3. 2B-3
Quality of Conformance
Costs incurred to prevent defects or that
result from defects in products are known as
quality costs. Many companies are working
hard to reduce their quality costs.
When the overwhelming majority of products
produced conform to design specifications
and are free from defects.
4. 2B-4
Prevention and Appraisal Costs
Appraisal Costs
Incurred to identify
defective products
before the products are
shipped to customers
5. 2B-5
Internal and External Failure Costs
Internal Failure
Costs
Incurred as a result of
identifying defects
before they are shipped
External Failure
Costs
Incurred as a result of
defective products
being delivered to
customers
6. 2B-6
Examples of Quality Costs
Prevention Costs
• Quality training
• Quality circles
• Statistical process
control activities
Internal Failure Costs
• Scrap
• Spoilage
• Rework
Appraisal Costs
• Testing and inspecting
incoming materials
• Final product testing
• Depreciation of testing
equipment
External Failure Costs
• Cost of field servicing and
handling complaints
• Warranty repairs
• Lost sales
9. Quality Cost Report
For Years 1 and 2
Year 2
Amount
Percent*
Prevention costs:
Systems development
Quality training
Supervision of prevention activities
Quality improvement
Total prevention cost
$
400,000
210,000
70,000
320,000
1,000,000
0.80% $
0.42%
0.14%
0.64%
2.00%
Appraisal costs:
Inspection
Reliability testing
Supervision of testing and inspection
Depreciation of test equipment
Total appraisal cost
600,000
580,000
120,000
200,000
1,500,000
Internal failure costs:
Net cost of scrap
Rework labor and overhead
Downtime due to defects in quality
Disposal of defective products
Total internal failure cost
900,000
1,430,000
170,000
500,000
3,000,000
External failure costs:
Warranty repairs
Warranty replacements
Allowances
Cost of field servicing
Total external failure cost
Total quality cost
400,000
870,000
130,000
600,000
2,000,000
7,500,000
$
2B-9
Year 1
Amount
Percent*
270,000
130,000
40,000
210,000
650,000
0.54%
0.26%
0.08%
0.42%
1.30%
1.20%
1.16%
0.24%
0.40%
3.00%
560,000
420,000
80,000
140,000
1,200,000
1.12%
0.84%
0.16%
0.28%
2.40%
1.80%
2.86%
0.34%
1.00%
6.00%
750,000
810,000
100,000
340,000
2,000,000
1.50%
1.62%
0.20%
0.68%
4.00%
900,000
2,300,000
630,000
1,320,000
5,150,000
9,000,000
1.80%
4.60%
1.26%
2.64%
10.30%
18.00%
0.80%
1.74%
0.26%
1.20%
4.00%
15.00% $
* As a percentage of total sales. In each year sales totaled $50,000,000.
Quality cost
reports provide
an estimate of
the financial
consequences
of the
company’s
current defect
rate.
10. 2B-10
Quality Cost Reports in Graphic Form
$10
20
Quality Cost (in millions)
8
7
6
External
Failure
External
Failure
5
Internal
Failure
4
3
Internal
Failure
2
1
0
Appraisal
Appraisal
Quality
reports
can also
be
prepared
in
graphic
form.
18
Quality Cost as a Percentage of Sales
9
16
14
12
Prevention
1
2
Year
External
Failure
10
Internal
Failure
8
6
Internal
Failure
4
2
Prevention
External
Failure
0
Appraisal
Appraisal
Prevention
Prevention
1
2
Year
11. 2B-11
Uses of Quality Cost Information
Help managers see the
financial significance of
defects.
Help managers identify
the relative importance
of the quality problems.
Help managers see
whether their quality
costs are poorly
distributed.
12. 2B-12
Limitations of Quality Cost Information
Simply measuring and
reporting quality cost
problems does not solve
quality problems.
Results usually lag
behind quality
improvement programs.
The most important
quality cost, lost sales, is
often omitted from
quality cost reports.
13. 2B-13
ISO 9000 Standards
Global View
ISO 9000 standards have become
international measures of quality.
To become ISO 9000 certified, a
company must demonstrate:
1. A quality control system is in use, and the system
clearly defines an expected level of quality.
2. The system is fully operational and is backed up with
detailed documentation of quality control procedures.
3. The intended level of quality is being achieved on a
sustained basis.
Editor's Notes
Appendix 2B: Cost of Quality.
Learning objective number 9 is to identify the four types of quality costs and explain how they interact.
The term quality has many meanings. Quality can mean that a product has many features not found in other products; it can mean that it is well-designed; or it can mean that it is defect-free. In this appendix, the focus is on the presence or absence of defects. Quality of conformance is the degree to which the actual product or service meets its design specifications. Anything that does not meet design specifications is a defect and is indicative of low quality of conformance. There are four broad categories of quality costs: prevention costs, appraisal costs, internal failure costs, and external failure costs.
There are four broad categories of quality costs. Two of which are prevention costs and appraisal costs.
Prevention costs are incurred to support activities whose purpose is to reduce the number of defects. Appraisal costs are incurred to identify defective products before the products are shipped to customers.
Internal failure costs are incurred as a result of identifying defects before they are shipped to customers. External failure costs are incurred as a result of defective products being delivered to customers.
Here are some examples of each type of quality cost.
Prevention costs include: quality training, quality circles, and statistical process control activities.
Appraisal costs include: testing and inspection of incoming materials, final product testing, and depreciation of testing equipment.
Internal failure costs include: scrap, spoilage, and rework.
External failure costs include: the cost of field servicing and handling customer complaints, warranty repairs, and lost sales arising from reputation of poor quality.
Graphs are often used to depict the relationship between the four types of quality costs. The graph on this slide illustrates four key concepts.
When the quality of conformance is low, total quality cost is high and most of this cost consists of internal and external failure costs.
Total quality costs drop rapidly as the quality of conformance increases.
Companies reduce their total quality costs by focusing their efforts on prevention and appraisal because the cost savings from reduced defects usually overwhelm the costs of additional prevention and appraisal.
Total quality costs are minimized when the quality of conformance is slightly less than 100%. This is a debatable point in the sense that some experts believe that total quality costs are not minimized until the quality of conformance is 100%.
Learning objective number 10 is to prepare and interpret a quality cost report.
A quality cost report details the prevention, appraisal, internal failure, and external failure costs that arise from a company’s current quality control efforts. When interpreting a cost of quality report managers should look for two trends. First, increases in prevention and appraisal costs should be more than offset by decreases in internal and external failure costs. Second, the total quality costs as a percent of sales should decrease.
Quality cost reports can also be prepared in graphic form. Managers should still look for the same two trends whether the data are presented in a graphic or table format.
Uses of quality cost information include the following:
It helps managers see the financial significance of defects.
It helps managers identify the relative importance of the quality problems faced by the company.
It helps managers see whether their quality costs are poorly distributed. In general, costs should be distributed more toward prevention and to a lesser extent appraisal than toward failures.
Limitations of quality cost information include the following:
Simply measuring and reporting quality cost problems does not solve quality problems.
Results usually lag behind quality improvement programs. Initially, prevention and appraisal cost increases may not be offset by decreases in failure costs.
The most important quality cost, lost sales arising from customer ill-will, is often omitted from quality cost reports because it is difficult to estimate.
The International Organization for Standardization, based in Geneva, Switzerland, has established quality control guidelines, known as the ISO 9000 standards. For a company to become ISO 9000 certified by a certifying agency, it must demonstrate that:
1. A quality control system is in use, and the system clearly defines an expected level of quality;
2. The system is fully operational and is backed up with detailed documentation of quality control procedures; and
3. The intended level of quality is being achieved on a sustained basis.
Although the ISO 9000 standards were developed in Europe, they have become widely accepted elsewhere, throughout the world, including the United States.
