Chap16 PDF

BlocherStoutCokinsChen: IV. Operational Control 16.
The Management and The McGrawHill

Cost Management: A Control of Quality Companies, 2008
Strategic Emphasis, Fourth
Edition
C H A P T E R S I X T E E N
The Management
OPERATIONAL CONTROL
and Control of Quality

After studying this chapter, you should be able to . . .
1. Dene accountings role in the management and control of quality
2. Dene quality and the characteristics of total quality management (TQM)
PART IV
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 nancial information to support TQM initiatives
6. Discuss the use of nonnancial performance data to support TQM initiatives
7. Describe and understand techniques that can be used to detect and correct quality problems
You cant turn quality on like a spigot. Its a culture, a lifestyle within a company.
A Ford 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.
Jurans prediction proved true.1 In the late 1970s and the early 1980s, many U.S. rms
had a rude awakening. Many U.S. executives realized, for the rst 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 rms 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 Hewlett-
Packard tested the quality of more than 300,000 new computer chips, it found those made 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 use, 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
prots.
1
N. Gross, M. Stepanek, O. Port, and J. Carey, Will Bugs Eat Up the U.S. Lead in Software? BusinessWeek, December 6, 1999.
648
BlocherStoutCokinsChen: IV. Operational Control 16. The Management and The McGrawHill
Edition
REAL-WORLD FOCUS Quality Comes to Child-Care Services
For decades, ve-star hotels and restaurants have had consumers quality. For example, in Oklahoma (the rst state to set up a rating
lining up to get in. Now comes a new consumer rating: ve-star child- system) close to 60 percent of all child-care slots in the state are in
care. Just as if they were restaurants or hotels, child-care concerns facilities rated in the top two tiers, up from 30 percent in 2003. In Ten-
(both childcare centers and family child-care homes) are being nessee, where provider participation in star ratings is mandatory, 50
assigned star ratings by state regulators. These ratings are fast be- percent of facilities have earned a top rating, up from 30 percent in
coming the linchpin of states drive to raise child-care quality. The 2002. Critics argue, however, that although participation by child-care
ratings systems evaluate facilities on such criteria as low childadult providers is growing, the systems are mostly voluntary; provider par-
ratios, teacher credentials, curriculum, group size, and the safety and ticipation ranges from 10 percent to 60 percent in states where the
richness of the environment. Some of these criteria have in research systems are voluntary.
studies been associated with better outcomes in children. There is Source: S. Shellenbarger, Finding Five-Star Child-Care: States Rate Facilities
some preliminary evidence that the ratings systems are improving in Effort to Boost Quality, The Wall Street Journal (March 23, 2006), p. D1.
The Strategic Importance of Quality

Many U.S. rms have made remarkable changes in the last two decades. Consumers have
witnessed major efforts by U.S. manufacturers to improve quality. Many rms in the United
States have engaged in relentless efforts to improve the quality of their products and services.
Continuous improvement has become a way of life for many rms 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 bil-
lion in payroll alone.2
Baldrige Quality Award

In 1987, Congress established the Malcolm Baldrige National Quality Award to enhance the
competitiveness of U.S. businesses by promoting quality awareness, recognizing quality and
performance achievements, and publicizing successful performance strategies of U.S. organi-
zations in the areas of manufacturing, service, small business, andadded in 1999education
and health-care. Seven broad categories make up the criteria: leadership, strategic planning,
customer and market focus, information and analysis, human resource focus, process manage-
ment, and business results. The erce competition to win the award is evidence of the impor-
tance these rms place on being recognized for their quality operations.
ISO 9000 and ISO 14000

Quality has become a major thrust of businesses worldwide. In response, various groups pro-
mulgated quality-related standards to guide business practice. In 1947, to standardize practices
for quality management, a specialized agency (the International Organization for Standardiza-
tion) 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 referred
ISO 9000: 2000 to as ISO 9000:2000. Worldwide, ISO 9000 has become a certication sought after by global
is a set of guidelines for quality companies to gain the stamp of approval on the quality of their products and services.
management and quality The ISO 9000:2000 standards focus on developing, documenting, and implementing ef-
standards developed by the fective procedures for ensuring consistency of operations and performance in production and
International Organization for service delivery processes, with an overall goal of continual improvement. These standards
Standardization, located in
actually consist of three documents: ISO 9000Fundamentals and vocabulary; ISO 9001
Geneva, Switzerland.
Requirements (i.e., specications for a quality management system, to which organizations
must adhere; these requirements are divided into four major sections: Management Respon-
sibility, Resource Management, Product Realization, and Measurement/Analysis/Improve-
ment); and ISO 9004Guidelines for Performance Improvements (i.e., guidelines to assist
organizations in improving their quality-management systems beyond the minimum require-
ments specied 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.
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REAL-WORLD FOCUS Environmental Quality Ratings for New-Building Construction
Eco-friendly, or green, buildings are one of the most talked-about Green certication is not cheap: costs can run anywhere from
trends in the trillion-dollar U.S. construction industry. Environmental $30,000 to $150,000 for administration and paperwork. Critics argue
quality concerns regarding new-building construction are important: that the existing standards are too lenient and that the scoring system
buildings today account for about one-third of U.S. energy consump- does not give differential weights to what are considered more criti-
tion, 30 percent of greenhouse gas emissions, and 30 percent of raw cal performance criteria.
material use. The U.S. Green Building Council (www.usgbc.org), a BRE, British Research Establishment Limited (www.bre.co.uk) is a
private environmental organization, now provides different levels of U.K. counterpart organization that, among other things, assesses and
green certication for new-building construction, based on six crite- certies both new and existing buildings using the BRE Environmental
ria and the use of a 69-point rating scale. Assessment Method (BREEAM) (see www.breeam.org). This method
The six evaluation criteria (i.e., green categories) are: sustainable is considered in the U.K.s construction and property sectors as the
sites (e.g., public transportation access); water efciency, energy measure of best practice in environmental design and management.
and atmosphere; materials and resources (e.g., use of materials with As worldwide demand for natural resources continues, the man-
post-consumer recycled contents); indoor environmental quality (e.g., agement and control of environmental quality costs will likely take on
carbon dioxide monitoring); and innovation and design process. In ad- increased importance, both in the United States and abroad.
dition to basic certication, higher-performance designations (silver, Source: A. Frangos, Is It Too Easy Being Green?, The Wall Street Journal
gold, and platinum) are awarded. (October 19, 2005), pp. B1, B6.
place that ensure that outputs of the organization satisfy customer quality requirements. Fur-
ther, these standards are intended to apply to all types of businesses, including services such
as transportation, health-care, and banking.
ISO 14000 ISO 14000 is a set of standards that relate to environmental management, that is, what an
is a set of quality standards organization does to minimize harmful effects to the environment. As with ISO 9000, ISO
designed to minimize 14000 is concerned with quality managementprocesses in place that ensure a product will
environmental effects of an have the least harmful impact on the environment, at any stage of its life cycle, either by pol-
organizations outputs. lution or by depleting natural resources.
In sum, ISO standards contribute to making the development, manufacturing, and supply
of products and services more efcient, safer, and cleaner. They make trade between countries
easier and fairer. They provide governments with a technical base for health, safety, and en-
vironmental 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 Protability: 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 prod-
ucts 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 managements 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. rms, 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, rms with quality products or services can earn high, and
sustainable, levels of protability.
Exhibit 16.1 shows that a rm with improved quality can achieve competitive advantage
and enjoy higher protability and a higher return on investment. Improved quality decreases
product returns. Lower returns decrease warranty costs and repair expenses. Improved qual-
ity lowers inventory levels for raw materials, components, and nished products because the
3
M. R. Ostrega, Return on Investment through Cost of Quality, Journal of Cost Management (Summer 1991), pp. 3777;
R. K. Youde, Cost of Quality Reporting, Management Accounting (January 1992), pp. 3338.
4
T. Wolf, Becoming a Total Quality Controller, The Small Business Controller (Spring 1992), pp. 2427.
Edition
Chapter 16 The Management and Control of Quality 651
EXHIBIT 16.1 Investments in Quality

Relationship between
Improved Quality and
Financial Performance Improved Quality
Lower Lower Higher More Faster

Lower
Return Manufacturing Perceived Satisfied Throughput
Inventory
Rate Cost Value Customers Time
Lower
Higher Higher Faster
Warranty
Turnover Prices Delivery
and
Service
Costs
Higher
Increased
Market
Revenues
Share
Financial Performance
rm has more reliable manufacturing processes and schedules. Improved product quality also
lowers manufacturing costs as the rm reduces or eliminates rework and increases productiv-
ity. Customers are likely to perceive quality products as having higher values, which allows
the rm to command higher prices and enjoy a larger market share. Higher prices and great-
er market shares increase revenues and prots. 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 rms return on investment (ROI).
Empirical EvidenceDoes TQM Matter?

Empirical studies provide evidence regarding the market reaction to and the nancial 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 rm characteristics, including nancial performance.5 Their data set in-
cluded approximately 2,300 rms and data from 19831992; during this period, rms 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 rms
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 rms
adopting TQM and that this improvement is consistently stronger for rms with more ad-
vanced 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 protability.
Businesses that offer premium-quality products and services are more likely to have rela-
tively large market shares.
Quality is positively and signicantly 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. 69106.
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. 253307.
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.
Edition
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 & Poors 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 researchers found
that the award-winning companies signicantly 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. Saccomano9 reports that companies with effective TQM programs have
higher stock prices, sales, and prots compared to a control sample of rms.
In sum, cost, quality, and time are among the critical factors in successful strategies. Hav-
ing quality products allows rms that compete on differentiation to be effective in sustaining
their strategy. A rm 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 rm 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 rms and organizations.
Accountings Role in the Management and Control of Quality

LEARNING OBJECTIVE 1 The preceding discussion should have conveyed to you that quality initiatives, such as TQM,
Dene accountings role in the are management, not accounting, initiatives or prerogatives. Thus, from our perspective the
management and control of appropriate question to ask is how accounting can add value to, or support, quality-related
quality. 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
nancial and nonnancial nature.
With their training and expertise in analyzing, measuring, and reporting information, man-
agement accountants can help in the design and operation of a comprehensive system for man-
aging 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 dene the term quality and then present a conceptual
framework for managing and controlling quality costs. This is followed by a discussion of
nancial performance measures related to quality (relevant cost analysis and cost of qual-
ity [COQ] reports). We then discuss the role of nonnancial 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
Dene quality and the There are many denitions of quality, and people often view it differently because of differ-
characteristics of total quality
ences in their roles in the production-marketing-consumption chain and in their expectations
management (TQM).
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
difcult 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. 12581274; K. B.
Hendricks and V. R Singhal, Firm Characteristics, Total Quality Management, and Financial Performance, Journal of Operations
Management 19 (2001), pp. 269285; 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. 359368.
9
A. Saccomano, TQM Works Over Time, Trafc World, 1998, p. 37.
Edition
REAL-WORLD FOCUS How Costly Is Poor Quality?
As noted earlier, some organizations have a quality orientation and Boston Scientic Corporation recently reached an agreement
embrace managerial initiatives such as TQM to support this competi- with the U.S. Food and Drug Administration (FDA) in which
tive strategy. For each of the following examples, consider (1) which the company committed itself to an aggressive timeline for
nonnancial performance indicators, or controls, might be instituted resolving quality-control problems. Prior to this agreement, the
to help control quality and (2) what kinds of quality-related costs might FDA had announced that it would withhold approval of some
be involved by failing to control quality: new products from the company until it resolved the issues.
The FDA alleged that the company had failed to report, or
A recent study published in the November 15, 2005, issue of Can-
delayed reporting, potential safety problems associated with its
cer (a journal of the American Cancer Society) underscores the
products.
difculty of improving screening rates to detect colon cancer,
the third leading cause of cancer deaths.* Based on a review of PeopleSoft, Incorporated, reached an agreement to pay Cleveland
patient charts from individuals associated with a California HMO, State University $4.25 million to settle a lawsuit over computer
fewer than 30 percent of eligible patients over age 50 received any problems that delayed nancial aid to thousands of students. The
of the three types of colon-cancer tests. According to the National university claimed that students often waited months for nancial
Committee for Quality Assurance, a Washington-based nonprot aid because of computer problems that also hindered other ser-
organization that promotes health-care quality, Tufts Health Plan vices for more than two years.
(Waltham, MA) achieved the highest score in the nation, 72 per-
Sources:
cent, for colorectal cancer screening. *
R. L. Rundle, Colon-Cancer Screening Rates Rise Only Slightly, Study Says,
UnumProvident Corporation, a disability-income insurer, paid an The Wall Street Journal (October 11, 2005), p. B1.

$8 million civil penalty and $600,000 court costs to settle a suit D. Gullapalli, UnumProvident Is Set to Pay $8 Million Penalty in California,
brought against the company by the California Department of In- The Wall Street Journal (October 3, 2005), p. C3.

Boston Scientic Sets to Fix Quality Issues, The Wall Street Journal
surance, to resolve allegations that it cheated policyholders by (February 4, 2006), p. A2.
improperly denying claims. This settlement followed an earlier
Software Firm Will Pay CSU $4.25M Settlement, The Wall Street Journal
ne of $15 million paid by the company to the U.S. Labor Depart- (February 4, 2006), p. A2.
ment in a multistate settlement.
Quality For purposes of discussion we dene the term quality to mean the total level of customer satis-
is dened as customer faction with the organizations product or service. Dened in this manner, we can decompose the
satisfaction with the total notion of quality into two broad components: features and performance. The former component
experience of a product or refers to whether the characteristics, attributes, or functionality of the product or service is com-
service, that is, the difference
patible with customer expectationsin short, design quality. Outputs that fail to meet such ex-
between customer desires and
pectations result in quality-of-design failure costs. Conceptually, you can think of design failure
actual performance of the
product or service. 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., re-
Design quality duce) design failure is through the use of target-costing procedures, as discussed in Chapter 10.
is the difference between In this chapter, we are concerned with the management and control of the other broad com-
customer desires (for attributes, ponent of quality, performance quality. Performance quality can be dened as the difference
services, functionality, etc.) and
between the design specications of the product and the actual performance of the product.
product design.
Thus, a personal computer whose electronic mouse consistently malfunctions or whose oper-
Performance quality ating system constantly locks up relates to what can be called conformance quality failures. As
is the difference between such, we dene performance quality costs as those related to providing a customers required
actual performance and design level of product or service performance.
specications. 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 rm can manufacture a 3/8-inch drill bit that costs $3
for home use and an industrial-strength drill bit that costs $15. The specications 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 replaced. 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 cars oil as specied: draining old oil, installing a new oil lter,
lubricating the chassis, and adding clean new oil. The service is a quality service even if the me-
chanic used a regular oil, not a new synthesized oil that improves engine performance, if the cus-
tomer asked for a regular, not a deluxe, oil change. The mechanic has failed to deliver a quality
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service, however, if the new oil lter falls off the next morning due to improper installation or if
the rell is four or six quarts of oil instead of the ve quarts specied by the manufacturer.
Characteristics of Total Quality Management

Total quality management (TQM) Total quality management (TQM) is the unyielding and continuous effort by everyone in the
is the unyielding and continuous rm to understand, meet, and exceed the expectations of customers.10 Although each organiza-
effort by everyone in the rm to tion is most likely to develop its own approach to total quality management to suit its particu-
understand, meet, and exceed the lar culture and management style, certain characteristics are common to most TQM systems.
expectations of customers. 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 reect 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 sys-
tem 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 iden-
tify 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 pro-
cess meets the following criteria:11
Addresses the information needs of internal customers.
Includes all relevant quality-related measures, including both nancial and nonnancial
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 Text Exhibits 16.1 and 16.2 provide broad guidance for the development of a comprehensive
Develop a comprehensive framework (or system) for the management and control of quality. One possible framework is
framework for the management presented in Exhibit 16.3. This exhibit serves as the focal point around which the discussion in
and control of quality. 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
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EXHIBIT 16.2 Support and Clear and

Timely Continuous
Critical Total Quality Involvement of Measurable
Recognition Training
Management (TQM) Factors Top Management Objectives
TOTAL QUALITY MANAGEMENT
Continuous Focusing on Involving All

Improvement Customers 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 fun-
damental aw in system design: failure to embrace an outward (i.e., customer-based) viewpoint.
EXHIBIT 16.3
Customer
Comprehensive Framework Expectations Satisfied
for Managing and Controlling Customers
Quality
Deliver
Set Quality- Perform Work/ Product /Service and
Work
Related Goals Monitor Output/ Monitor Customer
Processes
(i.e., Strategy) Correct Defects Satisfaction
Dissatisfied
Nonfinancial Customers
Taguchi Loss Quality Indicators
Functions,
Six Sigma Statistical
Programs Quality Control
and Run Charts
Prevention Appraisal Internal External

Costs Costs Failure Costs Failure Costs
Quality-Related Investments/Spending Diagnostic Control

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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 dissatised customers.
Financial Component
You will notice that the reporting of quality cost information is a key element of the compre-
hensive framework shown in Exhibit 16.3. In fact, we depict cost information in four separate
categories to give prominence to the different types of quality costs that organizations incur.
This nancial approach to the management and control of quality, known as cost of quality, is
dealt with in greater detail later in the chapter.
Nonnancial Performance Indicators

As illustrated in Exhibit 16.3, the nancial performance indicators of our comprehensive re-
porting framework are complemented by both internal and external nonnancial performance
indicators. As we explain later in the chapter, nonnancial performance indicators can be lead-
ing indicators (i.e., predictors) of future nancial performance. As such, any comprehensive
framework for managing and controlling quality should have a combination of both nancial
and nonnancial 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 organizations 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 nancial
and nonnancial 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 nancial and nonnancial performance measures. The question arises, then,
as to how managers then identify and analyze quality-related problems. For this, we draw from
the eld 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
qualityacross 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 reected 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.
Edition
REAL-WORLD FOCUS 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 discov- people. The cultural shift to Six Sigma allows companies to get
ered the benets of using Six Sigma principles to eliminate manu- their employees more engaged. Tying rewards to accomplish-
facturing process variation, defects, and inefciencies. A smaller ments is particularly important to instituting such a culture change.
number of such companies are applying Six Sigma to Research and Competitive advantage: early adopters of Six Sigma in the pharma-
Development (R&D), in addition to the manufacturing function. Some ceutical industry stand to gain competitive advantage. Tradition-
aggressive companies, however, are applying the concept to func- ally, cost-cutting and eliminating process variation (two targets of
tions across the entire value chain of activities. Among the benets Six Sigma) have not been widely embraced in the industry. Thus,
cited by pharmaceutical companies regarding Six Sigma are the early adopters of this approach can gain at least temporary com-
following: petitive advantage in an increasingly competitive environment.
Changing economics of the industry: the Medicare Modernization For Six Sigma to work, most consultants believe that top manage-
Act (January 2006) will likely motivate increased use of generic ment support and commitment are keythat is, that Six Sigma can be
equivalents. For companies that have a thin pipeline of new drugs used as a leadership tool. In order to change the culture of an organiza-
or major drugs going off patent, the only way to enhance prot- tion to support Six Sigma, signicant personnel training costs are likely.
ability (at least in the short run) is to focus on cost controls and Still the nancial return of such implementations can be signicant. For
process efciencies, both of which are supported by the use of example, Eli Lilly estimates that its cumulative benet to date from the
Six Sigma. use of Six Sigma, over 160 projects, is approximately $250 million.
Maximizing employee value: the biggest asset for knowledge- Source: N. DAmore, Six Sigma Adds Up for Pharma, MedAdNews 25, no. 2
based organizations, such as pharmaceutical companies, is (February 1, 2006), p. 18.
Setting Quality-Related Expectations

LEARNING OBJECTIVE 4 As seen from Exhibit 16.3, the actual quality goals embraced by the organization are affected
Understand two approaches principally by customer demandsthat is, the level of quality (including product functional-
for setting quality-related goals ity) that the targeted customer group is willing to pay for. In this section we discuss two ap-
(Six Sigma and Goalpost versus proaches to translating customer demands into quality-related goals: Six Sigma and goalpost
absolute conformance standards).
versus absolute conformance standards.
Setting Quality Expectations: A Six Sigma Approach

Six Sigma12 has been embraced by many organizations as the guiding principle that drives improve-
ments in products, services, and processes (e.g., product development, logistics, sales, market-
Six Sigma ing, and distribution). Six Sigma can perhaps best be dened as a business process improvement
is an overall strategy to approach that seeks to nd and eliminate causes of defects and errors, reduce cycle times and
accelerate improvements manufacturing costs, improve productivity, better meet customer expectations, and achieve higher
and achieve unprecedented asset utilization and returns on investment in both manufacturing and service operations.13
performance levels by focusing Rudisill and Clary14 offer the following actual examples of improvements realized by the
on characteristics that are critical move to Six Sigma:
to customers and identifying and
eliminating causes of errors or Reduction of scrap in a ball-bearing manufacturing plant and capacity assembly plant.
defects in processes. Identication and reduction of unnecessary spare parts inventory for a paper cup plant.
Reduction of defects and product variation in a textile nishing plant.
Reduction of lead-times for product development and scale-up in a pharmaceutical
company.
Reduction of wait-time for loan approval notication (from the bank).
Six Sigma is based on a simple problem-solving methodology, DMAICDene, Measure,
Analyze, Improve, and Control. Typically, the application of Six Sigma is done using cross-
12
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 Accountants Role in Six Sigma, Strategic Finance (November 2004), pp. 3539.
Edition
functional teams, more or less on a consulting project basis. In the design stage of the project,
the Six Sigma team denes the problem and the scope of the problem (i.e., species the deliv-
erables 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 identied 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 rms 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 nds, say, 12 errors per 1,000 checks processed, this is equivalent to an
error rate of 12,000 per millionsomewhere 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 stra-
tegic 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 impor-
tance 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 difcult projects.
Break up difcult projects. Top management should try to parse complicated projects into
smaller, short-term segments, each of which has its own milestone. This allows individu-
als 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. 3638) show, the above interpretation is a loose interpretation of the statistical basis for Six
Sigma. That is, they show that the general specication 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. 2733.
Edition
REAL-WORLD FOCUS Can Six Sigma Be Used to Increase Revenues?
Many organizations today are using Six Sigma principles to improve be dened as a transaction invoiced at a price lower than the one
manufacturing efciency and to lower costs. Others are using Six Pricing had approved); Measure (the team developed a map of the
Sigma to improve service processes. Sodhi and Sodhi (2005) provide pricing process, which included six sequential steps; in theory, the
a recent example of a global manufacturer of industrial equipment process was straightforward, but in practice shortcuts were often
that applied Six Sigma rigor to increase revenues. taken and the quality of information available at various steps was
The company in question offers a diverse product line, with many deemed decient); Analyze (the team used a cause-and-effect matrix
products manufactured to customer specication. Each sale, there- at each of the six steps to depict possible causes for lack of control);
fore, has its own individually approved discount and hence its own Improve (the goal here was to decrease the number of unapproved
invoiced price. With tens of thousands of sales transactions per year, prices without creating an onerous approval process); and, Control
the task of making sure that each invoice accords with the list and (in the present case, the company set up a monthly review process to
approved prices is indeed daunting. ensure that the company was experiencing higher transaction prices,
The company had already experienced success in applying Six fewer pricing exceptions, and no loss of market share).
Sigma principles to its manufacturing operations. In fact, several The overall result? The original goal was to increase sales rev-
individuals within the company had earned Six Sigma certications enues by $500,000 for the year. In just six months, however, revenues
(Green Belt, Black Belt). The company then decided to apply, on a had increased by a whopping $5.8 million, most of which went directly
pilot basis, a Six Sigma approach to its price-setting process. to the bottom line. As such, the company is now rolling out Six Sigma
The project in question involved a cross-disciplinary team (IT, pricing across the entire organization.
sales, pricing, nance, and marketing) and ve Six Sigma steps, re- Source: M. S. Sodhi and N. S. Sodhi, Six Sigma Pricing, Harvard Business
ferred to as DMAIC: Dene (the team decided that a defect should Review (May 2005), pp. 135142.
Setting Quality Expectations: Goalpost versus

Absolute Conformance Standards
tolerance An alternative approach to dening quality expectations, or product tolerances, is to choose
refers to an acceptable range between goalpost and absolute conformance standards. One advantage of the latter is that it
of a quality characteristic, such is consistent with the use of Taguchi loss functions for control purposes, a subject dealt with
as thickness (measured, for in Appendix A.
example, in centimeters).
Goalpost Conformance
Goalpost conformance Goalpost conformance is conformance to a quality specication expressed as a specied
is conformance to a quality range around the target. The target is the ideal or desirable outcome of the operation. The
specication expressed as a range around the target is referred to as the quality tolerance.
specied range around the target. 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 difcult, a rm often species a tolerance range. A rm that speci-
es 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 specied range. With the
specied range allowed for variations, management expects all outputs to be within this range.
Exhibit 16.4 depicts the goalpost conformance specications for the sheet metal example.
EXHIBIT 16.4
Goalpost Conformance
Loss No Loss Loss
Lower Target Upper Thickness

Limit Value Limit
.45 .50 .55
Tolerance
Edition
Cost Management in Action What Is the Most Effective Way

to Implement TQM?
Total quality management (TQM) is a key strategic and operational issue has identied implementation guidelines that can assist managers in the
for most rms, as their customers continue to have higher expectations for process. Some rms such as General Electric (http://ge.com), Honeywell
product and service quality. Because it involves most if not all the activities (http://honeywell.com/), and Weyerhaeuser (http://weyerhaeuser.com/)
in the rm, the implementation of TQM is usually a complex and difcult take additional steps to ensure the success of their quality initiatives. What
process. The full implementation of TQM may take several years. The IMA do you think these additional steps might include?
Absolute Quality Conformance

Absolute quality conformance Absolute quality conformance or the robust quality approach aims for all products or services
(robust quality approach) to meet the target value exactly with no variation. An absolute conformance requires all sheet
requires all products or services metal to have a thickness of 0.5 inch, not 0.5 inch 0.05 inch or even 0.5 inch 0.0005 inch.
to meet the target value exactly Exhibit 16.5 depicts the robust quality approach. This approach assumes that the smaller the
with no variation.
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 rm incurs no quality or failure cost or loss if all quality
measures fall within the specied limits. That is, the rm suffers quality costs or losses only
when the measure is outside the limits. No such quality tolerance exists in absolute confor-
mance, 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 nd 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 specica-
tion 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 confor-
mance. On examining the operating data over the same period, Sony found that all the units
produced at the San Diego plant fell within the specications (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 specication, 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. 112113.
Edition
EXHIBIT 16.6
Color Density of Sony TV Sets
Manufactured in the San Diego
Plant and a Japanese Plant
Japanese San Diego
Source: J. R. Evans and W. M. Lindsay, The plant plant
Management and Control of Quality, 6th ed.
(South-Western, 2005), p. 113.
.45 .50 .55

Target
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 eld 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 rms desiring to attain long-term protability and customer satisfaction, absolute confor-
mance is the better approach.
The extension of absolute performance standards to estimate Taguchi quality loss functions
is covered in Appendix A.
Financial Measures and Costs of Quality

LEARNING OBJECTIVE 5 As indicated in Exhibit 16.3, there are two major situations in which accountants can provide
Prepare and interpret relevant relevant nancial information as part of a comprehensive framework for managing and con-
nancial information to support trolling quality costs: relevant cost (and revenue) data for decision-making purposes and cost
TQM initiatives. of quality (COQ) reports.
Relevant Cost Analysis

Quality-related spending (investment) affects the target level of quality and ultimately work
processes and outputsas 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, nan-
cial 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 term
avoidable costs since, by denition, 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 ex-
ample, some manufacturers are moving from process layouts (batch processing) to cellular
manufacturing. Other rms are embracing a just-in-time (JIT) production philosophy. Obvi-
ously, there can be signicant 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
signicant cost savings. It is here that the managerial accountant can add value to the organi-
zation by providing decision makers with accurate estimates of costs and benets associated
with quality-related spending, such as a move to JIT. Benets could include the contribution
margin associated with increased sales (because of decreased cycle times associated with JIT
production or the use of cellular manufacturing). Benets could also include reduced spend-
ing on rework/scrap costs, lower nancing 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.
Edition
Cost of Quality (COQ) Reporting

Up until the mid-1980s, quality costs were essentially buried in a companys nancial state-
ments. 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
systemsboth job-order and processreport separately the cost of abnormal spoilage.
As indicated in Exhibit 16.3, however, quality costs are associated with activities across
the value chainfrom the design of work processes, to production of outputs (goods and ser-
vices), 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 rst to create a more expansive view of quality
Costs of quality (COQ) costs. According to Juran, the costs of quality (COQ) for an organization are costs of activities
are costs of activities associated with prevention, identication, repair, and rectication of poor quality, as well as
associated with the prevention, opportunity costs from lost production and lost sales as a result of poor quality. Exhibit 16.7
identication, repair, and provides examples of the components of the total cost of quality.
rectication of poor quality
and opportunity costs from lost
production time and sales as a Prevention Costs
result of poor quality. Prevention costs are incurred to keep quality defects from occurring. Prevention costs include
the following:
Prevention costs
are costs incurred to keep quality
Quality training costs. Costs incurred to conduct internal training programs and for em-
defects from occurring. ployees to participate in external programs to ensure proper manufacturing, delivering,
and servicing of products and services and to improve quality. These costs include salaries
and wages for time spent in training, instruction costs, clerical staff expenses and miscel-
laneous 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 ser-
vices received meet the rms 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 measur-
ing, auditing, and reporting of data on quality.
EXHIBIT 16.7 Prevention Costs Appraisal Costs

Examples of Quality Costs
Training Raw materials inspection
Instructor fees Work-in-process inspection
Testing equipment Finished goods inspection
Tuition for external training Test equipment
Wages and salaries for time spent Depreciation
on training and education Salaries and wages
Planning and execution of a quality program Maintenance
Salaries Software
Cost of meetings/Quality circles External Failure Costs
Investments
Sales returns and allowances
Product redesign
Warranty cost / eld service
Process improvement
Contribution margin of cancelled sales orders
Equipment maintenance
Contribution margin of lost sales orders*
Internal Failure Costs Product recalls
Scrap disposal (net cost) Product liability lawsuits
Rework (materials, labor, overhead)
Loss due to downgrades*
Reinspection costs
Loss due to work interruptions*
* Opportunity costs
Edition
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 circle Quality circles. Costs incurred to establish and operate quality control circles to identify
is a small group of employees quality problems and to offer solutions to improve the quality of products and services.
from the same work area that
meet regularly to identify and
solve work-related problems
Appraisal Costs
and to implement and monitor Appraisal (detection) costs are costs devoted to the measurement and analysis of data to
solutions to the problems. determine conformity of outputs to specications. These costs are incurred during produc-
tion and prior to deliveries to customers. Through measurement, analysis, and monitoring of
Appraisal (detection) costs
manufacturing processes and examination of products and services prior to delivery, rms
are expenditures devoted to the
measurement and analysis of
identify defective items and ensure that all units meet or exceed customer requirements.
data to determine conformity of Appraisal costs include the following:
outputs to specications. Test and inspection cost. Costs incurred to test and inspect incoming materials, work in
process, and nished goods, and the cost incurred to inspect machinery; also, eld-testing
of products at the site of the consumer.
Test equipment and instruments. Expenditures incurred to acquire, operate, or main-
tain facilities, software, machinery, and instruments for testing or appraising the quality of
products, services, or processes.
Internal Failure Costs

Internal failure costs Internal failure costs are incurred to correct defective processes or defective products found
are incurred to correct defective through appraisal prior to delivery to customers. These costs are not value-added and include:
processes or defective products
detected before delivery to Costs of corrective action. Costs for time spent to nd the cause of failure and to correct
customers. 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 down-
time 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 incurred 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. Contribu-
tions lost from units not produced because of the unavailability of the constrained resources
reduce the operating income potential of the rm.
External Failure Costs

External failure costs External failure costs are costs related to quality defects detected after unacceptable products
are associated with defective/ or services reach the customer. External failure costs include the following:
poor-quality outputs after being
delivered to customers. Repair or replacement costs. Repair or replacement of returned 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 restore the rms image and reputation.
Edition
REAL-WORLD FOCUS How Much Does External Failure Cost?
Ford Motor Company unveiled the 2001 model of its best-selling sport- When asked by nancial analysts to comment on the cost of delay
utility vehicle, the Ford Explorer, in late 2000. The 2001 model added a and repairing defects, Nasser responded, Pick a number. It is over
host of new safety features that enhanced the most popular SUV on $1 billion. The delay was expensive, but Ford executives say the cost
the market since its introduction a few years earlier. Ford expected of xing warranty claims later would be far higher. One defect caught
the new model to increase the rms market share and to add sub- by engineers was an internal steering-column switch that might have
stantial amounts to its bottom line. Yet, three months after the rede- led motorists to start the engine in the drive position. Left uncor-
signed Explorer began rolling off the assembly line not a single one of rected, this problem had the potential of resulting in big-time safety
the 5,000 built was in dealer showrooms. Instead, they were parked recalls. What was the root cause of the problem? It was traced to a
outside factories in St. Louis and Louisville while Ford engineers supplier who used too much solder on a $1 circuit board. When you
pored over them looking for defects. Jacques Nasser, CEO of the Ford get to the bottom of it, they are that trivial, says a company ofcial of
Motor Company, ordered factory managers to hold off on shipping the such glitches. But when you let them escape, they are just huge.
new Explorer until engineers had the opportunity to correct quality Source: N. Muller, Putting the Explorer under the Microscope, Business-
problems. Week, February 12, 2001, p. 40.
Conformance and Nonconformance Costs

Conceptually, the total cost of quality (COQ) can be broken down into conformance costs and
Costs of conformance nonconformance costs. Prevention and appraisal costs are costs of conformance because they
are prevention costs and are incurred to ensure that products or services meet customers expectations. Internal failure
appraisal costs. costs and external failure costs are costs of nonconformance. They are costs incurred, includ-
Costs of nonconformance
ing opportunity costs, because of rejection of products or services. The cost of quality (COQ)
are internal failure costs and is the sum of conformance and nonconformance costs.
external failure 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 eld 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 rst two months of the
recall, the rm 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 rst 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 rm 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-improve-
ment activities can be measured. Tasks for reporting quality costs include data denitions,
identication of data sources, data collection, and preparation and distribution of quality
cost reports.
Data Denition, Sources, and Collection

The rst step in generating a quality cost report is to dene quality cost categories and to iden-
tify quality costs within each category. The preceding discussion described common quality
cost categories. However, denitions of cost categories can vary among rms. Considering its
unique operating conditions and experience, each rm identies appropriate cost categories
and clearly states operational denitions of all quality costs. Every member of the design team
needs to have a clear understanding of the rms quality cost categories.
Edition
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 rm should se-
lect 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 stratications of quality cost reports by product line, department, plant, or division, and
the time periods of the reports so that the rm can easily identify the origins of quality costs.
To facilitate assessment of the magnitude of quality costs and their impact, rms 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 delineat-
ing 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 competi-
tors 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 three-
year TQM process. The rm 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 years quality costs to those of a base year. Alternative bases
for comparisons can be the budgeted amounts, exible 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 Finance Accounting Other Totals % of Sales
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.
Edition
EXHIBIT 16.9 Percent

Cost of Quality (COQ) Report Year 2 Year 0 Change
for Bally Company
Prevention Costs
Training $ 90,000 $ 20,000 350%
Quality planning 86,000 20,000 330
Other quality improvement 60,000 40,000 50
Supplier evaluation 40,000 30,000 33
Total $ 276,000 3.07% $ 110,000 1.38% 151
Appraisal Costs
Testing 120,000 100,000 20
Quality performance measurement 100,000 80,000 25
Supplier monitoring 60,000 10,000 500
Customer surveys 30,000 10,000 200
Total $ 310,000 3.44% $ 200,000 2.5% 55
Internal Failure Costs
Rework and reject 55,000 150,000 (63)
Reinspection and testing 35,000 30,000 16
Equipment failure 30,000 50,000 (40)
Downtime 20,000 50,000 (60)
Total $ 140,000 1.56% $ 280,000 3.5% (50)
External Failure Costs
Product liability insurance 70,000 250,000 (72)
Warranty repairs 100,000 120,000 (17)
Customer losses (estimated) 600,000 1,400,000 (57)
Total $ 770,000 8.56% $1,770,000 22.13% (56)
Total quality costs $1,496,000 16.62% $2,360,000 29.50% (37)
Total Sales $9,000,000 100% $8,000,000 100%
COQ and Activity-Based Costing (ABC)

An activity-based costing system is ideally suited to the preparation of COQ reports. An ABC
system identies 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 pro-
duction, sales, and administrations.
An organization with a good ABC system in place needs only to identify costs and activi-
ties relating to costs of quality and quality improvement and classify these costs according
to the cost of quality categories that the rm 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.
Nonnancial Quality Indicators

LEARNING OBJECTIVE 6 As seen from the preceding discussion, relevant nancial data are needed to guide investment
Discuss the use of nonnancial decision-making and in planning and controlling quality-related costs. As indicated in Exhibit
performance data to support 16.3, however, nonnancial performance data also play an important role in a comprehensive
TQM initiatives. framework for managing and controlling quality costs.
Internal Nonnancial Quality Metrics

Organizations strive to specify internal dimensions of quality that they must focus on in order
to meet customer expectations. Thus, we nd the following examples of internal nonnancial
quality measures:
Process yield (i.e., good output/total output).
Productivity (i.e., ratio of outputsgoods or servicesto resource inputs).
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Percentage of rst-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., outputsgoods or servicesproduced 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 efciency (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 efciency).
Throughput efciency (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 efciency. 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 cross-
functional 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 exter-
nal, 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 de-
livery date).
Market research information on customer preferences and satisfaction with specic prod-
uct 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 organizations strategy. As is the case with internal quality measures, the
preceding metrics require some benchmark (standard) against which actual performance for
a period can be compared.
Role of Nonnancial Performance Measures

Internal and external nonnancial measures of quality are important components of the frame-
work 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 nonnancial 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
Edition
REAL-WORLD FOCUS Airline Quality Ratings (AQR) and Competitive Benchmarking
What type of nonnancial performance data are available to passen- quality for each airline on a timely basis, using objective, performance-
gers of U.S. domestic airlines? How can such airlines benchmark their based data.
operating performance in terms of critical success factors? Since AQRs for the top three (of 17) and bottom three domestic airlines
1991 such data are provided on an annual basis in what is called the for 2005 and 2004, as well as composite data (based on AQRs for 17
Airline Quality Rating (AQR) report. The AQR reports for each domestic domestic airlines) are as follows:
carrier monthly performance data in four major categories, based on
data obtained from the U.S. Department of Transportations monthly
Air Travel Consumer Report (www.dot.gov/airconsumer/). 2005 AQR 2004 AQR
The AQR is a summary performance measure calculated as a Score Rank Score Rank
weighted average of performance in four categories important to
consumers, as follows: Jet Blue 0.88 1 0.59 1
Air Tran 0.99 2 0.76 2
(+8.63 OT) + ( 8.03 DB) + ( 7.92 MB) + ( 7.17 CC) Independence Air 1.05 3 N/A
AQR = U.S. Airways 2.77 15 1.55 12
(8.63 + 8.03 + 7.92 + 7.17)
COMAIR 2.96 16 3.27 15
where Atlantic Southeast 4.68 17 4.10 16
OT = On-time arrival Industry average 1.73 1.38
DB = Denied boardings
MB = Mishandled baggage
CC = Customer complaints Source: B. D. Bowen and D. E. Headley, 2006 Airline Quality Rating (April
Respective weights = 8.63, 8.03, 7.92, and 7.17 2006), available at www.aqr.aero/aqrreports/AQR2006nal.pdf
The creators of the above model state that the AQR provides both
consumers and industry watchers a means for looking at comparative
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 nancial measures of qualityin the extreme, these
measures of quality can be reported on a real-time basis (i.e., instantaneously as operations
occur). Nonnancial quality indicators provide immediate short-run feedback on whether
quality-improvement efforts have, in fact, succeeded in improving quality.
These nonnancial performance measures can be useful predictors (i.e., leading indicators)
of future nancial performance.
Detecting and Correcting Poor Quality

LEARNING OBJECTIVE 7 As indicated in Exhibit 16.3, a comprehensive framework for managing and controlling quality
Describe and understand relies on the use of a number of techniques for detecting poor quality and then taking appropriate
techniques that can be used corrective action. These techniques come principally from the eld of operations manage-
to detect and correct quality ment. In general, you can think of these techniques as embracing a single, overall goal: process
problems.
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

Once an appropriate set of nonnancial performance indicators has been specied, manage-
ment 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 correction. One way to
accomplish this is through the use of control charts.
A control chart A control chart plots successive observations of an operation, taken at constant intervals,
plots successive observations of to determine whether all observations fall within the specied range for the operation. The
an operation taken at constant operation can be a machine, workstation, individual worker, work cell, part, process, or de-
intervals. partment. Intervals 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
Edition
specication. The vertical measure has a specied 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 rm has determined all drill bits must be within 0.0005 inch of the specied
diameter. All units from workstation A are within the specied range (0.0005), and no further
investigation is necessary. Three units from workstation B are outside the specied rangean
indication that not all operations in workstation B are in control. Management should investigate
the cause of the aberration to prevent further quality failures. Although all units manufactured
by workstation C are within the specied range acceptable to the rm, the control chart reveals
that quality characteristics of workstation C are moving upward. (Using it in this manner, the
A run chart control chart is often referred to as a run chart. A run chart shows the trend of observations over
shows trends in quality measures time.) Management may want to launch an investigation because the trend suggests that in the
over time. near future the operation will most likely produce drill bits outside the specied 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 (, read mu)
of the observations and the limits, 0.1255 and 0.1245, are determined based on the standard
deviation (, read sigma) of the observations. For example, the standard deviation of the drill
bits is, say, 0.00025 and the rm has determined that variations within two standard devia-
tions are acceptable. Thus the limits are 2, or 0.125 2 0.00025, which are 0.1255
and 0.1245 for upper and lower limits, respectively.
A rm sets the upper and lower control limits based on experience, technology, customer
expectation, and cost and benet analysis that determine the extent of variations within which
the rm 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 failures.
EXHIBIT 16.10 WORKSTATION A

Control Charts for 1/8-Inch
Drill Bit .1255" Upper Limit
Size
.125"
.1245" Lower Limit
Units
WORKSTATION B
.1255" Upper Limit

Size
.125"
.1245" Lower Limit
Units
WORKSTATION C
.1255" Upper Limit

Size
.125"
.1245" Lower Limit
Units
Edition
However, for observations within the established limits to be considered random, the ob-
servations 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. Post-
ing 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 avail-
able 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 A histogram is a graphical representation of the frequency of attributes or events in a given set
is a graphical representation of of data. Patterns or variations that are often difcult to see in a set of numbers become clear in a
the frequency of attributes or histogram. Exhibit 16.11 contains a histogram of factors that contribute to the quality problems
events in a given set of data. identied by a rm that makes chocolate mousse.
The rm has experienced uneven quality in one line of its product. The rm identies 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 identied 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 the frequency A Pareto diagram is a histogram of factors contributing to a specied quality problem, ordered
of factors contributing to a from the most to the least frequent. Joseph Juran observed in the 1950s that a few causes usu-
quality problem, ordered from ally account for most of the quality problems, thus the name Pareto.20 See the Pareto diagram
the most to the least frequent. of the chocolate mousse quality problem in Exhibit 16.12.
EXHIBIT 16.11 70
Histogram of Quality Problem:
Contributing Factors 60
50
Frequency
40
30
20
10
0
(1) (2) (3) (4) (5) (6)
Causes of Poor Quality
Key:
(1) Quality of chocolate (4) Blending speed
(2) Liqueur (5) Blending duration
(3) Egg size (6) Improper refrigeration
20
V. Pareto, a nineteenth-century Italian economist, observed that 80 percent of the wealth in Milan was owned by 20 percent of
its residents.
Edition
A Pareto diagram not only discloses the frequency of factors associated with a quality
problem but also provides a useful visual aid. A Pareto diagram includes a curve that shows
the cumulative number of causes, as shown in Exhibit 16.12. Using a Pareto diagram, man-
agement 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 The cause-and-effect, or sh-bone, diagram organizes a chain of causes and effects to sort
is used to identify potential out root causes of an identied quality problem. Karou Ishikawa discovered that for situa-
causes of quality problems. tions with myriad factors the number of factors that inuenced 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 hori-
zontal 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 200
Contributing Factors
180
Cumulative
160
140
Frequency
120
100
80
60
40
20
0
(1) (2) (3) (4) (5) (6)
Causes of Poor Quality
Key: (1) Egg size (4) Blending duration

(2) Blending speed (5) Quality of chocolate
(3) Liqueur (6) Improper refrigeration
21
K. Ishikawa, Guides to Quality Control, 2nd ed. (Tokyo: Asian Productivity Organization, 1986).
Edition
EXHIBIT 16.13 Cause

Basic Cause-and-Effect (Fish- Contributor
Bone) Diagram to the Cause
Quality
Problem
Cause
In Exhibit 16.14 we show a cause-and-effect diagram for the quality problems in the manu-
facturing of chocolate mousse. The rm identied these main causes for the 20 percent rejec-
tion 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 rms have found brainstorming an effective technique in constructing cause-and-effect
diagrams.
EXHIBIT 16.14 Machine Materials

Materials
Cause-and-Effect Diagram for
the Chocolate Mousse Quality Erratic timer Irregular Low-quality
Problem Improper egg size chocolate
calibration
Wrong
liqueur 20%
Rejection
Rate
Improper Not
refrigeration following
Improper
instructions Inexperienced
timing or
preheating workers
Methods Manpower
Edition
REAL-WORLD FOCUS Quality Gain through Advanced Technology
Advanced technology is generating quality gains that help U.S. drying of nished foam cores. The facility quickly achieved a 30 per-
manufacturers distinguish themselves. For example, by digitizing the cent efciency gain over its predecessor and boosted capacity by
control of its factory, privately owned Latex Foam International (LFI) 50 percent, all in a smaller space with less than two-thirds of the
boosted its capacity, productivity, and quality. At a cost of $35 mil- workforce. The manufacturing system lets LFI track every mattress,
lion, LFI built a state-of-the-art digital plant at Shelton, Connecticut. right to when robots prod them to test for rmness with numerical
LFIs engineers can monitor all the factorys operationsfrom the precision.
mixing of latex and the distribution of liquid rubber into molding beds Source: Adam Aston, The Flexible Factory, BusinessWeek, May 5, 2003, p. 91.
by mantis-like hanging robots to the heating, cooling, cleaning, and
Summary In todays global competition, with short product life-cycles and rapidly changing technolo-
gies and consumer tastes, rms can sustain long-term survival and protability only by manu-
facturing quality products and rendering quality services.
Providing quality is the best strategy for attaining long-term protability. Businesses offer-
ing quality products and services gain market shares over the years; studies show that quality
is positively related to nancial 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 rms 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 continu-
ous process. One primary role in this process for accounting is to provide relevant nancial
information. We identify two such examples: relevant cost (and revenue) data for evaluating
spending and investments in quality and the preparation of cost of quality (COQ) reports.
Such nancial information regarding quality is supplemented with internal and external non-
nancial 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-and-
effect diagrams can then be used for diagnostic control purposes, that is, to identify the source
of quality problems in order to inform appropriate corrective action.
Management accountants, with training and expertise in analyzing, measuring, and report-
ing 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 specications entails a cost
or loss to the rm. 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. 594597, and T. L. Albright and H. P. Roth, The Measurement of Quality Costs: An Alternative Paradigm, Accounting
Horizons, June 1992, pp. 1527.

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BlocherStoutCokinsChen: IV. Operational Control 16.

The Management and The McGrawHill

and Control of Quality

3. Develop a comprehensive framework for the management and control of quality

REAL-WORLD FOCUS Quality Comes to Child-Care Services

The Strategic Importance of Quality

Baldrige Quality Award

ISO 9000 and ISO 14000

REAL-WORLD FOCUS Environmental Quality Ratings for New-Building Construction

Quality and Protability: Conceptual Linkage

Chapter 16 The Management and Control of Quality 651

EXHIBIT 16.1 Investments in Quality

Lower Lower Higher More Faster

Empirical EvidenceDoes TQM Matter?

652 Part Four Operational Control

Accountings Role in the Management and Control of Quality

Total Quality Management (TQM)

REAL-WORLD FOCUS How Costly Is Poor Quality?

654 Part Four Operational Control

Characteristics of Total Quality Management

The Need for a New Accounting System

Comprehensive Framework for Managing and Controlling Quality

Chapter 16 The Management and Control of Quality 655

EXHIBIT 16.2 Support and Clear and

TOTAL QUALITY MANAGEMENT

Continuous Focusing on Involving All

Expectations and Requirements

Specifications for Internal

controlling quality is best thought of as a cross-functional effort, with input of managers

Role of the Customer

Prevention Appraisal Internal External

Quality-Related Investments/Spending Diagnostic Control

656 Part Four Operational Control

Nonnancial Performance Indicators

Relevant Cost Analysis

Link to Operations Management

Breadth of the System

REAL-WORLD FOCUS Pharmaceutical Companies Use Six Sigma across

Setting Quality-Related Expectations

Setting Quality Expectations: A Six Sigma Approach

658 Part Four Operational Control

Implementation Tips: Six Sigma17

REAL-WORLD FOCUS Can Six Sigma Be Used to Increase Revenues?

Setting Quality Expectations: Goalpost versus

Lower Target Upper Thickness

Cost Management in Action What Is the Most Effective Way

Absolute Quality Conformance

Goalpost or Absolute Conformance?

Chapter 16 The Management and Control of Quality 661

.45 .50 .55

Financial Measures and Costs of Quality

Relevant Cost Analysis

662 Part Four Operational Control

Cost of Quality (COQ) Reporting

EXHIBIT 16.7 Prevention Costs Appraisal Costs

Chapter 16 The Management and Control of Quality 663

Internal Failure Costs

External Failure Costs

REAL-WORLD FOCUS How Much Does External Failure Cost?

Conformance and Nonconformance Costs

Quality Cost Reports

Data Denition, Sources, and Collection

Chapter 16 The Management and Control of Quality 665