chap16 (1).pdf

Blocher−Stout−Cokins−Chen:

IV. IV. Oper Operat atio iona nall Cont Contro roll

Cost Management: A Strategic Emphasis, Fourth Edition

C H A P T E R

16. 16. The The Mana Manage geme ment nt an and d Control of Quality

© The McGraw−Hill Companies, 2008

S I X T E E N

L O R T N O C L A N O I T A R E P O

The Management and Control of Quality

V I T R A P

2. Define quality and the characteristics of total quality management (TQM)

After studying this chapter, chapter, you should be able to . . . 1. Define accounting’s role in the management and control of quality 3. Develop a comprehensive framework for the management and control of quality 4. Understand two approaches for setting quality-related goals (Six Sigma and Goalpost versus absolute conformance standards) 5. Prepare and interpret relevant financial information to support TQM initiatives 6. Discuss the use of nonfinancial performance data to support TQM initiatives 7. Describe and understand techniques that can be used to detect and correct quality problems

You can’t turn quality on like a spigot. It’s a culture, a lifestyle within a company.

A Ford Ford Engineer Engineer

For decades, management experts in the United States, including W. Edwards Deming and J. M. Juran, urged manufacturers to “design in” quality at the beginning of the process, not to “inspect-in” quality at the end of the production line. The quality call-to-arms mainly fell on deaf ears in the United States, but not in Japan. More than 40 years ago, Juran predicted that a focus on quality would help turn Japan into an economic powerhouse. powerhouse. 1 Juran’s prediction proved true. In the late 1970s and the early 1980s, many U.S. firms had a rude awakening. Many U.S. executives realized, for the first time, that Made in the U.S.A. no longer stood for the best that was available. Once a term of mockery, Made in Japan became a term synonymous with quality. U.S. executives, especially those working for firms employing traditional management techniques that had paid off so well a scant 20 years earlier, found themselves searching frantically for answers and desperately seeking to remain competitive. U.S. auto manufacturers realized in the late 1970s that Japanese auto manufacturers were somehow able to sell automobiles that performed better, had far fewer defects, and cost less than those made in the United States and still earn high returns. Likewise, when HewlettPackard tested the quality of m ore than 300,000 new computer chips, it found those m ade by Japanese manufacturers had zero defects per thousand. Those made by U.S. manufacturers had 11 to 19 defects per thousand. After 1,000 hours of us e, the failure rate of U.S. chips was 27 times higher than those of the Japanese chips. Many industry and government leaders in the United States saw the handwriting on the wall: Get quality or lose the race. The world had changed. Global competition gave consumers abundant choices and they became more cost and value conscious, demanding high-quality products and services. Firms that failed to pay attention to quality often found eroding market shares and operating profits. 1

N. Gross, M. Stepanek, O. Port, and J. Carey, “Will Bugs Eat Up the U.S. Lead in Software?” BusinessWeek, BusinessWeek, December December 6, 1999.

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16. 16. The The Mana Manage geme ment nt an and d Control of Quality


Quality Comes to Child-Care Services

For decades, five-star hotels and restaurants have had consumers lining up to get in. Now comes a new consumer rating: five-star childcare. Just as if they were restaurants or hotels, child-care concerns (both child–care centers and family child-care homes) are being assigned star ratings by state regulators. These ratings are fast becoming the linchpin of states’ drive to raise child-care quality. The ratings systems evaluate facilities on such criteria as low child–adult ratios, teacher credentials, curriculum, group size, and the safety and richness of the environment. Some of these criteria have in research studies been associated with better outcomes in children. There is some preliminary evidence that the ratings systems are improving

quality. For example, in Oklahoma (the first state to set up a rating system) close to 60 percent of all child-care slots in the state are in facilities rated in the top two tiers, up from 30 percent in 2003. In Te Tennnessee, where provider participation in star ratings is mandatory mandatory,, 50 percent of facilities have earned a top rating, up from 30 percent in 2002. Critics argue, however however,, that although participation by child-care providers is growing, the systems are mostly voluntary; provider par ticipation ranges from 10 percent to 60 percent in states where the systems are voluntary. Source: S. Shellenbarger, “Finding Five-Star Child-Care: States Rate Facilities in Effort to Boost Quality,” The Wall Street Journal (March 23, 2006), p. D1.

The Strategic Importance of Quality Many U.S. firms have made remarkable changes in the last two decades. Consumers have witnessed major efforts by U.S. manufacturers to improve quality. Many firms in the United States have engaged in relentless efforts to improve the quality of their products and ser vices. Continuous improvement has become a way of life for many firms and organizations, both in the United States and abroad. For example, AT&T implemented “Concept of One,” which means “do it once, do it right, and do it everywhere.” In four years, AT&T saved about $2 billion in payroll alone. 2

Baldrige Quality Award In 1987, Congress established the Malcolm Baldrige National Quality Award Award to enhance the competitiveness competitiv eness of U.S. businesses by promoting quality awaren awareness, ess, recognizing quality and performance achievements, achievements, and publicizing publicizing successful performance performance strategies of U.S. U.S. organizations in the areas of manufacturing, service, small business, and—added in 1999—education and health-care. Seven broad categories make up the criteria: leadership, strategic planning, customer and market focus, information and analysis, human resource f ocus, process management, and business results. The fierce competition to win the award is evidence of the importance these firms place on being recognized for their quality operations.

ISO 9000 and ISO 14000

ISO 9000: 2000 is a set of guidelines for quality management and quality standards developed by the International Organization for Standardization, Standardizatio n, located in Geneva, Genev a, Switzerland.

Quality has become a major thrust of businesses worldwide. worldwide. In response, various groups promulgated quality-related standards to guide business practice. In 1947, to standardize practices for quality management, a specialized agency (the International Organization for Standardization) was formed. In 1987 this body adopted a set of quality standards, which were revised in 1994 and again in 2000. Thus, the current set of quality-management standards is refer red to as ISO 9000:2000. Worldwide, ISO 9000 has become a certification sought after by global companies to gain the stamp of approval on the quality of their products and services. The ISO 9000:2000 standards focus on developing, documenting, and implementing effective procedures for ensuring consistency of operations and performance in production and service delivery processes, with an overall goal of continual improvement. These standards actually consist of three documents: ISO 9000 —Fundamentals and vocabulary; ISO 9001 — Requirements (i.e., specifications for a quality management system, to which organizations must adhere; these requirements are divided into four major sections: Management Responsibility, Resource Management, Product Realization, and Measurement/Analysis/Improvement); and ISO 9004 —Guidelines for Performance Improvements (i.e., guidelines to assist organizations in improving their quality-management systems beyond the minimum requirements specified in ISO 9001). Note that the set of ISO 9000 standards relates to processes in 2

S N. Mehta, “How to Thrive When Prices Fall,” Fortune , May 12, 2003, p. 132.


IV. Operational Control


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16. The Management and Control of Quality

Environmental Quality Ratings for New-Building Construction

Eco-friendly, or “green,” buildings are one of the most talked-about trends in the trillion-dollar U.S. construction industry. Environmental quality concerns regarding new-building construction are important: buildings today account for about one-third of U.S. energy consump tion, 30 percent of greenhouse gas emissions, and 30 percent of raw material use. The U.S. Green Building Council (www.usgbc.org), a private environmental organization, now provides different levels of green certification for new-building construction, based on six criteria and the use of a 69-point rating scale. The six evaluation criteria (i.e., green categories) are: sustainable sites (e.g., public transportation access); water efficiency, energy and atmosphere; materials and resources (e.g., use of materials with post-consumer recycled contents); indoor environmental quality (e.g., carbon dioxide monitoring); and innovation and design process. In addition to basic certification, higher-performance designations (silver, gold, and platinum) are awarded.

ISO 14000 is a set of quality standards designed to minimize environmental effects of an organization’s outputs.


Green certification is not cheap: costs can run anywhere from $30,000 to $150,000 for administration and paperwork. Critics argue that the existing standards are too lenient and that the scoring system does not give differential weights to what are considered more critical performance criteria. BRE, British Research Establishment Limited (www.bre.co.uk) is a U.K. counterpart organization that, among other things, assesses and certifies both new and existing buildings using the BRE Environmental Assessment Method (BREEAM) (see www.breeam.org). This method is considered in the U.K.’s construction and property sectors as the measure of best practice in environmental design and management. As worldwide demand for natural resources continues, the management and control of environmental quality costs will likely take on increased importance, both in the United States and abroad. Source: A. Frangos, “Is It Too Easy Being Green?,” The Wall Street Journal (October 19, 2005), pp. B1, B6.

place that ensure that outputs of the organization satisfy customer quality requirements. Further, these standards are intended to apply to all types of businesses, including services such as transportation, health -care, and banking. ISO 14000 is a set of standards that relate to environmental management, that is, what an organization does to minimize harmful effects to the environment. As with ISO 9000, ISO 14000 is concerned with quality management—processes in place that ensure a product will have the least harmful impact on the environment, at any stage of its life cycle, either by pollution or by depleting natural resources. In sum, ISO standards contribute to making the development, manufacturing, and supply of products and s ervices more effi cient, safer, and cleaner. They make trade between countries easier and fairer. They provide governments with a technical base for health, safety, and environmental legislation and they aid in transferring technology to developing countries. ISO standards also serve to safeguard consumers, and users in general, of products and services— as well as to make their lives simpler. As of this writing, more than 700,000 organizations in 154 countries have implemented ISO 9000 and ISO 14000 standards (see www.iso.ch ).

Quality and Profitability: Conceptual Linkage Whether a company competes through a strategy of cost leadership or product differentiation, quality issues permeate every aspect of operations. A company choosing to compete through low prices is not necessarily choosing to produce low-quality products. Its low-priced pro ducts must still meet customer expectations. Similarly, a differentiation strategy will not be as successful, or at least will not be as successful as it could be, if the company fails to build quality into its products. Thus, from top management’s perspective, a key question is how best to manage and control total spending on quality-related costs. There is evidence that the total cost of quality for an organization can be high; for many U.S. firms, total quality costs amount to 20 to 25 percent of sales dollars. 3 One consultant estimates that 40 percent of the cost of doing business in the service sector can be attributed to poor quality. 4 On the other hand, firms with quality products or services can ear n high, and sustainable, levels of profitability. Exhibit 16.1 shows that a firm with improved quality can achieve competitive advantage and enjoy higher profitability and a higher return on investment. Improved quality decreases product returns. Lower returns decrease warranty costs and repair expenses. Improved quality lowers inventory levels for raw materials, components, and finished products because the 3

M. R. Ostrega, “Return on Investment through Cost of Quality,” Journal of Cost Management (Summer 1991), pp. 37–77; R. K. Youde, “Cost of Quality Reporting,” Management Accounting (January 1992), pp. 33–38. 4

T. Wolf, “Becoming a ‘Total Quality’ Controller,” The Small Business Controller (Spring 1992), pp. 24–27.






Chapter 16

EXHIBIT 16.1


651

Investments in Quality

Relationship between Improved Quality and Financial Performance

Improved Quality

Lower Return Rate

Lower Warranty and Service Costs

Lower Inventory

Higher Turnover

Higher Perceived Value

Lower Manufacturing Cost

More Satisfied Customers

Higher Prices

Increased Revenues

Faster Throughput Time

Faster Delivery

Higher Market Share

Financial Performance

firm has more reliable manufacturing processes and schedules. Improved product quality also lowers manufacturing costs as the firm reduces or eliminates rework and increases productivity. Customers are likely to perceive quality products as having higher values, which allows the firm to command higher prices and enjoy a larger market share. Higher prices and greater market shares increase revenues and profits. Improved quality also decreases cycle time. Faster cycle times speed deliveries, and prompt delivery makes happy customers, creates new demand, and increases market shares. Higher revenues and lower costs boost net income and increase the fir m’s return on investment (ROI).

Empirical Evidence—Does TQM Matter? Empirical studies provide evidence regarding the market reaction to and the financial effects of quality-related initiatives, such as total quality management (TQM). Barron and Gjerde (1996) presented early evidence regarding the relationship between adoption of TQM and firm characteristics, including financial performance. 5 Their data set included approximately 2,300 firms and data from 1983–1992; during this period, firms that had adopted TQM experienced a greater growth rate in net sales, employment, and total assets. Easton and Jarrell (1998) examined the impact of TQM on the performance of 108 firms that began TQM implementation between 1981 and 1991. 6 The authors provide evidence that performance, measured by both accounting variables and stock returns, is improved for firms adopting TQM and that this improvement is consistently stronger for firms with more advanced TQM systems. PIMS Associates, Inc., a subsidiary of the Strategic Planning Institute, maintains a data base of over 1,200 companies to study the relationship between product quality and corporate performance.7 Their analysis indicates that • Product quality is an important determinant of business profitability. • Businesses that offer premium-quality products and services are more likely to have relatively large market shares. • Quality is positively and significantly related to higher rates of return on investment for almost all kinds of products and market situations. 5

J. M. Barron and K. P. Gjerde, “Who Adopts Total Quality Management (TQM): Theory and an Empirical Test,” Journal of Economics and Management Strategy 5, no. 1 (Spring 1996), pp. 69–106. 6

G. S. Easton and S. L. Jarrell, “The Effects of Total Quality Management on Corporate Performance: An Empirical Investigation,”Journal of Business 71, no. 2 (1998), pp. 253–307. 7

As reported in J. R. Evans and W. M. Lindsay, The Management and Control of Quality , 6th ed. (Mason, OH: South-Western, 2005), p. 26.






652 Part Four Operational Control

For most years since 1995, the hypothetical “Baldrige Stock Index,” consisting of publicly traded U.S. companies that have received the Malcolm Baldrige National Quality Award, has outperformed the Standard & Poor’s 500 by a margin of almost three to one. In a series of papers,8 Hendricks and Singhal compared the performance of 600 quality award-winning com panies, including the Baldrige, state (e.g., the Georgia Oglethorpe Award), and other quality award programs, with the performance of a control group of companies. These researcher s found that the award-winning companies significantly outperformed the control group in many aspects of their business, including the value of their common stock, operating income, sales, return on sales, and asset growth. Saccomano 9 reports that companies with effective TQM programs have higher stock prices, sales, and profits compared to a control sample of firms. In sum, cost, quality, and time are among the critical factors in successful strategies. Having quality products allows firms that compete on differentiation to be effective in sustaining their strategy. A firm with low costs and quality products provides its customers with products equal to or better in quality at lower prices. Only with quality products can the firm truly be a cost leader. Continual improvements in the quality of products and services and in processes should be a fundamental strategic objective and a major item in the balanced scorecard of most firms and organizations.

Accounting’s Role in the Management and Control of Quality LEARNING OBJECTIVE 1 Define accounting’s role in the management and control of quality.

The preceding discussion should have conveyed to you that quality initiatives, such as TQM, are management, not accounting, initiatives or prerogatives. Thus, from our perspective the appropriate question to ask is how accounting can add value to, or support, quality-related initiatives of management. An inspection of Exhibit 16.1 suggests that accountants can add value to the process by providing managers with relevant and timely information, of both a financial and nonfinancial nature. With their training and expertise in analyzing, measuring, and reporting infor mation, management accountants can help in the design and operation of a comprehensive system for managing and controlling quality costs. This is where accountants have a competitive advantage within the organization.

Chapter Preview In the next section of this chapter, we define the term quality and then present a conceptual framework for managing and controlling quality costs. This is followed by a discussion of financial performance measures related to quality (relevant cost analysis and cost of quality [COQ] reports). We then discuss the role of nonfinancial quality indicators in the overall framework. We conclude the chapter with a discussion of a number of techniques that can be used to identify and analyze quality-related problems.

Total Quality Management (TQM) LEARNING OBJECTIVE 2

The Meaning of Quality

Define quality and the characteristics of total quality management (TQM).

There are many definitions of quality, and people often view it differently because of differences in their roles in the production-marketing-consumption chain and in their expectations for products or services. In simpler times, many CEOs perceived quality as a characteristic revealed by “I know it when I see it.” However, such an ad hoc approach to quality provides no clear guideline for meeting it and as such, makes the management and control of quality difficult if not impossible. 8

K. B. Hendricks and V. R Singhal, “Does Implementing an Effective TQM Program Actually Improve Operating Performance: Empirical Evidence from Firms That Have Won Quality Awards,” Management Science 43 (1997), pp. 1258–1274; K. B. Hendricks and V. R Singhal, “Firm Characteristics, Total Quality Management, and Financial Performance,” Journal of Operations Management 19 (2001), pp. 269–285; and, K. B. Hendricks and V. R Singhal, “The Long-Run Stock Price Performance of Firms with Effective TQM Programs as Proxied by Quality Award Winners,” Management Science 47 (2001), pp. 359–368. 9

A. Saccomano, “TQM Works Over Time,” Traffic World , 1998, p. 37.




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How Costly Is Poor Quality?

As noted earlier, some organizations have a quality orientation and embrace managerial initiatives such as TQM to support this competi tive strategy. For each of the following examples, consider (1) which nonfinancial performance indicators, or controls, might be instituted to help control quality and (2) what kinds of quality-related costs might be involved by failing to control quality: •

•

A recent study published in the November 15, 2005, issue of Can- cer (a journal of the American Cancer Society) underscores the difficulty of improving screening rates to detect colon cancer, the third leading cause of cancer deaths. * Based on a review of patient charts from individuals associated with a California HMO, fewer than 30 percent of eligible patients over age 50 received any of the three types of colon-cancer tests. According to the National Committee for Quality Assurance, a Washington-based nonprofit organization that promotes health-care quality, Tufts Health Plan (Waltham, MA) achieved the highest score in the nation, 72 percent, for colorectal cancer screening. UnumProvident Corporation, a disability-income insurer, paid an $8 million civil penalty and $600,000 court costs to settle a suit brought against the company by the California Department of Insurance, to resolve allegations that it cheated policyholders by improperly denying claims. † This settlement followed an earlier fine of $15 million paid by the company to the U.S. Labor Department in a multistate settlement.

Quality is defined as customer satisfaction with the total experience of a product or service, that is, the difference between customer desires and actual performance of the product or service. Design quality is the difference between customer desires (for attributes, services, functionality, etc.) and product design. Performance quality is the difference between actual performance and design specifications.


•

Boston Scientific Corporation recently reached an agreement with the U.S. Food and Drug Administration (FDA) in which the company committed itself to an “aggressive timeline” for resolving quality-control problems. ‡ Prior to this agreement, the FDA had announced that it would withhold approval of some new products from the company until it resolved the issues. The FDA alleged that the company had failed to report, or delayed reporting, potential safety problems associated with its products.

•

PeopleSoft, Incorporated, reached an agreement to pay Cleveland State University $4.25 million to settle a lawsuit over computer problems that delayed financial aid to thousands of students. § The university claimed that students often waited months for financial aid because of computer problems that also hindered other services for more than two years.

Sources: *

R. L. Rundle, “Colon-Cancer Screening Rates Rise Only Slightly, Study Says,” The Wall Street Journal (October 11, 2005), p. B1. † D. Gullapalli, “UnumProvident Is Set to Pay $8 Million Penalty in California,” The Wall Street Journa l (October 3, 2005), p. C3. ‡ “Boston Scientific Sets to Fix Quality Issues,” The Wall Street Journal (February 4, 2006), p. A2. § “Software Firm Will Pay CSU $4.25M Settlement,” The Wall Street Journal (February 4, 2006), p. A2.

For purposes of discussion we define the term quality to mean the total level of customer satisfaction with the organization’s product or service. Defined in this manner, we can decompose the notion of quality into two broad components: features and performance. The former component refers to whether the characteristics, attributes, or functionality of the product or service is com patible with customer expectations—in short, design quality. Outputs that fail to meet such ex pectations result in quality-of-design failure costs. Conceptually, you can think of design failure as the difference between the actual features of the product (or service) and what the customer wants. Such failures represent one component of total quality cost. One way to manage (i.e., reduce) design failure is through the use of target-costing procedures, as discussed in Chapter 10. In this chapter, we are concerned with the management and control of the other broad com ponent of quality, performance quality . Performance quality can be defined as the difference between the design specifications of the product and the actual perfor mance of the product. Thus, a personal computer whose electronic mouse consistently malfunctions or whose operating system constantly locks up relates to what can be called conformance quality failures. As such, we define performance quality costs as those related to providing a customer’s required level of product or service performance. Not all customers have the same expectations for a product or service. All 3/8-inch drill bits can drill 3/8-inch holes. Nevertheless, a firm can manufacture a 3/8-inch drill bit that costs $3 for home use and an industrial-strength drill bit that costs $15. The specifications and quality expectations for the less expensive drill bit are not the same as those for the more expensive one. The industrial strength drill bit is designed for heavy, continuous use and can be used for, say, 100 hours before it needs to be r eplaced. A drill bit for home use, on the other hand, is not designed for continuous use for long hours and has a shorter expected life of, say, 10 hours. Expectations for services also differ. A tourist does not expect the same services from a Motel 6 as from a Ritz-Carlton Hotel, although both provide rooms for tourists. A mechanic performs quality service by changing a car’s oil as specified: draining old oil, installing a new oil filter, lubricating the chassis, and adding clean new oil. The service is a quality service even if the mechanic used a regular oil, not a new synthesized oil that improves engine performance, if the customer asked for a regular, not a deluxe, oil change. The mechanic has failed to deliver a quality







service, however, if the new oil filter falls off the next morning due to improper installation or if the refill is four or six quarts of oil instead of the five quarts specified by the manufacturer.

Characteristics of Total Quality Management Total quality management (TQM) is the unyielding and continuous effort by everyone in the firm to understand, meet, and exceed the expectations of customers.

Total quality management (TQM) is the unyielding and continuous effort by everyone in the firm to understand, meet, and exceed the expectations of customers. 10 Although each organization is most likely to develop its own approach to total quality management to suit its particular culture and management style, certain characteristics are common to most TQM systems. These characteristics are as follows: • • • • • • •

Focusing on satisfying the customer. Striving for continuous improvement. Fully involving the entire work force. Actively supporting and involving top management. Using unambiguous and objective measures. Recognizing quality achievements in a timely manner. Continuously providing training on total quality management.

Exhibit 16.2 describes the critical factors for successful TQM.

The Need for a New Accounting System As noted above, a crucial factor for TQM success is having measures that truly reflect the needs and expectations of customers, both internal and external. A good measurement system that helps TQM often entails developing a new accounting system because the current system divides and spreads important quality data among myriad accounts. A good measurement system for TQM should also enable all employees to know at all times the progress being made toward quality-related goods and the additional improvements needed. A traditional accounting system often fails to associate costs with activities. As a result, quality teams (i.e., cross-functional teams that oversee the entire quality-management and continuous improvement process) do not have the information they need to focus on and identify quality problems. The accounting system needs to relate quality costs to activities so that quality teams can focus their efforts appropriately to ensure the success of the TQM effort. In short, management accountants need to ensure that the measurement and reporting process meets the following criteria: 11 • Addresses the information needs of internal customers. • Includes all relevant quality-related measures, including both financial and nonfinancial measures. • Adapts measures as needs change. • Is simple and easy to use, execute, and monitor. • Fosters improvement, rather than just monitoring. • Motivates and challenges team members to strive for the highest quality gains.

Comprehensive Framework for Managing and Controlling Quality LEARNING OBJECTIVE 3 Develop a comprehensive framework for the management and control of quality.

Text Exhibits 16.1 and 16.2 provide broad guidance for the development of a comprehensive framework (or system) for the management and control of quality. One possible framework is presented in Exhibit 16.3. This exhibit serves as the focal point around which the discussion in the rest of the chapter is built. By way of introduction, therefore, we now provide an overview of the primary elements of the framework.

Knowledge of Business Processes Because the model is comprehensive, it presumes knowledge of key business processes. Thus, the development and implementation of a comprehensive framework for managing and 10

“Managing Quality Improvements,” Statement on Management Accounting No. 4-R (Montvale, NJ: Institute of Management Accountants, 1993), p. 17. 11

Ibid, p. 31






Chapter 16

EXHIBIT 16.2 Critical Total Quality Management (TQM) Factors

Support and Involvement of Top Management

Clear and Measurable Objectives

Timely Recognition


655

Continuous Training

TOTAL QUALITY MANAGEMENT

Continuous Improvement

Focusing on Customers

Involving All Employees

Expectations and Requirements of External Customers

Specifications for Internal Suppliers/Customers

Specifications for External Suppliers

controlling quality is best thought of as a cross-functional effort, with input of managers from across the value chain. Because of their record-keeping and reporting responsibilities, accountants can be viewed as the key point of contact across various subunits and managers within the organization. Thus, the development of such a comprehensive system requires the accountant to have broad business knowledge, including knowledge of fundamental business processes.

Role of the Customer In the past, most quality control reporting systems had a decidedly inward focus. That is, measures and techniques were developed and used based on what the organization felt were appropriate to the situation. More recently, however, organizations have begun to realize a fundamental flaw in system design: failure to embrace an outward (i.e., customer-based) viewpoint.

EXHIBIT 16.3 Comprehensive Framework for Managing and Controlling Quality

Customer Expectations

Set QualityRelated Goals (i.e., Strategy)

Satisfied Customers Perform Work/ Monitor Output/ Correct Defects

Work Processes

Nonfinancial Quality Indicators

Taguchi Loss Functions, Six Sigma Programs

Prevention Costs

Deliver Product/Service and Monitor Customer Satisfaction Dissatisfied Customers

Statistical Quality Control and Run Charts Appraisal Costs

Quality-Related Investments/Spending

Internal Failure Costs

External Failure Costs

Diagnostic Control







Thus, in the comprehensive model shown in, Exhibit 16.3, we depict consumer expectations as the cornerstone of the entire framework. In this sense, then, the model can be viewed as customer-based. As well, the model attempts to capture (as “external failure costs”) various costs associated with dissatisfied customers.

Financial Component You will notice that the reporting of quality cost information is a key element of the comprehensive framework shown in Exhibit 16.3. In fact, we depict cost inform ation in four separate categories to give prominence to the different types of quality costs that organizations incur. This financial approach to the management and control of quality, known as cost of quality , is dealt with in greater detail later in the chapter.

Nonfinancial Performance Indicators As illustrated in Exhibit 16.3, the financial performance indicators of our comprehensive re porting framework are complemented by both internal and external nonfinancial performance indicators. As we explain later in the chapter, nonfinancial performance indicators can be leading indicators (i.e., predictors) of future financial performance. As such, any comprehensive framework for managing and controlling quality should have a combination of both financial and nonfinancial performance indicators.

Feedback Loops You will notice that the comprehensive framework illustrated in Exhibit 16.3 contains a number of feedback loops, designed to inform future decisions and to support an organization’s overall goal of continuous improvement. Thus, for example, the entire model continually helps the organization better understand “customer expectations” and, in turn, set appropriate quality goals for the organization.

Relevant Cost Analysis As indicated in Chapter 9, one important role for management accountants is to provide decision-relevant information to managers. In the present context, based on both financial and nonfinancial performance indicators, managers make decisions regarding quality-related investments. Thus, management accountants can add value to the overall management and control of quality by providing decision makers with decision-relevant information, using the approach outlined in Chapter 9.

Link to Operations Management The framework presented in Exhibit 16.3 provides a wonderful example of cross-disciplinary inputs to a management process. As noted above, accounting has primary reporting responsi bility for relevant financial and nonfinancial performance measures. The question arises, then, as to how managers then identify and analyze quality-related problems. For this, we draw from the field of operations management techniques such as control charts, Pareto diagrams, and cause-and-effect diagrams. Management accountants, as members of the overall management team, should have at least cursory knowledge of these techniques, including the role they play in the control and management of quality.

Breadth of the System In the past, for many organizations (particularly manufacturers), quality was assumed to be the responsibility of production (i.e., the manufacturing process). Thus, as indicated earlier in this text, companies can calculate and report production-related failure costs, such as the cost of normal spoilage, the cost of abnormal spoilage, and so on. However, as indicated at the beginning of this chapter, many organizations today are embracing a broader responsibility for quality—across all elements of both the internal and external value chain. Any comprehensive framework developed to support a TQM strategy should therefore have a broad reporting perspective. You will note that the performance measures reflected in Exhibit 16.3 cut across the entire value chain. In the remaining sections of this chapter, we discuss in greater detail the elements of the framework illustrated in Exhibit 16.3 .




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Pharmaceutical Companies Use Six Sigma across the Value Chain to Speed Time to Market, Reduce Costs, and Address Manufacturing Inefficiencies

In recent years, many major pharmaceutical companies have discovered the benefits of using Six Sigma principles to eliminate manufacturing process variation, defects, and inefficiencies. A smaller number of such companies are applying Six Sigma to Research and Development (R&D), in addition to the manufacturing function. Some aggressive companies, however, are applying the concept to func tions across the entire value chain of activities. Among the benefits cited by pharmaceutical companies regarding Six Sigma are the following:

people. The cultural shift to Six Sigma allows companies to get their employees more engaged. Tying rewards to accomplishments is particularly important to instituting such a culture change. •

Competitive advantage: early adopters of Six Sigma in the pharmaceutical industry stand to gain competitive advantage. Traditionally, cost-cutting and eliminating process variation (two targets of Six Sigma) have not been widely embraced in the industry. Thus, early adopters of this approach can gain at least temporary competitive advantage in an increasingly competitive environment.

•

Changing economics of the industry: the Medicare Modernization Act (January 2006) will likely motivate increased use of generic equivalents. For companies that have a thin pipeline of new drugs or major drugs going off patent, the only way to enhance profitability (at least in the short run) is to focus on cost controls and process efficiencies, both of which are supported by the use of Six Sigma.

For Six Sigma to work, most consultants believe that top management support and commitment are key—that is, that Six Sigma can be used as a leadership tool. In order to change the cultur e of an organiza tion to support Six Sigma, significant personnel training costs are likely. Still the financial return of such implementations can be significant. For example, Eli Lilly estimates that its cumulative benefit to date from the use of Six Sigma, over 160 projects, is approximately $250 million.

•

Maximizing employee value: the biggest asset for knowledgebased organizations, such as pharmaceutical companies, is

Source: N. D’Amore, “Six Sigma Adds Up for Pharma,” MedAdNews 25, no. 2 (February 1, 2006), p. 18.

Setting Quality-Related Expectations LEARNING OBJECTIVE 4 Understand two approaches for setting quality-related goals (Six Sigma and Goalpost versus absolute conformance standards).

As seen from Exhibit 16.3, the actual quality goals embraced by the organization are affected principally by customer demands—that is, the level of quality (including product functionality) that the targeted customer group is willing to pay for. In this section we discuss two ap proaches to translating customer demands into quality-related goals: Six Sigma and goalpost versus absolute conformance standards.

Setting Quality Expectations: A Six Sigma Approach Six Sigma is an overall strategy to accelerate improvements and achieve unprecedented performance levels by focusing on characteristics that are critical to customers and identifying and eliminating causes of errors or defects in processes.

Six Sigma12 has been embraced by many organizations as the guiding principle that drives improvements in products, services, and processes (e.g., product development, logistics, sales, marketing, and distribution). Six Sigma can perhaps best be defined as a business process improvement approach that seeks to find and eliminate causes of defects and errors, reduce cycle times and manufacturing costs, improve productivity, better meet customer expectations, and achieve higher asset utilization and returns on investment in both manufacturing and service operations. 13 Rudisill and Clary 14 offer the following actual examples of improvements realized by the move to Six Sigma: • • • •

Reduction of scrap in a ball-bearing manufacturing plant and capacity assembly plant. Identification and reduction of unnecessary spare parts inventory for a paper cup plant. Reduction of defects and product variation in a textile finishing plant. Reduction of lead-times for product development and scale-up in a pharmaceutical company. • Reduction of wait-time for loan approval notification (from the bank). Six Sigma is based on a simple problem-solving methodology, DMAIC —Define, Measure, Analyze, Improve, and Control. Typically, the application of Six Sigma is done using cross12

Six Sigma is a federally registered trademark and service mark of Motorola, Inc.

13

J. R. Evans and W. M. Lindsay, An Introduction to Six Sigma and Process Improvement (Mason, OH: South-Western, 2005), p. 3.

14

F. Rudisill and D. Clary, “The Management Accountant’s Role in Six Sigma,” Strategic Finance (November 2004), pp. 35–39.







functional teams, more or less on a consulting project basis. In the design stage of the project, the Six Sigma team defines the problem and the scope of the problem (i.e., specifies the deliverables of the project). In the measure stage, the team collects relevant process performance data. In the analyze stage, the team tries to uncover root causes of an underlying quality problem. This is followed by the improve stage, in which proposed solutions to the underlying problem(s) are generated and then implemented. Finally, in the control stage of the project, appropriate controls are put in place to ensure that the identified problem does not recur. Motorola, Inc. pioneered the concept of Six Sigma as a structured approach for assessing and improving both product and service quality. Today, this approach has gained notoriety and credibility because of its adoption by firms such as Allied Signal and General Electric. The term Six Sigma actually comes from statistics: in a normal distribution, the area outside of +/ six standard deviations from the mean is very small. From a control standpoint, we can express this area in terms of relative number of defects. One interpretation of a Six Sigma quality expectation is approximately 3.4 defects per million items produced. 15 The move from, say, a 3-sigma to a 6-sigma quality level is dramatic. For example, sup pose your bank tracks the number of errors associated with checks written on the bank by its customers. If the bank finds, say, 12 errors per 1,000 checks processed, this is equivalent to an error rate of 12,000 per million—somewhere between 3.5 and 4 sigma levels! As Evans and Lindsay point out, 16 a change from 3 to 4 sigma represents a 10-fold improvement in quality; a change from 4 to 5 sigma, a 30-fold improvement; and a change from 5 to 6 sigma, a 70-fold improvement. For this reason, Six Sigma is not likely the goal for all processes and operations. The appropriate quality expectation is a function of the strategic importance of the process and the anticipated costs of taking the process to a higher level of quality.

Implementation Tips: Six Sigma17 Following are steps management can take to ensure the success of Six Sigma projects. • First and foremost, provide necessary leadership and resources. As with many other strategic initiatives, the CEO and top-management team must exhibit strong support for the Six Sigma program. Such support can come in the form of employee training and making sure that there is appropriate buy-in for the concept on the part of key managers in the organization. • Implement a reward system. Bonus and incentive schemes for the organization might have to be amended to accommodate rewards associated with reaching Six Sigma goals. • Provide ongoing training . Since Six Sigma is a process (think of the DMAIC approach as iterative in nature), employee training should be ongoing, reinforcing the strategic importance of the process and the need for continual improvement. • Judiciously select early projects. As noted above, Six Sigma principles can be applied to processes throughout the value chain of the organization. It is recommended, however, that top management starts with easy, nonpolitical, and noncontroversial projects that support the strategic goals of the organization. Given success with these projects, Six Sigma can then be rolled out to other more complicated and difficult projects. • Break up difficult projects. Top management should tr y to parse complicated projects into smaller, short-term segments, each of which has its own milestone. This allows individuals to experience success along the way and to be recognized for their efforts to help the organization succeed. • Avoid employee lay-offs. From a motivational standpoint, it is crucial that improvements based on Six Sigma should not jeopardize the jobs of those who helped accomplish the goal. Judicious job reassignment is one strategy for dealing with this situation; layoffs should probably be viewed as a last resort. 15

As Evans and Lindsay (2005, pp. 36–38) show, the above interpretation is a loose interpretation of the statistical basis for Six Sigma. That is, they show that the general specification for a k -sigma quality level is as follows: k  Process standard deviation = Tolerance/2. 16

Ibid., p. 39.

17

This discussion is adapted from P. C. Brewer and J. E. Eighme, “Using Six Sigma to Improve the Finance Function: Here Are Some Tips for Success,” Strategic Finance (May 2005), pp. 27–33.





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Can Six Sigma Be Used to Increase Revenues?

Many organizations today are using Six Sigma principles to improve manufacturing efficiency and to lower costs. Others are using Six Sigma to improve service processes. Sodhi and Sodhi (2005) provide a recent example of a global manufacturer of industrial equipment that applied Six Sigma rigor to increase revenues. The company in question offers a diverse product line, with many products manufactured to customer specification. Each sale, therefore, has its own individually approved discount and hence its own invoiced price. With tens of thousands of sales transactions per year, the task of making sure that each invoice accords with the list and approved prices is indeed daunting. The company had already experienced success in applying Six Sigma principles to its manufacturing operations. In fact, several individuals within the company had earned Six Sigma certifications (Green Belt, Black Belt). The company then decided to apply, on a pilot basis, a Six Sigma approach to its price-setting process. The project in question involved a cross-disciplinary team (IT, sales, pricing, finance, and marketing) and five Six Sigma steps, referred to as DMAIC: Define (the team decided that a defect should

be defined as a transaction invoiced at a price lower than the one Pricing had approved); Measure (the team developed a map of the pricing process, which included six sequential steps; in theory, the process was straightforward, but in practice shortcuts were often taken and the quality of information available at various steps was deemed deficient); Analyze (the team used a cause-and-effect matrix at each of the six steps to depict possible causes for lack of control); Improve (the goal here was to decrease the number of unapproved prices without creating an onerous approval process); and, Control (in the present case, the company set up a monthly review process to ensure that the company was experiencing higher transaction prices, fewer pricing exceptions, and no loss of market share). The overall result? The original goal was to increase sales revenues by $500,000 for the year. In just six months, however, revenues had increased by a whopping $5.8 million, most of which went directly to the bottom line. As such, the company is now rolling out Six Sigma pricing across the entire organization. Source: M. S. Sodhi and N. S. Sodhi, “Six Sigma Pricing,” Harvard Business Review (May 2005), pp. 135–142.

Setting Quality Expectations: Goalpost versus Absolute Conformance Standards tolerance refers to an acceptable range of a quality characteristic, such as thickness (measured, for example, in centimeters).

An alternative approach to defining quality expectations, or product tolerances, is to choose between goalpost and absolute conformance standards. One advantage of the latter is that it is consistent with the use of Taguchi loss functions for control purposes, a subject dealt with in Appendix A.

Goalpost Conformance Goalpost conformance is conformance to a quality specification expressed as a specified range around the target.

Goalpost conformance is conformance to a quality specification expressed as a specified range around the target. The target is the ideal or desirable outcome of the operation. The range around the target is referred to as the quality tolerance . For example, the target for a production process to manufacture 0.5-inch sheet metal is 0.5-inch thickness for all sheet metal manufactured. Recognizing that meeting the target every time in manufacturing is difficult, a firm often specifies a tolerance range. A firm that specifies a tolerance of ± 0.05 inch meets the quality standard when the thickness of its products is between 0.55 inch and 0.45 inch. This approach assumes that the customer would accept any value within the tolerance range. As such, the approach assumes that quality-related costs do not depend on the actual value of the quality characteristic, as long as this value falls within the specified range. With the specified range allowed for variations, management expects all outputs to be within this range. Exhibit 16.4 depicts the goalpost conformance specifications for the sheet metal example.

EXHIBIT 16.4 Goalpost Conformance Loss

No Loss

Lower Limit .45

Target Value .50 Tolerance

Loss

Upper Limit .55

Thickness





Cost Management in Action


What Is the Most Effective Way to Implement TQM?

Total quality management (TQM) is a key strategic and operational issue for most firms, as their customers continue to have higher expectations for product and service quality. Because it involves most if not all the activities in the firm, the implementation of TQM is usually a complex and difficult process. The full implementation of TQM may take several years. The IMA

has identified implementation guidelines that can assist managers in the process. Some firms such as General Electric (http://ge.com), Honeywell (http://honeywell.com/), and Weyerhaeuser (http://weyerhaeuser.com/) take additional steps to ensure the success of their quality initiatives. What do you think these additional steps might include?

Absolute Quality Conformance Absolute quality conformance (robust quality approach) requires all products or services to meet the target value exactly with no variation.

Absolute quality conformance or the robust quality approach aims for all products or ser vices to meet the target value exactly with no variation. An absolute conformance requires all sheet metal to have a thickness of 0.5 inch, not 0.5 inch ± 0.05 inch or even 0.5 inch ± 0.0005 inch. Exhibit 16.5 depicts the robust quality approach. This approach assumes that the smaller the departure from the target value, the better the quality. Variations from the target value are assumed to have negative economic consequences. Robustness in quality comes with meeting the exact target consistently. Any deviation from the target is viewed as a quality failure and weakens the overall quality of the product or service.

Goalpost or Absolute Conformance? Goalpost conformance assumes that a firm incurs no quality or failure cost or loss if all quality measures fall within the specified limits. That is, the firm suffers quality costs or losses only when the measure is outside the limits. No such quality tolerance exists in absolute conformance, which views quality costs or losses as a continuously increasing function starting from the target value. Quality costs, hidden or out-of-pocket, occur whenever the quality measure deviates from its target value. Which of these two approaches, goalpost or absolute conformance, is better? Perhaps we can find an answer in the experience Sony had in two of its plants that manufacture color televisions.18 The two Sony plants manufacture the same television sets and follow the same specification for color density. The two plants, however, adopt different types of quality conformance. The San Diego plant uses goalpost conformance, and the Tokyo plant adopts absolute conformance. On examining the operating data over the same period, Sony found that all the units produced at the San Diego plant fell within the specifications (zero defect), but some of those manufactured at the Japanese plant did not. The quality of the Japanese units, however, was more uniform around the target value, while the quality of the San Diego units was uniformly distributed between the lower and upper limits of the specification, the goalpost, as depicted in Exhibit 16.6.

EXHIBIT 16.5 Absolute Conformance (Robust Quality Approach)

Loss

Loss .5 Target Value

18

Evans and Lindsay, The Management and Control of Quality , pp. 112–113.






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EXHIBIT 16.6 Color Density of Sony TV Sets Manufactured in the San Diego Plant and a Japanese Plant Source: J. R. Evans and W. M. Lindsay, The Management and Control of Quality, 6th ed.

San Diego plant

Japanese plant

(South-Western, 2005), p. 113.

.45

.50 Target

.55

Tolerance Limits

The average quality cost (loss) per unit of the San Diego plant, however, was $0.89 higher than that of the Japanese plant. One reason for the higher quality cost for units produced at the San Diego plant was the need for more frequent field service. Customers are more likely to complain when the density is farther away from the target value. Although the plant in Tokyo had a higher rejection rate, it experienced lower warranty and repair costs for its products. For firms desiring to attain long-term profitability and customer satisfaction, absolute conformance is the better approach. The extension of absolute perfor mance standards to estimate Taguchi quality loss functions is covered in Appendix A.

Financial Measures and Costs of Quality LEARNING OBJECTIVE 5 Prepare and interpret relevant financial information to support TQM initiatives.

As indicated in Exhibit 16.3 , there are two major situations in which accountants can provide relevant financial information as part of a comprehensive framework for managing and controlling quality costs: relevant cost (and revenue) data for decision-making purposes and cost of quality (COQ) reports.

Relevant Cost Analysis Quality-related spending (investment) affects the target level of quality and ultimately work processes and outputs—as depicted in Exhibit 16.3 . In terms of spending on quality-related initiatives, we can employ the same decision framework discussed in Chapter 9. That is, financial information relevant to quality-related decisions consists of future costs (and revenues) that differ between decision alternatives. In terms of relevant costs, we can also use the ter m avoidable costs since, by definition, these are future costs that can be avoided by choosing one decision alternative over another. Activity and process decisions are prime examples of quality-related investments. For example, some manufacturers are moving from process layouts (batch processing) to cellular manufacturing. Other firms are embracing a just-in-time (JIT) production philosophy. Obviously, there can be significant outlay costs associated with a plant-layout change or a change in manufacturing philosophy. However, improvements in quality provide an opportunity for increasing revenues and for significant cost savings. It is here that the managerial accountant can add value to the organization by providing decision makers with accurate estimates of costs and benefits associated with quality-related spending, such as a move to JIT. Benefits could include the contribution margin associated with increased sales (because of decreased cycle times associated with JIT production or the use of cellular manufacturing). Benefits could also include reduced spending on rework/scrap costs, lower financing costs associated with inventory reductions, reduced inventory obsolescence costs, reduced spending on inventory-recording costs, and reduced inventory-handling and storage-activity costs. Note that, as in Chapter 9, relevant costs include both opportunity costs and out-of-pocket costs .







Cost of Quality (COQ) Reporting

Costs of quality (COQ) are costs of activities associated with the prevention, identification, repair, and rectification of poor quality and opportunity costs from lost production time and sales as a result of poor quality. Prevention costs are costs incurred to keep quality defects from occurring.

Up until the mid-1980s, quality costs were essentially buried in a company’s financial statements. Some costs appeared in manufacturing (factory) overhead accounts (e.g., product testing, materials inspection, normal spoilage costs), while other quality costs were included as part of general and administrative expenses. When warranted, traditional cost accounting systems—both job-order and process—report separately the cost of abnormal spoilage. As indicated in Exhibit 16.3 , however, quality costs are associated with activities across the value chain—from the design of work processes, to production of outputs (goods and services), to delivery of outputs to customers. Thus, quality costs include costs associated with support functions such as product design, purchasing, public relations, and customer services. Quality guru Joseph Juran was probably the first to create a more expansive view of quality costs. According to Juran, the costs of quality (COQ) for an organization are costs of activities associated with prevention, identification, repair, and rectification of poor quality, as well as opportunity costs from lost production and lost sales as a result of poor quality. Exhibit 16.7 provides examples of the components of the total cost of quality.

Prevention Costs Prevention costs are incurred to keep quality defects from occur ring. Prevention costs include the following: • Quality training costs. Costs incurred to conduct internal training programs and for em ployees to participate in exter nal programs to ensure proper manufacturing, delivering, and servicing of products and se rvices and to improve quality. These costs include salaries and wages for time spent in training, instruction costs, clerical staff expenses and miscellaneous supplies, and costs expended to prepare handbooks and instructional manuals.

• Equipment maintenance costs. Costs incurred to install, calibrate, maintain, repair, and inspect production equipment. • Supplier assurance costs. Costs incurred to ensure that materials, components, and services received meet the firm’s quality standards. These costs include costs of selection, evaluation, and training of suppliers to conform with the requirements of TQM. • Information systems costs. Costs expended for developing data requirements and measuring, auditing, and reporting of data on quality.

EXHIBIT 16.7 Examples of Quality Costs

Prevention Costs Training Instructor fees Testing equipment Tuition for external training Wages and salaries for time spent on training and education Planning and execution of a quality program Salaries Cost of meetings/Quality circles Investments Product redesign Process improvement Equipment maintenance Internal Failure Costs Scrap disposal (net cost) Rework (materials, labor, overhead) Loss due to downgrades* Reinspection costs Loss due to work interruptions* * Opportunity costs

Appraisal Costs Raw materials inspection Work-in-process inspection Finished goods inspection Test equipment Depreciation Salaries and wages Maintenance Software External Failure Costs Sales returns and allowances Warranty cost / field service Contribution margin of cancelled sales orders Contribution margin of lost sales orders* Product recalls Product liability lawsuits






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Quality circle is a small group of employees from the same work area that meet regularly to identify and solve work-related problems and to implement and monitor solutions to the problems. Appraisal (detection) costs are expenditures devoted to the measurement and analysis of data to determine conformity of outputs to specifications.


663

• Product redesign and process improvement. Costs incurred to evaluate and improve product designs and operating processes to simplify manufacturing processes or to reduce or eliminate quality problems. • Quality circles. Costs incurred to establish and operate quality control circles to identify quality problems and to offer solutions to improve the quality of products and ser vices.

Appraisal Costs Appraisal (detection) costs are costs devoted to the measurement and analysis of data to determine conformity of outputs to specifications. These costs are incurred during production and prior to deliveries to customers. Through measurement, analysis, and monitoring of manufacturing processes and examination of products and services prior to delivery, firms identify defective items and ensure that all units meet or exceed customer requirements. Appraisal costs include the following: • Test and inspection cost. Costs incurred to test and inspect incoming materials, work in process, and finished goods, and the cost incurred to inspect machinery; also, field-testing of products at the site of the consumer.

• Test equipment and instruments. Expenditures incurred to acquire, operate, or maintain facilities, software, machinery, and instruments for testing or appraising the quality of products, services, or processes.

Internal Failure Costs Internal failure costs are incurred to correct defective processes or defective products detected before delivery to customers.

Internal failure costs are incurred to correct defective processes or defective products found through appraisal prior to delivery to customers. These costs are not value-added and include: • Costs of corrective action. Costs for time spent to find the cause of failure and to correct the problem. • Rework and (net) scrap costs. Materials, labor, and overhead costs for scrap, rework, and reinspection. • Process costs. Costs expended to redesign the product or processes, unplanned machine downtime for adjustment, and lost production due to process interruption for repair or rework. • Expediting costs. Costs incurred to expedite manufacturing operations due to time spent for repair or rework. • Reinspection and retest costs. Salaries, wages, and expenses incur red during reinspection or retesting of reworked or repaired items. • Lost contributions due to increased demand on constrained resources. Constrained resources spent on defective units increase cycle time and reduce total output. Contributions lost from units not produced because of the unavailability of the constrained resources reduce the operating income potential of the firm.

External Failure Costs External failure costs are associated with defective/ poor-quality outputs after being delivered to customers.

External failure costs are costs related to quality defects detected after unacceptable products or services reach the customer. External failure costs include the following: • Repair or replacement costs. Repair or replacement of retur ned failed products. • Costs to handle customer complaints and returns. Salaries and administrative overhead of the customer service department; allowance or discount granted for poor quality; and, freight charges for returned products. • Product recall and product liability costs. Administrative costs to handle product recalls, repairs, or replacements; legal costs; and settlements resulting from legal actions. • Lost sales and customer ill-will due to defective outputs. Lost contribution margins on canceled orders, lost sales, and decreased market shares. • Costs to restore reputation. Costs of marketing activities to minimize damages from a tarnished reputation and to r estore the firm ’s image and reputation.




REAL-WORLD FOCUS



How Much Does External Failure Cost?

Ford Motor Company unveiled the 2001 model of its best-selling sportutility vehicle, the Ford Explorer, in late 2000. The 2001 model added a host of new safety features that enhanced the most popular SUV on the market since its introduction a few years earlier. Ford expected the new model to increase the firm’s market share and to add substantial amounts to its bottom line. Yet, three months after the redesigned Explorer began rolling off the assembly line not a single one of the 5,000 built was in dealer showrooms. Instead, they were parked outside factories in St. Louis and Louisville while Ford engineers pored over them looking for defects. Jacques Nasser, CEO of the Ford Motor Company, ordered factory managers to hold off on shipping the new Explorer until engineers had the opportunity to correct quality problems.

When asked by financial analysts to comment on the cost of delay and repairing defects, Nasser responded, “Pick a number. It is over $1 billion.” The delay was expensive, but Ford executives say the cost of fixing warranty claims later would be far higher. One defect caught by engineers was an internal steering-column switch that might have led motorists to start the engine in the “drive” position. Left uncorrected, this problem had the potential of resulting in big-time safety recalls. What was the root cause of the problem? It was traced to a supplier who used too much solder on a $1 circuit board. “When you get to the bottom of it, they are that trivial,” says a company official of such glitches. “But when you let them escape, they are just huge.” Source: N. Muller, “Putting the Explorer under the Microscope,” Business- Week, February 12, 2001, p. 40.

Conformance and Nonconformance Costs Costs of conformance are prevention costs and appraisal costs. Costs of nonconformance are internal failure costs and external failure costs.

Conceptually, the total cost of quality (COQ) can be broken down into conformance costs and nonconformance costs. Prevention and appraisal costs are costs of conformance because they are incurred to ensure that products or services meet customers’ expectations. Internal failure costs and external failure costs are costs of nonconformance. They are costs incurred, including opportunity costs, because of rejection of products or services. The cost of quality (COQ) is the sum of conformance and nonconformance costs. Prevention costs are usually the least expensive and the easiest among the four costs of quality for management to control. Internal and external failure costs are among the most expensive costs of quality, especially external failure costs. In a typical scenario, the cost of prevention may be $0.10 per unit, the cost of testing and replacing poor quality parts or com ponents during production may be $5, the cost of reworking or reassembling may be $50, and the cost of field repair and other external costs may be $5,000 or higher. External failure costs can be substantial. For instance, Firestone Tire Company was forced to recall and replace 6.5 million ATX tires in 2000. In the first two months of the recall, the firm incurred more than $500 million of out-of-pocket cost and suffered sales decreases of more than 40 percent. The price of its stock fell to less than half of the value prior to the recall. Better prevention of poor quality 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 repairs, rework, and recalls decrease. By spending more on prevention and appraisal, companies spend less on internal or external failure costs. The savings alone can be substantial. Meanwhile, the firm enjoys higher perceived values of its products, increased sales and market share, and improved earnings and return on investment.

Quality Cost Reports The purpose of reporting quality costs is to make management aware of the magnitude of these costs and to provide a baseline against which the impact of quality-improvement activities can be measured. Tasks for reporting quality costs include data definitions, identification of data sources, data collection, and preparation and distribution of quality cost reports.

Data Definition, Sources, and Collection The first step in generating a quality cost report is to define quality cost categories and to identify quality costs within each category. The preceding discussion described common quality cost categories. However, definitions of cost categories can vary among firms. Considering its unique operating conditions and experience, each firm identifies appropriate cost categories and clearly states operational definitions of all quality costs. Every member of the design team needs to have a clear understanding of the firm ’s quality cost categories.






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Ideally, each quality cost should have its own account so that quality cost information is readily apparent, not buried in myriad accounts. These quality cost accounts are the source of quality cost information.

Report Format A report on cost of quality is useful only if its recipients understand, accept, and can use the content of the report. COQ reports can be prepared in different ways. Each firm should select and design a reporting system that (1) can be integrated into its information system and (2) promotes TQM. Among considerations in establishing a quality cost report system are proper stratifications of quality cost reports by product line, department, plant, or division, and the time periods of the reports so that the firm can easily identify the origins of quality costs. To facilitate assessment of the magnitude of quality costs and their impact, firms often express cost of quality in percentages of net sales (or total operating costs) for the period. A cost of quality matrix, as illustrated in Exhibit 16.8 , is a convenient and useful tool in reporting quality costs. With columns identifying functions or departments and rows delineating COQ categories, a cost of quality matrix enables each department, function, process, or product line to identify and recognize the effects of its actions on the cost of quality and to pinpoint areas of high-quality costs.

Illustration of a Cost of Quality Report Exhibit 16.9 illustrates a COQ report. 19 Bally Company is a small midwestern manufacturing company with annual sales of around $9 million. The company operates in a highly competitive environment and has been experiencing increasing pressures from new and existing competitors to raise quality and lower cost. The report shows that the external failure costs for such items as warranty claims, customer dissatisfaction, and loss of market share accounted for 75 percent of the total cost of quality in year 0 ($1,770,000 ÷ $2,360,000, or 22.13% ÷ 29.5%). To be more competitive and to increase market share, Bally began a corporatewide threeyear TQM process. The firm started with substantial increases in prevention and appraisal expenditures. The investment started to pay off in year 2. The internal failure, external failure, and total quality costs have all decreased. Exhibit 16.9 compares the current year’s quality costs to those of a base year. Alternative bases for comparisons can be the budgeted amounts, flexible budget costs, or long-range goals.

EXHIBIT 16.8

Cost of Quality Matrix

Source: J. R. Evans and W. M. Lindsay, The Management and Control of Quality, 6th ed. (South-Western, 2005), p. 400.

Design Engineering

Purchasing

Production

Prevention costs Quality planning Training Other Appraisal costs Test and Inspect Instruments Other Internal failure costs Scrap Rework Other External failure costs Returns Recalls Other Totals 19

Adapted from IMA Statement No. 4R.

Finance

Accounting

Other

Totals

% of Sales







EXHIBIT 16.9 Cost of Quality (COQ) Report for Bally Company

Year 2 Prevention Costs Training Quality planning Other quality improvement Supplier evaluation Total Appraisal Costs Testing Quality performance measurement Supplier monitoring Customer surveys Total Internal Failure Costs Rework and reject Reinspection and testing Equipment failure Downtime Total External Failure Costs Product liability insurance Warranty repairs Customer losses (estimated) Total Total quality costs Total Sales

$

Year 0

90,000 86,000 60,000 40,000

$ 276,000

$

3.07%

120,000 100,000 60,000 30,000 $ 310,000

3.44%

$1,496,000 $9,000,000

350% 330 50 33

$ 110,000

1.38%

1.56%

$ 200,000

2.5%

$ 280,000

100%

$1,770,000 $2,360,000 $8,000,000

55 (63) 16 (40) (60)

3.5%

250,000 120,000 1,400,000 8.56% 16.62%

151 20 25 500 200

150,000 30,000 50,000 50,000

70,000 100,000 600,000 $ 770,000

20,000 20,000 40,000 30,000

100,000 80,000 10,000 10,000

55,000 35,000 30,000 20,000 $ 140,000

Percent Change

(50) (72) (17) (57)

22.13% 29.50%

(56) (37)

100%

COQ and Activity-Based Costing (ABC) An activity-based costing system is ideally suited to the preparation of COQ reports. An ABC system identifies cost with activities and thus increases the visibility of costs of quality. Costs of activities that are the result of poor quality become clear to the organization. Traditional costing systems, in contrast, focus the cost reporting on organizational functions such as production, sales, and administrations. An organization with a good ABC system in place needs only to identify costs and activities relating to costs of quality and quality improvement and classify these costs according to the cost of quality categories that the firm chooses to use. Firms with traditional costing systems require additional analyses to identify and measure cost of quality and to prepare cost of quality reports. Additional tasks and costs of obtaining the necessary cost measures can discourage management from implementing TQM.

Nonfinancial Quality Indicators LEARNING OBJECTIVE 6 Discuss the use of nonfinancial performance data to support TQM initiatives.

As seen from the preceding discussion, relevant financial data are needed to guide investment decision-making and in planning and controlling quality-related costs. As indicated in Exhibit 16.3, however, nonfinancial performance data also play an important role in a comprehensive framework for managing and controlling quality costs.

Internal Nonfinancial Quality Metrics Organizations strive to specify internal dimensions of quality that they must f ocus on in order to meet customer expectations. Thus, we find the following examples of internal nonfinancial quality measures: • Process yield (i.e., good output/total output). • Productivity (i.e., ratio of outputs—goods or ser vices—to resource inputs).






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• Percentage of first-pass yields (i.e., percentage of initial output meeting quality standards). • Number of defective parts produced (e.g., parts-per-million, ppm). • Machine up-time (or, machine down-time). • Trend in dollar amount of inventory held. • Employee turnover (e.g., number of employees who voluntarily leave the company/total number of employees). • Safety record (e.g., number of accidents per month, number of days since last accident). • Throughput (i.e., outputs—goods or services—produced and delivered to customers). • Customer response time (CRT) (i.e., the total lapse of time between when a customer places an order and when the customer actually receives the completed goods; this total time can be broken down into three components: receipt time, manufacturing lead time, and delivery time). • Production (manufacturing) lead time (i.e., difference between when an order is received by manufacturing and when that order is completed). • Cycle time efficiency (i.e., ratio of time spent on value-added activities to the sum of time spent on value-added and non-value-added activities; also known as throughput time ratio or process cycle efficiency). • Throughput efficiency (i.e., the ratio of throughput to resources used). • New product (or service) development time. You will notice that many of the preceding metrics relate to process efficiency. Improving quality should improve many if not most of these measures. In actual practice, responsibility for implementing process changes designed to improve these measures is assigned to crossfunctional teams. Further, some type of benchmark, either internal or external, is generally used as the standard against which actual performance is gauged.

External (Customer Satisfaction) Quality Metrics A comprehensive framework for managing and controlling quality will include a set of external, as well as internal, quality measures. These metrics are customer-based, as shown by the following examples: • • • •

Number of defective units shipped to customers as a percentage of total units shipped. Number of customer complaints. Percentage of products that experience early or excessive failure. Delivery delays (e.g., difference between scheduled delivery date and date requested by the customer). • On-time delivery rate (e.g., percentage of shipments made on or before the scheduled delivery date). • Market research information on customer preferences and satisfaction with specific product features. • Customer response time, CRT (i.e., elapsed time between when a customer places an order and when the customer receives that order). The preceding list is meant to be illustrative, not exhaustive. In practice, the actual metrics used are based on an organization’s strategy. As is the case with internal quality measures, the preceding metrics require some benchmark (standard) against which actual perfor mance for a period can be compared.

Role of Nonfinancial Performance Measures Internal and external nonfinancial measures of quality are important components of the framework presented in Exhibit 16.3 for a number of reasons: • They are, for the most part, readily available (compared, for example, to the generation of activity-based costs, the preceding list of nonfinancial quality performance data are much less costly to obtain). • Such information is relevant to operating personnel (production employees, salespersons, etc.)—that is, operating personnel understand these metrics and therefore can use them as





REAL-WORLD FOCUS

Airline Quality Ratings (AQR) and Competitive Benchmarking

What type of nonfinancial performance data are available to passengers of U.S. domestic airlines? How can such airlines benchmark their operating performance in terms of critical success factors? Since 1991 such data are provided on an annual basis in what is called the Airline Quality Rating (AQR) report. The AQR reports for each domestic carrier monthly performance data in four major categories, based on data obtained from the U.S. Department of Transportation’s monthly Air Travel Consumer Report (www.dot.gov/airconsumer/). The AQR is a summary performance measure calculated as a weighted average of performance in four categories important to consumers, as follows: AQR =

(+8.63 × OT) + ( −8.03

×

DB) + ( −7.92


×

MB) + ( − 7.17

×

CC)

(8.63 + 8.03+ 7.92+ 7.17)

where OT = On-time arrival DB = Denied boardings MB = Mishandled baggage CC = Customer complaints Respective weights = 8.63, 8.03, 7.92, and 7.17 The creators of the above model state that the AQR provides both consumers and industry watchers a means for looking at comparative

quality for each airline on a timely basis, using objective, perfor mancebased data. AQRs for the top three (of 17) and bottom three domestic airlines for 2005 and 2004, as well as composite data (based on AQRs for 17 domestic airlines) are as follows:

2005 AQR Jet Blue Air Tran Independence Air U.S. Airways COMAIR Atlantic Southeast Industry average

Score

Rank

0.88 0.99 1.05 2.77 2.96 4.68 1.73

1 2 3 15 16 17

 

2004 AQR Score

Rank

0.59 0.76 N/A 1.55 3.27 4.10 1.38

1 2

 

12 15 16

Source: B. D. Bowen and D. E. Headley, 2006 Airline Quality Rating (April 2006), available at www.aqr.aero/aqrreports/AQR2006final.pdf

the basis for improving operations. Because these measures relate to physical processes, they focus attention on precise problem areas that need attention. • Such information is more timely than financial measures of quality—in the extreme, these measures of quality can be reported on a real-time basis (i.e., instantaneously as operations occur). Nonfinancial quality indicators provide immediate short-run feedback on whether quality-improvement efforts have, in fact, succeeded in improving quality. • These nonfinancial performance measures can be useful predictors (i.e., leading indicators) of future financial performance.

Detecting and Correcting Poor Quality LEARNING OBJECTIVE 7 Describe and understand techniques that can be used to detect and correct quality problems.

As indicated in Exhibit 16.3 , a comprehensive framework for managing and controlling quality relies on the use of a number of techniques for detecting poor quality and then taking appropriate corrective action. These techniques come principally from the field of operations management. In general, you can think of these techniques as embracing a single, overall goal: process improvement. As part of a cross-disciplinary design/implementation team, management accountants need to have at least rudimentary knowledge and understanding of these techniques.

Detecting Poor Quality

A control chart plots successive observations of an operation taken at constant intervals.

Once an appropriate set of nonfinancial performance indicators has been specified, management needs to determine how to analyze the data it collects. The overall goal is to determine when the underlying process is not in control and, therefore, in need of corr ection. One way to accomplish this is through the use of control charts. A control chart plots successive observations of an operation, taken at constant intervals, to determine whether all observations fall within the specified range for the operation. The operation can be a machine, workstation, individual worker, work cell, part, process, or de partment. Inter vals can be time periods, batches, production runs, or other demarcations of the operation. A typical control chart has a horizontal axis representing units, time intervals, batch num bers, or production runs, and a vertical axis denoting a measure of conformance to the quality






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A run chart shows trends in quality measures over time.


669

specification. The vertical measure has a specified allowable range of variations, which are referred to as upper and lower limits, respectively. Exhibit 16.10 contains control charts for manufacturing 1/8-inch drill bits in three workstations. Assume that a firm has determined all drill bits must be within 0.0005 inch of the specified diameter. All units from workstation A are within the specified range (±0.0005˝), and no further investigation is necessary. Three units from workstation B are outside the specified range—an indication that not all operations in workstation B are in control. Mana gement should investigate the cause of the aberration to prevent further quality failures. Although all units manufactured by workstation C are within the specified range acceptable to the firm, the control chart reveals that quality characteristics of workstation C are moving upward. (Using it in this manner, the control chart is often referred to as a run chart. A run chart shows the trend of observations over time.) Management may want to launch an investigation because the trend suggests that in the near future the operation will most likely produce drill bits outside the specified range. When the central line and the limits in a control chart are determined through a statistical process, the control chart is a statistical quality control (SQC) chart or statistical process control (SPC) chart . The control charts presented in Exhibit 16.10 are SQC (or SPC) charts if the line in the center, 0.125˝, is determined by calculating the arithmetic mean (µ, read mu) of the observations and the limits, 0.1255˝ and 0.1245˝, are determined based on the standard deviation ( σ, read sigma) of the observations. For example, the standard deviation of the drill bits is, say, 0.00025˝ and the firm has determined that variations within two standard deviations are acceptable. Thus the limits are µ ± 2 σ, or 0.125˝ ± 2 × 0.00025˝, which are 0.1255˝ and 0.1245˝ for upper and lower limits, respectively. A firm sets the upper and lower control limits based on experience, technology, customer expectation, and cost and benefit analysis that determine the extent of variations within which the firm is willing to accept or tolerate. The purpose of a control chart is to distinguish between random and nonrandom variations. A process is considered to be in statistical control if no sample observation is outside the established limits. Variations that fall within the established limits are deemed random variations so that no further investigation is needed. Observations outside the limits may signal quality f ailures.

EXHIBIT 16.10

WORKSTATION A

Control Charts for 1/8-Inch Drill Bit

.1255" e z i S

Upper Limit

.125" Lower Limit

.1245" Units

WORKSTATION B .1255" e z i S

Upper Limit

.125" Lower Limit

.1245" Units

WORKSTATION C .1255" e z i S

Upper Limit

.125" Lower Limit

.1245" Units





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Part Four


Operational Control

However, for observations within the established limits to be considered random, the observations have to show no apparent patterns or runs, with an approximately equal number of observations above and below the center line and most points nearing the center line. A process may be out of control if the observations show trends, cycles, clusters, or sudden shifts hugging the center line or the control limits. Control charts are useful in establishing the state of control and monitoring processes. Posting control charts in a common area facilitates early detection of quality problems, promotes awareness of workers on the quality status of their products or services, and encourages active participation in efforts to raise quality.

Taking Corrective Action Once control charts indicate that a process may be out of control, what techniques are available for diagnostic control purposes, that is, to guide corrective action? Histograms, Pareto charts (diagrams), and cause-and-effect diagrams are useful techniques for diagnosing causes of quality problems and identifying possible solutions to these problems.

Histogram A histogram is a graphical representation of the frequency of attributes or events in a given set of data.

A Pareto diagram is a histogram of the frequency of factors contributing to a quality problem, ordered from the most to the least frequent.

A histogram is a graphical representation of the frequency of attributes or events in a given set of data. Patterns or variations that are often difficult to see in a set of numbers become clear in a histogram. Exhibit 16.11 contains a histogram of factors that contribute to the quality problems identified by a firm that makes chocolate mousse. The firm has experienced uneven quality in one line of its product. The firm identifies six contributing factors to the quality problem: substandard chocolate, improper liqueur mixture, uneven egg size, uneven blending speed, variant blending time, and improper refrigeration after production. It identified 210 batches as having poor quality. The histogram in Exhibit 16.11 suggests that variations in egg size may be the largest contributor to the quality problem, followed by uneven speed in blending ingredients.

Pareto Diagram A Pareto diagram is a histogram of factors contributing to a specified quality problem, ordered from the most to the least frequent. Joseph Juran observed in the 1950s that a few causes usually account for most of the quality problems, thus the name Pareto. 20 See the Pareto diagram of the chocolate mousse quality problem in Exhibit 16.12 .

EXHIBIT 16.11

70

Histogram of Quality Problem: Contributing Factors

60 50 y c n e u q e r F

40 30 20 10 0 (1)

(2)

(3)

(4)

(5)

(6)

Causes of Poor Quality Key: (1) Quality of chocolate (2) Liqueur (3) Egg size 20

(4) Blending speed (5) Blending duration (6) Improper refrigeration

V. Pareto, a nineteenth-century Italian economist, observed that 80 percent of the wealth in Milan was owned by 20 percent of its residents.






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671

A Pareto diagram not only discloses the frequency of factors associated with a quality problem but also provides a useful visual aid. A Pareto diagr am includes a curve that shows the cumulative number of causes, as shown in Exhibit 16.12 . Using a Pareto diagram, management can separate the few major causes of quality problems from the many trivial ones and identify areas that contribute most to poor quality. Thus, management can focus its efforts on areas that are likely to have the greatest impact on quality improvement. For example, the cumulative line in Exhibit 16.12 shows that improper egg size and erratic blending speed account for 110 quality problems in manufacturing chocolate mousse. To improve quality, management would most likely demand that all suppliers deliver eggs uniform in size and that operating personnel regulate the speed of blenders.

Cause-and-Effect Diagram A cause-and-effect diagram is used to identify potential causes of quality problems.

The cause-and-effect, or “fish-bone,” diagram organizes a chain of causes and effects to sort out root causes of an identified quality problem. Karou Ishikawa discovered that for situations with myriad factors the number of factors that influenced a process or contributed to a quality problem were often overwhelming. He developed cause-and-effect diagrams as an organizing aid. 21 A cause-and-effect diagram consists of a spine, ribs, and bones. At the right end of the horizontal spine is the quality problem at hand. The spine connects causes to the effect, the quality problem. Each branch or rib pointing into the spine describes a main cause of the problem. Bones pointing to each rib are contributing factors to the cause. In Exhibit 16.13 we illustrate the general structure of a cause-and-effect diagram. Typical main causes for quality problems in manufacturing operations are • • • •

Machines Materials Methods Manpower

Some users refer to the four main categories as 4M.

EXHIBIT 16.12

220

Pareto Diagram of Quality Problem: Ranking of Contributing Factors

200 180

Cumulative

160 140 y c n e u q e r F

120 100 80 60 40 20 0

(1)

(2)

(3)

(4)

(5)

(6)

Causes of Poor Quality Key:

21

(1) Egg size (2) Blending speed (3) Liqueur

(4) Blending duration (5) Quality of chocolate (6) Improper refrigeration

K. Ishikawa, Guides to Quality Control, 2nd ed. (Tokyo: Asian Productivity Organization, 1986).




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Operational Control

EXHIBIT 16.13

Cause

Basic Cause-and-Effect (“FishBone”) Diagram

Contributor to the Cause

Quality Problem

Cause

In Exhibit 16.14 we show a cause-and-effect diagram for the quality problems in the manufacturing of chocolate mousse. The firm identified these main causes for the 20 percent rejection rate: • Machines Equipment not properly calibrated Timer functions erratically • Materials Suppliers delivered wrong or irregular-size eggs Low-quality chocolate Wrong liqueur used • Methods Improper refrigeration of ingredients Ingredients not added at proper time or in prescribed sequence Inappropriate preheating • Manpower Hiring of new workers without proper experience and not giving adequate training Workers failed to follow instructions Many firms have found brainstorming an effective technique in constructing cause-and-effect diagrams.

EXHIBIT 16.14 Cause-and-Effect Diagram for the Chocolate Mousse Quality Problem

Machine

Materials Materials Erratic timer

Improper calibration

Irregular egg size

Low-quality chocolate

Wrong liqueur

Improper refrigeration

Methods

Improper timing or preheating

Not following instructions

Manpower

20% Rejection Rate

Inexperienced workers




REAL-WORLD FOCUS


Quality Gain through Advanced Technology

Advanced technology is generating quality gains that help U.S. manufacturers distinguish themselves. For example, by digitizing the control of its factory, privately owned Latex Foam International (LFI) boosted its capacity, productivity, and quality. At a cost of $35 million, LFI built a state-of-the-art digital plant at Shelton, Connecticut. LFI’s engineers can monitor all the factory’s operations—from the mixing of latex and the distribution of liquid rubber into molding beds by mantis-like hanging robots to the heating, cooling, cleaning, and

Summary


drying of finished foam cores. The facility quickly achieved a 30 percent efficiency gain over its predecessor and boosted capacity by 50 percent, all in a smaller space with less than two-thirds of the workforce. The manufacturing system lets LFI track every mattress, right to when robots prod them to test for firmness with numerical precision. Source: Adam Aston, “The Flexible Factory,” BusinessWeek, May 5, 2003, p. 91.

In today’s global competition, with short product life-cycles and rapidly changing technologies and consumer tastes, fir ms can sustain long-term survival and profitability only by manufacturing quality products and rendering quality ser vices. Providing quality is the best strategy for attaining long-term profitability. Businesses offering quality products and services gain market shares over the years; studies show that quality is positively related to financial performance. A quality product or service meets or exceeds customer expectations at a price customers are willing to pay. To achieve quality products or services, many firms adopt total quality management, which requires continuous efforts by everyone in an organization to understand, meet, and exceed the expectations of both internal and external customers. How can accounting add value to the organization by supporting quality-related initiatives of management? We propose, in Exhibit 16.3 , a comprehensive framework that can be used to manage and control quality for a business. This framework begins, and ends, with the goal of meeting customer expectations. That is, the framework implies an iterative or continuous process. One primary role in this process for accounting is to provide relevant financial information. We identify two such examples: relevant cost (and r evenue) data for evaluating spending and investments in quality and the preparation of cost of quality (COQ) reports. Such financial information regarding quality is supplemented with internal and external nonfinancial measures of quality. To detect poor quality (i.e., out-of-control processes), these data can be analyzed using run or control charts. Histograms, Pareto diagrams, and cause-andeffect diagrams can then be used for diagnostic control purposes, that is, to identify the source of quality problems in order to inform appropriate cor rective action. Management accountants, with training and expertise in analyzing, measuring, and reporting information, can help design and implement the type of comprehensive control system depicted in Exhibit 16.3.

Appendix A Taguchi Quality Loss Function Genichi Taguchi and Y. Wu proposed the absolute quality conformance approach as an off-line quality control. 22 This approach pays more attention to upstream activities such as product design and planning of manufacturing or operation processes. Taguchi believes that these dimensions need to be perfected before embarking on manufacturing. Taguchi and Wu hypothesize that any variation from the exact specifications entails a cost or loss to the fir m. This cost or loss can be depicted by a quadratic function similar to the one shown in Exhibit 16.5. 22

Taguchi and Wu, Introduction to Off-Line Quality Control. See also Evans and Lindsay, The Management and Control of Quality, pp. 594–597, and T. L. Albright and H. P. Roth, “The Measurement of Quality Costs: An Alternative Paradigm,” Accounting Horizons , June 1992, pp. 15–27.

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