Quality

Cost
Management
Prepared
Preparedby
by

Douglas
DouglasCloud
Cloud

Pepperdine
PepperdineUniversity
University
17-1

Objectives
Objectives
1. Define quality,
describe
thethis
four types of
After
studying
After
studying
this
quality cost.chapter,
chapter,you
you should
should
able
to:
2. Prepare a qualitybe
cost
report,
be
able
to: and explain its
use.
3. Explain why quality cost information is
needed and how it is used.
4. Describe and prepare three different types of
quality performance reports.
17-2

The Meaning of Quality

A quality product
or service is one
that meets or
exceeds customer
expectations.

17-3

Distribution
Distribution of
of Color
Color Density
Density of
of
Sony
Sony Television
Television Sets
Sets
Sony of Tokyo TVs
Sony of San
Diego TVs

Lower
Specification
Limit

Target
Value

Upper
Specification
Limit

17-4

Measuring
Measuring the
the Costs
Costs of
of Quality
Quality
Prevention costs
Appraisal costs
Internal failure costs
External failure costs

17-5

Quality
Quality Cost
Cost Measurement
Measurement
Prevention Costs
Quality engineering
Quality training
Recruiting
Quality audits
Design reviews
Quality circles
Marketing research
Vendor certification

Appraisal (Detection) Costs

Inspection of materials
Packaging inspection
Product acceptance
Process acceptance
Field testing
Continuing supplier
verification
Prototype inspection

17-6

Quality
Quality Cost
Cost Measurement
Measurement
Internal Failure Costs
Scrap
Rework
Downtime (defect-related)
Reinspection
Retesting
Design changes
Repairs

External Failure Costs

Lost sales (performancerelated)
Returns/allowances
Warranties
Discounts and defects
Product liability
Complaint adjustment
Recalls
Ill will
17-7

Estimating
Estimating Hidden
Hidden Quality
Quality Costs
Costs
Hidden Quality Costs are
opportunity costs resulting from
poor quality.
The Multiplier Method
The Market Research Method
The Taguchi Quality Loss

Function

17-8

The
The Multiplier
Multiplier Method
Method
The multiplier method assumes that the total failure
cost is simply some multiple of measured failure
costs:
Total external failure cost = k(Measured external
failure costs)
where k is the multiplier effect
If k = 4, and the measured external failure costs are $3
million, then the actual external failure costs are estimated
to be $12 million.
17-9

The
The Market
Market Research
Research Method
Method
The 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
companys sales force can provide significant insights into
the magnitude of a companys hidden costs.
Market research results can be used to project future profit
losses attributable to poor quality.

17-10

The
The Taguchi
Taguchi Quality
Quality Loss
Loss Function
Function
The Taguchi loss function assumes
any variation from the target value of
a quality characteristic causes hidden
quality costs.
Furthermore, the hidden quality
costs increase quadratically as the
actual value deviates from the
target value.
17-11

The
The Taguchi
Taguchi Quality
Quality Loss
Loss Function
Function
L(y) = k(y T)
k = A proportionately constant dependent
upon the organizations external failure
cost structure
y = Actual value of quality characteristic
T = Target value of quality characteristic
L = Quality loss

17-12

The
The Taguchi
Taguchi Quality
Quality Loss
Loss Function
Function
$ Cost

Lower
Specification
Limit

Target
Value

Upper
Specification
Limit

17-13

Quality Cost Report

Time Gained
Unit No. (Lost) (y)
1
-1

y-T
-1

(y T)
1

k(y-T)
$ 2.00

8.00

16

32.00

-3

-3

18.00

30

$60.00

7.5

$15.00

Units
Average

17-14

Goates Company
Quality Cost Report
For the Year Ended June 30, 2001
Quality Costs
Prevention costs:
Quality training
Reliability engineering
Appraisal costs:
Materials inspection
Product acceptance
Process acceptance

$10,000
65,000

$ 75,000

$ 5,000
20,000
75,000

100,000

% of Sales

1.50 %

2.00

Continued
Continued
17-15

Quality Costs
Internal failure costs:
Scrap
Rework
External failure costs:
Customer complaints
Warranty
Returns and allowances
Total quality costs

$150,000
100,000
$150,000
250,000
175,000

% of Sales

250,000

5.00 %

575,000
$1,000,000

11.50
20.00 %

17-16

Quality
Quality Cost
Cost Categories
Categories
8%
10%

External Failure
Prevention
Appraisal
Internal Failure

57%

25%

17-17

AQLQuality
AQLQuality Cost
Cost Graph
Graph
Cost
Failure

Control

0
Optimal
(AQL)

100%
Percent Defects
17-18

Zero-Defect
Zero-Defect Quality
Quality Cost
Cost Graph
Graph
Cost

Failure

Control
0

100%
Percent Defects
17-19

Strategy
Strategy Pricing
Pricing
Revenues (1,000,000 @ $20) $20,000,000
Cost of goods sold

-15,000,000

Operating expenses

- 3,000,000

Product-line income

$ 2,000,000

17-20

Strategy
Strategy Pricing
Pricing
Data from the low-level instruments are:
Quality costs (estimated):
Inspection of materials

$ 200,000

Scrap

800,000

Rejects

500,000

Rework

400,000

Product inspection

300,000

Warranty work
Total estimate

1,000,000
$3,200,000
17-21

Reports: New Product Analysis, Project #675

Projected sales potential: 44,000 units
Production capacity: 45,000 units
Unit selling price: $60
Unit variable costs: $40
Fixed costs:
Product development
Manufacturing
Selling
Total

$ 500,000
200,000
300,000
$1,000,000

Projected break-even: 50,000 units

Decision: Reject
Reason(s): The break-even point is greater than the production
capacity as well as the projected sales volume.
17-22

ISO
ISO 9000
9000 Standards
Standards
ISO 8402: QualityVocabulary
ISO 9000: Quality management and quality assurance
standardsGuidelines for selection and use
ISO 9001: Quality systemsModel for quality assurance in
design/development, production, installation, and
servicing
ISO 9002: Quality systemsModel for quality assurance in
production and installation
ISO 9003: Quality systemsModel for quality assurance in
final inspection and test
ISO 9004: Quality management and quality system elements
Guidelines
17-23

Controlling
Controlling Quality
Quality Costs
Costs
Zero-defect standards
reflects a philosophy of total
quality control and calls for
products and services to be
produced and delivered that
meet the targeted value.

17-24

Types
Types of
of Quality
Quality
Performance
Performance Reports
Reports
1. Progress with respect to a current-period
standard or goal (an interim standard report)
2. The progress trend since the inception of the
quality-improvement program (a multipleperiod trend report)
3. Progress with respect to the long-range
standard or goal (a long-range report)
17-25

AMD, Inc.
Interim Standard Performance Report: Quality Costs
For the Year Ended June 30, 2004
Actual Costs

Prevention costs:
Quality training
Reliability engineering
Total prevention costs
Appraisal costs:
Materials inspection
Product acceptance
Process acceptance
Total appraisal costs

Budgeted Costs

Variance

$ 80,000
160,000
$240,000

$ 80,000
160,000
$240,000

$ 75,000
40,000
65,000
$180,000

$ 83,000
40,000
55,000
$178,000

$ 8,000 F
0
10,000 U
$ 2,000 U

Continued
Continued

0
0
0

17-26

AMD, Inc.
Interim Standard Performance Report: Quality Costs
For the Year Ended June 30, 2004
Actual Costs

Internal failure costs:

Scrap
Rework
Total internal failure
External failure costs:
Customer complaints
Warranty
Repair
Total external failure
Total quality costs
Percentage of actual sales

Budgeted Costs

Variance

$ 50,000
100,000
$150,000

$ 44,000
96,500
$140,500

$ 6,000 U
3,500 U
$ 9,500 U

$ 65,000
78,000
87,000
$230,000
$800,000
10.0%

$ 65,000
68,500
79,000
$212,500
$771,000
9.64%

0
9,500 U
8,000 U
$17,500 U
$29,000 U
0.36% U
17-27

Multiple-Period
Multiple-Period Trend
Trend Report
Report
Quality Costs

Actual Sales

% of Sales

2000

$1,000,000

$5,000,000

2001

990,000

5,500,000

18.0

2002

900,000

6,000,000

15.0

2003

899,000

6,200,000

14.0

2004

800,000

8,000,000

10.0

20.0 %

17-28

Multiple-Period
Multiple-Period Trend
Trend Report
Report
Prevention

Appraisal

Internal
Failure

External
Failure
10.0 %

2000

2.0 %

2.0 %

6.0 %

2001

3.0

2.4

4.0

8.6

2002

3.0

3.0

3.0

6.0

2003

4.0

3.0

2.5

4.5

2004

4.1

2.4

2.0

1.5

17-29

Multiple-Period Trend Graph: Total Quality Costs

Percentage of Sales

25
20
15
10
5
0
2000

2001

2002

2003

2004
17-30

Percentage of Sales

Multiple-Period Trend Graph: Individual

Quality Cost Categories
10
9
8
7
6
5
4
3
2
1
0

Prevention
Appraisal
Internal Failure
Exteral Failure

2000 2001 2002 2003 2004

17-31

Percentage of Sales

Multiple-Period Trend Graph:

Relative Quality Costs
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

Exteral Failure
Internal Failure
Appraisal
Prevention

2000 2001 2002 2003 2004

17-32

End of

Chapter
17-33

17-34