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Quality costing


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Quality costing

  1. 1. Costs of Quality: Measurement, Reporting and Control Importance of Quality Costs of Quality Measuring Quality Costs Methods to identify Quality Problems Reporting Quality Costs Relevant Costs and Benefits of Quality Improvement
  2. 2. Importance of Quality Quality as a competitive tool (improving quality can improve their financial and competitive position) Research has shown that there is a positive correlation between quality and firm value
  3. 3. Importance of Quality Quality improvement can increase firm value because it increases a firm’s profitability by: – Increasing customer demand – Decreasing the cost of providing goods and services Close association between quality and customer satisfaction
  4. 4. Meaning of Quality (cont.) Two basic aspects of Quality – Quality of design (how closely the characteristics of a product or services meet the needs and wants of customers) – Conformance quality (performance of product or service relative to its design and product specifications Conformance is strongly emphasized because it is the key to meet customer expectations
  5. 5. Meaning of Quality Meaning of Quality – Quality as the degree or grade of excellence – A quality product or service is one that meets or exceeds customer expectations on the key attributes of product performance, reliability, durability and fitness for use
  6. 6. Cost of Quality Costs of quality are the price of non conformances The optimal level of the cost of quality should be about 2 to 4 percent of sales The difference between actual and optimal levels represents a rich opportunity of improving quality, thus improving profitability
  7. 7. Cost of Quality Costs of quality are the costs that exist because poor quality may or does exist. Refers to costs incurred to prevent or the costs arising as a result of producing a low-quality product
  8. 8. Cost of Quality (cont.) Quality costs are associated with 2 sub categories of quality related activities: – Control activities – Failure activities
  9. 9. Control activities/costs Control costs are the costs of performing control activities.
  10. 10. Control activities • Control activities are made up of: prevention activities appraisal activities
  11. 11. Costs of Quality Four categories of quality costs: – Prevention costs (costs incurred to preclude the production of products that do not conform to specifications) Examples: Quality engineering, quality training training programs, quality planning, quality reporting, supplier evaluation and selection, quality audits, quality circles, field trials and design reviews As prevention cost increase , the costs of failure are expected to decrease
  12. 12. Appraisal Costs  Costs incurred to detect which of the individual units of products do not conform to specifications)  Main objective of appraisal function is to prevent nonconforming goods from being shipped to customers  Incurred to determine whether products and services are conforming to their requirements or customer needs  Examples: inspecting and testing materials, packaging inspection, supervising appraisal activities, product acceptance, process acceptance, measurement (inspection and test) equipment and outside endorsements
  13. 13. Failure activities (cont.) – Failure activities are made of: internal activities external activities
  14. 14. Failure Activities/Costs Failure activities refer to those activities performed by an organisation or its customers in response to poor quality Failure costs are the cost incurred by an organisation because failure activities are performed
  15. 15. Internal failure costs Costs incurred on a defective product before it is shipped to customers) Incurred because products and services do not conform to specifications or customer needs Detected prior to being shipped to outside parties
  16. 16. Internal failure costs Internal failure costs – Internal failures are those that can be detected by appraisal activities – Examples: scrap, rework, downtime (due to defects), re-inspection, retesting and design changes
  17. 17. External failure costs Costs incurred on a defective product after it is shipped to customers) Incurred because products and services fail to conform to requirements or satisfy customer needs after being delivered to customers The most expensive type of quality costs Examples: costs of recalls, lost sales because of poor product performance, returns and allowances because of poor quality, warranties, repair, product liability, customer dissatisfaction, lost market share
  18. 18. Prevention costs Appraisal costs Systems development Quality engineering Quality training Quality circles SPC activities Supervision of prevention activities Quality improvement projects Audit of the effectiveness of the quality system Quality data gathering, analysis and reporting Technical support provided to suppliers Test and inspection of incoming materials and inprocess goods Final product testing and inspection Supplies used in testing and inspection activities Depreciation and maintenance of test equipment Field testing and appraisal at customer site Plant utilities in the inspection area
  19. 19. Internal failure Net cost of scrap and spoilage Rework labour and overhead Reinspection and retesting of reworked products Disposal of defective goods Downtime caused by quality problems External failure Cost of field servicing and handling complaints Warranty repairs and replacement Product Recalls Liability arising from defective products Returns and allowance arising from quality products Lost of sales arising from a reputation for poor quality
  20. 20. Measuring Quality Costs Quality costs may be classified as: – Observable (quality costs available from an organisation accounting records) – Hidden (opportunity costs resulting from poor quality) Usually in the external failure category
  21. 21. Measuring costs of quality Multiplier method – Assumes that total failure cost is some multiple of measured failure costs – Formula: Total failure costs= k (Measured external failure costs) K = multiplier effect whose value depends on experience
  22. 22. Measuring Quality Costs Market Research Method – Uses formal market research methods to assess the effect of poor quality on sales and market share – Customer surveys and interviews with members of a firm’s sales force would provide insights into the magnitude of the firm’s hidden quality costs – May use to project future profit losses attributable to poor quality
  23. 23. Measuring Quality Costs The Taguchi Quality loss Function – Assumes that any variation from the target value of a quality characteristic causes hidden quality costs – The hidden quality costs increase quardratically as the actual value deviates from the target value as follows:
  24. 24. The Taguchi Quality loss Function (cont.) L(y) = k (y –T)2 Where y = actual value of quality characteristic T = Target value of quality characteristic L = Quality loss K = proportionality constant dependent on the organisation’s external failure cost structure that can be estimated as follows: K = c/d 2
  25. 25. The Taguchi Quality loss Function (cont.) Where c = Loss at the lower or upper specification limit d = distance of the limit from t (the target value) Total hidden quality costs = L (y) x Number of units produced
  26. 26. The Taguchi Quality loss Function (cont.) Example: ABC Sdn Bhd makes components for inclusion in electronic testing equipment. Component 5A has a target value of 500 grams. Specifications limits are minus or plus 10 grams. ABC’s industrial engineers have determined that losses at the lower specification limit equal RM300. A sample of 5 units yielded the following: Sample Actual weight 1 495 grams 2 503 3 511 4 487 5 499
  27. 27. The Taguchi Quality loss Function (cont.) Calculate the loss for each unit and average loss for the sample of 5. k = c/d2 = 300/102 = RM3 per unit
  28. 28. Sample Actual wt (y) Y -T (y-T)2 K(y-T)2 1 495 -5 25 RM75 2 503 3 9 RM27 3 511 11 121 RM363 4 487 -13 169 RM507 5 499 -1 1 RM3 325 RM975 65 195 Average Total hidden quality cost = 195 x 2,500 = RM487,500
  29. 29. Methods to identify Quality problems Control charts – Also known as statistical process control (SPC) - A control chart is a graph of a series of successive observations of a particular step/procedure/operation taken at a regular intervals of time – Formal means of distinguishing between random and nonrandom variations in an operating process
  30. 30. Methods to identify Quality problems – Random variations : power surges or chance fluctuation in temperature cause defective products to be produced in a chemical process – Nonrandom variation occur when defective products are produced as a result of a systematic problem such as inaccurate temperature readings
  31. 31. Methods to identify Quality problems (cont.) Pareto diagrams – A chart that indicates how frequently each type of defect occurs, ordered from the most frequent to the least frequent – Helps the TQM team visualize and communicate to others what the most serious types of defects are. Steps can be taken to tackle the most serious and most frequent problems first
  32. 32. Methods to identify Quality problems Cause and Effect diagrams – Identifies potential causes of defects – Can be used to analyse the most frequently recurring and costly problems – Also known as fishbone /Ishikawa diagrams – Example: refer to Ishikawa diagram used by Xerox Corp. to identify the causes of errors in its billing process – Identification of possible causes helps the management to take systematic steps to eliminate the root causes of the errors
  33. 33. External customers Billing system Communication Cumbersome System errors Input requirement Reading an invoice Billing meters Pricing actions Current price information Employee driven Timeliness Ownership Ownership Awareness Awareness Training/Education Training/Education Communication Communication Out of district personnel District personnel Cause and effect diagram: Billing quality at Xerox Corporation
  34. 34. Reporting Quality Costs To create a quality cost reporting system, need to assess current actual quality costs A detail listing of actual quality costs by category can provide 2 important insights: – Reveals the magnitude of the quality costs in each category , allowing managers to assess their financial impact – Shows the distribution of quality costs by a category allowing the managers to assess the relative importance of each category
  35. 35. Reporting Quality Costs (cont.) Quality Cost Reports – Express the quality costs as a percentage(%) of actual sales in order to assess the financial significance of quality costs – Illustration of a Quality Cost Report
  36. 36. ABC Sdn Bhd Quality Cost Report For the year ended June 30, 2003 Costs Quality Costs Percentage of Sales Prevention costs: Quality training Reliability engineering 10,000 65,000 75,000 1.5% Appraisal costs: Material inspection Product acceptance Process acceptance 5,000 20,000 75,000 100,000 2.00% Internal failure costs: Scrap Rework 150,000 100,000 250,000 5.00% 150,000 250,000 175,000 575,000 11.50% 1,000,000 20.00% External failure costs: Customer complaints Warranty Returns and allowances Total quality costs
  37. 37. Types of Quality Performance Report Interim standard report Measures and reports the progress achieve by the firm with respect to a current period std or goal Compares the actual quality costs for the period with the budgeted costs
  38. 38. Types of Quality Performance Report (cont.) Multiple Period Trend report Multi period report which tracks the progress trend since the inception of the quality improvement program as follows: – The change in total quality costs as a percentage of sales over time – The change of the relative distribution of quality costs as a percentage of sales over time
  39. 39. Types of Quality Performance Report (cont.) Long range report – The long range report which tracks progress with respect to long range standard or goal of zero defects – Compares the current period’s actual costs with the target costs and identifies the variances Target costs are the costs that would be allowed if the zero-defects standard were met. The target costs are the non value added costs The variances are nonvalue added costs
  40. 40. Incentives for Quality Improvement Should provide both monetary and nonmonetary recognition for significant contributions to quality improvement as follows: Non monetary incentives such as nonfinancial awards and public recognition for outstanding performance are useful because they create greater employee job satisfaction and further commitment to quality
  41. 41. Incentives for Quality Improvement (cont.) Non-monetary incentives also allows management to underscore its commitment to quality improvement Participation helps employees internalize quality improvement goals as their own through the following program: – Error cause identification (a program in which employees describe the problems that prevent them from doing their jobs right for the first time) – Error cause removal approach encourages employees to submit quality improvement suggestions. An employee submitting an entry will receive a note of appreciation from management.
  42. 42. Incentives for Quality Improvement (cont.) Monetary incentives – Gainsharing provides cash incentives for the entire workforce that are keyed to quality or productivity gains – The incentive bonuses might be equal to a percentage of the cost savings – Gainsharing are entirely complementary to an integrated measurement system such as Balanced Scorecard