Quality Costing

Defintion of Quality

Literature survey on the definitions of quality has shown a great deal of variation. Some of
the commonly referred definitions of quality for software products/IT-Services are as
follows:
Webster's Definition of Quality:
The totality of features and characteristics of a product or service that bear on its ability to
satisfy stated or implied need.
Juran's view of Quality –Manufacturer’s Perspective:
Product quality is fitness of the product (or IT Service) for intended use.
Deming's view of Quality – Consumer’s Perspective:
Product quality is ability of the product (or IT-Service) to meet or exceed the end-user
expectations.

Costs of Quality

Financial controls are an important part of business management. These financial controls involve a
comparison of actual and budgeted costs, along with analysis and action on the differences between
actual and budget. It is customary to apply these financial controls on a department or functional level.
For many years, there was no direct effort to measure or account for the costs of the quality function.
However, many organizations now formally evaluate the cost associated with quality. There are several
reasons why the cost of quality should be explicitly considered in an organization.
These include the following:
1. The increase in the cost of quality because of the increase in the complexity of manufactured products
associated with advances in technology.
2. Increasing awareness of life-cycle costs, including maintenance, spare parts, and the cost of field
failures 3. Quality engineers and managers can most effectively communicate quality issues in a way
that management understands.
As a result, quality costs have emerged as a financial control tool for management and as an
aid in identifying opportunities for reducing quality costs. Generally speaking, quality costs are those
categories of costs that are associated with producing, identifying, avoiding, or repairing products that do
not meet requirements. Many manufacturing and service organizations use four categories of quality
costs: prevention costs, appraisal costs, internal failure costs, and external failure costs. These cost
categories are shown in Table below. We will now discuss these categories in more detail.

Prevention Costs

Prevention costs are those costs associated with efforts in design and manufacturing that are directed
toward the prevention of nonconformance. Broadly speaking, prevention costs are all costs incurred in
an effort to “make it right the first time.” The important subcategories of prevention costs follow.

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Quality planning and engineering
Costs associated with the creation of the overall quality plan, the inspection plan, the reliability plan, the
data system, and all specialized plans and activities of the quality-assurance function; the preparation of
manuals and procedures used to communicate the quality plan; and the costs of auditing the system.
New products review
Costs of the preparation of bid proposals, the evaluation of new designs from a quality viewpoint, the
preparation of tests and experimental programs to evaluate the performance of new products, and other
quality activities during the development and preproduction stages of new products or designs.
Product/process design
Costs incurred during the design of the product or the selection of the production processes that are
intended to improve the overall quality of the product. For example, an organization may decide to
make a particular circuit component redundant because this will increase the reliability of the product by
increasing the mean time between failures. Alternatively, it may decide to manufacture a component
using process A rather than process B, because process A is capable of producing the product at tighter
tolerances, which will result in fewer assembly and manufacturing problems. This may include a
vendor’s process, so the cost of dealing with other than the lowest bidder may also be a prevention cost.
Process control
The cost of process-control techniques, such as control charts, that monitor the manufacturing process in
an effort to reduce variation and build quality into the product.
Burn-in
The cost of pre-shipment operation of the product to prevent early-life failures in the field. Training. The
cost of developing, preparing, implementing, operating, and maintaining formal training programs for
quality.
Quality data acquisition and analysis
The cost of running the quality data system to acquire data on product and process performance; also the
cost of analyzing these data to identify problems. It includes the work of summarizing and publishing
quality information for management

Appraisal Costs

Appraisal costs are those costs associated with measuring, evaluating, or auditing products,
components, and purchased materials to ensure conformance to the standards that have been imposed.
These costs are incurred to determine the condition of the product from a quality viewpoint and ensure
that it conforms to specifications. The major subcategories follow. Inspection and test of incoming
material. Costs associated with the inspection and testing of all material. This subcategory includes
receiving inspection and test; inspection, test, and evaluation at the vendor’s facility; and a periodic audit
of the quality-assurance system. This could also include intra-plant vendors.
Product inspection and test
The cost of checking the conformance of the product throughout its various stages of manufacturing,
including final acceptance testing, packing and shipping checks, and any test done at the customer’s
facilities prior to turning the product over to the customer. This also includes life testing, environmental
testing, and reliability testing.
Materials and services consumed.

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The cost of material and products consumed in a destructive test or devalued by reliability tests.
Maintaining accuracy of test equipment
The cost of operating a system that keeps the measuring instruments and equipment in calibration.

Internal Failure Costs

Internal failure costs are incurred when products, components, materials, and services fail to meet
quality requirements, and this failure is discovered prior to delivery of the product to the customer.
These costs would disappear if there were no defects in the product. The major subcategories of internal
failure costs follow.
Scrap
The net loss of labor, material, and overhead resulting from defective product that cannot economically
be repaired or used. Rework. The cost of correcting nonconforming units so that they meet
specifications. In some manufacturing operations rework costs include additional operations or steps in
the manufacturing process that are created to solve either chronic defects or sporadic defects.
Retest
The cost of reinsertion and retesting of products that have undergone rework or other modifications.
Failure analysis
The cost incurred to determine the causes of product failures.
Downtime
Downtime cost is The cost of idle production facilities that results from nonconformance to
requirements. The production line may be down because of nonconforming raw materials supplied by a
supplier, which went undiscovered in receiving inspection.
Yield losses
The cost of process yields that is lower than might be attainable by improved controls (for example, soft
drink containers that are overfilled because of excessive variability in the filling equipment).
Downgrading/off-specing
It is the price differential between the normal selling price and any selling price that might be obtained
for a product that does not meet the customer’s requirements. Downgrading is a common practice in the
textile, apparel goods, and electronics industries. The problem with downgrading is that products sold do
not recover the full contribution margin to profit and overhead as do products that conform to the usual
specifications.

E x t e r n a l Fa i l u r e C o s t s

External failure costs occur when the product does not perform satisfactorily after it is delivered to the
customer. These costs would also disappear if every unit of product conformed to requirements.
Subcategories of external failure costs follow.
Complaint adjustment
All costs of investigation and adjustment of justified complaints attributable to the nonconforming
product.
Returned product/material

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All costs associated with receipt, handling, and replacement of the nonconforming product or material
that is returned from the field.
Warranty charges
All costs involved in service to customers under warranty contracts.
Liability costs
Costs or awards incurred from product liability litigation.

Figure Costs of Quality

Objectives of Collection and Measuring Costs of Quality

There is little point in collecting costs of quality just to see what they may reveal. If the
purpose is to set a percentage cost – reduction target on the company’s total quality – related
costs, it will be necessary to identify and measure all the contributing cost elements in order

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to be sure that costs are reduced and not simply transferred elsewhere. Before setting up a
quality cost collection system, it is advisable to examine the potential for charge of a cost
element in both absolute and relative terms. The inclusion of fixed or immutable costs also
has the effect of reducing the sensitivity of costs to performance – improving changes on the
other hand, if costs are not being monitored, how does one know that they are not going to
change? An acceptable compromise is to carryout occasional total cost exercises but to
monitor regularly and emphasize only those costs, which are likely to change with
improvement activities. The basis of the argument supporting this view is that it is
unnecessary to know all the costs to be sure, for example, that quality costs are decreasing.

Method of Collection of Quality Costs

The aspect of measuring and collecting quality costs is basically a quality cost reduction
exercise. The costs collectors have to develop their own list of quality costs elements from
company specific experience. The cost collector has to identify potential elements of cost,
which are relevant to their organization. Then it is required to quantify the elements and
finally is to cost the elements. The usual approach is for a quality assurance specialist, in
conjunction with other appropriate company personnel, to take responsibility for identifying
the elements and provide appropriate quantitative data relating to each element. The
accountant will put costs on the elements, which have been identified. It is helpful if the
quality assurance and technical personnel liaise with the accountant during this activity.

Method 1 –After an introduction by the company’s chief executive officer, confirming their
commitment to quality costing as an essential aspect of TQM, a quality assurance specialist
will give a briefing on what are costs of quality, their uses, the concept of quality cost
categories and elements, examples of specific cost elements in the organization, why the
organization is setting out to identify quality costs, and the methodology which is to be
employed to identify, collect and measure the costs to all departmental heads and members of
the senior management team. In order to help managers for distinguishing quality parameters
into types of prevention, appraisal and failure activities, some organizations use a
questionnaire relating to the various activities of the organizations. This assists in developing
a common understanding within the organization of the three types of quality costs
categories. Some organizations take the view that in the initial stages of the quality costing
exercise, the emphasis is on just identifying the costs of failure and appraisal activities. To
facilitate identification of quality costs elements, the Quality Management tools and
techniques, such as brainstorming, cause and effect analysis are useful for each department
using a team approach. Once the quality costs elements are identified for each department,
departmental head in discussion with quality assurance specialist refine each department’s list
of quality cost elements. After the elements have been agreed the next step is for each
department to determine the amount of time they are spending on each cost element, which
has been identified. During this activity the cost of wastage on items such as paper, materials,
forms, etc., is also identified. The quality assurance specialists assist the departments in the
task. The accountant then works with each departmental manager and with quality assurance
specialists in putting a cost on each element identified.

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Method 2 – Each department is treated as a process using the computer aided manufacturing
integrated program definition method. The process modeling method employs an activity box
with inputs, outputs, control and mechanisms.

Quality Cost Reports

Quality Cost Reports is an accounting report of costs associated with maintaining production
and output quality. The report details the costs of preventing production loss, internal and external
failure expenses, and an appraisal of the company's quality assurance program.

Uses of Quality Cost Information

There is no point in collecting quality costs information if it is not to be used. The uses of
quality costs are grouped into three broad categories.
a) To improve product and service quality as a business parameter.
b) Facilitating performance measures and improvement.
c) Provide the means for planning and controlling future quality costs.

Limitations of Quality Cost Information

In this section the author discusses some problems associated with quality cost reports. He
notes that, in general, these reports are too aggregated to be of use in making specific
decisions. He then names five major problems with quality cost reports. These problems
include the following

1. Much of the information is subjective.

2. Important costs are omitted from the report.
3. Overhead cost assignments to scrap and rework may be imprecise.
4. Variations in activity may reduce the comparability of quality costs from different
periods.
5. Effort and accomplishment are probably not matched in a single reporting period.

International Aspects of Quality

ISO is an independent, non-governmental international organization with a membership of
162 national standards bodies.

Through its members, it brings together experts to share knowledge and develop voluntary,
consensus-based, market relevant International Standards that support innovation and provide
solutions to global challenges.

You'll find our Central Secretariat in Geneva, Switzerland. Learn more about our structure and how
we are governed.

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What are standards?
International Standards make things work. They give world-class specifications for products,
services and systems, to ensure quality, safety and efficiency. They are instrumental in
facilitating international trade.
ISO has published 22017 International Standards and related documents, covering almost
every industry, from technology, to food safety, to agriculture and healthcare. ISO
International Standards impact everyone, everywhere.

What are the benefits of ISO International Standards?

ISO International Standards ensure that products and services are safe, reliable and of good quality.
For business, they are strategic tools that reduce costs by minimizing waste and errors and increasing
productivity. They help companies to access new markets, level the playing field for developing
countries and facilitate free and fair global trade.

How does ISO develop standards?

Our standards are developed by the people that need them, through a consensus process. Experts from
all over the world develop the standards that are required by their sector. This means they reflect a
wealth of international experience and knowledge.

ISO Standards in Action

Learn about how International Standards work in the real world, address shared challenges and the
things that matter most for people, the environment and business.

ISO 9000 - Quality management

The ISO 9000 family addresses various aspects of quality management and contains some of
ISO’s best known standards. The standards provide guidance and tools for companies and
organizations who want to ensure that their products and services consistently meet
customer’s requirements, and that quality is consistently improved.

ISO 9001:2015
ISO 9001:2015 sets out the criteria for a quality management system and is the only standard
in the family that can be certified to (although this is not a requirement). It can be used by any
organization, large or small, regardless of its field of activity. In fact, there are over one
million companies and organizations in over 170 countries certified to ISO 9001.
This standard is based on a number of quality management principles including a strong
customer focus, the motivation and implication of top management, the process approach and
continual improvement. Using ISO 9001:2015 helps ensure that customers get consistent,
good quality products and services, which in turn brings many business benefits.

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ISO 9000 series Quality Management Principles
The ISO 9000 series are based on seven quality management principles (QMP)
The seven quality management principles are:

 QMP 1 – Customer focus

 QMP 2 – Leadership
 QMP 3 – Engagement of people
 QMP 4 – Process approach
 QMP 5 – Improvement
 QMP 6 – Evidence-based decision making
 QMP 7 – Relationship management
Principle 1 – Customer focus
Organizations depend on their customers and therefore should understand current and
future customer needs, should meet customer requirements and strive to exceed
customer expectations.
Principle 2 – Leadership
Leaders establish unity of purpose and direction of the organization. They should
create and maintain the internal environment in which people can become fully
involved in achieving the organization's objectives.
Principle 3 – Engagement of people
People at all levels are the essence of an organization and their full involvement
enables their abilities to be used for the organization's benefit.
Principle 4 – Process approach
A desired result is achieved more efficiently when activities and related resources are
managed as a process.
Principle 5 – Improvement
Improvement of the organization's overall performance should be a permanent
objective of the organization.
Principle 6 – Evidence-based decision making
Effective decisions are based on the analysis of data and information.
Principle 7 – Relationship management
An organization and its external providers (suppliers, contractors, service providers)
are interdependent and a mutually beneficial relationship enhances the ability of both
to create value.

Effectiveness
The debate on the effectiveness of ISO 9000 commonly centers on the following questions:

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 1. Are the quality principles in ISO 9001 of value?
2. Does it help to implement an ISO 9001-compliant quality management system?
3. Does it help to obtain ISO 9001 certification?
Effectiveness of the ISO system being implemented depends on a number of factors, the most
significant of which are:

1. Commitment of senior management to monitor, controls, and improve quality.

Organizations that implement an ISO system without this desire and commitment
often take the cheapest road to get a certificate on the wall and ignore problem areas
uncovered in the audits.
2. How well the ISO system integrates into current business practices. Many
organizations that implement ISO try to make their system fit into a cookie-cutter
quality manual instead of creating a manual that documents existing practices and
only adds new processes to meet the ISO standard when necessary.
3. How well the ISO system focuses on improving the customer experience. The
broadest definition of quality is "Whatever the customer perceives good quality to
be." This means that a company doesn't necessarily have to make a product that never
fails; some customers will have a higher tolerance for product failures if they always
receive shipments on-time or have a positive experience in some other dimension of
customer service. An ISO system should take into account all areas of the customer
experience and the industry expectations, and seek to improve them on a continual
basis. This means taking into account all processes that deal with the three
stakeholders (customers, suppliers, and organization); only then will a company be
able to sustain improvements in the customer's experience.
4. How well the auditor finds and communicates areas of improvement. While ISO
auditors may not provide consulting to the clients they audit, there is the potential for
auditors to point out areas of improvement. Many auditors simply rely on submitting
reports that indicate compliance or non-compliance with the appropriate section of
the standard; however, to most executives, this is like speaking a foreign language.
Auditors that can clearly identify and communicate areas of improvement in language
and terms executive management understands facilitate action on improvement
initiatives by the companies they audit. When management doesn't understand why
they were non-compliant and the business implications associated with non-
compliance, they simply ignore the reports and focus on what they do understand.
Advantages
Proper quality management can improve business, often having a positive effect on
investment, market share, sales growth, sales margins, competitive advantage, and avoidance
of litigation. The quality principles in ISO 9000:2000 are also sound, according to Wade and
Barnes, who says that "ISO 9000 guidelines provide a comprehensive model for quality
management systems that can make any company competitive". Sroufe and Curkovic, (2008)
found benefits ranging from registration required to remain part of a supply base, better
documentation, to cost benefits, and improved involvement and communication with

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management. According to ISO the 2015 version of the standard brings the following
benefits:

1. By assessing their context, organizations can define who is affected by their work and
what they expect. This enables clearly stated business objectives and the
identification of new business opportunities.
2. Organizations can identify and address the risks associated with their organization.
3. By putting customers first organizations can make sure they consistently meet
customer needs and enhance customer satisfaction. This can lead to more repeat
custom, new clients and increased business for the organization.
4. Organizations work in a more efficient way as all their processes are aligned and
understood by everyone. This increases productivity and efficiency, bringing internal
costs down.
5. Organizations will meet necessary statutory and regulatory requirements.
6. Organizations can expand into new markets, as some sectors and clients require ISO
9001 before doing business.
Criticisms of ISO 9000
A common criticism of ISO 9000 and 9001 is the amount of money, time, and paperwork
required for registration. Dalgleish cites the "inordinate and often unnecessary paperwork
burden" of ISO, and says that "quality managers feel that ISO's overhead and paperwork are
excessive and extremely inefficient".
According to Barnes, "Opponents claim that it is only for documentation. Proponents believe
that if a company has documented its quality systems, then most of the paperwork has already
been completed". Wilson suggests that ISO standards "elevate inspection of the correct
procedures over broader aspects of quality", and therefore, "the workplace becomes
oppressive and quality is not improved".
One study showing reasons for not adopting this standard include the risks and uncertainty of
not knowing if there are direct relationships to improved quality, and what kind and how
many resources will be needed. Additional risks include how much certification will cost,
increased bureaucratic processes and risk of poor company image if the certification process
fails. According to John Seddon, ISO 9001 promotes specification, control, and procedures
rather than understanding and improvement. Wade argues that ISO 9000 is effective as a
guideline, but that promoting it as a standard "helps to mislead companies into thinking that
certification means better quality, [undermining] the need for an organization to set its own
quality standards". In short, Wade argues that reliance on the specifications of ISO 9001 does
not guarantee a successful quality system.
The standard is seen as especially prone to failure when a company is interested in
certification before quality. Certifications are in fact often based on customer contractual
requirements rather than a desire to actually improve quality. "If you just want the certificate
on the wall, chances are you will create a paper system that doesn't have much to do with the
way you actually run your business", said ISO's Roger Frost. Certification by an independent

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auditor is often seen as the problem area, and according to Barnes, "has become a vehicle to
increase consulting services".
Dalgleish argues that while "quality has a positive effect on return on investment, market
share, sales growth, better sales margins and competitive advantage," "taking a quality
approach is unrelated to ISO 9000 registration." In fact, ISO itself advises that ISO 9001 can
be implemented without certification, simply for the quality benefits that can be achieved.
Abrahamson argues that fashionable management discourse such as Quality Circles tends to
follow a lifecycle in the form of a bell curve, possibly indicating a management fad.
Pickrell argues that ISO systems merely gauge whether the processes are being followed. It
does not gauge how good the processes are or whether the correct parameters are being
measured and controlled to ensure quality. Furthermore, when unique technical solutions are
involved in the creation of a new part, ISO does not validate the robustness of the technical
solution which is a key part of advanced quality planning. It is not unheard of for an ISO-
certified plant to display poor quality performance due to poor process selection and/or poor
technical solutions.
Conclusion
The only presentation and uses of quality-related costs in company 1 are the monthly
reporting of the quality control department costs for budgetary control purposes and reporting
of gross costs of scrap and warranty in management account. Although ratios are used as
performance indicators in some aspects of the business, gross values are preferred. Quality
costs do not feature in any of the ratios used. These typically involve measures of labour,
sales and manufacturing cost. Costs do not appear to feature specifically in the day-to-day
decisions about quality matters though it must be said that there is a very cost conscious
atmosphere about the factory. On the other hand, dealing with warranty claims is a very cost-
oriented activity, the basic documentation for which is a list of product applications, normal
warranty limits, exceptions, warranty reimbursement costs, and agreed labour rates for
agencies and service centers.

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 Overview of Cost Control and Cost Reduction
One of the major concerns of the enterprise is to maximize the profit, which is possible only through
decreasing the cost of production. For this purpose, two efficient tools are used by the management,
i.e. cost control and cost reduction. Cost Control is a technique which provides the necessary
information to the management that actual costs are aligned with the budgeted costs or not.
Conversely, Cost Reduction is a technique used to save the unit cost of the product without
compromising its quality

Definition of Cost Control

Cost Control is a process which focuses on controlling the total cost through competitive
analysis. It is a practice which works to maintain the actual cost in agreement with the
established norms. It ensures that the cost incurred on an operation should not go beyond the
pre-determined cost.

Cost Control involves a chain of functions, which starts from preparation of the budget in
relation to the operation, thereafter evaluating the actual performance, next is to compute the
variances between the actual cost & the budgeted cost and further, to find out the reasons for
the same, finally to implement the necessary actions for correcting discrepancies.

The major techniques used in cost control are standard costing and budgetary control. It is a
continuous process as it helps in analyzing the causes for variances which control wastage of
material, any embezzlement and so on.

Characteristics of Cost Control

The characteristics of cost control are presented below:

1. Delineation of Centers of Responsibility: Overlapping operations and responsibilities

destroy the very essence of cost control.
2. Delegation of Authority: If persons are charged with responsibility without authority, the
cost control will be ineffective. Hence, proper or adequate delegation of authority is
necessary for proper cost control.
3. Measurement of Performance: A performance is to be measured with the help of
reasonable criteria. Standard costing can be used as reasonable criteria. The person whose
performance is being measured should participate in setting the standards employee with
the help of costs incurred that are controllable.
4. Relevance of Controllable Cost: Only few costs are controllable at different levels of
management. The management evaluates the performance of an
5. Cost Reporting: Cost report provides a basis for effective cost control. Hence, if the cost
reports is not prepared and submitted in time, the cost control cannot be exercised.
6. Constant Efforts: The measurement of performances, knowing functioning of
manufacturing department and analysis of costs require constant efforts. This type of
constant efforts leads to cost consciousness and result in cost control.

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7. Policies and General Objectives: All the employees of the organization are
communicated the policies and general objectives. If so, cost control is very easy.
Cost control is exercised through various techniques like standard costing, budgetary control,
inventory control, quality control, performance analysis and reporting.

Steps involved in Cost Control

The following steps have been adopted to exercise cost control.

1. Planning: Planning may be done as in the form of budget, standard, estimate and the
like. The past events have been considered for proper planning. The planning is
expressed both in physical as well as monetary terms. The standards are used as
yardsticks.

2. Communication: The planning and policy should be communicated to the

employees. If so, they can assume the responsibility and do the work properly.
Communication has two directions. They are upward direction and downward
direction. Instructions flow from the top level to lower level. Likewise, report on
performance move towards upwards.

3. Motivation: The performance is evaluated; costs are ascertained and reported to the
management regarding the results of performance. Such report may be act as
motivating force and leads to better performance in the days to come.

4. Appraisals and Reporting: The actual performance is compared with preplanned

standard and finds the deviations. The causes for such deviations are also analyzed.
Finally, the deviations with reasons are reported to the top level of management for
cost control.

5. Decision Making: The top management may review the report on many directions.
Lastly, the management takes necessary corrective actions. Finally, the existing
standard or budget may be revised according to the prevailing situations.

The responsible executives can exercise physical control for the successful implementation of
cost control system. In the manufacturing place, the supervisor can exercise control over the
amount of expenditure incurred as in the form of cash or in the utilization of labor, material
and other resources. If minimum materials are used, cost of material may be controlled to
some extent.

Advantages of Cost Control

The chief advantages of cost control are briefly explained below:

1. Return on capital employed may be increased.

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2. The volume of profit is also increased with minimum output and sales.

3. Management can increase the productivity with available resources.

4. The employees are getting job continuously.

5. The employees can get reasonable remuneration with bonus.

6. The available factors of production and resources are effectively used.

7. The credit worthiness of the company is increased.

8. There is a possibility of prosperity and economic stability of the industry.

Definition of Cost Reduction

Cost Reduction is a process, aims at lowering the unit cost of a product manufactured
or service rendered without affecting its quality by using new and improved methods
and techniques. It ascertains substitute ways to reduce the cost of a unit. It ensures
savings in per unit cost and maximization of profits of the organization.

Cost Reduction aims at cutting off the unnecessary expenses which occur during the
production, storing, selling and distribution of the product. To identify cost reduction,
the following are the major elements:

 Savings in per unit cost.

 No compromise with the quality of the product.
 Savings are non-volatile in nature.

Tools of cost reduction are Quality operation and research, Improvement in product
design, Job Evaluation & merit rating, variety reduction, etc.

Characteristics of Cost Reduction:

The characteristics of cost reduction include:

(i) The cost is a permanent one. The reduction should be through improvements in methods
of production from research. It would be short lived if it comes through reduction in the
prices of inputs, such as material, labor etc.

(ii) The reduction in cost is real one in the course of manufacture or service rendered. Real
cost reduction comes through greater productivity.

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(iii) The reduction should not be at the cost of essential characteristics, such as quality of the
products or services rendered.

Advantages of Cost Reduction:

There are many advantages of cost reduction. Some of these are:

1. Cost reduction will help in making goods available to the consumers at cheaper rates.

2. Cost reduction increases profit. It provides a basis for more dividends to the shareholders,
more bonuses to the staff and more retention of profit for expansion of the business.

3. As a result of reduction in cost, export price may be lowered which may increase total
export.

4. Cost reduction is obtained by increasing productivity, so as a developing country like

India, which suffers from shortage of resources, can develop faster if it makes the best use of
resources by increasing productivity.

5. Higher profit will provide more revenue to the government by way of taxation.

6. Cost reduction will provide more money for labor welfare scheme and thus improve men-
management relationship.

Tools and Techniques of Cost Reduction:

The various techniques and tools used for achieving cost reduction are practically the same
which have been suggested for cost control. Some of these are:

1. Simplification and variety reduction.

2. Budgetary control.

3. Standard costing.

4. Overheads control.

5. Planning & control of finance.

6. Automation.

7. Market research.

8. Operations research.

9. Value analysis.

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 10. Standardizations of products and tools & equipments.

11. Improvement in design.

12. Simplification and variety reduction.

13. Labor control.

14. Materials control.

Differences Between Cost Control and Cost Reduction

BASIS FOR COST CONTROL COST REDUCTION
COMPARISON

Meaning A technique used for A technique used to economize the unit

maintaining the costs as per the cost without lowering the quality of the
set standards is known as Cost product is known as Cost Reduction.
Control.

Savings in Total Cost Cost Per Unit

Retention of Not Guaranteed Guaranteed

Quality

Nature Temporary Permanent

Emphasis on Past and Present Cost Present and Future Cost

Ends when The pre-determined target is No end

achieved.

Type of Function Preventive Corrective

Conclusion
The two techniques cost control and cost reduction are used by many manufacturing concerns
to diminish the cost of production. Cost Reduction has a larger scope than cost control as cost
reduction is applicable for all the industries, but cost control is applicable only to the
industries where pre- optimization of the cost which is not yet incurred is possible. Cost
Control works as a road map for the organization to incur costs as per the set standard. On the
other hand, cost reduction challenges the established standards by decreasing the costs and
increasing the profit.

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 Productivity and Profitability

Definition of Productivity
Productivity describes various measures of the efficiency of production. A productivity
measure is expressed as the ratio of output to inputs used in a production process, i.e. output
per unit of input. Productivity is a crucial factor in production perfomance of firms.

Productivity is the relationship between the amount of outputs and amount of inputs needed
to produce a product. In other words, management measures productivity by comparing the
amount of a product produced to the amount of raw materials and manpower needed to
produce a product. If less raw materials and manpower are used to produce more of a
product, then productivity is considered high.

Let's take a look at the Chicken Valley Poultry Company, a large producer of chicken
products. Chicken Valley Poultry Company produces chicken nuggets in its manufacturing
plant. In order for management to determine whether the plant has high productivity rates,
management will look at a few things:

 The amount of raw materials, like chicken, eggs, bread crumbs and food additives,
used to make the nuggets
 The amount of time and labor involved in running the machinery and production lines
to process and package the nuggets
 The amount of chicken nuggets produced in a standard timeframe, like every hour.

What Does Profitability Mean?

Profitability is one of four building blocks for analyzing financial statements and company
performance as a whole. The other three are efficiency, solvency, and market prospects.
Investors, creditors, and managers use these key concepts to analyze how well a company is
doing and the future potential it could have if operations were managed properly.

The two key aspects of profitability are revenues and expenses. Revenues are the business
income. This is the amount of money earned from customers by selling products or providing
services. Generating income isn’t free, however. Businesses must use their resources in order
to produce these products and provide these services.

Resources, like cash, are used to pay for expenses like employee payroll, rent, utilities, and
other necessities in the production process. Profitability looks at the relationship between the
revenues and expenses to see how well a company is performing and the future potential
growth a company might have.

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Definition: Profitability is ability of a company to use its resources to generate revenues in
excess of its expenses. In other words, this is a company’s capability of generating profits
from its operations.

Example
There are many reports to use when measuring the profitability of a company, but external
users typically use the numbers reported on the income statement. The financial statements
list the profitability of the company in two main areas.

The first signs of profit show in the profit margin or gross margin usually calculated and
reported on the face of the income statement. These ratios measure how well the company is
using its resources to generate profits.

The second sign of profit isn’t really a sign; it’s more like the real thing. The income
statement always reports the net income at the bottom of the report. This is often the true sign
of profitability because it shows external users the total amount of revenues that exceeded the
expenses during the period.

How Does Productivity Affect Profitability?

Profitability is the revenue left over after all expenses and taxes have been paid. A company
is profitable by simply producing more finished product and paying less for raw materials and
labor.

Productivity and quality affect profitability when:

 Production is lower than projected

 Cost of raw materials is higher than the budgeted cost
 Cost of labor is higher than expected
 Quality is lower than the quality standard

Factors that affect profitability can be both external and internal to the organization. A severe
drought is an external factor that may cause wheat crops to die. As a result, the cost of
breadcrumbs may rise. The breadcrumbs are a raw material used to make the nuggets. The
rise in cost for one raw material will lower the profitability of the final product.

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 References
1. BS 6143 (1981) The Determination and Use of Quality-Related Costs, British Standards
Institution, London.
2. ASQC Quality Costs Committee (1974) Quality Costs – What and How, American Society
for Quality Control, Milwaukee WI.
3. BS 6143: Part 2 (1990) Guide to the Economics of Quality: Prevention, Appraisal and
Failure Model, British Standards Institution, London.
4. Anon (1977) Quality cost survey. Quality, 20 – 2.

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