention Costs • Appraisal Costs Cost of Nonconformity: • Internal Failure Costs • External Failure Costs

18. Detecting & Correcting Poor Quality • Detecting Poor Quality • Control Charts • Statistical Control Charts • Run Charts • Correcting Quality Problems • Histograms • Pareto Diagrams (Charts) • “Cause-and-Effect” (“fishbone”) Diagrams

19. Control Charts

20. Control Charts (continued) The circled observations are unacceptable, that is, they suggest an out-of-control process. Management may want to investigate the underlying causes of these observations and take appropriate corrective action.

21. Histograms 1 Quality of chocolate 2 Liqueur 3 Egg size 4 Blending speed 5 Blending duration 6 Improper refrigeration

22. Pareto Diagram

23. Cause-and-Effect Diagram

24. Chocolate MousseCause-and Effect Diagram

25. Appendix: Taguchi Loss Functions General expression of the loss function, L(x), for an observed quality characteristic, x, is: L(x) = k(x -T)2 where: x = an observed value of the quality characteristic T = the target value of the quality characteristic k = the cost coefficient, determined by the firm’s failure costs Total Quality Cost k = --------------------------------------------- (ToleranceAllowed)2

26. Total Quality Cost (Tolerance Allowed)2 $5,000 0.05 k = = $2,000,000 2 Taguchi Loss Functions (continued) Your firm has determined that no customer will accept sheet-metal deviating more than 0.05” from the target thickness (0.50”). The cost to the firm is $5,000 for each rejection by a customer. k =

27. Taguchi Loss Functions (continued) L(x) = k(x -T) L(0.47) = $2,000,000(0.47 - 0.50)2 L(0.47) = $1,800  If the actual thickness of a unit is 0.47, then the estimated total loss for the unit is $1,800.

28. Chapter Summary • We specified accounting’s role in the management & control of quality • We defined “quality” and the characteristics of total quality management (TQM) • We developed and discussed comprehensive framework for the management & control of quality, and the role of accounting within this framework • We discussed two different approaches for setting quality-related goals (Six Sigma and Goalpost versus Absolute Conformance)

29. Chapter Summary (continued) • We discussed two areas where financial information can be supplied by the accountant to support TQM initiatives: • Relevant cost information for decision-making purposes • Cost of Quality (COQ) Reporting • We discussed the use of nonfinancial information to support TQM initiatives • We described techniques, borrowed from operations management, that can be used for detecting & correcting quality problems