Professional Documents
Culture Documents
CHAPTER 27
MANAGING ACCOUNTING IN
A CHANGING ENVIRONMENT
I.
Questions
1. The American Heritage Dictionary defines quality as 1. a characteristic
or attribute of something; property; a feature. 2. the natural or essential
character of something. 3. excellence; superiority.
Quality for a product or service can be defined as a product or service
that conforms with a design which meets or exceeds the expectations of
customers at a price they are willing to pay.
2. Procter & Gamble defines TQM as the unyielding and continually
improving effort by everyone in an organization to understand, meet, and
exceed the expectations of customers. Typical characteristics of TQM
include focusing on satisfying customers, striving for continuous
improvement, and involving the entire workforce.
TQM is a continual effort and never completes. Global competition, new
technology, and ever-changing customer expectations make TQM a
continual effort for a successful firm.
3. The core principles of TQM include (1) focusing on satisfying the
customer, (2) striving for continuous improvement, and (3) involving the
entire work force.
4. Continuous improvement (Kaizen) in total quality management is the
belief that quality is not a destination; rather, it is a way of life and firms
need to continuously strive for better products with lower costs.
In todays global competition, where firms are forever trying to
outperform the competition and customers present ever-changing
expectations, a firm can never reach the ideal quality standard and needs
to continuously improve quality and reduce costs to remain competitive.
5. The Institute of Management Accountants (IMA) believes an effective
implementation of total quality management will take between three and
five years and involves the following tasks:
Year 1
27-1
Year 2
Year 3
6. Reward and recognition are the best means of reinforcing the emphasis
on TQM. Moreover, proper reward and recognition structures can be
very powerful stimuli to promote TQM. Efforts and progress will most
likely be short-lived if no change is made to the compensation / appraisal
/ recognition systems to make them in line with the objectives of the
firms TQM.
7. The purposes of conducting a quality audit are to identify strengths and
weaknesses in quality practices and levels of a firms quality and to help
the firm identify the target areas for quality improvements.
8. A gap analysis is a type of benchmarking that includes analyzing the
differences in practices between the firm and the best-in-class. The
objective of gap analyses is to identify strengths, weaknesses, and target
areas for quality improvement.
9. Some examples of costs associated with cost of quality categories are:
Prevention costs: Training costs such as instructors fees, purchase of
training equipment, tuition for external training, training wages and
salaries; salaries for quality planning and executions, cost of preventive
equipment, printing and promotion costs for quality programs, awards
for quality.
Appraisal costs: Costs of raw materials, work-in-process, and finished
goods inspections.
27-2
27-4
Warranty repairs
Scrap
Allowance granted due
to blemish
Internal
Failure
Externa
l
Failure
x
x
x
Contribution margins of
lost sales
Tuition for quality
courses
Raw materials
inspections
Work-in-process
inspection
Shipping cost for
replacements
27-6
x
x
x
x
x
Recalls
Attorneys fee for
unsuccessful defense of
complaints about quality
k.
Inspection of reworks
l.
Overtime caused by
reworking
m.
Machine maintenance
n.
Tuning of testing
equipment
x
x
x
x
x
x
2006
Peso
2005
Peso
P 40,000
300,000 P 340,000
5.67
P 50,000
270,000
P320,000
5.33
P 80,000
1.33
P 60,000
60,000
1.00
425,000
7.08
80,000
P200,000
50,000
90,000
P360,000
230,000
P250,000
90,000
340,000
5.67
590,000
P1,350,000
9.83
22.50
85,000
P500,000
350,000
850,000 14.17
P1,655,000 27.58
a. There were slight increases in both prevention and appraisal costs from
2005 to 2006. Each of these two cost of quality increased by
approximately 0.33 percent of the total sales. These two costs increased
by P40,000 over the two years.
b. Both internal failure costs and external failure costs decreased
substantially in 2006 as compared to those in 2005. The firm
experienced a 1.41 percent decrease in internal failure and a 4.34 percent
decrease in external failure costs with the total savings of P345,000. The
savings was 863 percent of the increases in prevention and appraisal
costs.
27-7
Requirement 3
Among nonfinancial measures the firm may want to monitor are:
Prevention
Appraisal
Internal
Failure
P 6,000
External
Failure
P15,000
P 9,000
12,000
12,000
5,000
P18,000
9,000
15,000
7,000
18,000
10,000
9,000
5,000
1,000
27-8
15,000
Requirement 2
Total spent by
category
P25,000
P48,000
P42,000
P51,000
Requirement 3
The company is currently spending the least on preventive costs. They
should concentrate their efforts on preventive costs because they prevent
poor quality products from being manufactured.
By increasing amount spent on prevention, they could reduce spending on
the other cost of quality categories.
Exercise 4 (Cost of Quality Analysis, Nonfinancial Quality Measures)
Requirements 1 and 2
Revenues
Costs of Quality
Prevention costs
Design engineering
Preventive maintenance
Training
Supplier evaluation
Total prevention
costs
Appraisal costs
Line inspection
Product-testing
equipment
Incoming materials
2006
P12,500,000
Percentage
of Revenues
(2) = (1)
Cost
(1)
P12,500,000
P240,000
90,000
120,000
50,000
500,000
2005
P10,000,000
Percentage
of Revenues
(4) = (3)
Cost
(3)
P10,000,000
P100,000
35,000
45,000
20,000
4.0%
200,000
85,000
110,000
50,000
40,000
50,000
20,000
27-9
2.0%
75,000
250,000
2.0%
220,000
400,000
200,000
135,000
250,000
160,000
40,000
90,000
375,000
145,000
30,000
100,000
200,000
475,000
P1,600,000
4.0%
3.0%
500,000
5.0%
3.8%
12.8%
60,000
40,000
200,000
300,000
600,000
P1,700,000
6.0%
17.0%
Between 2005 and 2006, Gabriels costs of quality have declined from 17%
of sales to 12.8% of sales. The analysis of individual costs of quality
categories indicates that Gabriel began allocating more resources to
prevention activities design engineering, preventive maintenance, training
and supplier evaluations in 2006 relative to 2005. As a result, appraisal costs
declined from 4% of sales to 2%, costs of internal failure fell from 5% of
sales to 3%, and external failure costs decreased from 6% of sales to 3.8%.
The one concern here is that, although external failure costs have decreased,
the cost of returned goods has increased. Gabriels management should
investigate the reasons for this and initiate corrective action.
Requirement 3
Examples of nonfinancial quality measures that Gabriel Corporation could
monitor are:
a. Number of defective grinders shipped to customers as a percentage of
total units of grinders shipped.
b. Ratio of good output to total output at each production process.
c. Employee turnover.
Exercise 5 (Costs of Quality Analysis, Nonfinancial Quality Measures)
27-10
Requirements 1 and 2
Revenues, Costs of Quality and Costs of Quality as a
Percentage of Revenues for Victoria
Revenues = P2,000 x 10,000 units = P20,000,000
Costs of Quality
Prevention costs
Design engineering (P75 x
6,000 hours)
Appraisal costs
Testing and inspection (P40 x
1 hour x 10,000 units)
Internal failure costs
Rework (P500 x 5% x 10,000
units)
External failure costs
Repair (P600 x 4% x 10,000
units)
Total costs of quality
Costs
(1)
Percentage of
Revenues
(2) = (1)
P20,000,000
P 450,000
2.25%
400,000
2.00%
250,000
1.25%
240,000
1.20%
P1,340,000
6.70%
Costs
27-11
Percentage of
(1)
Prevention costs
Design engineering (P75 x
1,000 hours)
Appraisal costs
Testing and inspection (P40 x
0.5 x 5,000 units)
Internal failure costs
Rework (P400 x 10% x 5,000
units)
External failure costs
Repair (P450 x 8% x 5,000
units)
Estimated forgone
contribution margin on
lost sales [(P1,500
P800) x 300]
Total external failure
costs
Total costs of quality
Revenues
(2) = (1)
P7,500,000
P 75,000
1.00%
100,000
1.33%
200,000
2.67%
180,000
2.40%
210,000
2.80%
390,000
5.20%
P765,000
10.20%
Requirement 3
Examples of nonfinancial quality measures that Canada Industries could
monitor as part of a total quality-control effort are:
a. Outgoing quality yield for each product
27-12
P12,000,000
3,000,000
P15,000,000
Requirement 2
Quality cost if no change is made:
Rework
3,000 x 40% x P2,000 =
Repair
3,000 x 15% x P2,500 =
Appraisal
Inspection
3,000 x P50 =
Lost contribution:
Contribution margin per unit P12,000 x 85% - P2,500 = P7,700
Lost sales
3,000 0.8 3,000 = x 750
Total current cost of quality
P 2,400,000
1,125,000
600,000
150,000
5,775,000
P10,050,000
187,500
P 9,862,500
x
3
P29,587,500
750,000
P28,837,500
Requirement 3
Yes. The cost of the new process is P15,000,000 and the expected benefits is
P28,837,500 over three years. The firm can expect to earn a return of over
90%.
27-13
Requirement 4
The following factors should be considered before making the final decision:
a. Accuracy of cost estimates including
Contribution margin per unit
Costs of current repair and rework
Cost of repair with the new process
Cost of the new process
b. Reliability of estimations of
Rates of rework and repair
Lost sales
Amount of time before the current product become obsolete
c. Reaction of competitors
Requirement 5
The member of the board would be right if we ignore the financial payoff of
the new process and if the firm is going to be in business for only three years.
Having high quality products, especially for a high-end product such as the
one the firm is selling, is crucial for a long term success.
Problem 2 (Preparing a Cost of Quality Report)
The Adoracion Company
Comparative Costs of Quality Report
Costs Categories
Prevention costs:
Training
Product design
Total prevention
Appraisal costs:
Testing
Calibration
Total appraisal
2006
Increase
(Decrease)
75,000
150,000
225,000
P 100,000
175,000
275,000
P 25,000
25,000
50,000
50,000
75,000
125,000
150,000
100,000
250,000
100,000
25,000
125,000
2005
P
27-14
325,000
250,000
575,000
100,000
200,000
300,000
(225,000)
(50,000)
(275,000)
150,000
400,000
125,000
675,000
75,000
200,000
75,000
350,000
(75,000)
(200,000)
(50,000)
(325,000)
P1,600,000
P1,175,000
P (425,000)
Relevant Items
Annual tooling costs
Required return on investment
12% per year x P900,000 of average
inventory per year
12% per year x P200,000 of average
inventory per year
Insurance, space, materials handling,
and setup costs
Rework costs
Incremental revenues from higher
selling prices
Total net incremental costs
Annual difference in favor of JIT
production
a
P200,000 (1 0.30) = P140,000
b
P350,000 (1 0.20) = P280,000
c
P3 x 30,000 units = P90,000
Requirement 2
27-15
Incremental
Costs under
Current
Production
System
Incremental
Costs under JIT
Production
System
P150,000
P108,000
24,000
200,000
350,000
140,000a
280,000b
P658,000
(90,000)c
P504,000
P154,000
Incremental
Costs under JIT
Purchasing
Policy
P120,000
P
14,000
60,000
0
0
(13,500)a
0
40,000
0
130,000
P194,000
P156,500
P37,500
Note that the incremental costs of P40,000 for overtime premiums to make
the additional 15,000 units are less than the contribution margin from losing
these sales equal to P97,500 (P6.50 x 15,000). Josefina would rather incur
overtime than lose 15,000 units of sales.
Problem 5 (Theory of Constraints, Throughput Contribution, Relevant
Costs)
Requirement 1
Finishing is a bottleneck operation. Hence, producing 1,000 more units will
generate additional throughput contribution and operating income.
Increase in throughput contribution (P72 P32) x 1,000
Incremental costs of the jigs and tools
Net benefit of investing in jigs and tools
P40,000
30,000
P10,000
Zashi should invest in the modern jigs and tools because the benefit of higher
throughput contribution of P40,000 exceeds the cost of P30,000.
Requirement 2
The Machining Department has excess capacity and is not a bottleneck
operation. Increasing its capacity further will not increase throughput
contribution. There is, therefore, no benefit from spending P5,000 to
27-17
P480,000
120,000
P360,000
27-18
P 64,000
80,000
P144,000
Alternatively, the cost of 2,000 defective units at the finishing operation can
be calculated as the lost revenue of P72 x 2,000 = P144,000. This line of
reasoning takes the position that direct materials costs of P32 x 2,000 =
P64,000 and all fixed operating costs in the machining and finishing
operations would be incurred anyway whether a defective or good unit is
produced. The cost of producing a defective unit is the revenue lost of
P144,000.
Problem 8
Requirement (a)
The following table reclassified the cost-of-quality expenses:
Anthony Foods
Quality Costs
2005-2006
(Millions)
27-19
140
2005
Quarters
2006
2005
Q1
100
80
Q2
2006
Q3
Q4
Q1
Q2
Q3
Q4
Quality assurance
administration
P 6.20 P 6.52 P 6.86 P 7.19 P 7.93 P 8.74 P 9.61 P10.53
Training
13.10
14.39
15.90
17.46
21.12
25.50
30.37
36.35
Process
engineering
2.20
2.46
2.76
3.11
3.87
4.86
6.13
7.58
Prevention
21.50
23.37
25.52
27.76
32.92
39.10
46.11
54.46
Inspection
1.40
1.56
1.75
1.95
2.39
2.96
3.63
4.46
Testing
1.60
1.72
1.85
1.99
2.29
2.62
3.01
3.45
Appraisal
3.00
3.28
3.60
3.94
4.68
5.58
6.64
7.91
Rework
15.80
12.65
10.03
8.49
7.25
6.16
5.56
5.00
Scrap
17.60
14.48
11.92
10.32
8.92
7.72
7.00
6.34
Internal failure
33.40
27.13
21.95
18.81
16.17
13.88
12.56
11.34
Returns
26.90
21.09
16.35
13.53
11.32
9.50
8.43
7.52
Customer complaint
dept.
3.90
3.45
3.03
2.76
2.50
2.27
2.14
2.01
Lost sales
49.20
40.31
33.11
28.42
24.45
21.08
19.20
17.44
External failure
80.00
64.85
52.49
44.71
38.27
32.85
29.77
26.97
Total costs
P137.90 P118.63 P103.56 P95.22 P92.04 P91.41 P95.08 P100.68
Requirement (b)
From the preceding data we see that prevention and appraisal costs are
increasing while internal and external failure costs have been decreasing.
60 The following graph plots three series: prevention and appraisal costs,
failure costs, and total quality costs.
40
20
0
27-20
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
C
B
C
D
D
11.
12.
13.
14.
15.
C
A
C
B
C
27-21
6.
7.
8.
9.
10.
A
C
C
D
D
16.
17.
18.
19.
20.
D
D
D
A
A
27-22