Professional Documents
Culture Documents
QUESTIONS
16-1 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.
For purposes of management accounting and control, quality can be broken down
into two components: design quality and performance quality. The former refers to
the extent to which the features (attributes or characteristics) of the product or
service are those desired by the customer. The latter refers to the difference
between the design specifications of the product and the actual performance of the
product. Chapter 16 deals primarily with the management and control of
performance quality failures.
16-2 Among factors that might have caused lapses in quality in some firms in the United
States were: (1) years of success, (2) lack of competition from foreign companies
and (3) absence of information regarding total spending on quality. These and other
factors contributed to a lack of awareness that the cost of quality could be
substantial and, more often than not, more than the cost of manufacturing.
Alternatively, minimizing the total quality-related costs could be the source of
competitive advantage for an organization.
16-3 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 therefore never complete. Global competition, new
technologies, and ever-changing customer expectations make TQM a continual
effort for a successful firm.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-1 The McGraw-Hill Companies 2008
inspection and testing, installation, and servicing of products, services, and
processes. To be certified, an organization has to document its process for
controlling quality and must pass a rigorous third-party audit of its manufacturing
and customer-service processes.
As quality became a major focus of many businesses throughout the world, being
recognized as having high quality, or at least processes in place to ensure quality,
opens the door to potential customers, increases the confidence of current
customers, raises the morale of employees, and improves operating results. Many
European companies and governments purchase products or services only from
ISO-9000 certified firms.
16-5 Traditional accounting systems do not attempt to track the total cost of quality. That
is, quality-related costs are spread throughout various accounts, including overhead,
selling, general, and administrative expenses. As a result, organizations cannot
know how much of each sales dollar is consumed by quality costs and, further, for
any quality-related investments what the financial return might be. That is, traditional
systems are not helpful for managing and controlling quality and quality-related
costs.
16-6 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.
16-8 The purposes of conducting a periodic 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.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-2 The McGraw-Hill Companies 2008
16-9 Six Sigma is an analytical method designed to achieve near-perfect results in terms
of quality. In statistics, the Greek letter sigma stands for standard deviation (i.e., a
measure of dispersion around a mean value). On a standard normal bell curve, one
sigma above and below the mean covers approximately 68% of the area. The
complement of this, 32%, represents the area outside of the mean +/- 1 standard
deviation. In absolute terms, a one-sigma quality level represents approximately
320,000 defects per million. A two-sigma quality level represents approximately
4,000 errors per million. By contrast, a Six-Sigma quality level represents
approximately 3.4 defects per million!
In the Measurement stage, the Six Sigma team studies and evaluates relevant
measurement systems to determine whether they are capable of measuring key
inputs and quality attributes (e.g., product dimensions) with the desired level of
accuracy.
In the Analysis stage, the team performs graphical and statistical analyses in order
to develop preliminary hypotheses for improvement. This involves the identification
of root causes and the enablers of poor performance that need to be corrected.
In the Improve stage, the Six Sigma team designs and conducts experiments to find
the optimal conditions needed to operate the process.
In the final stage, Control, the team implements an on-going auditing and control
mechanism to help ensure the sustainability of the new process.
16-10 One can think of Six Sigma as a management process. Thus, the basic literature
from change management may provide useful tips for successfully implementing
such programs. Brewer and Eighme, Using Six Sigma to Improve the Finance
Function, Strategic Finance (May 2005), pp. 27-33, provide the following
implementation guidance regarding Six Sigma:
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-3 The McGraw-Hill Companies 2008
Make training ongoingavoid one-time-event training by providing refresher
courses for all Six-Sigma participants. Such courses not only reinforce prior
training, they also introduce new ideas.
Select initial projects carefully (i.e., simple ones with high probability of
success)successful projects build momentum and credibility.
Design projects for short-term winsshort-term wins provide confirmation
that efforts are paying off. Recognitions for a job well done along the way can
help sustain long-term commitment to Six Sigma projects.
Keep people informedto overcome the fear of change, people must
understand the reasons for change. Special efforts should be made to explain to
employees why current Six Sigma projects are needed and to keep them
informed as to the progress of such projects.
Set up a Websitea dedicated Six-Sigma Web site can help project teams
avoid reinventing the wheel by providing access to a project library and
message board.
16-12 A goalpost conformance specifies quality as a range around the target (or ideal)
value while absolute conformance requires exact meeting of the target value with no
variation allowed.
16-13 Taguchi argues that any variation from the exact specifications entails a cost or loss
to the firm and that this loss is a quadratic functionthat is, the loss grows larger as
the variation from target, in either direction, increases.
Deviation from the exact specification increases costs such as rework, loss on
disposal, warranty repair or replacement, and hidden quality losses such as
customer dissatisfaction and loss of future business and market share. In todays
global competitive environment, these quality costs increase rapidly as customers
become ever more demanding for complete satisfaction.
16-14 In general, financial data (such as COQ reports) will be more relevant to managers.
These individuals have overall decision-making authority and responsibility for the
financial results of operations. Note that such information is prepared only
periodically.
On the other hand, nonfinancial quality data are likely to be of greater value to
operating personnel. For one thing, such measures are readily understandable by
these individuals. For another thing, such information can be used by operating
personnel to make process changes/interventions. That is, they direct attention to
underlying quality problems in the process. Finally, such measures can be produced
on a timely basisin the extreme, in a real-time basis.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-4 The McGraw-Hill Companies 2008
16-15 Some examples of costs associated with cost of quality (COQ) categories are:
Internal Failure Costs: Net cost of scrap, rework cost, loss due to downgrade of
product (opportunity cost), re-inspection costs, and loss due to work interruptions.
16-16 Prevention costs rise during the early years of implementing TQM as the firm
engages in education to prepare its employees and in the planning and promotion
of the quality program. Appraisal costs will also likely rise during the early years of
TQM, because the firm needs to ensure that quality is actually being achieved. The
increase in appraisal cost, however, is most likely to occur at a slower pace than
those of the prevention costs because at the beginning of a TQM program there will
be substantial increases in quality training and in promotion to raise awareness on
the importance of quality.
The firm may see some decreases in internal and external failure costs in the early
years of implementing TQM. However, these two costs most likely will remain at
about the same level as before during the first several years of TQM. Many firms
may actually see internal failure cost rise, because of the higher standard
demanded by the TQM or the higher level of employees awareness on the critical
importance of perfection in every step of the process. As the firm makes progress in
TQM, both internal failure and external failure costs should decrease.
16-17 Costs of conformance are costs incurred to ensure that products or services meet
quality standards and include prevention costs and appraisal costs.
Internal and external failure costs are costs of nonconformance. They are costs
incurred or opportunity costs because of poor-quality outputs (goods or services).
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-5 The McGraw-Hill Companies 2008
16-18 Better prevention of poor quality often reduces all other costs of quality. With fewer
problems in quality, less appraisal is needed because the products are made right
the first time. Fewer defective units also reduce internal and external failure costs as
the occasion for repairs, rework, and recall decreases.
Thus, it is generally considered easier to design and build quality in than try to
inspect or repair quality in. Theoretically, if prevention efforts are completely
successful, there will be no need to incur appraisal costs and there will be no
internal failure or external failure costs. In practice, appraisal costs usually do not
decrease, partly because management needs to ensure that quality is there as
expected. Nonconformance costs, however, decrease at a much faster pace than
prevention costs increase.
16-19 A cost of quality (COQ) report describes quality cost items a firm incurred during the
reporting period. A COQ report can help users identify and recognize the effects of
their actions on quality costs and to pinpoint areas that need attention.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-6 The McGraw-Hill Companies 2008
16-23 A Pareto chart (diagram) is a vertical bar chart (graph) displaying the frequency or
the number of occurrences of each quality problem, ordered from the most to the
least frequent. As such, a Pareto chart can be used diagnostically to identify the
primary sources of quality problems and to help managers prioritize quality
improvement efforts.
16-24 Customer-response time (CRT) is defined as the amount of time between the time a
customer places an order and the time the order is received by the customer. CRT
can be broken down into three components: receipt time (lapse of time between
when a customer places an order and when that order is received by
manufacturing); manufacturing lead time (the amount of time between when an
order is received by manufacturing and when that order is completedsee below);
and, delivery time (lapse of time between when an order is finished and when the
customer receives that order).
Manufacturing lead (manufacturing cycle) time is defined as the lapse of time
between when an order is received by manufacturing and when that order is
completed. Thus, manufacturing lead time is equal to the sum of waiting time +
processing (manufacturing) time.
Cycle time efficiency (also known as throughput time ratio or process cycle
efficiency) is the ratio of time spent on value-added activities to the sum of time
spent on value-added and non-value-added activities; for example, cycle time
efficiency = processing time/(processing time + moving time + storage time +
inspection time).
16-25 As indicated by Exhibit 16.3 and the accompanying discussion in the chapter,
management accountants are involved extensively in the design and operation of a
comprehensive model (framework) for managing and controlling quality. However,
the key role played by management accountants, because of their expertise in this
regard, is the generation of relevant financial and nonfinancial measures of quality.
In terms of the former, accounting provides relevant cost (and revenue) data that
decision-makers can use to evaluate the desirability of spending and investments in
quality. (This role is compatible with the discussion in Chapter 9 of the text.) As well,
management accountants play a key role in helping a cross-disciplinary team
develop a COQ reporting systemthat is, a comprehensive model, with
subcategories, for capturing quality costs across the value chain.
Also noted in Exhibit 16.3 is the use of nonfinancial quality indicators, both internal
and external (customer satisfaction measures). The management accountant would
typically be involved in the design of systems or processes that would capture and
report this information.
Finally, the management accountant can help in the design of two internal audit
functions associated with the comprehensive framework: one, the development of
quality audits (designed to ensure quality); two, the Control stage of Six Sigma
(where processes are put in place to monitor progress and to sustain the gains
associated with process improvements).
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-7 The McGraw-Hill Companies 2008
16-26 To be relevant for decision-making, financial information (i.e., costs and revenues)
must meet the dual test of being: (a) a future item, that (b) differs between decision
alternatives. Relevant costs can also be defined as avoidable costs, or as the sum
of opportunity costs plus out-of-pocket costs.
16-27 From a design standpoint, the following are likely desirable qualities (attributes) of a
COQ reporting system:
The system collects costs across the entire value chain, both internal and
external (so, for example, costs related to gathering consumer-preference data
and costs associated with certifying external suppliers would be captured as part
of the total cost of quality).
The system focuses on costing of activities (i.e., uses data obtained from an
ABC system).
The system includes both out-of-pocket and opportunity costs (the latter occur
within the performance failure category, i.e., either as an internal failure or an
external failure cost).
The system provides a breakdown of total quality-related costs according to
logical categories (such as prevention, appraisal, internal failure, and external
failure).
The system reports data in a time-series fashion (this would allow managers to
assess the financial effects of spending and investments in quality; it would also
allow managers to assess trade-offs between COQ categories over time).
The system includes some baseline or appropriate benchmark (e.g., quality
costs could be reported as a percentage of sales or as a percentage of total
operating costs; benchmarks could include best-in-class performance, either
on an internal or an external basis).
16-28 In most cases, external failure costs (of the four categories) would be most
damaging to the organization. Some costs within this category (e.g., product-liability
lawsuits) can be huge in terms of out-of-pocket terms. Other costs in this category
relate to loss of reputation or market share associated with customer dissatisfaction
or ill-will. These costs are referred to as opportunity costs and can also be huge in
dollar terms.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-8 The McGraw-Hill Companies 2008
16-29 As shown in Exhibit 16.1, investments in quality can lead to improved business
processes, which in turn result in improved quality of outputs (goods and services).
Improvement in quality of outputs reduces external failure costs (e.g., warranty
expenses), reduces the amount of inventory, can lower total manufacturing costs
(e.g., inspection, rework, and inventory control costs). On the revenue side,
improvements in quality can result in an improved product image of the company in
the mind of consumers and faster throughput times. These, in turn, can lead in the
mind of the consumer to higher perceived value of the organizations output, the
financial consequence of which is higher selling prices and increased market share.
The combination of reduced costs and increased revenues provides an increase in
financial performance (e.g., ROI, earnings per share, etc.).
16-30 High degree of process variation from target usually leads to variation in product
attributes, which are important contributors to the quality of a product. Significant
variation in process activities usually implies that there is an increased chance that
product attributes are below customer expectations. For this reason, the Taguchi
Loss Function is represented by a quadratic functionthe more the departure from
the target, the greater the assumed quality loss.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-9 The McGraw-Hill Companies 2008
BRIEF EXERCISES
16-31 Total customer response time (CRT) = order receipt time + order wait time +
production processing (manufacturing) time + order delivery time = 10 days + 15
days + 20 days + 10 days = 55 days.
16-32 Manufacturing cycle efficiency is defined as the ratio of value-added time to the
sum of value-added time + non-value-added time. In this case, PCE = 4/(4 + 4 +
3 + 2) = 4/13 = 31% (approximately). That is, actual processing time is
approximately 31% of total cycle time for a typical order. Note that manufacturing
cycle efficiency is also referred to as process cycle efficiency (PCE).
16-34 The estimated cost coefficient, k, in the Taguchi loss function is calculated as
follows:
2
L(x) = k (x T)
$500 = k (5)2
k = $20
16-35 The estimated total quality loss (cost) using the Taguchi loss function is calculated
as follows:
2
L(78) = $20 (78 75)
16-37 Total prevention cost = equipment maintenance = $1,154; total appraisal cost =
product testing = $786. Total prevention + appraisal costs = $1,940.
16-38 Customer Response Time (CRT) = elapsed time between when a customer
places an order (September 1, 2008) and when the customer receives the order
(December 1, 2008). Thus, for this example, the CRT = 3 months.
Receipt time can be defined as the elapsed time between the date an order is
placed (September 1, 2008) and the date Manufacturing receives the order
(September 15, 2008). In this case, receipt time = 2 weeks.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-10 The McGraw-Hill Companies 2008
Manufacturing lead time (cycle time) is the elapsed time between when
Manufacturing Department receives an order (September 15, 2008) and when
actual manufacturing is completed (November 15, 2008). In this case,
manufacturing lead time is 2 months (8 weeks).
Manufacturing lead time (8 weeks) can be broken down into waiting time and
processing (manufacturing) time, as follows:
Delivery time = time lapse between when an order is finished (November 15,
2008) and when the order is received by the customer (December 1, 2008). Here,
delivery time = 2 weeks.
16-40 Each TV set contains 100 components; thus, if each component is produced
according to a 3-sigma quality level, then the probability that a given unit will be
100
defect-free is: 0.997 = 0.740484. Therefore, the probability that a unit has one
or more defective modules is: 1 0.740484 = 0.259516. In practical terms, this
means that, on average, for each 100 sets produced only 74 will be defect-free.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-11 The McGraw-Hill Companies 2008
EXERCISES
1. d 5. b
2. c 6. d
3. b 7. b
4. e 8. c
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-13 The McGraw-Hill Companies 2008
16-42 Interpretation of Six-Sigma quality expectations (ppm) (30 minutes)
The preceding data indicate suggest a common misconception regarding the quality
level assumed under Six Sigma. Only when a defect is defined as any deviation from
the targeted level of the attribute (i.e., only when the tolerance is zero) will the above
approach represent the maximum number of defects per million opportunities for error.
Note, for example, that the expected number of errors (defects) under Six Sigma is
approximately 2 per billion (when any deviation from target is considered a defect).
In actual practice, based on initial experience by Motorola, the application of Six Sigma
allows some variation (drift) around the target value. That is, there is an assumption
that no process can be maintained in perfect control (i.e., no drift at all). Thus, in
practice, a drift of 1.5 standard deviations around the target value is allowed. Any
deviation beyond this allowable drift would be considered a defect or out-of-control
process.
What this means is that a revised formula is needed to calculate the defects per million
as the Six Sigma methodology is applied in practice. According to Pyxdek
(http://www.qualitydigest.com/may01/html/ sixsigma.html) the Excel formula (under the
assumption of an allowable drift of 1.5 sigma) is: 1000000*(1-NORMSDIST(Z-1.5)),
where 1.5 = allowable drift (in standard deviations) and Z = Sigma level. For Z = 6.0,
the Excel formula returns: 3.398, the defect-per-million figure commonly, but perhaps
mistakenly, reported in the literature. (Also see, J. R. Evans and W. M. Lindsay, The
th
Management and Control of Quality, 6 ed. (South-Western, 2005), Chapter 10.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-14 The McGraw-Hill Companies 2008
16-43 Quality RatingsGraduate Business Programs (30 Minutes)
As indicated in the exercise, the various ranking sources to some extent use different
quality-related criteria. We provide an example response below, that is, an overview of
the ranking criteria used by U.S. News & World Report in their annual ranking of
graduate schools of business. U.S. News & World Report bases 40% of its judgment on
opinions of business school deans, program directors, and corporate recruiters.
Placement success accounts for 35% of the ranking, while the remaining 25% is based
on student selectivity. The intent of this question is not to develop a definitive listing of
quality criteria. Rather, the intent is to provide a nonmanufacturing example of quality
rankings that would likely be of interest to many students.
In the 2005 survey, all 399 master's programs in business accredited by AACSB
International were surveyed by U.S. News & World Report (347 responded, of which
240 provided the data needed to calculate rankings based on a weighted average of
the quality indicators described below).
Peer Assessment Score (25%)In the fall of 2005, business school deans and
directors of accredited master's programs in business were asked to rate programs
on a scale from "marginal" (1) to "outstanding" (5). Those individuals who did not
know enough about a school to evaluate it fairly were asked to mark "don't know." A
school's score is the average of all the respondents who rated it. Responses of
"don't know" counted neither for nor against a school. About 50 percent of those
surveyed responded.
Recruiter Assessment Score (15%)In the fall of 2005, corporate recruiters and
company contacts who hire from previously ranked programs were asked to rate
programs on a scale from "marginal" (1) to "outstanding" (5). Those individuals who
did not know enough about a school to evaluate it fairly were asked to mark "don't
know." A school's score is the average of all the respondents who rated it.
Responses of "don't know" counted neither for nor against a school. About 31
percent of those surveyed responded.
Mean Starting Salary and Bonus (14%)The average starting salary and bonus
of 2005 graduates of a full-time master's program in business. Salary figures are
based on the number of graduates that reported data. The mean signing bonus is
weighted by the proportion of those graduates that reported a bonus, since not
everyone who reported a base salary figure reported a signing bonus.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-15 The McGraw-Hill Companies 2008
16-43 (Continued)
Overall Program Rank: Data were standardized about their means, and standardized
scores were weighted, totaled, and rescaled so that the top school received a score of
100; others received their percentage of the top score.
Source: U.S. News & World Report, April 10, 2006 (or, http://www.usnews.com/usnews/
edu/grad/rankings/about/07biz_meth_brief.php, accessed on April 4, 2006).
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-16 The McGraw-Hill Companies 2008
16-44 Spotting Quality in Business Programs (30 Minutes)
Bulletin Boards: take a look at what is posted on the bulletin boards of the business
school. Will you find a cluttering of cheap magazine offers and offers for temporary
employment, or do you observe notices of distinguished visiting speakers, upcoming
chamber music series, meeting news from discipline-based student clubs, and fliers for
study-abroad opportunities and graduate education? (This is an example of what is
considered an unobtrusive indicator of educational quality.)
Intellectual capital represented in the Faculty: Are the faculty active in the
profession? Do they conduct research and publish in areas that support the educational
mission of the school?
Educational Content of the Curricula: Are the curricula offered in the business school
up to date? Are there specified educational objectives associated with each degree
program? Is there a comprehensive, program-level assessment plan to provide
assurances of learning?
Assurances of Learning: Does the institution have in place a process for determining
value added? That is, is there a formal process for determining learning outcomes vis-
-vis stated learning goals?
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-17 The McGraw-Hill Companies 2008
16-44 (Continued)
Placement: What firms and organizations regularly recruit graduates of the business
school?
Alumni: How active are alumni in terms of providing financial support and placement
opportunities (i.e., internships and full-time jobs) for graduates? Does the school have
an active business advisory board/council? In what other ways are alumni involved in
the business school?
Characteristics of Entering Students: What are the average SAT scores and high
school ranks of the most recent entering class of freshmen?
Faculty Qualifications: From what institutions did faculty earn their terminal degrees?
What proportion of faculty is considered full-time? What percentage of faculty have
recent relevant professional experience? To what extent are faculty actively engaged in
the profession?
Source: The preceding listing of quality criteria is drawn from M. R. Blood, Spotting
Quality, Decision Line, Vol. 36, No. 4 (July 2005), pp. 1420.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-18 The McGraw-Hill Companies 2008
16-45 Management Accountings Role in Six Sigma (20-30 Minutes)
At the most general level, the management accountant (because of expertise in the
measurement process) should be included as a member of the cross-functional Six-
Sigma project team whose responsibility it is to focus on a particular business process,
improve that process, and then move on to another project. The role of the
management accountant on the project team can perhaps best be described within the
context of the five phases of the DMAIC approach to process improvement: Define,
Measure, Analyze, Improve, and Control.
In the define phase, management accountants, because they are in the best position
to observe and document waste and excessive costs, can help identify opportunities
that warrant Six-Sigma-type projects. As a follow-up, management accountants can
help in the project selection process by providing reliable data regarding estimated
costs (e.g., required resources degree of difficulty, chance of success) and benefits
(e.g., cost savings, customer impact, expected time for project completion) associated
with alternative projects under review. In other words, they can play a key role in
making sure that the organization does not assume projects where the expected
savings wont justify the investment of Six-Sigma resources.
In the measurement phase, the management accountant would work with other
members of the project team to determine whether the current measurement system is
able to collect accurate and timely data for both process inputs (e.g., temperatures,
speeds, pressures) and process outputs (e.g., product dimensions or product
performance). Furthermore, the management accountant in this phase of the project
helps define and measure the factors that have the most influence on process
performance.
In the improvement phase, the project team chooses the most useful and feasible
solutions to the root causes identified in the preceding step. Here, the management
accountant can help verify and document that planned or anticipated improvement
actually occur.
Finally, in the control phase, the management accountant can help in the development
of control tools such as audits and check sheets that can be used to ensure
sustainability of the process improvements implemented in the preceding stage.
Source: F. Rudisill and D. Clary, The Management Accountants Role in Six Sigma,
Strategic Finance (November 2004), pp. 35-39.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-19 The McGraw-Hill Companies 2008
16-46 Applying Six-Sigma Principles to the Accounting Function (30 Minutes)
Perhaps the most fundamental step in the project is selection of an appropriate cross-
functional team, including a project champion (in this case, it was the CFO of the
organization) and a project leader (usually either a Green Belt or Black Belt). One
framework for the project management process is DMAIC (Design, Measure, Analyze,
Improve, and Control). In the present example, the DMAIC phases consisted of the
following stages:
The Define Stagethe project team developed a statement of the problem (Too many
hours are being spent preparing quarter-end financial statements.) and a goals
statement (Reduce direct hours worked for 18 schedules from over 100 hours to 26
hours.). The latter was determined in consultation with the primary customer of these
quarterly financial statements: the controller of the parent company. This stage also
included the development of a graphical representation of the quarterly closing process,
from the recording of journal entries to the electronic transmission (E-trans submission)
of 18 end-of-quarter schedules to the parent company.
The Measure Stagethe project team assessed the current cycle time of the quarterly
closing process and then developed a cycle-time goal for the process (in hours). The
current process consumed approximately 109 hours, as follows: preparation of eight
balance sheet schedules, 65 hours; preparation of eight income statement schedules,
16 hours; and, preparation of two inter/intracompany schedules, 28 hours. Thus, the
overall cycle-time reduction goal was approximately 84 hours!
The Analyze Stagein this stage, the team created a fish-bone (i.e., cause-and-
effect) diagram to identify possible root causes of the excessive cycle time for quarterly
closings. Four primary causes were identified: (1) a high number of hours were spent
on the balance sheet schedules, (2) the E-Trans submissions were started late in the
day; (3) one-time items were a surprise; and (4) there was a lack of valid references.
After completing the fish-bone diagram, the project team hypothesized that three critical
root causes were responsible for a large portion of the excess cycle time: (1) lack of
ongoing review of balance sheet and inter/intracompany schedules; (2) insufficient
automation in generating data; and (3) lack of communication in financial reporting. For
each of these three primary root causes, the team identified one or more failure
modes, that is, ways in which a process could fail and what could be done to prevent
or minimize such failures.
The Improve Stagefor each failure mode identified in the preceding stage, the
team calculated a risk priority number (RPN), which was defined as the product of
three characteristics of the failure mode: severity of the potential failure mode,
frequency of occurrence, and detectability. After all RPNs were calculated, the team
compiled a list of actions that addressed the causes of the potential failure modes.
Implementing these actions resulted in substantial process improvements: in the first
quarter alone, the total cycle time of the process was reduced to 32 hours, slightly
above the 26-hour goal.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-20 The McGraw-Hill Companies 2008
16-46 (Continued)
The Control Stagein a sense, the most important control-related decision occurred
at the beginning of the project: selection of the CFO as the project champion (process
owner). After the project had been completed, the team kept its measurement system
in place so schedule-preparation times could be monitored on an on-going basis. The
team also documented for future staff members new process procedures.
Source: P. C. Brewer and J. E. Eighme, Using Six Sigma to Improve the Finance
Function, Strategic Finance (May 2005), pp. 2733.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-21 The McGraw-Hill Companies 2008
16-47 Cost of Quality Reporting for Environmental Performance (2030 Minutes)
The purpose of this exercise is to get students to think strategically as to how COQ
reporting might be used as part of a comprehensive approach to the management and
control of environmental costs.
2. There is no set answer to this part of the assignment, but student samples might
include some of the following elements:
Prevention Costs:
Process design/redesign (to produce environmentally friendly outputs)
Product design/redesign (to consume fewer natural resources, emit fewer
by-products and pollutants, etc.)
Supplier evaluation/certification costs (for example, do preferred suppliers
have ISO 14000 certification?)
Product recycling costs
ISO 14000 application costs
Appraisal/Detection Costs:
Product or process inspection
Contamination testing
Verifying supplier environmental performance
Development of environmental performance standards
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-22 The McGraw-Hill Companies 2008
16-47 (Continued)
3. There are likely opposing points of view. Companies that are included in portfolios
of high performance in the environmental (or social) area are certainly likely to favor
such disclosures. Stockholders (and potential investors) may favor such disclosures,
particularly since the external failure costs that some companies face can have
devastating effects on the ability of an organization to be a going concern. That is,
investors may value the disclosure of environmental performance data as part of
their risk-management objectives. As well, companies that are performing well in
terms of environmental performance are likely to favor such disclosures to the
investing public.
On the negative side, there is a likely bias: unless all companies would be required
to disclose such information, it might be difficult to benchmark environmental
performance. Also, it may be difficult (or even impossible) to achieve
standardization, which may reduce the informativeness of such disclosures.
Finally, some companies may oppose the disclosure of this information for
competitive reasons (that is, the disclosure of such information might be used
strategically by the companys competitors).
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-23 The McGraw-Hill Companies 2008
16-48 Cost of Environmental Quality Report (30 Minutes)
2. With only a single year of data, it is difficult to draw any meaningful conclusions.
However, a tentative conclusion is that the company may be spending far too little in
the conformance quality area (i.e., Prevention and Detection Costs) and, as a
consequence, is incurring significant failure costs in the environmental area.
Collect environmental quality-cost data from across the value chain (i.e., the
scope of data collection should be broad).
If possible, utilize activity-based cost (ABC) data, which could be used to
motivate (a) the elimination of non-value-added activities, and (b) improved
efficiency in the conduct of value-added activities.
Baseline data: environmental cost data should be compared to one or more
relevant benchmarks (sales, best-in-class performance, etc.).
Time-series results (data from a single time period are not likely to be very
informative and, in fact, can be misleading; the provision of time-series data will
inform management as to the success in reducing total spending in the
environmental cost area and trade-offs between categories).
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-24 The McGraw-Hill Companies 2008
16-49 Nonfinancial (operational) Control Measures: Environmental Performance
(1520 Minutes)
The purpose of this exercise is to get students to think about the process of developing
nonfinancial quality indicators, based on specified Environmental Objectives (five in the
present case). The purpose of these indicators is to gauge progress in accomplishing
the specified Environmental Objectives and, as such, to motivate improved quality in
environmental performance. The following answers are suggestive only:
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-25 The McGraw-Hill Companies 2008
16-49 (Continued-1)
The instructor might want to use some of the following example disclosures from First
Energy Corporation (www.firstenergycorp.com/environment) for illustrative purposes:
30
25
20
Projected
Tons
15
Actual
10
5
0
Carbon Sulfur Dioxide Nitrogen Regional
Dioxide Oxides Average
Emissions
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-26 The McGraw-Hill Companies 2008
16-49 (Continued-2)
2004 2005
Projected Actual Projected Actual
Quantity Quantity Quantity Quantity Measure
High-Level
Radioactive 0.0036 0.0018 0.0040 0.0018 Lbs./1,000 kWh
Waste
Low-Level
Radioactive 0.0001 <0.0001 0.0001 <0.0001 Ft3/1,000 kWh
Waste
Source: www.firstengergycorp.com/environment
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-27 The McGraw-Hill Companies 2008
16-50 Graphical Depiction: Is there an Optimal Level of Spending on Quality, or,
Is Quality Free? (30-40 Minutes)
Revenues/
Costs
Revenues
Maximum
Profit
Level
Costs
Quality
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-28 The McGraw-Hill Companies 2008
16-50 (Continued-1)
Diminishing-Returns Conceptualization
Cost of Total
Quality Cost of
Quality
Failure
Costs
Prevention &
Appraisal Costs
Quality
Zero Optimum Quality Maximum Level
Quality Level Quality
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-29 The McGraw-Hill Companies 2008
16-50 (Continued-2)
Total
Costs
Total Maximum
Revenue Profit
s
Quality
Optimum Level
Quality Level
Basically, the above representation assumes that after a point, increases in quality
spending do not generate commensurate financial benefits (marginal revenues).
The quality is free argument would hold that marginal revenues always exceed
marginal costs. The diminishing-returns representation, however, assumes that,
as is the case with other economic activities, at some point the marginal cost of
increasing quality will exceed the marginal revenues from doing so.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-30 The McGraw-Hill Companies 2008
16-51 Pareto Diagram (15 min)
Page: 1
Fonts different from the rest of text.
Can not edit graphic. Let me know if
you want me to recreate it.
Pareto Charts (Diagrams) can be used for diagnostic control purposes, that is, to
identify the primary causes of an identified quality problem (such as absenteeism)
and, as such, to identify possible solutions to the problem. These charts are named
after the Italian economist Wilfredo Pareto; they provide a prioritization of causes of
an indicated quality problem, based on frequency of occurrence. Thus, they focus
attention on causes that could offer the greatest potential for improving quality. A
loose interpretation of the information contained in Pareto charts is that a relatively
small number (e.g., 20%) of causes represent a majority (e.g., 80%) of reasons for
the quality failure (here, absenteeism).
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-31 The McGraw-Hill Companies 2008
16-52 COQ Histogram (30 min)
1. COQ Histogram
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
Prevention Appraisal costs Internal failure External failure Total cost of
costs costs costs quality
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-32 The McGraw-Hill Companies 2008
16-52 (continued)
Prevention costs increased, then decreased, over the past three years.
Appraisal costs decreased steadily over the years.
Total failure costs, as well as internal and external components, decreased over
the years.
Total COQ as a percentage of CGS decreased from 62.0 percent to 29.5 percent.
3. The company can probably expect its total cost of quality to continue declining
provided it maintains adequate level of quality training and other efforts to prevent poor
quality from occurring and to continue emphasis on the importance of quality.
The company was able to see the results within one year of increased efforts in
prevention. The company increased its spending on prevention costs fourfold from
2007 to 2008 and both internal and external failure costs decreased in the same year
and continued into 2009. However, the company reduced its spending on prevention
costs in 2009 to only half of the level the year before; therefore, it may need to monitor
closely the internal failure and external failure costs in 2010. It will be a good
investment to increase prevention costs if the failure costs start to climb in 2010.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-33 The McGraw-Hill Companies 2008
16-53 Quality Cost Classification (5-10 min)
3. Appraisal cost
4. Prevention cost
5. Prevention cost
6. Prevention cost
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-34 The McGraw-Hill Companies 2008
16-54 Quality Cost Classification (10 min)
3. Appraisal cost
5. Appraisal cost
6. Prevention cost
7. Prevention cost
8. Prevention cost
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-35 The McGraw-Hill Companies 2008
16-55 Cost of Quality ImprovementRelevant Cost Analysis (20-30 Minutes)
3. As indicated in Exhibit 16.3 and the accompanying text discussion, the management
accountant plays a pervasive role in a comprehensive quality management and control
system. Fundamentally, the management accountant is involved in generating relevant
financial and nonfinancial quality-related data. Such data are used by managers for
decision-making purposes (as in this exercise) and for controlling quality-related costs.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-36 The McGraw-Hill Companies 2008
16-56 Cost of Quality Improvements (510 Minutes)
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-37 The McGraw-Hill Companies 2008
16-57 Taguchi Loss Function Analysis (Appendix) (3040 Minutes)
3. Expected Loss Using Variance Data (see table below), per Albrecht and Roth, The
Measurement of Quality Costs: An Alternative Paradigm, Accounting Horizons (June
1992), pp. 1527:
2 2
a. D = (0.199991 0.2) , where 0.20 = target value and 0.199991 = x (bar)
= 0.000000000081
2 2
b. Expected loss = k ( + D )
= $500,000,000 x (0.000000025419 + 0.000000000081)
= $12.75
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-38 The McGraw-Hill Companies 2008
16-57 (Continued)
2
X Probability, f(x) x*f(x) (x 0.199991) f(x)
0.1996 0.02 0.003992 0.00000000305762
0.1997 0.05 0.009985 0.00000000423405
0.1998 0.12 0.023976 0.00000000437772
0.1999 0.11 0.021989 0.00000000091091
0.2000 0.45 0.090000 0.00000000003645
0.2001 0.10 0.020010 0.00000000118810
0.2002 0.08 0.016016 0.00000000349448
0.2003 0.05 0.010015 0.00000000477405
0.2004 0.02 0.004008 0.00000000334562
x (bar) = 0.199991 0.00000002541900
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-39 The McGraw-Hill Companies 2008
16-58 Using Taguchi Function to Determine Tolerance (10 Minutes)
2
Total quality cost = k * (Tolerance), where k = cost coefficient and Tolerance =
quality tolerance allowed
2
$40.00 = k * (0.0001)
k = $4,000,000,000
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-40 The McGraw-Hill Companies 2008
16-59 Relevant Cost AnalysisConversion to JIT (20 Minutes)
Current After
Income Statement Items Situation JIT
Note to Instructor: An Excel spreadsheet solution file for this exercise is embedded in
this document. You can open the spreadsheet object that follows by doing the
following:
Data Input
Current After
Item Situation JIT
Manufacturing Costs as a Percentage of Sales:
Product-level support costs 12.00% 5.00%
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-41 The McGraw-Hill Companies 2008
16-60 Relevant Cost AnalysisQuality Improvements (20 Minutes)
Estimated cost savings resulting from the recently enacted quality program come from
two sources:
(reduction in reject rate) x (annual volume of output) x (total rework cost per unit)
x annual volume
= (0.05 0.035) x 15,000 units x [($480 70 200) + ($362 80) + ($80
40)]/unit
= (0.015) x 15,000 units/year x $532/unit = $119,700
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-42 The McGraw-Hill Companies 2008
16-61 Control Chart (3040 Minutes)
26
(Weekly Average)
24
22
20
18 Average
16
14
12
10
10
11
12
#
1
2
3
4
5
6
7
8
9
k
ee
W
Week #
2. The target cycle time is 14.0 minutes; the lower control limit is 12.0 minutes and the
upper control limit is 16.0 minutes. As indicated in the accompanying Excel file, the
mean of the 12 weekly observations is 15.2, while the sample standard deviation is
3.6 minutes (which seems high).
Note: An Excel spreadsheet solution file for this exercise is embedded in this
document. You can open the spreadsheet object that follows by doing the following:
Data Input
Average
Week # Cycle Time
1 12.5 Target Value = 14.0
2 18.0 Upper Limit Value - 16.0
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-43 The McGraw-Hill Companies 2008
16-61 (Continued)
3. As indicated in part (2), the mean of the sample observations (15.2) is not that far
from the target value (14.0). However, inspection of the control chart suggests wide
variability in the process, which is confirmed by the sample standard deviation of the
12 observations around the mean value of the dataset. As well, we note that six of the
12 observations lie outside of the control limits (4 exceed the upper control limit, while
2 are below the lower control limit). The control of process variability is one of the key
goals of quality improvement. It may be the case that the underlying process in this
case needs to be investigated in order to determine why there seems to be so much
variability in weekly cycle times. Perhaps some type of intervention/correction is
warranted.
4. Management can determine the upper and lower control limits on their control charts
through experience (e.g., trial and error) or through the use of statistical procedures.
When these control limits are determined statistically (based on process variability,
measured either by standard deviations or on the range of observations over time),
the control chart is referred to as a statistical control chart. Thus, the principal
difference between the two types of charts is the method used to construct the control
limits.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-44 The McGraw-Hill Companies 2008
16-62 Quality Cost Classification (10 Minutes)
1.
Internal External
Prevention Appraisal Failure Failure
a. Materials for repair of goods under
warranty x
b. Inspection of goods repaired under x
warranty
c. Processing customer returns x
d. Canceled sales orders due to
unsatisfactory products previously
delivered to its customers x
e. Maintenance costs for testing x
equipment
f. Inspecting finished goods x
g. Time spent to determine courses
needed for quality training x
h. Debugging production software x
before production begins
i. Technical help to resolve a
customers production problems that
may have been caused by bugs in the
software shipped with the companys x
product
j. Supervision of testing personnel x
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-45 The McGraw-Hill Companies 2008
16-63 Quality Cost Classification (10 Minutes)
Internal External
Prevention Appraisal Failure Failure
a. Warranty repairs x
b. Scrap (net) x
k. Inspection of reworked x
products
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-46 The McGraw-Hill Companies 2008
16-64 Cost of Quality Category (3040 Minutes)
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. Such failure costs (internal + external) are generally far
more costly to the organization. Therefore, by increasing the amount spent on
prevention, management should be able to reduce spending on the other cost of quality
categories.
It is not clear from the sample report above whether the company takes a value-
chain approach to collecting COQ data; that is, in theory COQ data should be
collected from across the entire value chain of activities, both internal and external
(another way to put this is that it is not clear from the report whether a
comprehensive framework is being used to collect COQ data for the organization)
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-47 The McGraw-Hill Companies 2008
16-64 (Continued)
Relative cost informationbecause the sample report includes only absolute dollar
amounts, it is impossible to determine the relative importance of both total cost of
quality and the mix of spending across the four cost categories; thus, Brooks can
relate spending to total sales revenue for the period or perhaps total operating
expenses.
Time-series datain order to properly evaluate spending on quality (i.e., assess the
results of investments in quality), it is necessary to collect time-series data. That is,
there is generally a lag between time of investment outlay and realized financial
returnsas is the case with other capital budgeting investments. Ideally, for
example, a company would want to show a decrease in total COQ over time, with
perhaps a greater proportion of conformance, rather than failure, costs.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-48 The McGraw-Hill Companies 2008
16-65 Cost of Quality (COQ) Analysis (4550 Minutes)
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-49 The McGraw-Hill Companies 2008
16-65 (Continued)
3. From 2007 to 2008, Duncans total cost of quality (COQ) has decreased from 23%
of sales to 11% of sales. Part of the decrease in COQ as a percentage of sales is
the higher sales in 2008 compared to 2007. However, even without the sales
increase, the total COQ has decreased, both in absolute and relative amount
($2,045/2007 sales of $15,000 = 13.6%).
Duncan increased spending in 2008 on prevention (241% of 2007 amount). As a
result, each of the other three categories of COQ (viz., appraisal, internal failure,
and external failure) decreased in 2008, in both absolute dollars and as a
percentage of sales dollars.
4. To complement the COQ data, the company may want to collect both internal and
external nonfinancial measures of quality, such as the following:
Internal Measures of Quality
The number of defects per period
Process yield (ratio of good output to total output)
Percentage first-pass yield
The percentage of defective units shipped to customers to total units of
products shipped
Throughput (or, throughput efficiency)
External Measures of Quality
The number of customer complaints
Difference between delivery date and date requested by the customer
On-time delivery percentage (total units shipped on or before the scheduled
date to the total units shipped)
Surveys of customer satisfaction
5. As should be obvious from an examination of Exhibit 16.3, there is a role for both
financial and nonfinancial quality data (metrics) in a comprehensive framework for
managing and controlling quality. COQ (i.e., financial) data are reported only
periodically. As such, they are likely of greater interest/value to managers. After all,
these are the individuals who ultimately have responsibility over financial
performance and who make spending and investment decisions regarding quality
costs.
Operating personnel, on the other hand, are likely to find nonfinancial quality
data to be more useful. For one thing, such data are expressed in terms that are
understandable/comprehensible to operating personnel. For another thing, these
measures focus attention on processes, techniques, and procedures that are at
the root cause of quality problems. Finally, to maximize the value of quality-related
data, the information should be presented to users as quickly as possiblein the
extreme, in real-time basis. Current accounting systems are less capable of
reporting financial data in such a timely basis. Thus, for all of the above reasons,
one can argue that nonfinancial quality indicators are likely of greater value to
operating personnel.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-50 The McGraw-Hill Companies 2008
16-66 Cost of Quality (COQ) AnalysisExcel Application (50 Minutes)
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-51 The McGraw-Hill Companies 2008
16-66 (Continued-1)
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
Prevention Appraisal Internal External Total cost
costs costs failure failure of quality
costs costs
2008 2007
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-52 The McGraw-Hill Companies 2008
16-66 (Continued-2)
7. Sensitivity Analysis
2008 2008Revised
Cost as a Cost as a
Amount % of Sales Amount % of Sales
1
Sales $18,750 $19,688
2
Prevention costs $530 2.83% $562 2.85%
Appraisal costs 405 2.16% 405 2.06%
3
Internal Failure Cost 540 2.88% 216 1.10%
4
External Failure Cost 570 3.04% 285 1.45%
Total COQ $2,045 10.91% $1,468 7.46%
Notes:
1 3
1.05 x $18,750 0.40 x $540
2 4
1.06 x $530 0.50 x $570
Note: An Excel spreadsheet solution file for this Problem is embedded in this
document. You can open the spreadsheet object that follows by doing the following:
2008 2007
Sales $18,750 $15,000
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-53 The McGraw-Hill Companies 2008
16-67 Cost of Quality (COQ) Report (40 Minutes)
1&2
BUSTER COMPANY
Cost of Quality (COQ) Report
For 2008 and 2007
Appraisal costs:
Testing $80,000 80,000 1.33 $60,000 60,000 1.00
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-54 The McGraw-Hill Companies 2008
16-67 (Continued)
There were slight increases in both prevention and appraisal costs from 2007 to
2008. The share of sales dollars consumed by each of these two categories also
increased slightly (0.33 percentage points). These two costs increased by
$40,000 over the two years.
Both internal failure costs and external failure costs decreased substantially in
2008 as compared to those in 2007. The company experienced a 1.41 percent
decrease in internal failure and a 4.34 percent decrease in external failure costs,
which together provided a total savings of $345,000. The savings was 863
(345,000/40,000) percent of the increase in the sum of conformance costs
(prevention plus appraisal cost).
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-55 The McGraw-Hill Companies 2008
16-68 Ethics (4045 Minutes)
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-56 The McGraw-Hill Companies 2008
16-68 (Continued)
3. In accordance with the IMA Standards, the first alternative (seeking the advice of
her boss) is appropriate. To resolve an ethical conflict, the IMA Standards specify
that the first step is to discuss the problem with the individuals immediate
supervisor, unless it appears that the supervisor is involved in the conflict. In this
case, it does not appear that Williams boss is involved.
4. Jan Williams should follow the established policy of the organization bearing on the
resolution of such conflict. If these policies do not resolve the ethical conflict,
Williams should report the problem to successively higher levels of management, up
to the Board of Directors, until it is satisfactorily resolved. There is no requirement
for Williams to inform her superior of this action because there is credible evidence
that the supervisor is involved in the conflict. If the conflict is not resolved after
exhausting all courses of internal review, Williams may have no other recourse but
to resign from the organization and to submit an informative memo to an
appropriate member of the organization.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-57 The McGraw-Hill Companies 2008
16-69 Cost of Quality (COQ) Reporting (4550 Minutes)
2.
12000
10000
8000
6000
4000
2000
0
Prevention Appraisal Internal External
Failure Failure
2008 2007
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-58 The McGraw-Hill Companies 2008
16-69 (Continued)
3. The firm increased spending on prevention and appraisal and saw its external
failure cost decrease by 64%. Although the internal failure costs increased from
2007 to 2008, the efforts to improve quality had begun to pay off as indicated by a
decrease of $2,600 (16%) in total quality cost from 2007 to 2008.
The most significant decreases in external failure costs were in costs for product
recalls and customer returns of defective goods. These two costs accounted for 42
percent of the total COQ in 2007. Decreases in these two cost categories in 2008
led to the decrease in the overall COQ. Customers were apparently more satisfied
with the product in 2008 than the year before.
4. No. The company has just started to improve its quality and increase customer
satisfaction. A cut in quality cost will likely jeopardize the improvements in quality
the company has achieved so far. Furthermore, the cut may cast doubt on the
dedication of the company to quality improvements. Continuing the efforts to
improve quality will eventually reduce the total cost of manufacturing and selling the
product, as the company witnessed in 2008. The company most likely will enjoy
increases in sales in the long run as its customers realize the high product quality of
the companys products.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-59 The McGraw-Hill Companies 2008
16-70 Cost of Quality (COQ) ReportingExcel-Generated Solution (4550 Minutes)
1. LEE ENTERPRISES
COST OF QUALITY REPORT
FOR YEARS 2008 AND 2007
2008 2007 % Change
PREVENTION COSTS
Systems development $106 $64 + 66
Quality engineering 80 56 + 43
Total $186 $120 + 55
APPRAISAL COSTS
Inspection $120 $ 76 + 58
Product testing 160 98 + 63
Statistical process control (SPC) 74 - N/A
Supplies used in testing 6 4 + 50
Depreciation of testing equipment 34 22 + 55
Total $394 $200 + 97
INTERNAL FAILURE COSTS
Disposal of defective products $ 76 $ 54 + 41
Net cost of scrap 124 86 + 44
Rework labor 200 140 + 43
Total $400 $280 + 43
EXTERNAL FAILURE COSTS
Product recalls $ 82 $ 340 76
Warranty repairs 140 420 67
Warranty replacements 18 60 70
Field servicing 120 180 33
Total $ 360 $1,000 64
TOTAL QUALITY COSTS $1,340 $1,600 16
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-60 The McGraw-Hill Companies 2008
16-70 (Continued-1)
2.
Cost of Quality (COQ) Summary: 2007 vs. 2008
$1,800
$1,600
$1,400
$1,200
$1,000
$800
$600
$400
$200
$0
Prevention Appraisal Internal External Total quality
failure failure cost
2008 2007
3. The report indicates that prevention, appraisal, and internal failure costs have increased
from 2007 to 2008. The external failure cost category decreased by 64%. It is likely that
the intensive efforts to improve quality has begun to pay off as, indicated by a decrease
of 16% in total COQ, from 2007 to 2008.
Lee Enterprises benefits from decreases in its external failure costs. Three external
failure costs (product recalls, warranty repairs, and warranty replacements) have
decreased by approximately 70 percent from what these costs were the year before.
The cost of field services decreased 33%. Some of the field services in 2008 were likely
for sales prior to the launching of the intensive quality-improvement effort. As the
company continues with its quality improvement program, field service costs should
continue to decrease.
4. One of the most effective ways for production workers to be conscientious in their work
is to hold them responsible for mistakes. Holding employees responsible for their work
can include a policy for workers to do rework on their own time and to pay for costs
incurred for rework. Lincoln Electric Company (Harvard Business School case) has
successfully implemented such a policy for years. However, Carrie Lee is more likely to
be successful in adopting this proposal if she can implement the new procedure
gradually over a period of two to three years. The firm also would need to revise its
compensation scheme to reflect the change.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-61 The McGraw-Hill Companies 2008
16-70 (Continued-2)
Note: An Excel spreadsheet solution file for this Problem is embedded in this
document. You can open the spreadsheet object that follows by doing the following:
LEE ENTERPRISES
COST OF QUALITY REPORT
FOR YEARS 2007 AND 2008
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-62 The McGraw-Hill Companies 2008
16-71 Ethics (45 Minutes)
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-63 The McGraw-Hill Companies 2008
16-71 (Continued)
The request by Sanchez is unethical because it would suppress information that could
influence an understanding of the results of operations by the company. Also, by
withholding information about the contingent liability, Sanchez is not communicating
information objectively.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-64 The McGraw-Hill Companies 2008
16-72 Relevant Costs and Quality Improvement (2030 min)
1.
Lightening Bulk Company
Cost and Benefit Analysis of the Proposed
Scheduling and Tracking System
The new scheduling and tracking system will most likely decrease the firms pre-tax
cash flow per year. Thus, from a purely financial point of view the company cannot
justify the purchase of the new system.
2. Among other factors the manager needs to consider are: reliability and accuracy of the
estimates, including contribution margins, cost of tracking misplaced and lost items (and
their behavior patterns), and the estimated decreases in misplaced and lost items; sales
growth; useful life of the new system; changes in technologies (how soon will a newer
system replace the new system); and, training cost, including possible downtime, for the
new system.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-65 The McGraw-Hill Companies 2008
16-73 Relevant Costs and Quality Improvement (50 Minutes)
3. Yes. The cost of the new process is $15,000,000 and the expected benefits total
$28,837,500 over three years. The pattern of pre-tax cash flows for this investment
opportunity is as follows:
Year 0 = ($15,000,000)
Year 1 = $9,112,500 (i.e., $9,862,500 $750,000)
Year 2 = $9,862,500
Year 3 = $9,862,500
Thus, the payback period for this proposed investment is less than two years. Its
internal rate of return (IRR) is approximately 41%, as shown in the following screen
shot from Excel:
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-66 The McGraw-Hill Companies 2008
16-73 (Continued)
4. The following factors should be considered before making the final decision:
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
5. The member of the board would be right if we ignore the financial payoff of the new
process and if the company 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 company
is selling, is crucial for a long-term success.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-67 The McGraw-Hill Companies 2008
16-74 Taguchi Loss Function Analysis (Appendix) (1520 Minutes)
2
1. a. $150 = k x (0.0025)
k = $24,000,000
2
b. L(x = 0.1893) = $24,000,000 x (0.1893 0.1875) = $77.76
2
2. a. Total quality cost = k x (Tolerance)
2
$6 = $24,000,000 x (Tolerance)
Tolerance = 0.0005 inches
b. The specification should be set at 0.1875 0.0005
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-69 The McGraw-Hill Companies 2008
16-75 Taguchi Loss Function Analysis (Appendix) (1520 Minutes)
2
1. a. $200 = k x (5.0)
k = $8.00
2
b. L(x = 122) = $8.00 x (122 125)
= $72.00
2
2. a. Total quality cost = k x (Tolerance)
2
$12.00 = $8.00 x (Tolerance)
Tolerance = 1.2247
b. The specification should be set at 125 1.2247
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-70 The McGraw-Hill Companies 2008
16-76 Taguchi Loss Function Analysis (60 Minutes)
2
1. k = ($50 + $70)/(0.025) = $192,000
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-71 The McGraw-Hill Companies 2008
16-76 (Continued)
Inputs
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-72 The McGraw-Hill Companies 2008
16-77 Analyzing Cost of Quality (COQ) Reports (50 Minutes)
2.
BERGEN, INC
Quality Cost Report
Most Recent and Most-Distant Quarter
6/30/2007 9/30/2008
% of % of % of % of
Quality Amount Quality Prod. Amount Quality Prod
Cost Category (In 000) Cost Cost (In 000) Cost Cost
From an analysis of the COQ Report (oldest vs. most recent quarterly results) it would
appear that Bergen Inc.'s program has been successful because:
Total COQ as a percentage of total production cost has declined from 23.4% to
13.1%.
External failure costs, those costs signaling customer dissatisfaction, have declined
from 8.03% of total production cost to 2.28%. These declines in warranty repairs
and customer returns should translate into increased sales and lower costs (and
therefore increased profitability) in the future.
The total internal failure cost was 4.56% of the total production cost in 2007, and is
now only 2.26% of the total production cost.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-73 The McGraw-Hill Companies 2008
16-77 (Continued)
Appraisal costs have decreased 48%from 4.98% to 2.57% of production cost.
Higher initial quality (via Prevention expenditures) is likely reducing the demand for
testing.
Quality costs have shifted to the area of prevention where problems are solved
before the customer becomes involved. Prevention costs, such as maintenance,
training, and design reviews, have increased from 5.83% of total production to
5.99% and from 25% of total quality costs to 46%. This $30,000 increase was more
than offset by decreases in other quality costs.
3. Tony Reese's current reaction to the quality-improvement program is more favorable as
he is seeing the benefits of having the quality problems investigated and solved before
they reach the production floor. Because of improved designs, quality training, and
additional preproduction inspections, scrap, and rework costs have declined.
Production does not have to spend an inordinate amount of time with customer service
since those individuals are now making the product right the first time. It is plausible
that throughput has increased and that throughput time has decreased: work is now
moving much faster through the department. (Of course, this last assertion can be
tested through the collection of relevant nonfinancial quality indicators.)
4. To measure the opportunity cost of not implementing the quality program, Bergen Inc.
could assume that:
a. Sales and market share would continue to decline and then estimate the revenue
and income lost.
b. The company would have to compete on price rather than quality and calculate the
impact of having to lower product prices to do so.
5. This question is designed to make students think about a proper role of a COQ
reporting system as part of a comprehensive framework for managing and controlling
quality, such as the framework presented in Exhibit 16.3. The main point is that COQ
data can be a valuable attention-director. For example, many organizations (confirmed
by our own in-class discussions with MBA students) are surprised to see how much
spending (i.e., portion of each sales dollar) is consumed by spending on quality. For
many organizations, a reduction in overall quality costs can be a key to significantly
increasing financial performance (a point substantiated by the empirical evidence
referenced early in the chapter). Therefore, if COQ reports are accessible,
comprehensible, and viewed as reliable, they can inform managers and operating
personnel alike that quality failures can be exceedingly expensive to the organization.
However, COQ measures are not diagnostic in nature. That is, these financial
measures do not point to ways to eliminate quality problems; however, it does quantify
in financial terms the impact of these failures on profitability. In short, diagnostic
control of quality is probably better achieved through the application of techniques
borrowed from operations management (cause-and-effect diagrams, Pareto charts,
etc.) applied to nonfinancial measures of quality. This suggests, therefore, that one
characteristic of a comprehensive framework for managing and controlling quality is the
use of both financial and nonfinancial quality indicators.
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-74 The McGraw-Hill Companies 2008
16-78 Expected Quality Cost, Confidence Intervals, and Sample Size
(30-40 Minutes, requires some material from Chapter 6: Cost Estimation)
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-75 The McGraw-Hill Companies 2008
16-78 (Continued)
2. The sample size that Ross Webster should select from a lot of 800 housings is 265
units, calculated as follows:
2
nc = (2.00) (0.01) (0.99)
2
(0.01)
= 0.0396 0.0001
= 396
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-76 The McGraw-Hill Companies 2008
16-79 Benefits of Switching to JIT (50-60 Minutes)
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-77 The McGraw-Hill Companies 2008
16-79 (Continued)
4. Based solely on the short-term financial effect, ABC should replace the
equipment and move to JIT. The annual pre-tax net benefit ($712,900)
greatly exceeds the one-time penalty the company would have to pay to
break its existing lease.
5. Additional considerations:
Blocher, Stout, Cokins, Chen, Cost Management, 4/e 16-78 The McGraw-Hill Companies 2008