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TQM 23,4

Measuring economic effects of quality management systems

Leonardo A. Sedevich Fons
cleo de Asistencia Profesional, Management Control Department, Nu rdoba, Argentina Co
Abstract
Purpose The aim of this paper is to discuss methods to quantify, in monetary terms, the effects of having a quality management system that can help to make decision making easier by company managers easier. Design/methodology/approach There are many different management tools and theories which have been developed in both academic and entrepreneurial environments like the quality management theory, traditional accounting, quality cost measurement and balanced scorecard. The method proposed in this paper takes the form of taking these tools into consideration and analyzing them in detail in order to combine them to form a unique system which can maximize their individual benets from a holistic point of view of total quality. Findings The paper proposes a measurement method that can be put into practice to ascertain the actual economic effects of quality management systems and to help decision makers. Research limitations/implications The method developed must be validated bearing in mind its limitations for implementation in each company in order to prove its benets. Originality/value The method is developed by combining many management tools, which are normally used individually. Keywords Quality management system, Accounting, Quality costs, Scorecard, Argentina Paper type Research paper

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1. Introduction There are many companies in Argentina that need quality management systems (QMS) implementation similar to other organizations in the world. This paper begins with a theoretical framework to dene the topics followed by a description of the current situation of Argentinas SMEs regarding QMS, and analyzes the monetary benets provided by QMS that could be generated. Finally, the methodologies to measure real economic effects of QMS are described. 2. Theoretical framework 2.1 Quality management systems A Quality Management System (QMS) is . . . a management system to direct and control an organization with regard to quality (International Organization for Standardization, 2005) Implementing a QMS under ISO reference means the accomplishment of the requirements included in ISO 9001 Standard, which are detailed in chapters four to eight of that document. The overall requirement consist of a process approach application (which requires the company to identify the processes, understand its sequence and interaction, elaborate the necessary procedures, assure resource availability, control performance and take the necessary actions to achieve continuous improvement) and

The TQM Journal Vol. 23 No. 4, 2011 pp. 458-474 q Emerald Group Publishing Limited 1754-2731 DOI 10.1108/17542731111139527

have everything through documentation (which includes documents like quality policies, quality objectives, quality manual, procedures and records and so on). 2.2 Accounting Accounting has been described as a science, but also considered as being a technical discipline. However, most people agree that its function is to register economic and nancial facts of companies with the purpose of supplying users with relevant information so that they are able to make sound decisions. The American Accounting Association (AAA) has dened accounting as the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of information (cited in Tulsian, 2002). 2.3 Quality costs Quality costs represent the amount of money that a company has relinquished (lost; either expended or did not obtain) due to ineffectiveness or inefciency when developing its activities. It can be classied into direct and indirect quality costs. Direct quality cost consists of money expended due to ineffectiveness or inefciency in company performance. This type of cost is attributable according to the degree of control. Controllable cost is the amount of money expended voluntarily in order to improve levels of effectiveness and efciency of company processes and it may be separated into prevention cost (money expended to avoid failures) and appraisal cost (money expended to detect failures). On the other hand, non-controllable cost is the amount of money expended due to failures that have occurred in company processes and it can be divided into internal failure cost (failures detected internally in the company) and external failure cost (failures detected by customers). Indirect quality cost consists of money not realized due to ineffectiveness or inefciency in company performance. This is the outcome that a company would have earned if it had carried out sales transactions, which were unsuccessful due to failures. 2.4 Scorecard A scorecard is a set of indicators about the operation of the company which are interrelated through cause and effect relationships and provides summarized useful information in order to contribute to the decision making process. The scorecard must only disclose essential data in a simple and brief manner and include only a few indicators, which can enable managers to have an overview of company performance. Even though it is not mentioned explicitly in ISO 9001 standard, the scorecard is a very helpful tool in order to accomplish the requirements demanded on the company given that it has two important functions: (1) As a control tool, it provides performance indicators as a verication on the level of achievement of each of the companys objective. (2) As an improvement tool, it provides information about cause and effect relationship between pairs of indicators that allow managers to make better decisions.

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3. Problem statement: QMS exploitation by Argentine SMEs With the passing of time on a worldwide scale, it has been proven that organizations that manage quality are able to boost their effectiveness and efciency levels and promote the use of QMS. At the same time, the same companies who use this kind of system also realize that they could enhance its effects if they managed the quality in their whole value chain rather than only in parts. The result of this setting gave rise to the emergence of a system formed by certication institutes and international standards, which added a new element to be considered by customers when they had to choose a supplier. In other words, the system allowed customers to identify companies that used QMS in their entire operation from those who did only in parts. In Argentina, SMEs are starting to use different management tools, which have been successfully applied by international organizations aspiring long term growth. Nonetheless, there are signs on the walls indicating that these tools are not being exploited in a comprehensive manner either because there are conceptually mistaken for their benet or they are being implemented inaccurately. One of this management tools whose utilization has grown is QMS ever since globalization increased business relationships between Argentine SMEs and foreign national companies. Multi-national organizations, which at some point become part of the whole value chain of most Argentine products and services, have incorporated the quality philosophies and consequently they demand their suppliers to do the same. Hence, the situation is that a myriad of Argentine SMEs now need to comply with QMS requirements. The problem, however, is that even when many local SMEs set up a QMS (which is highly positive), they do it for the sole reason of showing the quality of their products through an accrediting certication, such as ISO 9000. This parochial insight about quality management has brought in the following difculties: . companies that are not explicitly demanded by their potential customers (as a requirement) to get an accrediting certicate, do not implement a QMS and are deprived of its associated benets; and . companies that implement a QMS use it simply as an element to prove the quality of their products rather than using it a genuine long-term tool as a winner. Consequently, the system is not exploited or used for its real purpose, such as customer satisfaction leading to increased prot and improved process efciency and long-term growth. One of principal reasons is the absence of quantitative measurement methods used by many companies. The lack in use of this sort of technique makes entrepreneurs unable to notice QMS benets in a tangible way. Thus, either they prefer not to use these systems or, if they do it, they just want to reach to the stage of getting the ISO certicate without the conviction that it could be a real protable venture for the organization beyond the accreditation. There are various reasons, which discourage organizations from measuring economic effects of quality management system implementation: . QMS economic effect measurement is not compulsory (it is not required by National Accounting Standards nor by international standards);

the shortage and dispersion of QMS monetary data makes the data collection very difcult and the information gathered is usually not precise; and most usually the accounting department is not covered in the QMS implementation strategy due either to the dissociation between accounting and other areas and or for the reason that QMS are thought to be associated with production or provision of service activities.

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4. Benets of measuring economic effects 4.1 Direct benets: decision making Knowing the economic effects of implementing a QMS grants certain advantages to companies because it provides additional information for decision making. Some of these advantages are as follows: . It allows organizations to become acquainted with the economic importance of QMS implementation through comparing the actual outcomes achieved with those which would have been reached if this system had not been used. Therefore, it provides evidence of the attainment of the quality management genuine goals, beyond the mere point of receiving a certicate. This information encourages companies to manage quality voluntarily (even if they are not required to do it) and once implemented, pushes companies to take full advantage of the QMS. . It enables organizations to learn how much they could increase their prots by implementing quality management given that this method compares actual economic outcomes to those which would have been gained if QMS had not been implemented with different stringency levels (the measurement tool that is presented in this paper includes simulation of different settings). This information can serve a decisive factor when making business decisions. For instance, it would allow a company to tell whether it is able to enhance its cost structure in the future by means of reducing quality costs. . It allows companies to give proper relevance to different kinds of problems or failures that have occurred and allows them to investigate and nd causes. A virtue of every common QMS lies in detecting various causes of the non-conforming products, remarks and improving opportunities. Additionally, a company can use this measurement tool to make it possible to assign a monetary value to each of these ndings on mistakes and errors. The managers then become more challenged if they have to allocate resources in order to give solution to those problems. The method thus makes it possible to assign or establish a priority to quality problems using an economic consequence criterion. . It provides information on cost- benet relationship of each prevention and appraisal action, which the company undertakes. Ordinarily QMS gives information about effects caused by prevention and appraisal actions but only through non-nancial indicators. But, in this proposed method, these non-nancial data could become valued in monetary units, which, when compared against its cost, could give an essential element to decide the implementation of these kinds of actions. For instance, it could inform about

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whether it is convenient to perform a quality control to the output of a process or not and by how much. 4.2 Indirect benets: operational performance Companies using the method proposed in this article to measure economic effects of QMS would be able to obtain some collateral operational performance advantages because they would be forced to reach certain work patterns. The indirect benets are: . This method demands companies to consider accounting activities as a part of QMS, and manage them following the same guidelines as they do in the rest of processes. Consequently, making accounting areas more effective and efcient. . The measurement system requires companies to set permanent communication and coordination mechanisms amongst the different departments, resulting in a decrease of the usual existing dissociation between accounting and production goals. . Quantity and quality of information generated by both accounting system and QMS could be improved through the measurement method since it would establish a dependent relationship (QMS would contribute to measuring economic effects and accounting systems would become helpful in decision on quality management improvement actions). . Using the measurement method requires generating information about relationships between nancial and non-nancial indicators and it can foster utilization of certain tools like scorecard. 5. Description of the method 5.1 The overall characteristics The method consists of starting from traditional accounting report analysis to obtaining additional information through QMS in order to be able to know the economic effects of the quality management actions. The supplementary information includes actual and hypothetical economic outcome disaggregated according to quality perspective requirements. It is important to note that this measurement tool implies setting assumptions and estimates when measuring; however, they are always supported by evidence records. Moreover, the purpose of this method is not to become an information source for external accounting information users, but to provide an extra element for managers who carry out the internal decision making. As a prerequisite, the presumption here is that the company has to have an accounting information system (since it has been mentioned that the starting point for obtaining information about quality management economic effects are the companys nancial statements). Generally, this is not a hindrance given that with different degrees of detail, every SME has an accounting system in order to issue the reports demanded by accounting standards. A second prerequisite is that the organization must have implemented a QMS. Evidently, if a company wants to measure economic effects of quality management, it must have implemented a system of this kind, regardless of whether it has achieved an external accrediting certicate. This prerequisite stresses the need of a certain maturity

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level of the QMS given that economic measurement task involves obtaining data from many records generated by the use of the system. 5.2 Four stages of implementation The process to implement a system to measure economic effects of QMS consists of the following four stages. 5.2.1 To incorporate accounting and administrative departments into QMS. Setting up a QMS calls for a process approach used to be used and managed in every activity of the company. A point to make is that the regulatory requirements included in international standards quote just some of the processes existing in most organizations (such as commercialization, design and development, purchasing, production or provision, human resources) and, in a certain way, they overlook the accounting part. Therefore, many Argentine SMEs do not consider accounting activities (invoicing, collection, supplier payments, bank deposits and withdrawals, accounting adjustment entries, and so on) as being part of QMS. Disregarding these accounting and administrative processes constitutes not only a defect (pitfall) in many QMS implementations (even though the intention of measuring economic effects does exist), it also creates a gap between accounting processes and the rest of the company overall progress. As a result, the processes that are ignored are deprived of continual improvement benets in real money terms achieved through quality management system application. The difculty becomes even more noticeable when companies wish to measure economic effects of the QMS, given that: . Accounting processes can generate quality costs as any other process of the company since they consume resources from prevention and appraisal actions and they suffer failures when ever these activities are not carried out. . Accounting activities produce essential information (such as unit costs) in order to nd values of the events related to quality (such as prevention and appraisal actions or internal and external failure costs) that happen in every process. It is clear that the organization have to integrate QMS activities into all accounting department performance. 5.2.2 To dene a chart of accounts. As described before, the proposed measurement method consists of analyzing economic results through criteria related to quality. This activity involves grouping outcome causes into accounts, which would allow such analysis. In other words, it would be necessary to create a chart of all accounts, which will enable managers to classify revenue and expenses according to quality perspectives. The main accounts that should be included in this chart are the following: (1) Revenues: . I.1 Basic revenue: It includes all the revenues produced by normal activities of the company regardless of quality management system related actions. . I.2 QMS indirect revenue: It includes the additional revenue realized because of QMS activities implementation. In practice, it is the amount of sales which would not have taken place if the QMS had not been implemented.

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(2) Costs: . II.1 Basic cost: It includes all the costs incurred on normal activities of the company which are not related to quality. . II.2 QMS controllable cost: It includes costs that are associated with implementation and operation of QMS, such as prevention and appraisal costs. . II.3 QMS non-controllable cost: It includes all the costs caused by failures produced due to quality management shortcomings. In practice, it is the monetary amount spent by direct effect of failures (internal and external costs). . II.4 Cost associated with QMS indirect revenue: It includes the cost of sales of product units which constitute the additional revenue generated because of QMS implementation. (3) Net income: . III.1 Net income: It is obtained subtracting costs from revenues. It is important to mention that, when considering particular cases, these accounts must be disaggregated into subsidiary ones. 5.2.3 To adapt or design needed records. Records are amongst the most relevant documents of QMS. In order to be able to measure quality management economic effects, companies must generate records that provide further information other than an ordinary QMS would do to fulll standard requirements. This additional information should allow the company: . To reclassify actual accounting costs according to the quality chart of accounts described above (item 5.2.2.). . To make estimates about economic results that would have been achieved if the company had managed its quality with various degrees of stringency (different from the actual ones). Consequently, this stage consists of rst of all dening the types of information that are necessary to enable the company to carry out these tasks, and then comparing it to what are already available and nally removing the gap between them. It would require adapting the ordinary QMS records (adding data spaces if necessary) and designing and implementing new record system. Some of the ordinary QMS records are, for instance: personnel training records (number of hours, trained employees, and teachers), maintenance records (number of repaired machineries, number of hours spent, type of maintenance done), production records (number of produced units, consumed resources) and non-conforming records (rejects, detail of failures and rejects and decisions made in each cases). With reference to the new records to be designed to carry out economic measurements, there could be, for instance, a personnel unit cost record (such as unit cost for each category of employee), a xed charge record, a resource unit cost record (unit cost of each raw material type) and a sales evolution record (including overall sales records and those based upon individual customer information).

5.2.4 To create or adapt a scorecard. Scorecard management, or the use of a similar tool, is indispensable in order to be able to measure QMS economic effects. Its use allows, starting from past information about non-nancial indicators of various dimensions, to deduce cause- effect relationships amongst such indicators. In other words, it allows knowing how a variable or indicator would behave if another one suffered any change. For example, a manager could estimate what the evolution of the number of failures in a process would be like if certain prevention or appraisal action were implemented; or, in the same way, a sales manager could know how customers would react if certain number of failures did happen or didnt happen. Even though the scorecard is an extremely important tool to manage quality, international standards do not require it as a mandatory requirement to QMS certication. Hence, it is possible that companies that do not use scorecards may have in place a QMS. This stage will require a verication of the fact that a company is managing a scorecard (or a similar tool) and, if not, suggestions would be that they do design and implement one. 5.3 Measurement activities Once the measurement system is designed it must get implemented. Measurement activities are performed at the end of each period in order to obtain reports which can show economic effect of QMS implementation. In this section, measurement activities should be described through a practice example. Data displayed in the following example is a simplied model and it is not obtained from an actual case given here merely to simplify understanding of the overall operation of the tool. If applied to a particular organization, it would provide further information with a greater degree of detail. This example is from a company that has implemented a QMS and has considered only two actions: (1) preventive action example: training of production department staff. Let us assume that this training service is outsourced. (Assuming further that the current level of training is optimal); and (2) appraisal action example: control of product quality at the end of the production line carried out by internal staff (Assuming that managers are analyzing the choice of purchasing a machine which can perform this control activity automatically, but it has not yet been decided). Let us assume further that every product with a defect as a failure must be discarded and the company needs to know the economic effects of implementing such quality management decision. This situation would encourage managers to resort to the proposed measurement method. Let u suppose that that the company has performed the required action and has incorporated accounting departments into the QMS, and dened a quality chart of accounts, and adapted and designed the needed records and created a scorecard. This scenario would create a data table as depicted in Table I. Now, the company should be ready to carry out the next measurement activities. 5.3.1 Obtaining real economic information under an accounting perspective. A report, such as given in Table II, would follow.

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Concept Total revenue Total cost and expenses Average price per product unit Average cost per product unit

M. unit Dollars Dollars Dollars Dollars

Number Source of information 2,300 2,050 1 0.80 Income Statement record (Accounting) Income Statement record (Accounting) Price list record (Commercialization) Design record (D&D); personnel cost record (Human resources); Raw material cost (Purchasing) 0.50 Customer contract record (Commercialization) 120 Personnel training record (Human resources) 0.50 Outsourced service costs record (Purchasing) 200 Activities per employee record (Human resources) 0.20 Personnel/staff cost record (Human resources) 100 Scorecard (Data analysis) 170 Customer claims record (Customer satisfaction) 100 Non-conforming product record (Quality control) 3 Scorecard (Data analysis) 50 110 160 Durable good price record (Purchasing) Scorecard (Data analysis)/Machine specications (Purchasing) Scorecard (Data analysis)/Machine specications (Purchasing)

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Compensation cost per product unit Dollars paid to customers due to failures Time spent on staff training Hours Cost per hour of staff training Time spent on product quality control Cost per hour of product quality control Failures avoided due to training Failures occurred but not detected Failures occurred but detected by control Product units whose sale does not take place due to every non-detected failure Cost of quality control machine (if it was purchased) Period depreciation Hypothetical non-detected failures (if the new quality control machine was used) Hypothetical detected failures (if the new quality control machine was used) Dollars Hours Dollars Number Number Number Number Dollars Number Number

Table I. Periodic cost information

Table II. Report of actual economic information under an accounting perspective

Concept Total revenue Total cost and expenses Net income

Actual gures (dollars) (accounting perspective) 2,300 (2,050) 250

Data in this report (Table II) are obtained directly from the period information (Table I). 5.3.2 Obtaining actual economic information according to the quality perspective. Accounting for actual income categories must be classied according to the chart of accounts under the quality perspective created during previous stages (item 5.2.2). Net income should be the same as that from Table II, but added components will be different. This is shown in Table III.

Figures in this report (Table III) are obtained by means of formulae presented in the Appendix (Section I: actual setting formulae). 5.3.3 Obtaining hypothetical economic information according to the quality perspective. Simulation technique must be used in order to calculate economic results, which would have been achieved provided the company had adopted different actions regarding quality management actions. Hence, an estimation of QMS impact on the organizations economic result will become known. For instance, two extreme hypothetical settings could be simulated; such as: (1) Setting A: If QMS had not been implemented at all (If the company had implemented neither prevention nor appraisal actions). (2) Setting B: If QMS had in fact been implemented with absolute strictness (If the company had purchased the machine to performs quality control checks automatically). A report such as the following should then be created (as shown in Table IV) giving out the information. Note that the gures for Actual Setting column have already been calculated. Figures for settings A and B are obtained by means of formulae included in the appendix (Section II for Setting A and section III for Setting B). 5.3.4 Understanding the information obtained. Starting from the information disclosed through these tables, managers should be able to draw some conclusions about the economic relevance of quality management. For instance:

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Concept I.1 Basic revenue I.2 QMS indirect revenue II.1 Basic cost II.2 QMS controllable cost II.3 QMS non-controllable cost II.4 Cost associated with QMS indirect revenue Net income

Actual gures (dollars) (quality perspective) 1,700 600 (1,169) (100) (301) (480) 250

Table III. Report of actual economic information according to a quality perspective

Concept I.1 Basic revenue I.2 QMS indirect revenue II.1 Basic cost II.2 QMS controllable cost II.3 QMS non-controllable cost II.4 Cost associated with QMS indirect revenue Net income

Different settings (dollars) (quality perspective) Setting A Actual setting Setting B 1,700 0 (1,169) (0) (481) 0 50 1,700 600 (1,169) (100) (301) (480) 250 1,700 780 (1,169) (110) (271) (624) 306

Table IV. Report of hypothetical economic information according to the quality perspective

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Implementing a QMS was the right decision to take since it has produced an increase of net income by U$S 200, coming from the difference between Setting A net income (U$S 50) and Actual Setting net income (US$ 250). This information proves that a QMS is not a window dressing to improve the image of companies, but a real thing to help increase company prot. If the company implemented the QMS with absolute strictness through changing manual quality control for the automatic one (Setting B), it could cause economic improvement. Resulting data show that, keeping other variables constant, QMS actions alone were able to provide an additional net income of U$S 56 (difference between Setting B net income, which equals U$S 306, and the Actual Setting net income that amounts to U$S 250). Comparing QMS non-controllable cost for Setting A (U$S 481) to that for Actual Setting (U$S 301), it may further be concluded that failure costs (both internal and external) have a big economic impact on account of product replacement cost (every product suffering a failure must be discarded). Similarly, comparing QMS indirect revenue for Setting A (U$S 0) to that for Actual Setting (U$S 600), it is clear that the decrease of sales caused by external failures takes way a big chunk of prot.

The report highlights that actions, which have been carried out through the QMS are worthwhile, and that the benets outweigh the cost (it may be understood by comparing either Setting A to Actual Setting or Actual Setting to Setting B). In general, the revenue increase and the cost decrease are greater than the cost increase as the company improves its quality. If observed with greater detail and seriousness, the report shows that preventive actions (training) will have a yet higher overall economic impact; whereas appraisal actions (quality control inspections), even though they do not have great inuence over QMS non-controllable cost because of being after the fact event, they do have strong effects on QMS indirect revenue. 6. Conclusions Argentine SMEs show deciencies in quality commitment both during the QMS implementation stage and during the performance stage. The main reason for these difculties is the existence of a lack of knowledge and grasp about the actual purpose of quality management and about the economic effects that it may have on the bottom line of these companies. The measurement tool described in this paper allows company to know, on the one hand, the actual economic result generated by QMS implementation; and on the other hand, the prots, which could have been obtained if the system had been managed with utter strictness. The method described in this paper becomes a valuable tool when managers need to make valuable decisions. It contributes to improve the operational performance of the company and allows better communication between accounting departments and those related to production or provision processes. It is important to mention that this measurement method has been described in overall simplied terms and in order to draw further conclusions, it ought to be applied

in practice to verify various particular cases. It may just require only some minor adjustments in ordinary QMS and a lot remains to be learned by way of further future research.
References International Organization for Standardization (2005), Norma internacional ISO 9000:2005: n de la Calidad Fundamentos y vocabulario, Ginebra. Sistemas de Gestio Tulsian, P.C. (2002), Tulsians Accountancy, Ratna Sagar, New Delhi. Further reading Adam, E.E. Jr, Hershaver, J.C. and Ruch, W.A. (1985), Productividad y Calidad, Editorial Trillas, xico DF. Me n 2000, Barcelona. Amat, O. (1993), Costes de Calidad y de no Calidad, Ediciones Gestio ola de Contabilidad y Administracio n Espan n de Empresas (1995), Costes de Calidad, Asociacio ola de Contabilidad y Administracio n de Empresas, Madrid. Asoc. Espan as de Santos, Campanella, J. (1992), Principios de los Costes de la Mala Calidad, Ediciones D Madrid. n de Calidad Total, Asociacio n cooperadora: FCE UNC, Castellano, N. (2002), TQM Gestio rdoba. Co xico. Crosby, P.B. (1989), La Calidad no cuesta, Continental S.A., Me as de Santos, Madrid. Deming, W.E. (1989), Calidad, Productividad y Competitividad, Ediciones D xico DF. Feigenbaum, A.V. (1990), Control Total de la Calidad, ECSA, Me a, N. (1999), Contabilidad de Gestio n, Asociacio n Cooperadora, FCE-UNC, Co rdoba. Garc as de Santos, Madrid. Harrington, H.J. (1990), El Coste de la Mala Calidad, Ediciones D International Organization for Standardization (2008), Norma internacional ISO 9001:2008: n de la Calidad Requisitos, Ginebra. Sistemas de Gestio n para la Calidad, D az de Santos, Madrid. Juran, J.M. (1990), Juran y la planicacio Juran, J.M. (1993), Manual de Control de Calidad, McGraw-Hill, Madrid. n 2000, Kaplan, R.S. and Norton, D.P. (2002), Cuadro de Mando Integral, Vol. 2000, Gestio Barcelona. xico. Laboucheix, V. (1994), Tratado de la Calidad Total (Tomo I), Limusa Noriega editores, Me n 2000 S.A., Barcelona. Senlle, A. (2001), ISO 9000:2000 Calidad y excelencia, Ediciones Gestio gica de Costos: La nueva herramienta Shank, J.K. and Govindarajan, V. (1995), Gerencia Estrate . para desarrollar una ventaja competitiva, Norma, Bogota Tague, N.R. (2005), The Quality Toolbox, ASQ Quality Press, Milwaukee, WI. a, R.J. and Chavez, O.A. (1997), Contabilidad Viegas, J.C., Fronti de Garcia, L., Pahlen Acun Presente y Futuro, Ediciones Macchi, Buenos Aires.

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Appendix. Formulae This Appendix gives formulae to obtain the gures displayed in Table II and Table III. The information necessary for these calculations are obtained from Table I. Section I: Actual setting formulae I.1 Basic revenue. It is obtained by subtracting QMS indirect revenue (calculated below, formulae 2 to 4) from total revenue (in accounting perspective), i.e.: 2; 300 2 600 1; 700 1

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I.2 QMS indirect revenue. Indirect revenue depends on external (non-detected) failures. First of all, the number of non-detected failures that have been avoided by QMS must be determined. As an example, say if 100 failures could have been prevented due to proper training (which would have been not detected because the quality control checks had not been made). And, 100 more failures could have been prevented because of quality control checks. Therefore, 200 external failures could have been prevented, i.e.: 100 100 200 2

We know that non-detected failures can cause loss of sales or three product units lost per failure. Hence, product units whose sale loss has could have been avoided by (or product unit whose sale was due to) QMS implementation amounts to: 200 3 600 3

Taking into account the price per product unit being US$1, it can be concluded that revenue indirectly retained due to QMS amounts to U$S 600, i.e: 600 1 600 4

II.1 Basic cost. The basic cost is obtained by subtracting all QMS controllable cost, QMS non-controllable cost and cost associated with QMS indirect revenue (all calculated below, formulae 6 to 12) from total cost and expenses (accounting perspective), i.e.: 2; 050 2 100 2 301 2 480 1; 169 5

II.2 QMS controllable cost. It is the result of adding costs expended to implementing both types of quality management actions that is, preventive and appraisal actions. The preventive action, such as training of production department staff, requires the company to spend US$60, which is the result of multiplying the number of training hours by the cost per hour, i.e.: 120 0:50 60 6

The cost of the appraisal action by quality control checks or inspection at the end of productive process amounts to US$40, which is the result of multiplying the number of hours worked by employees by the cost per hour, i.e.: 200 0:20 40 Therefore, total QMS controllable cost equals: 60 40 100 8 7

II.3 QMS non-controllable cost. It equals the sum of internal and external failure costs. Internal failure cost is obtained by multiplying the number of failures detected by quality control by the

average cost per product unit, given it was alleged that every product suffering a failure must be discarded, i.e.: 100 0:80 80 9

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External failure cost may be calculated by multiplying the number of non-detected failures (external failures) by the resulting gure of adding the average cost per product unit (U$S 0.80) and the compensation that must be paid to customers per each failure (U$S 0.50), i.e.: 170 1:30 221 Consequently, total QMS non-controllable cost equals: 80 221 301 11 10

II.4 Cost associated with QMS indirect revenue. As previously mentioned, this is the cost corresponding to product units whose sale loss has been avoided by (or product unit sold due to) the implementation of a QMS. The reason for subtracting this cost is that if these sales had been lost, this cost would not exist. The amount of product units sold due to QMS was already calculated above (formula 3) and is 600 (units). Then, the cost associated with QMS indirect revenue results from multiplying this amount by the average cost per product unit, i.e.: 600 0:80 480 12

Section II: Setting A formulae I.1 Basic revenue (Setting A). It equals Actual Setting basic revenue given that these are the returns that would have been obtained if the company had not implemented the QMS (see formula 1). Then it is U$S 1700. I.2 QMS indirect revenue (Setting A). This is the revenue achieved by means of QMS. Because in this setting the company has performed neither prevention nor appraisal action, QMS indirect revenue equals U$S 0. II.1 Basic cost (Setting A). It equals Actual Setting basic cost (see formula 5) given that this is the cost spent in current transactions and, therefore, not caused by lack of quality Management. Thus, this cost amounts to U$S 1169. II.2 QMS controllable cost (Setting A). There is no QMS controllable cost in this setting, because no quality action (preventive or appraisal) has been carried out. Consequently, its value is U$S 0. II.3 QMS non-controllable cost (Setting A). If any prevention action had not been taken, no failures would have been prevented from happening. Therefore, the amount of failures would have been equal to the sum of avoided and occurred (detected or not) failures in Actual Setting, i.e.: 100 170 100 370 13

Moreover, because no appraisal action had been performed either, all these failures would have been external (non-detected by control), which means that the cost of each one would be the result of adding the average cost per product unit and the compensation cost paid to customers due to failures. That is to say: 0:80 0:50 1:30 14

TQM 23,4

Therefore, QMS non-controllable cost would amount to: 370 1:30 481 15

472

II.4 Cost associated with QMS indirect revenue (Setting A). This kind of cost is not seen in Setting A as there is no QMS indirect revenue. Thus, the cost associated with QMS indirect revenue amounts to U$S 0. Section III: Setting B formulae I.1 Basic revenue (Setting B). It equals Actual Setting basic revenue as it is the revenue, which is not associated with QMS (see formula 1). Then it is U$S 1700. I.2 QMS indirect revenue (Setting B). The effect of the appraisal action, which has not been taken in Actual setting (purchasing a machine to replace manual quality control) would have been a decrease of external failures. In other words, the amount of failures would have been the same but some of the external ones (non-detected) would have been internal because they would have been detected by the new control. In order to estimate the hypothetical revenues in case the control method had been changed, the rst thing to do is to obtain the number of additional product units that would have been sold. If the new control method had been implemented, 60 more failures would have been detected. This is the result of subtracting failures occurred and detected by control (100 failures) from hypothetical detected failures (if the new quality control machine was used) (160 failures). This amount must be multiplied by unsold product units due to every undetected failure, i.e. three units. 60 3 180 16

Then, additional revenue in this hypothetical case is obtained by multiplying the number of additional product units that would have been sold by the average price per product unit, i.e.: 180 1 180 17

And, the total amount of QMS indirect revenue is obtained by adding up this additional revenue (US$180) to QMS indirect revenue for the Actual Setting (US$ 600). 180 600 780 18

II.1 Basic cost (Setting B). It equals Actual Setting basic cost (see formula 5) given that this is the cost of current transactions of the company and therefore, is not inuenced by quality management. Thus, basic cost amounts to U$S 1169. II.2 QMS controllable cost (Setting B):. In order to know the amount of this concept, the cost of each implemented action (prevention and appraisal) must be considered. Preventive action would have been the same as it is for Actual Setting, given that, as mentioned before, training level is optimal. Consequently, prevention cost would have been as high as for Actual setting, i.e: 120 0:50 60 19

Appraisal action, related to quality control inspection would have been different for Setting B. Its cost would not have been US$40 (as for Actual Setting) but US$50, given this is the hypothetical amount of depreciation per period of the purchased machine.

Therefore, QMS controllable cost would have been: 60 50 110 20

II.3 QMS non-controllable cost (Setting B). As mentioned before, if the manual preventive action had been replaced by the automatic inspection method (that is to say if the quality control inspection machine had been purchased), the amount of external failures would have been lower and the amount of the internal ones would have been higher, given that more failures would have been detected. And, because internal failures costs are cheaper than the external ones, non-controllable cost would have been less in this setting. One way of reaching this amount is by obtaining the differences between this setting and the actual one for each category. In this setting, the amount of internal failures would have been higher by 60 units than in Actual Setting, (hypothetical failures that would have been detected if the new quality control machine had been used are 160, and failures actually detected by manual control are 100). But, the cost of each internal failure is US$0.80. Therefore, the additional cost would have been: 60 0:80 48 21

Measuring economic effects 473

The total internal failure cost for Setting B is obtained by adding this gure to the one for Actual Setting (US$80, see formula 9), i.e; 80 48 128 22

Therefore, the amount of external failures would have been lower by 60 units than in Actual Setting (hypothetical non-detected failures that would have occurred in case when the new quality control machine had been used which would be equal to 110 failures actually occurring but not detected by manual control as being at 170). The cost of each external failure is US$ 1.30 (adding compensation cost paid to customers due to failures and average cost per product unit) and therefore, the avoided cost would have been: 60 1:30 78 23

The total external failure cost for Setting B is obtained by subtracting this gure from the one for Actual Setting (US$ 221, see formula 10), i.e: 221 2 78 143 Consequently, non-controllable cost would have amounted to: 128 143 271 25 24

II.4 Cost associated with QMS indirect revenue (Setting B). As explained above, this is the cost corresponding to product units whose sale loss has been avoided by QMS implementation. The number of additional product units (compared to Actual Setting) that could have been sold in Setting B has already been calculated when obtaining the QMS indirect revenue (formula 16). It amounts to 180 units. Then, the additional cost would have been this gure multiplied by the average cost per product unit, i.e; 180 0:80 144 26

Finally, the total cost associated with QMS indirect revenue for Setting B would have been this amount plus that one for Actual Setting (US$480, see formula 12). 144 480 624 27

TQM 23,4

474

About the author Leonardo A. Sedevich Fons achieved a Degree in Accounting from Universidad Nacional de rdoba, Argentina in 2000 and he is now nishing his PhD Degree in Economic Science from Co the same institution. He held several positions related to accounting and management with different Argentine companies before becoming a freelance adviser in 2007. Since then he has led various consultation projects for Argentine companies. As a researcher, he has taken part in several research projects and written papers in the eld of management control for Universidad rdoba. He has also worked as a trainer for IRAM Filial Mediterra neo (Argentine Nacional de Co Standardization and Certication Institute). He can be contacted at: lsedevich@napcc.com.ar; nonsedevich@hotmail.com

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