Cost Accounting Ch07

Cost Accounting
Chapter 7
The Cost of Quality and
Accounting for Production Losses
Learning Objectives
1. Identify and differentiate among the three kinds of quality costs.
2. Explain total quality management and the need for continuous
improvement.
3. Compute the cost of scrap, spoilage, and rework in a job order
cost system.
4. Prepare journal entries to account for scrap, spoilage, and rework
in a job order cost system.
5. Compute the cost of spoilage in a process cost system with fifo
costing and prepare a cost of production report when spoilage
occurs.
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Learning Objectives
6. Prepare journal entries to account for spoilage in a process cost
system.
7. (Appendix) Compute the cost of spoilage and prepare a cost of
production report when spoilage occurs in a process cost system
with an average cost flow assumption.
The Cost of Quality and
Accounting for Production Losses
• Most companies today are highly concerned about the
quality of their products.
• Manufacturers are reorganizing their manufacturing
systems to improve efficiency and reduce costs,
emphasizing product quality.
7-1 The Cost of Quality
• Types of Quality Costs
1. Prevention costs are the costs incurred to prevent product
failure.
2. Appraisal costs are the costs incurred to detect product
failure.
3. Failure costs are the costs incurred when a product fails;
they can occur internally or externally.
• Internal failure costs
• External failure costs
• Total Quality Management
– To survive a company must provide a quality product at a
reasonable price.
– Total quality management (TQM) is a company wide
approach to quality improvement that seeks to improve
quality in all processes and activities.
• Total Quality Management
• The following characteristics are common to all.
1. The company’s objective for all business activity is to serve its
customers.
2. Top management provides an active leadership role in quality
improvement.
3. All employees are actively involved in quality improvement.
4. The company has a system of identifying quality problems,
developing solutions, and setting quality-improvement objectives.
5. The company places a high value on its employees and provides
continuous training as well as recognition for achievement.
• Continuous Quality Improvement
– The best way to reduce total quality costs is to reduce the
lack of quality. Historically, companies attacked the quality
problem through high volume production and inspection
strategies.
– This approach to ensuring quality has several deficiencies.
First, the approach waits too late to detect production
losses.
– Second, the magnitude of the cost of these production
losses is rarely measured.
– A better approach to quality improvement is to concentrate
on prevention.
– This approach begins at the point of product design and
proceeds through the entire production process.
– The product must meet the functional needs of the
customer, should be reliable and durable.
– The product should be designed for efficient production.
– The production facility should be organized to promote
efficiency.
– Minimize materials handling and promote coordination.
– Machinery should be upgraded to minimize breakdowns
and stoppages.
– Employees should be trained and be encouraged to find
ways of improving product and process quality.
– Inspecting production for defects is still important.
– One such approach is the use of statistical process control
to monitor production quality and reduce product
variability.
– Quality improvement efforts also must be extended to
marketing activities.
– Improvements in quality cannot be obtained in one large
step.
– Continuous quality improvement presumes that constraints
change over time as techniques, practices, and customers’
needs change.
• Measuring and Reporting the Cost of Quality
– To monitor successfully the cost of quality and evaluate
improvements, must be able to measure the cost of quality.
– The volume of scrap, spoilage, rework, warranty repairs
and replacements, and the handling of customer complaints
can be monitored, costed, and reported to management
quarterly, monthly, or more often.
– Failure costs may be caused by poor-quality parts from
vendors, worn-out machinery, poor-quality product design,
or other factors beyond the control of a cost center
manager.
7-2 Accounting for Production Losses in
a Job Order Cost System
• Accounting for Scrap
– Scrap includes
(1) the filings or trimmings remaining after processing
materials.
(2) defective materials that cannot be used or returned
to the vendor.
(3) broken parts resulting from employee or machine
failures.
– The amount accumulated in Scrap Sales can be closed
directly to Income Summary.
– The amount accumulated can be credited to Cost of Goods
Sold.
– The amount accumulated can be credited to Factory
Overhead Control, thereby reducing the cost of factory
overhead for the period.
– If scrap results from defective materials or broken parts, it
should be considered an internal failure cost which can be
reduced or eliminated.
• Accounting for Spoiled Goods
– Spoiled goods are partially or fully completed units that are
defective in some way.
– Spoiled goods are not correctable either because it is not
technically possible or because it is not economical to
correct them.
– Spoilage can be caused by an act of the customer, such as a
change in specifications after production is begun or
imposition of unusually close production tolerances.
Spoilage also can be caused by an internal failure.
• Accounting for Spoiled Goods
– Spoilage Caused by the Customer. It should not be
regarded as a cost of quality. The customer should pay for
this kind of spoilage.
– Spoilage Caused by an Internal Failure. The unrecovered
cost of the spoiled goods should be charged to Factory
Overhead Control and reported periodically to
management.
– Spoilage can be predicted but not eliminated, the
predetermined factory overhead rate should be adjusted by
including spoilage in total overhead cost.
• Accounting for Rework
– Rework is the process of correcting defective goods.
– Rework Caused by the Customer. If the rework is caused
by the customer, the cost of rework is charged to the job, is
recovered through an increased sales price.
– Costs charged to Job 901 are:
– The customer decides the trailers need suspension springs
heavier than those originally specified
– As a result, the following rework costs are added to Job
901:
– Rework Caused by an Internal Failure. Rework costs
should be charged to Factory Overhead Control and
periodically reported to management.
a Process Cost System
• Spoilage Attributable to Internal Failures
– The cost should be measured and charged to Factory
Overhead Control
– Equivalent units would include not only the number
transferred out and the number in ending inventory but also
the number in the spoiled units.
– To facilitate control of quality costs, the dollar amount of
spoilage in each department is determined each period, and
the unrecoverable cost of spoiled units is charged to
Factory Overhead Control.
– Beginning inventory for November is complete as to
materials in both departments but only 60 percent and 70
percent complete as to conversion cost in Molding and
Glazing.
– Units still in process at the end of November are complete
as to materials in both departments, but only 30 percent and
25 percent complete as to conversion cost in Molding and
Glazing.
EXHIBIT 7-1
28
EXHIBIT 7-2
• Normal Production Shrinkage
– The following production data are available for the
Cooking Department for February:
– Beginning work in process inventory for February is
complete as to materials but only 60 percent as to
conversion cost.
– Units still in process at the end of February are complete as
to materials and 25 percent complete as to conversion cost.
EXHIBIT 7-3
Appendix: Process Costing with an
Average Cost Flow Assumption
– In Molding, materials are added at the beginning of the
process and spoilage occurs at the 80-percent stage of
conversion.
– Broken mugs have no salvage value. Mugs rarely break in
the second department, Glazing, but defects in the ceramic
glaze often occur.
– Equivalent units for each cost element in the Molding
Department are:
EXHIBIT 7-4
• Equivalent units for each cost element in the Glazing
Department are:
EXHIBIT 7-5

Cost Accounting Ch07

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