COST MANAGEMENT Accounting Control HansenMowenGuan Quality and Environmental

COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan • Quality and Environmental Cost Management 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

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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 7

Costs of Quality Multiplier Method Assumes that the total failure cost is simply some multiple of measured failure costs: 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 Actual sales of $5, 000. b $1, 000 = 20%. ÷ $5, 000 10

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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: Production capacity: Unit selling price: Unit variable costs: Fixed costs: Product development Manufacturing Selling Total 44, 000 units 45, 000 units $60 $40 $ 500, 000 200, 000 300, 000 $1, 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: Production capacity: Unit selling price: 44, 000 units 45, 000 units $60 Unit variable costs: Fixed costs: Product development Manufacturing Selling Total Break-even: 50, 000 units Decision: Reject (breakeven exceeds capacity and potential) $40 $35 $ 500, 000 $500, 000 200, 000 100, 000 300, 000 $1, 000$900, 000 Break-even: 36, 000 units Decision: Accept 14

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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

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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

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Defining, Measuring, and Controlling Environmental Costs continued 35

Defining, Measuring, and Controlling Environmental Costs Note: “S” = societal costs 36

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COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan • End Chapter 14 40