Sol16 4e

CHAPTER 16: THE MANAGEMENT AND CONTROL OF QUALITY
QUESTIONS
16-1 The American Heritage Dictionary defines quality as: 1. a characteristic or
attribute of something; property; a feature. 2. the natural or essential character of
something. 3. excellence; superiority.
From a managerial perspective, quality can be defined as the degree of
conformity between what a customer receives and what a customer is promised.
Alternatively, we can conceptualize quality as the total level of satisfaction
received by the customer.
For purposes of management accounting and control, quality can be broken
down into two components: design quality and performance quality. The former
refers to the extent to which the features (attributes or characteristics) of the
product or service are those desired by the customer. The latter refers to the
difference between the design specifications of the product and the actual
performance of the product. Chapter 16 deals primarily with the management
and control of performance quality failures.
16-2 Among factors that might have caused lapses in quality in some firms in the
United States were: (1) years of success, (2) lack of competition from foreign
companies and (3) absence of information regarding total spending on quality.
These and other factors contributed to a lack of awareness that the cost of
quality could be substantial and, more often than not, more than the cost of
manufacturing. Alternatively, minimizing the total quality-related costs could be
the source of competitive advantage for an organization.
16-3 Procter & Gamble defines TQM as the unyielding and continually improving
effort by everyone in an organization to understand, meet, and exceed the
expectations of customers. Typical characteristics of TQM include focusing on
satisfying customers, striving for continuous improvement, and involving the
entire workforce.
TQM is a continual effort and therefore never complete. Global competition, new
technologies, and ever-changing customer expectations make TQM a continual
effort for a successful firm.
16-4 The Malcolm Baldridge National Quality Award (www.quality.nist.gov) is an
annual award created by the U.S. government to recognize U.S. companies in
manufacturing, small business, service, education, and healthcare that excel in
quality achievement and quality management. ISO 9000 is a set of certification
guidelines for quality management and quality standards developed by the
International Organization for Standardization in Geneva, Switzerland
(www.iso.ch/welcome.html). To be ISO-9000 certified, a firm must document a
process to ensure quality related to the design, development, production, final
Blocher, Stout, Cokins, Chen, Cost Management, 4/e
16-1
The McGraw-Hill Companies 2008
inspection and testing, installation, and servicing of products, services, and

processes. To be certified, an organization has to document its process for
controlling quality and must pass a rigorous third-party audit of its manufacturing
and customer-service processes.
As quality became a major focus of many businesses throughout the world,
being recognized as having high quality, or at least processes in place to ensure
quality, opens the door to potential customers, increases the confidence of
current customers, raises the morale of employees, and improves operating
results. Many European companies and governments purchase products or
services only from ISO-9000 certified firms.
16-5 Traditional accounting systems do not attempt to track the total cost of quality.
That is, quality-related costs are spread throughout various accounts, including
overhead, selling, general, and administrative expenses. As a result,
organizations cannot know how much of each sales dollar is consumed by
quality costs and, further, for any quality-related investments what the financial
return might be. That is, traditional systems are not helpful for managing and
controlling quality and quality-related costs.
16-6 Continuous improvement (Kaizen) in total quality management is the belief that
quality is not a destination; rather, it is a way of life and firms need to
continuously strive for better products with lower costs.
In today's globally competitive environment, where firms are forever trying to
outperform the competition and customers present ever-changing expectations,
a firm may never reach an ideal quality standard and, as such, needs to
continuously improve quality and reduce costs to remain competitive.
16-7 As illustrated in Exhibit 16.3, a comprehensive framework for managing quality
consists of a number of elements and characteristics. For example, the driving
force behind the framework is the goal of understanding and then satisfying
customer expectations. Second, consistent with the principle of TQM, the
framework depicts a cyclical (or continuous) process. Third, the framework
includes the reporting and analysis of both financial and nonfinancial quality
indicators. Fourth, techniques from outside of accounting (e.g., Taguchi loss
functions, Six Sigma goals, Pareto charts, cause-and-effect diagrams, etc.) are
needed to help identify and then correct quality problems. Finally, the framework
depicts a process that involves the entire value-chain of activities (i.e., upstream
activities, production activities, and downstream activities).
16-8 The purposes of conducting a periodic quality audit are to identify strengths and
weaknesses in quality practices and levels of a firms quality and to help the firm
identify the target areas for quality improvements.
16-9 Six Sigma is an analytical method designed to achieve near-perfect results in
terms of quality. In statistics, the Greek letter sigma stands for standard deviation
16-2
(i.e., a measure of dispersion around a mean value). On a standard normal bell

curve, one sigma above and below the mean covers approximately 68% of the
area. The complement of this, 32%, represents the area outside of the mean +/1 standard deviation. In absolute terms, a one-sigma quality level represents
approximately 320,000 defects per million. A two-sigma quality level represents
approximately 4,000 errors per million. By contrast, a Six-Sigma quality level
represents approximately 3.4 defects per million!
In terms of implementing Six Sigma, organizations typically use a DMAIC
process. In the Define stage, managers identify the underlying quality problem,
establish baseline measures and benchmarks (goals for improvement), and
agree upon measures of success.
In the Measurement stage, the Six Sigma team studies and evaluates relevant
measurement systems to determine whether they are capable of measuring key
inputs and quality attributes (e.g., product dimensions) with the desired level of
accuracy.
In the Analysis stage, the team performs graphical and statistical analyses in
order to develop preliminary hypotheses for improvement. This involves the
identification of root causes and the enablers of poor performance that need
to be corrected.
In the Improve stage, the Six Sigma team designs and conducts experiments to
find the optimal conditions needed to operate the process.
In the final stage, Control, the team implements an on-going auditing and control
mechanism to help ensure the sustainability of the new process.
16-10 One can think of Six Sigma as a management process. Thus, the basic literature
from change management may provide useful tips for successfully
implementing such programs. Brewer and Eighme, Using Six Sigma to Improve
the Finance Function, Strategic Finance (May 2005), pp. 27-33, provide the
following implementation guidance regarding Six Sigma:
Provide necessary leadership and resourcesfor Six Sigma to succeed,

the CEO and other senior managers must commit to the program.
Furthermore, they must provide the necessary resources, such as funding,
training, and time. Finally, top management should get key people to buy into
the need for Six Sigma; once buy-in is secured by key people, others are
likely to follow.
Use top talentusing top talent within the organization provides a strong
signal that top management is committed to Six Sigma.
16-3
Make training ongoingavoid one-time-event training by providing

refresher courses for all Six-Sigma participants. Such courses not only
reinforce prior training, they also introduce new ideas.
Select initial projects carefully (i.e., simple ones with high probability of
success)successful projects build momentum and credibility.
Design projects for short-term winsshort-term wins provide confirmation
that efforts are paying off. Recognitions for a job well done along the way
can help sustain long-term commitment to Six Sigma projects.
Keep people informedto overcome the fear of change, people must
understand the reasons for change. Special efforts should be made to
explain to employees why current Six Sigma projects are needed and to keep
them informed as to the progress of such projects.
Set up a Websitea dedicated Six-Sigma Web site can help project teams
avoid reinventing the wheel by providing access to a project library and
message board.
16-11 Goalpost conformance is conformance to a quality specification expressed as a

specified range (quality tolerance) around the target, where the target is the
ideal value for the process.
16-12 A goalpost conformance specifies quality as a range around the target (or ideal)
value while absolute conformance requires exact meeting of the target value
with no variation allowed.
16-13 Taguchi argues that any variation from the exact specifications entails a cost or
loss to the firm and that this loss is a quadratic functionthat is, the loss grows
larger as the variation from target, in either direction, increases.
Deviation from the exact specification increases costs such as rework, loss on
disposal, warranty repair or replacement, and hidden quality losses such as
customer dissatisfaction and loss of future business and market share. In todays
global competitive environment, these quality costs increase rapidly as
customers become ever more demanding for complete satisfaction.
16-14 In general, financial data (such as COQ reports) will be more relevant to
managers. These individuals have overall decision-making authority and
responsibility for the financial results of operations. Note that such information is
prepared only periodically.
On the other hand, nonfinancial quality data are likely to be of greater value to
operating personnel. For one thing, such measures are readily understandable
by these individuals. For another thing, such information can be used by
operating personnel to make process changes/interventions. That is, they direct
attention to underlying quality problems in the process. Finally, such measures
can be produced on a timely basisin the extreme, in a real-time basis.
16-4
16-15 Some examples of costs associated with cost of quality (COQ) categories are:
Prevention Costs: Training costs such as instructors fees, purchase of training
equipment, tuition for external training, training wages and salaries; salaries for
quality planning, cost of preventive equipment, printing and promotion costs for
quality programs, application expenses in conjunction with awards for quality;
costs incurred to certify suppliers; research on customer needs; quality audits.
Appraisal Costs: Cost of inspecting raw materials, work-in-process, and
finished goods inventories; maintenance of test equipment; process control
monitoring; inspecting machines; field testing; using statistical process control.
Internal Failure Costs: Net cost of scrap, rework cost, loss due to downgrade of
product (opportunity cost), re-inspection costs, and loss due to work
interruptions.
External Failure Costs: handling of sales returns; customer complaint
resolution; sales allowances due to quality deficiency; warranty claims; product
liability lawsuits; service calls; product liability recalls; repair costs in the field;
cancelled sales orders due to quality deficiency; loss of sales and market share
due to customer ill-will and dissatisfaction.
16-16 Prevention costs rise during the early years of implementing TQM as the firm
engages in education to prepare its employees and in the planning and
promotion of the quality program. Appraisal costs will also likely rise during the
early years of TQM, because the firm needs to ensure that quality is actually
being achieved. The increase in appraisal cost, however, is most likely to occur
at a slower pace than those of the prevention costs because at the beginning of
a TQM program there will be substantial increases in quality training and in
promotion to raise awareness on the importance of quality.
The firm may see some decreases in internal and external failure costs in the
early years of implementing TQM. However, these two costs most likely will
remain at about the same level as before during the first several years of TQM.
Many firms may actually see internal failure cost rise, because of the higher
standard demanded by the TQM or the higher level of employees awareness on
the critical importance of perfection in every step of the process. As the firm
makes progress in TQM, both internal failure and external failure costs should
decrease.
16-17 Costs of conformance are costs incurred to ensure that products or services
meet quality standards and include prevention costs and appraisal costs.
Internal and external failure costs are costs of nonconformance. They are costs
incurred or opportunity costs because of poor-quality outputs (goods or
services).
16-5
16-18 Better prevention of poor quality often reduces all other costs of quality. With
fewer problems in quality, less appraisal is needed because the products are
made right the first time. Fewer defective units also reduce internal and external
failure costs as the occasion for repairs, rework, and recall decreases.
Thus, it is generally considered easier to design and build quality in than try to
inspect or repair quality in. Theoretically, if prevention efforts are completely
successful, there will be no need to incur appraisal costs and there will be no
internal failure or external failure costs. In practice, appraisal costs usually do
not decrease, partly because management needs to ensure that quality is there
as expected. Nonconformance costs, however, decrease at a much faster pace
than prevention costs increase.
16-19 A cost of quality (COQ) report describes quality cost items a firm incurred during
the reporting period. A COQ report can help users identify and recognize the
effects of their actions on quality costs and to pinpoint areas that need attention.
16-20 Tools for identifying and/or correcting quality problems include:
Control chartA graph that depicts successive observations taken at a constant
interval with the horizontal line representing time intervals, batch number, or
production run and the vertical line representing a measure of conformance to
the quality specification.
HistogramA graphical representation of the frequency of events or causes of
an indicated (i.e., identified) quality problem.
Pareto diagram (chart)A histogram of factors contributing to a quality problem,
ordered from the most to the least frequent.
Cause-and-effect (fishbone or Ishikawa) diagramA graph that consists of
spine, ribs, and bones. At the end of the horizontal spine is an indicated
(specified) quality problem. The spine itself connects causes to the effectthe
quality problem. Each branch or rib pointing into the spine describes a main
cause of the problem. Bones pointing to each rib are contributing factors to the
cause.
16-21 A cause-and-effect diagram is a graphical method to represent a chain of
causes and effects used to sort out root causes and identify relationships
between causes or between variables. Because of its shape, the diagram also is
called a fishbone diagram. Cause-and-effect diagrams can be used
diagnostically, in conjunction with control charts, to identify the principal causes
of an identified quality problem.
16-22 Typical main causes of quality problems in manufacturing operations are: 1)
machines, 2) materials, 3) methods, and 4) manpower.
16-6
16-23 A Pareto chart (diagram) is a vertical bar chart (graph) displaying the frequency
or the number of occurrences of each quality problem, ordered from the most to
the least frequent. As such, a Pareto chart can be used diagnostically to identify
the primary sources of quality problems and to help managers prioritize quality
improvement efforts.
16-24 Customer-response time (CRT) is defined as the amount of time between the
time a customer places an order and the time the order is received by the
customer. CRT can be broken down into three components: receipt time (lapse
of time between when a customer places an order and when that order is
received by manufacturing); manufacturing lead time (the amount of time
between when an order is received by manufacturing and when that order is
completedsee below); and, delivery time (lapse of time between when an
order is finished and when the customer receives that order).
Manufacturing lead (manufacturing cycle) time is defined as the lapse of time
between when an order is received by manufacturing and when that order is
completed. Thus, manufacturing lead time is equal to the sum of waiting time +
processing (manufacturing) time.
Cycle time efficiency (also known as throughput time ratio or process cycle
efficiency) is the ratio of time spent on value-added activities to the sum of time
spent on value-added and non-value-added activities; for example, cycle time
efficiency = processing time/(processing time + moving time + storage time +
inspection time).
16-25 As indicated by Exhibit 16.3 and the accompanying discussion in the chapter,
management accountants are involved extensively in the design and operation
of a comprehensive model (framework) for managing and controlling quality.
However, the key role played by management accountants, because of their
expertise in this regard, is the generation of relevant financial and nonfinancial
measures of quality. In terms of the former, accounting provides relevant cost
(and revenue) data that decision-makers can use to evaluate the desirability of
spending and investments in quality. (This role is compatible with the discussion
in Chapter 9 of the text.) As well, management accountants play a key role in
helping a cross-disciplinary team develop a COQ reporting systemthat is, a
comprehensive model, with subcategories, for capturing quality costs across the
value chain.
Also noted in Exhibit 16.3 is the use of nonfinancial quality indicators, both
internal and external (customer satisfaction measures). The management
accountant would typically be involved in the design of systems or processes
that would capture and report this information.
Finally, the management accountant can help in the design of two internal audit
functions associated with the comprehensive framework: one, the development
of quality audits (designed to ensure quality); two, the Control stage of Six
Sigma (where processes are put in place to monitor progress and to sustain the
gains associated with process improvements).
16-7
16-26
To be relevant for decision-making, financial information (i.e., costs and

revenues) must meet the dual test of being: (a) a future item, that (b) differs
between decision alternatives. Relevant costs can also be defined as
avoidable costs, or as the sum of opportunity costs plus out-of-pocket costs.
In terms of quality-related spending and investments, firms can anticipate the
following financial benefits: reduction in scrap/waste costs; reductions in rework
and re-inspection costs; reduction in inventory-holding costs; reduction in
inventory recordkeeping costs; reduction in inventory financing costs; and,
increases in sales due to improvements in quality (e.g., reduction in production
cycle times).
16-27 From a design standpoint, the following are likely desirable qualities (attributes)
of a COQ reporting system:
The system collects costs across the entire value chain, both internal and
external (so, for example, costs related to gathering consumer-preference
data and costs associated with certifying external suppliers would be
captured as part of the total cost of quality).
The system focuses on costing of activities (i.e., uses data obtained from an
ABC system).
The system includes both out-of-pocket and opportunity costs (the latter
occur within the performance failure category, i.e., either as an internal failure
or an external failure cost).
The system provides a breakdown of total quality-related costs according to
logical categories (such as prevention, appraisal, internal failure, and
external failure).
The system reports data in a time-series fashion (this would allow managers
to assess the financial effects of spending and investments in quality; it would
also allow managers to assess trade-offs between COQ categories over
time).
The system includes some baseline or appropriate benchmark (e.g., quality
costs could be reported as a percentage of sales or as a percentage of total
operating costs; benchmarks could include best-in-class performance,
either on an internal or an external basis).
16-28 In most cases, external failure costs (of the four categories) would be most
damaging to the organization. Some costs within this category (e.g., productliability lawsuits) can be huge in terms of out-of-pocket terms. Other costs in this
category relate to loss of reputation or market share associated with customer
dissatisfaction or ill-will. These costs are referred to as opportunity costs and
can also be huge in dollar terms.
16-8
16-29 As shown in Exhibit 16.1, investments in quality can lead to improved business
processes, which in turn result in improved quality of outputs (goods and
services). Improvement in quality of outputs reduces external failure costs (e.g.,
warranty expenses), reduces the amount of inventory, can lower total
manufacturing costs (e.g., inspection, rework, and inventory control costs). On
the revenue side, improvements in quality can result in an improved product
image of the company in the mind of consumers and faster throughput times.
These, in turn, can lead in the mind of the consumer to higher perceived value of
the organizations output, the financial consequence of which is higher selling
prices and increased market share. The combination of reduced costs and
increased revenues provides an increase in financial performance (e.g., ROI,
earnings per share, etc.).
16-30 High degree of process variation from target usually leads to variation in product
attributes, which are important contributors to the quality of a product. Significant
variation in process activities usually implies that there is an increased chance
that product attributes are below customer expectations. For this reason, the
Taguchi Loss Function is represented by a quadratic functionthe more the
departure from the target, the greater the assumed quality loss.
16-9
BRIEF EXERCISES
16-31
Total customer response time (CRT) = order receipt time + order wait time +
production processing (manufacturing) time + order delivery time = 10 days +
15 days + 20 days + 10 days = 55 days.
16-32
Manufacturing cycle efficiency is defined as the ratio of value-added time to

the sum of value-added time + non-value-added time. In this case, PCE = 4/(4
+ 4 + 3 + 2) = 4/13 = 31% (approximately). That is, actual processing time is
approximately 31% of total cycle time for a typical order. Note that
manufacturing cycle efficiency is also referred to as process cycle efficiency
(PCE).
16-33
Manufacturing cycle efficiency = ratio of actual processing (manufacturing)

time to total cycle time (processing time + moving time + storage time +
inspection time) = 8/(8 + 2 + 5 + 1) = 8/16 = 50%. That is, for a typical order,
actual manufacturing (processing) time is 50% of total cycle time.
16-34
The estimated cost coefficient, k, in the Taguchi loss function is calculated as

follows:
L(x) = k (x T)2
$500 = k (5)2
k = $20
16-35
The estimated total quality loss (cost) using the Taguchi loss function is
calculated as follows:
L(78) = $20 (78 75)2
L(78) = $20 x 9 = $180
16-36
Average cost per unit, based on the Taguchi loss function, is:
EL(x) = k (2 + D2) = $20 (22 + 02) = $80
16-37
Total prevention cost = equipment maintenance = $1,154; total appraisal cost =

product testing = $786. Total prevention + appraisal costs = $1,940.
16-38
Customer Response Time (CRT) = elapsed time between when a customer

places an order (September 1, 2008) and when the customer receives the
order (December 1, 2008). Thus, for this example, the CRT = 3 months.
Receipt time can be defined as the elapsed time between the date an order is
placed (September 1, 2008) and the date Manufacturing receives the order
(September 15, 2008). In this case, receipt time = 2 weeks.
16-10
Manufacturing lead time (cycle time) is the elapsed time between when
Manufacturing Department receives an order (September 15, 2008) and when
actual manufacturing is completed (November 15, 2008). In this case,
manufacturing lead time is 2 months (8 weeks).
Manufacturing lead time (8 weeks) can be broken down into waiting time and
processing (manufacturing) time, as follows:
Manufacturing wait time = time between when manufacturing receives an

order (September 15, 2008) and when manufacturing on the order actually
begins (October 15, 2008). In this case, wait time = 4 weeks
Manufacturing (processing) time = time between when manufacturing

commences (October 15, 2008) and when the job is completed (November
15, 2008). In this case, processing time = 4 weeks.
Delivery time = time lapse between when an order is finished (November 15,
2008) and when the order is received by the customer (December 1, 2008).
Here, delivery time = 2 weeks.
16-39
Correct answer is a (an increase in conformance costs resulted in a higherquality product, and therefore a decrease in nonconformance costs).
Conformance costs include prevention and appraisal costs; nonconformance
costs include failure costs (internal and external). In the present case,
conformance costs in total increased by 50% in total while total failure costs
decreased by $655 (i.e., $1,390 $735).
16-40
Each TV set contains 100 components; thus, if each component is produced

according to a 3-sigma quality level, then the probability that a given unit will
be defect-free is: 0.997100 = 0.740484. Therefore, the probability that a unit has
one or more defective modules is: 1 0.740484 = 0.259516. In practical terms,
this means that, on average, for each 100 sets produced only 74 will be defectfree.
16-11
EXERCISES
16-41 Cost of Quality (COQ) ReportingMultiple-Choice (15 minutes)
1. d
2. c
3. b
4. e
5. b
6. d
7. b
8. c
16-13
16-42 Interpretation of Six-Sigma quality expectations (ppm) (30 minutes)

Sigma
Level
1
2
One-Tailed
Area1
0.158655254
0.022750132
0.001349898
3.16712E-05 6.33425E-05
2.86652E-07
9.86588E-10 1.97318E-09
3
4
5
6
1
Two-Tailed
Area
0.317310508
0.045500264
0.002699796
63.34
5.73303E-07
0.00
Errors (Defects)
Per Million
317,310.51
45,500.26
2,699.80
0.57
Excel formula: = 1 - NORMSDIST(n), where n = sigma level (1, 2,...)
The preceding data indicate suggest a common misconception regarding the quality
level assumed under Six Sigma. Only when a defect is defined as any deviation
from the targeted level of the attribute (i.e., only when the tolerance is zero) will
the above approach represent the maximum number of defects per million
opportunities for error. Note, for example, that the expected number of errors
(defects) under Six Sigma is approximately 2 per billion (when any deviation from
target is considered a defect).
In actual practice, based on initial experience by Motorola, the application of Six
Sigma allows some variation (drift) around the target value. That is, there is an
assumption that no process can be maintained in perfect control (i.e., no drift at
all). Thus, in practice, a drift of 1.5 standard deviations around the target value is
allowed. Any deviation beyond this allowable drift would be considered a defect
or out-of-control process.
What this means is that a revised formula is needed to calculate the defects per
million as the Six Sigma methodology is applied in practice. According to Pyxdek
(http://www.qualitydigest.com/may01/html/ sixsigma.html) the Excel formula (under
the assumption of an allowable drift of 1.5 sigma) is: 1000000*(1-NORMSDIST(Z1.5)), where 1.5 = allowable drift (in standard deviations) and Z = Sigma level. For Z
= 6.0, the Excel formula returns: 3.398, the defect-per-million figure commonly, but
perhaps mistakenly, reported in the literature. (Also see, J. R. Evans and W. M.
Lindsay, The Management and Control of Quality, 6th ed. (South-Western, 2005),
Chapter 10.
16-14
16-43 Quality RatingsGraduate Business Programs (30 Minutes)

As indicated in the exercise, the various ranking sources to some extent use
different quality-related criteria. We provide an example response below, that is, an
overview of the ranking criteria used by U.S. News & World Report in their annual
ranking of graduate schools of business. U.S. News & World Report bases 40% of
its judgment on opinions of business school deans, program directors, and
corporate recruiters. Placement success accounts for 35% of the ranking, while the
remaining 25% is based on student selectivity. The intent of this question is not to
develop a definitive listing of quality criteria. Rather, the intent is to provide a
nonmanufacturing example of quality rankings that would likely be of interest to
many students.
In the 2005 survey, all 399 master's programs in business accredited by AACSB
International were surveyed by U.S. News & World Report (347 responded, of which
240 provided the data needed to calculate rankings based on a weighted average of
the quality indicators described below).
Quality Assessment (weight = 40%):
Peer Assessment Score (25%)In the fall of 2005, business school deans and
directors of accredited master's programs in business were asked to rate
programs on a scale from "marginal" (1) to "outstanding" (5). Those individuals
who did not know enough about a school to evaluate it fairly were asked to mark
"don't know." A school's score is the average of all the respondents who rated it.
Responses of "don't know" counted neither for nor against a school. About 50
percent of those surveyed responded.
Recruiter Assessment Score (15%)In the fall of 2005, corporate recruiters

and company contacts who hire from previously ranked programs were asked to
rate programs on a scale from "marginal" (1) to "outstanding" (5). Those
individuals who did not know enough about a school to evaluate it fairly were
asked to mark "don't know." A school's score is the average of all the
respondents who rated it. Responses of "don't know" counted neither for nor
against a school. About 31 percent of those surveyed responded.
Placement Success (weight = 35%):
Mean Starting Salary and Bonus (14%)The average starting salary and
bonus of 2005 graduates of a full-time master's program in business. Salary
figures are based on the number of graduates that reported data. The mean
signing bonus is weighted by the proportion of those graduates that reported a
bonus, since not everyone who reported a base salary figure reported a signing
bonus.
Employment Rates for Full-time Master's Program in Business Graduates

(11%)The employment rate for 2005 graduates of a full-time master's program
in business. Those not seeking jobs or for whom no job-seeking information is
16-15
16-43 (Continued)
available are excluded. If the proportions of graduates for whom no job-seeking
information is available and who are not seeking jobs are high, then the
information
is not used in calculating the rankings. Employment rates at graduation (0.07)
and
three months after graduation (0.14) are used in the ranking model.
Student Selectivity (weight = 25%):
Mean GMAT Scores (16.25%)The average Graduate Management Admission

Test score of students entering the full-time program in fall 2005. Scores on the
test range from 200 to 800.
Mean Undergraduate GPA (7.5%)The average undergraduate grade-point
average of those students entering the full-time program in Fall 2005.
Acceptance Rate (1.25%)The percent of applicants to the full-time program in
fall 2005 who were accepted.
Overall Program Rank: Data were standardized about their means, and
standardized scores were weighted, totaled, and rescaled so that the top school
received a score of 100; others received their percentage of the top score.
Source: U.S. News & World Report, April 10, 2006 (or, http://www.usnews.com/usnews/
edu/grad/rankings/about/07biz_meth_brief.php, accessed on April 4, 2006).
16-16
16-44 Spotting Quality in Business Programs (30 Minutes)

The purpose of this exercise is to provide an example of nonfinancial quality
measures in a context likely to be of interest to most students, not to provide a
definitive list. The instructor might point out that, depending on the mission of the
institution and its competitive strategy, items listed below could be of greater or
lesser importance (i.e., could be assigned different weights in evaluating the overall
quality of a business school).
Bulletin Boards: take a look at what is posted on the bulletin boards of the
business school. Will you find a cluttering of cheap magazine offers and offers for
temporary employment, or do you observe notices of distinguished visiting
speakers, upcoming chamber music series, meeting news from discipline-based
student clubs, and fliers for study-abroad opportunities and graduate education?
(This is an example of what is considered an unobtrusive indicator of educational
quality.)
Intellectual capital represented in the Faculty: Are the faculty active in the
profession? Do they conduct research and publish in areas that support the
educational mission of the school?
Educational Content of the Curricula: Are the curricula offered in the business
school up to date? Are there specified educational objectives associated with each
degree program? Is there a comprehensive, program-level assessment plan to
provide assurances of learning?
Resources Devoted to Education: Does the program have adequate resources
(human and financial) to accomplish its specified mission? Is the institution
financially stable? Is there adequate spending on technology?
Student-Faculty Interactions: Are the faculty involved in significant out-ofclassroom activities related to the educational process? Is there ample opportunity
for independent studies and joint faculty-student research? Are there sufficient
study-abroad opportunities in which business school faculty participate?
Mission Statement/Vision Statement: What is the societal role fulfilled by the
business school? That is, how is the world different because this business school
exists? Is the mission of the school adequately communicated to stakeholders, both
internal and external?
Assurances of Learning: Does the institution have in place a process for
determining value added? That is, is there a formal process for determining
learning outcomes vis--vis stated learning goals?
16-17
16-44 (Continued)
Diversity: Is there diversity of faculty background? To what extent does a diverse
student body exist?
Placement: What firms and organizations regularly recruit graduates of the
business school?
Alumni: How active are alumni in terms of providing financial support and
placement opportunities (i.e., internships and full-time jobs) for graduates? Does the
school have an active business advisory board/council? In what other ways are
alumni involved in the business school?
Characteristics of Entering Students: What are the average SAT scores and high
school ranks of the most recent entering class of freshmen?
Faculty Qualifications: From what institutions did faculty earn their terminal
degrees? What proportion of faculty is considered full-time? What percentage of
faculty have recent relevant professional experience? To what extent are faculty
actively engaged in the profession?
Source: The preceding listing of quality criteria is drawn from M. R. Blood, Spotting
Quality, Decision Line, Vol. 36, No. 4 (July 2005), pp. 1420.
16-18
16-45 Management Accountings Role in Six Sigma (20-30 Minutes)

At the most general level, the management accountant (because of expertise in the
measurement process) should be included as a member of the cross-functional Six Sigma project team whose responsibility it is to focus on a particular business
process, improve that process, and then move on to another project. The role of the
management accountant on the project team can perhaps best be described within
the context of the five phases of the DMAIC approach to process improvement:
Define, Measure, Analyze, Improve, and Control.
In the define phase, management accountants, because they are in the best
position to observe and document waste and excessive costs, can help identify
opportunities that warrant Six-Sigma-type projects. As a follow-up, management
accountants can help in the project selection process by providing reliable data
regarding estimated costs (e.g., required resources degree of difficulty, chance of
success) and benefits (e.g., cost savings, customer impact, expected time for
project completion) associated with alternative projects under review. In other
words, they can play a key role in making sure that the organization does not
assume projects where the expected savings wont justify the investment of Six Sigma resources.
In the measurement phase, the management accountant would work with other
members of the project team to determine whether the current measurement system
is able to collect accurate and timely data for both process inputs (e.g.,
temperatures, speeds, pressures) and process outputs (e.g., product dimensions or
product performance). Furthermore, the management accountant in this phase of
the project helps define and measure the factors that have the most influence on
process performance.
In the analysis phase, the management accountant participates in the development
of process maps, development of hypotheses regarding potential root causes of
quality-related problems, and collection of data that either confirm or refute the
hypothesized root causes. Finally, the management accountant would help in the
determination of the most important root causes.
In the improvement phase, the project team chooses the most useful and feasible
solutions to the root causes identified in the preceding step. Here, the management
accountant can help verify and document that planned or anticipated improvement
actually occur.
Finally, in the control phase, the management accountant can help in the
development of control tools such as audits and check sheets that can be used to
ensure sustainability of the process improvements implemented in the preceding
stage.
Source: F. Rudisill and D. Clary, The Management Accountants Role in Six Sigma,
Strategic Finance (November 2004), pp. 35-39.
16-19
16-20
16-46 Applying Six-Sigma Principles to the Accounting Function (30 Minutes)

Perhaps the most fundamental step in the project is selection of an appropriate
cross-functional team, including a project champion (in this case, it was the CFO of
the organization) and a project leader (usually either a Green Belt or Black Belt).
One framework for the project management process is DMAIC (Design, Measure,
Analyze, Improve, and Control). In the present example, the DMAIC phases
consisted of the following stages:
The Define Stagethe project team developed a statement of the problem (Too
many hours are being spent preparing quarter-end financial statements.) and a
goals statement (Reduce direct hours worked for 18 schedules from over 100 hours
to 26 hours.). The latter was determined in consultation with the primary customer
of these quarterly financial statements: the controller of the parent company. This
stage also included the development of a graphical representation of the quarterly
closing process, from the recording of journal entries to the electronic transmission
(E-trans submission) of 18 end-of-quarter schedules to the parent company.
The Measure Stagethe project team assessed the current cycle time of the
quarterly closing process and then developed a cycle-time goal for the process (in
hours). The current process consumed approximately 109 hours, as follows:
preparation of eight balance sheet schedules, 65 hours; preparation of eight income
statement schedules, 16 hours; and, preparation of two inter/intracompany
schedules, 28 hours. Thus, the overall cycle-time reduction goal was approximately
84 hours!
The Analyze Stagein this stage, the team created a fish-bone (i.e., cause-andeffect) diagram to identify possible root causes of the excessive cycle time for
quarterly closings. Four primary causes were identified: (1) a high number of hours
were spent on the balance sheet schedules, (2) the E-Trans submissions were
started late in the day; (3) one-time items were a surprise; and (4) there was a lack
of valid references. After completing the fish-bone diagram, the project team
hypothesized that three critical root causes were responsible for a large portion of
the excess cycle time: (1) lack of ongoing review of balance sheet and
inter/intracompany schedules; (2) insufficient automation in generating data; and (3)
lack of communication in financial reporting. For each of these three primary root
causes, the team identified one or more failure modes, that is, ways in which a
process could fail and what could be done to prevent or minimize such failures.
The Improve Stagefor each failure mode identified in the preceding stage, the
team calculated a risk priority number (RPN), which was defined as the product of
three characteristics of the failure mode: severity of the potential failure mode,
frequency of occurrence, and detectability. After all RPNs were calculated, the team
compiled a list of actions that addressed the causes of the potential failure modes.
Implementing these actions resulted in substantial process improvements: in the
first quarter alone, the total cycle time of the process was reduced to 32 hours,
slightly above the 26-hour goal.
16-21
16-46 (Continued)
The Control Stagein a sense, the most important control-related decision
occurred at the beginning of the project: selection of the CFO as the project
champion (process owner). After the project had been completed, the team kept its
measurement system in place so schedule-preparation times could be monitored on
an on-going basis. The team also documented for future staff members new process
procedures.
Source: P. C. Brewer and J. E. Eighme, Using Six Sigma to Improve the Finance
Function, Strategic Finance (May 2005), pp. 2733.
16-22
16-47 Cost of Quality Reporting for Environmental Performance (2030 Minutes)

The purpose of this exercise is to get students to think strategically as to how COQ
reporting might be used as part of a comprehensive approach to the management
and control of environmental costs.
1. As global natural resources become more scarce, and therefore subject to
increasing demand, society may demand greater accountability as to the
environmental performance of businesses. One recognition of this is the ISO
14000 family of standards that relate to the processes organizations have in
place to ensure environmental quality. Other firms simply feel that, as with the
case of business ethics, good environmental performance can lead to
sustainable competitive advantage.
2. There is no set answer to this part of the assignment, but student samples might
include some of the following elements:
Prevention Costs:
Process design/redesign (to produce environmentally friendly outputs)
Product design/redesign (to consume fewer natural resources, emit fewer
by-products and pollutants, etc.)
Supplier evaluation/certification costs (for example, do preferred suppliers
have ISO 14000 certification?)
Product recycling costs
ISO 14000 application costs
Appraisal/Detection Costs:
Product or process inspection
Contamination testing
Verifying supplier environmental performance
Development of environmental performance standards
Internal Failure Costs:
Treating/Disposing of Toxic Materials
Maintaining Pollution-Control Equipment
Licensing of facilities for producing contaminants
Using materials and energy inefficiently
External Failure Costs:
Government-imposed fines
Restoring land to natural state
Cleaning up contaminated soil
Cleaning up a polluted lake
Loss of reputation
16-23
16-47 (Continued)
3. There are likely opposing points of view. Companies that are included in
portfolios of high performance in the environmental (or social) area are certainly
likely to favor such disclosures. Stockholders (and potential investors) may favor
such disclosures, particularly since the external failure costs that some
companies face can have devastating effects on the ability of an organization to
be a going concern. That is, investors may value the disclosure of environmental
performance data as part of their risk-management objectives. As well,
companies that are performing well in terms of environmental performance are
likely to favor such disclosures to the investing public.
On the negative side, there is a likely bias: unless all companies would be
required to disclose such information, it might be difficult to benchmark
environmental performance. Also, it may be difficult (or even impossible) to
achieve standardization, which may reduce the informativeness of such
disclosures. Finally, some companies may oppose the disclosure of this
information for competitive reasons (that is, the disclosure of such information
might be used strategically by the companys competitors).
16-24
16-48 Cost of Environmental Quality Report (30 Minutes)

1. Sample Cost of Environmental Quality Report:
Prevention Costs:
Employee training
Product design
Supplier certification
Detection Costs:
Process inspection
Internal Failure Costs:
Depreciationpollutioncontrol equipment
Maintaining pollutioncontrol equipment
External Failure Costs:
Lake clean-up
Land restoration
Property-damage claim
Totals
Amounts
Subtotals
% of Total
Operating
Cost
$100,000
$140,000
$40,000
$280,000
2.8%
$320,000
3.2%
$600,000
6.0%
$1,800,000
$3,000,000
18.0%
30.0%
$400,000
$200,000
$500,000
$700,000
$600,000
2. With only a single year of data, it is difficult to draw any meaningful conclusions.
However, a tentative conclusion is that the company may be spending far too
little in the conformance quality area (i.e., Prevention and Detection Costs) and,
as a consequence, is incurring significant failure costs in the environmental
area.
3. Some qualities (attributes) of an effective (good) environmental quality cost
system:
Collect environmental quality-cost data from across the value chain (i.e., the
scope of data collection should be broad).
If possible, utilize activity-based cost (ABC) data, which could be used to
motivate (a) the elimination of non-value-added activities, and (b) improved
efficiency in the conduct of value-added activities.
Baseline data: environmental cost data should be compared to one or more
relevant benchmarks (sales, best-in-class performance, etc.).
Time-series results (data from a single time period are not likely to be very
informative and, in fact, can be misleading; the provision of time-series data
will inform management as to the success in reducing total spending in the
environmental cost area and trade-offs between categories).
16-25
16-49
Nonfinancial (operational) Control Measures: Environmental Performance

(1520 Minutes)
The purpose of this exercise is to get students to think about the process of
developing nonfinancial quality indicators, based on specified Environmental
Objectives (five in the present case). The purpose of these indicators is to gauge
progress in accomplishing the specified Environmental Objectives and, as such, to
motivate improved quality in environmental performance. The following answers are
suggestive only:
Minimize Hazardous Materials:
Types and quantities of hazardous materials produced (in total,
and per unit of output)
Hazardous materials as a percentage of total materials cost
Productivity measures (ratio of hazardous outputs to inputs)
Minimize Raw Materials Usage:
Types and quantities of virgin (i.e., non-recycled) materials used (in total,
and per unit of output)
Productivity measures (e.g., ratio of outputs to virgin/raw materials
consumed)
Minimize Energy Requirements:
Types and quantities of energy consumed
Productivity measures (energy consumption per unit produced, etc.)
Minimize Release of Residues into the Environment:
Pounds of toxic waste produced
Cubic metric tons of effluents
Tons of greenhouse gases produced
Percent reduction in materials used for packing product
Maximize Opportunities to Recycle:
Pounds (or tons) of material recycled
Percentage of units of output that had to be remanufactured
Power (energy) produced from incineration
16-26
16-49 (Continued-1)
The instructor might want to use some of the following example disclosures from First
Energy Corporation (www.firstenergycorp.com/environment) for illustrative purposes:
Environmental Characteristics Associated with Various
Sources of Power Generation
Biomass Power
Coal Power
Hydro Power
Natural Gas Power
Nuclear Power
Oil Power
Other Sources
Solar Power
Unknown Purchased Resources
Wind Power
Air Emissions & Solid Waste

Wildlife Impacts
Radioactive Wastes
Unknown Impacts
No Significant Impacts
Unknown Impacts
Wildlife Impacts
Air Emission Disclosure: First Quarter 2005
16-27
16-49 (Continued-2)
Radioactive Waste Produced:
Projected vs. Actual, 2004 & 2005
2004
Projected
Actual
Quantity
Quantity
2005
Projected
Actual
Quantity Quantity
Measure
High-Level
Radioactive
Waste
0.0036
0.0018
0.0040
0.0018
Low-Level
Radioactive
Waste
0.0001
<0.0001
0.0001
<0.0001 Ft3/1,000 kWh
Lbs./1,000 kWh
Source: www.firstengergycorp.com/environment
16-28
16-50 Graphical Depiction: Is there an Optimal Level of Spending on Quality, or, Is

Quality Free? (30-40 Minutes)
Quality is Free Representation
Revenues/
Costs
Revenues
Maximum
Profit
Level
Costs
Maximum quality level

(e.g., zero defects)
Quality
Interpretation: Under this conceptualization, profit maximization occurs under only

when total (i.e., maximum) quality-levels are achieved for the organizations
outputs. This view is based on a premise that customers seek the highest-quality
products and services and are willing to pay for this level of quality, even if at a
premium price. Thus, there is an underlying assumption that increases in spending
on quality are more than offset by increases in revenues; in short, quality is free.
Individuals who subscribe to this point of view maintain that increases in product
and service quality lead to increased customer satisfaction which, in turn, is a
leading indicator of improved financial performance.
16-29
16-50 (Continued-1)
Diminishing-Returns Conceptualization
Cost of
Quality
Total
Cost of
Quality
Failure
Costs
Prevention &
Appraisal Costs
Zero
Quality
Optimum Quality
Level
Maximum
Quality
Quality
Level
Interpretation: This conceptualization for spending on quality assumes a trade-off

between the costs and financial benefits of improving quality. As compared to the
previous graph, the one above suggests that optimum profits are obtained at a
quality level below maximum quality. In other words, at some point, there are
decreasing financial returns on additional spending on quality. Beyond a point,
the financial returns (benefits) from additional spending on quality are less than
the costs incurred to improve quality. This point is illustrated in the graph below.
16-30
16-50 (Continued-2)
Diminishing Returns Conceptualization: Trading Off Costs and
Benefits for Spending on Quality
Revenues
& Costs
Total
Costs
Total
Revenue
s
Maximum
Profit
Optimum
Quality Level
Quality
Level
Basically, the above representation assumes that after a point, increases in

quality spending do not generate commensurate financial benefits (marginal
revenues). The quality is free argument would hold that marginal revenues
always exceed marginal costs. The diminishing-returns representation,
however, assumes that, as is the case with other economic activities, at some
point the marginal cost of increasing quality will exceed the marginal revenues
from doing so.
16-31
16-51
Pareto Diagram (15 min)
(1)
(2)
(1) Personal emergency (32)

(2) A childs illness (26)
(3) Personal illness (12)
(3)
(4)
(5)
(6)
(4) Unexpected visitor (11)

(5) Overslept (9)
(6) Car broke down (8)
Pareto Charts (Diagrams) can be used for diagnostic control purposes, that is,
to identify the primary causes of an identified quality problem (such as
absenteeism) and, as such, to identify possible solutions to the problem. These
charts are named after the Italian economist Wilfredo Pareto; they provide a
prioritization of causes of an indicated quality problem, based on frequency of
occurrence. Thus, they focus attention on causes that could offer the greatest
potential for improving quality. A loose interpretation of the information contained
in Pareto charts is that a relatively small number (e.g., 20%) of causes represent
a majority (e.g., 80%) of reasons for the quality failure (here, absenteeism).
16-32
16-52 COQ Histogram (30 min)

1. COQ Histogram
Genova Company: Cost of Quality as % of Cost of

Goods Sold, 2007 - 2009
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
Prevention
costs
Appraisal costs Internal failure External failure

costs
costs
2009
2008
16-33
Total cost of
quality
2007
16-52 (continued)
2. Cost of Quality (COQ) as Percentage of Costs of Goods Sold (CGS):
Prevention Costs
Appraisal Costs
Internal Failure Costs
External Failure Costs
Total Cost of Quality
2009
2.0%
1.5%
14.0%
12.0%
29.5%
2008
2007
4.0%
2.5%
23.0%
18.0%
47.5%
1.0%
3.0%
27.0%
31.0%
62.0%
Prevention costs increased, then decreased, over the past three years.
Appraisal costs decreased steadily over the years.
Total failure costs, as well as internal and external components, decreased over
the years.
Total COQ as a percentage of CGS decreased from 62.0 percent to 29.5
percent.
3.
The company can probably expect its total cost of quality to continue declining
provided it maintains adequate level of quality training and other efforts to prevent
poor quality from occurring and to continue emphasis on the importance of quality.
The company was able to see the results within one year of increased efforts in
prevention. The company increased its spending on prevention costs fourfold from
2007 to 2008 and both internal and external failure costs decreased in the same
year and continued into 2009. However, the company reduced its spending on
prevention costs in 2009 to only half of the level the year before; therefore, it may
need to monitor closely the internal failure and external failure costs in 2010. It will
be a good investment to increase prevention costs if the failure costs start to climb
in 2010.
16-34
16-53 Quality Cost Classification (5-10 min)

1. Internal failure cost
3. Appraisal cost
4. Prevention cost
5. Prevention cost
6. Prevention cost
7. External failure cost
16-35
16-54
Quality Cost Classification (10 min)

3. Appraisal cost
5. Appraisal cost
6. Prevention cost
7. Prevention cost
8. Prevention cost
9.
External failure cost
16-36
16-55 Cost of Quality ImprovementRelevant Cost Analysis (20-30 Minutes)

1. Relevant cost analysis (short-term impact on annual operating profit):
Annual Cost of Lighting:
Cost of a new lighting system: $100,000 5 years =
Additional operating cost per year
Incremental cost per year
Annual Cost Savings:
Current cost of scrapped components:
50,000 units x 5% x $30/unit =
Cost of scrapped units with adequate lighting:
50,000 units x 3% x $30/unit =
Net annual cost savings
Net Annual Cost
$20,000
5,000
$25,000
$75,000
45,000
30,000
($5,000)
2. Some additional factors that might bear on this decision:
Time-value-of money (this type of problem is an example of a capital budgeting

decision; as such, the time-value-of-money should be taken into consideration).
The reduction in waste/scrapped products produced effectively increases the
capacity of the manufacturing facilityare there any viable uses for this freed-up
capacity?
What effect might the improvement in quality have on the reputation of the
company and hence sales and market share?
The financial return from reducing scrap is limited (above) to the manufacturing
cost of units that must be discarded. Are there any additional cost savings that
might be realized because of the reduction in scrap costs?
3. As indicated in Exhibit 16.3 and the accompanying text discussion, the management
accountant plays a pervasive role in a comprehensive quality management and
control system. Fundamentally, the management accountant is involved in
generating relevant financial and nonfinancial quality-related data. Such data are
used by managers for decision-making purposes (as in this exercise) and for
controlling quality-related costs.
16-37
16-56 Cost of Quality Improvements (510 Minutes)

Cost of auditors
$80,000 x 3 =
Office space and equipment
100,000
Total cost
Savings from reduced errors =
$240,000
$340,000
$600,000 x 90% =
Net savings per year
540,000
$200,000
16-38
16-57 Taguchi Loss Function Analysis (Appendix) (3040 Minutes)

1. Value of k, the cost coefficient, in the Taguchi Loss Function:
k = $20/0.0002 2
= $20/0.00000004 = $500,000,000
2. Expected Loss Using Taguchi Function:
X
0.1996
Quality Loss
L(x)
80
Probability
f(x)
0.02
Expected
Loss
1.60
0.1997
45
0.05
2.25
0.1998
20
0.12
2.40
0.1999
0.11
0.55
0.2000
0.45
0.00
0.2001
0.10
0.50
0.2002
20
0.08
1.60
0.2003
45
0.05
2.25
0.2004
80
0.02
1.60
$12.75
3. Expected Loss Using Variance Data (see table below), per Albrecht and Roth,
The Measurement of Quality Costs: An Alternative Paradigm, Accounting
Horizons (June 1992), pp. 1527:
a. D2 = (0.199991 0.2)2, where 0.20 = target value and 0.199991 = x (bar)
= mean value of the quality characteristic
= 0.000000000081
b. Expected loss = k (2 + D2)
=
$500,000,000 x
(0.000000025419 +
0.000000000081)
= $12.75
16-39
16-57 (Continued)
Probability, f(x)
x*f(x)
(x 0.199991)2f(x)
0.1996
0.02
0.003992
0.00000000305762
0.1997
0.05
0.009985
0.00000000423405
0.1998
0.12
0.023976
0.00000000437772
0.1999
0.11
0.021989
0.00000000091091
0.2000
0.45
0.090000
0.00000000003645
0.2001
0.10
0.020010
0.00000000118810
0.2002
0.08
0.016016
0.00000000349448
0.2003
0.05
0.010015
0.00000000477405
0.2004
0.02
0.004008
0.00000000334562
0.199991
0.00000002541900
x (bar) =
16-40
16-58 Using Taguchi Function to Determine Tolerance (10 Minutes)
Total quality cost = k * (Tolerance),2 where k = cost coefficient and Tolerance =

quality tolerance allowed
$40.00 = k * (0.0001)2
k = $4,000,000,000
The loss function, L(x), is therefore
$1.60 = $4,000,000,000 (x 0.2)2
So that tolerance = 0.00002, which provides the following specification:
0.2 0.00002
16-41
16-59 Relevant Cost AnalysisConversion to JIT (20 Minutes)
Income Statement Items

Sales
Less: Costs
Direct materials
Direct labor
Variable overhead
Product-level support costs
Inventory carrying costs
Operating profit
Current
Situation
After
JIT
$1,350,000
$1,650,000
405,000
297,000
378,000
162,000
18,000
$90,000
330,000
247,500
165,000
82,500
3,000
$822,000
$300,000
(75,000)
(49,500)
(213,000)
(79,500)
(15,000)
$732,000
Note to Instructor: An Excel spreadsheet solution file for this exercise is embedded
in this document. You can open the spreadsheet object that follows by doing the
following:
1. Right click anywhere in the worksheet area below.
2. Select worksheet object and then select Open.
3. To return to the Word document, select File and then Close and return
to... while you are in the spreadsheet mode. The screen should then return
you to the Word document.
16-42
16-60 Relevant Cost AnalysisQuality Improvements (20 Minutes)

Estimated cost savings resulting from the recently enacted quality program come from
two sources:
1. Manufacturing cost savings associated with the reduction in rework costs:
(reduction in reject rate) x (annual volume of output) x (total rework cost per unit)
x annual volume
= (0.05 0.035) x 15,000 units x [($480 70 200) + ($362 80) + ($80
40)]/unit
= (0.015) x 15,000 units/year x $532/unit = $119,700
2. Financing cost savings associated with the reduction in inventory holdings:
Reduction in Inventory Holdings = $400,000 $250,000 =
$150,000
Estimated inventory carry cost rate, per annum
x 0.12
Estimated annual savings due to reduction in inventories =
$18,000
3. Total estimated savings due to quality improvement program

= rework cost savings + inventory financing cost savings
= $119,700 + $18,000 = $137,700
16-43
16-61 Control Chart (3040 Minutes)

1. Control ChartManufacturing Cycle Times (Weekly Data)
2. The target cycle time is 14.0 minutes; the lower control limit is 12.0 minutes and
the upper control limit is 16.0 minutes. As indicated in the accompanying Excel
file, the mean of the 12 weekly observations is 15.2, while the sample standard
deviation is 3.6 minutes (which seems high).
Note: An Excel spreadsheet solution file for this exercise is embedded in this
document. You can open the spreadsheet object that follows by doing the
following:
3. To return to the Word document, select File and then Close and return to...
while you are in the spreadsheet mode. The screen should then return you to
the Word document.
16-44
16-61 (Continued)
3. As indicated in part (2), the mean of the sample observations (15.2) is not that far
from the target value (14.0). However, inspection of the control chart suggests
wide variability in the process, which is confirmed by the sample standard
deviation of the 12 observations around the mean value of the dataset. As well, we
note that six of the 12 observations lie outside of the control limits (4 exceed the
upper control limit, while 2 are below the lower control limit). The control of
process variability is one of the key goals of quality improvement. It may be the
case that the underlying process in this case needs to be investigated in order to
determine why there seems to be so much variability in weekly cycle times.
Perhaps some type of intervention/correction is warranted.
4. Management can determine the upper and lower control limits on their control
charts through experience (e.g., trial and error) or through the use of statistical
procedures. When these control limits are determined statistically (based on
process variability, measured either by standard deviations or on the range of
observations over time), the control chart is referred to as a statistical control
chart. Thus, the principal difference between the two types of charts is the method
used to construct the control limits.
16-45
16-62 Quality Cost Classification (10 Minutes)

1.
Prevention
Appraisal
Internal
Failure
External
Failure
a. Materials for repair of goods under

warranty
b. Inspection of goods repaired under

warranty
c. Processing customer returns
d. Canceled sales orders due to

unsatisfactory products previously
delivered to its customers
e. Maintenance costs for testing

equipment
f. Inspecting finished goods

g. Time spent to determine courses
needed for quality training
h. Debugging production software before
production begins
x
x
x
i. Technical help to resolve a

customers production problems that
may have been caused by bugs in the
software shipped with the companys
product
j.
Supervision of testing personnel
2. Conformance costs include prevention and appraisal costs. Nonconformance

costs are internal and external failure costs.
16-46
16-63 Quality Cost Classification (10 Minutes)
Prevention
Appraisal
Internal
Failure
a. Warranty repairs
External
Failure
x
b. Scrap (net)
c. Sales allowance granted due
to blemish
d. Contribution margin of lost
sales
e. Tuition for quality
management courses
f. Raw materials inspections
g. Work-in-process inspection
h. Shipping cost for product

replacements
i. Recallsprocessing costs
x
x
j. Attorneys fee for handling
environmental litigation
k. Inspection of reworked
l. Overtime premium caused by
products
rework
m. Machine maintenance
n. Tuning of testing equipment
16-47
16-64 Cost of Quality Category (3040 Minutes)

1. Cost of Quality (COQ) Report
Quality-Related Costs
Rework (labor + materials)
Recalls (processing costs)
Reengineering efforts
Repairs to Equipment
Product Replacements
Retesting
Supervision (Inspection)
Scrap (net cost)
TrainingTQM
Testing of incoming
materials
Inspection of Workin-Process Inventories
Downtime (estimated lost
production)
Product liability insurance
Quality audits
Process evaluation (to
remove causes of defects)
Warranty repairs
15,000
2. Category Totals
Prevention
Appraisal
Internal
Failure
$6,000
External
Failure
$15,000
$9,000
12,000
12,000
5,000
$18,000
9,000
15,000
7,000
18,000
10,000
9,000
5,000
1,000
$25,000
$48,000
$42,000
$51,000
3. The company is currently spending the least on preventive costs. They should
concentrate their efforts on preventive costs because they prevent poor quality
products from being manufactured. Such failure costs (internal + external) are
generally far more costly to the organization. Therefore, by increasing the amount
spent on prevention, management should be able to reduce spending on the other
cost of quality categories.
4. There are a number of possible improvements to the COQ reporting framework
illustrated above:
It is not clear from the sample report above whether the company takes a valuechain approach to collecting COQ data; that is, in theory COQ data should be
collected from across the entire value chain of activities, both internal and
external (another way to put this is that it is not clear from the report whether a
comprehensive framework is being used to collect COQ data for the
organization)
16-48
16-64 (Continued)
Does Brooks Company have an activity-based costing (ABC) system? If so, it

should identify the drivers of good quality (and poor quality!) and the activity
costs across the value chain; armed with this information the company should
work to eliminate non-value-added costs of quality (such as internal and external
failure costs).
Relative cost informationbecause the sample report includes only absolute

dollar amounts, it is impossible to determine the relative importance of both total
cost of quality and the mix of spending across the four cost categories; thus,
Brooks can relate spending to total sales revenue for the period or perhaps total
operating expenses.
Benchmarkingas noted above, in the absolute it is difficult to draw conclusions

regarding spending on quality (in total, and across categories); thus, some type
of standard or benchmark information is needed against which the companys
results can be compared. One possibility is to compare this periods results to
those from last period. A comparison to budgeted results or best-in-class
performance (either internal or external) would likely be even more informative.
Time-series datain order to properly evaluate spending on quality (i.e., assess

the results of investments in quality), it is necessary to collect time-series data.
That is, there is generally a lag between time of investment outlay and realized
financial returnsas is the case with other capital budgeting investments.
Ideally, for example, a company would want to show a decrease in total COQ
over time, with perhaps a greater proportion of conformance, rather than failure,
costs.
Relevant costsconsistent with the definition of relevant costs in Chapter 9,

COQ should include both out-of-pocket and opportunity costs.
16-49
16-65 Cost of Quality (COQ) Analysis (4550 Minutes)

1 and 2. Cost of Quality (COQ) Report
Duncan Materials Company
Cost of Quality (COQ) Report
2008 and 2007
2008
% of
Amount
Sales
Sales
$18,750
Cost of Quality
Prevention Cost
Preventive equipment maintenance
$60
Vendor certification
60
Training of factory workers
140
Product design engineering
270
Total prevention costs
$530
Appraisal Cost
Materials inspection
60
Production inspection
125
Finished product inspection
70
Product testingequipment maintenance
60
Product testing labor
90
Total appraisal costs
$405
Internal Failure Cost
Scrap (net)
300
Rework (before shipment)
180
Emergency repair and maintenance
60
Total internal failure costs
$540
External Failure Cost
Warranty repairs
400
Direct costs of returned goods
80
Field repairs
30
Product-liability settlement
60
Total external failure costs
$570
Total cost of quality (COQ)
2007
Amount
% of
Sales
$15,000
2.83%
$20
10
40
150
$220
1.47%
2.16%
300
160
225
60
210
$955
6.37%
2.88%
500
240
190
$930
6.20%
3.04%
700
250
70
360
$1,380
9.20%
$2,045 10.91%
$3,485
23.23%
16-50
16-65 (Continued)
3. From 2007 to 2008, Duncans total cost of quality (COQ) has decreased from
23% of sales to 11% of sales. Part of the decrease in COQ as a percentage of
sales is the higher sales in 2008 compared to 2007. However, even without the
sales increase, the total COQ has decreased, both in absolute and relative
amount ($2,045/2007 sales of $15,000 = 13.6%).
Duncan increased spending in 2008 on prevention (241% of 2007 amount). As
a result, each of the other three categories of COQ (viz., appraisal, internal
failure, and external failure) decreased in 2008, in both absolute dollars and as
a percentage of sales dollars.
4.
To complement the COQ data, the company may want to collect both internal
and external nonfinancial measures of quality, such as the following:
Internal Measures of Quality
The number of defects per period
Process yield (ratio of good output to total output)
Percentage first-pass yield
The percentage of defective units shipped to customers to total units of
products shipped
Throughput (or, throughput efficiency)
External Measures of Quality
The number of customer complaints
Difference between delivery date and date requested by the customer
On-time delivery percentage (total units shipped on or before the scheduled
date to the total units shipped)
Surveys of customer satisfaction
5.
As should be obvious from an examination of Exhibit 16.3, there is a role for

both financial and nonfinancial quality data (metrics) in a comprehensive
framework for managing and controlling quality. COQ (i.e., financial) data are
reported only periodically. As such, they are likely of greater interest/value to
managers. After all, these are the individuals who ultimately have responsibility
over financial performance and who make spending and investment decisions
regarding quality costs.
Operating personnel, on the other hand, are likely to find nonfinancial quality
data to be more useful. For one thing, such data are expressed in terms that
are understandable/comprehensible to operating personnel. For another thing,
these measures focus attention on processes, techniques, and procedures that
are at the root cause of quality problems. Finally, to maximize the value of
quality-related data, the information should be presented to users as quickly as
possiblein the extreme, in real-time basis. Current accounting systems are
less capable of reporting financial data in such a timely basis. Thus, for all of
the above reasons, one can argue that nonfinancial quality indicators are likely
of greater value to operating personnel.
16-51
16-66 Cost of Quality (COQ) AnalysisExcel Application (50 Minutes)

1-4: Cost of Quality (COQ)Excel-Generated Report
Cost of Quality Report
2008 and 2007
2008
2007
Cost as a
Cost as a
Amount % of Sales Amount % of Sales
$18,750
$15,000
Sales
Cost of Quality
Prevention Cost
Preventive equipment maintenance
Vendor certification
Training of factory workers
Product design engineering
Total prevention costs
Appraisal Cost
Materials inspection
Production inspection
Finished product inspection
Product testing equipment
maintenance
Product testing labor
Total appraisal costs
Scrap
Rework before shipment
Emergency repair and maintenance
Total internal failure costs
Warranty repair
Direct costs of returned goods
Field Repairs
Product liability settlement
Total external failure costs
Total cost of quality
$60
60
140
270
$530
2.83%
$20
10
40
150
$220
1.47%
60
125
70
300
160
225
60
90
$405
2.16%
60
210
$955
6.37%
2.88%
500
240
190
$930
6.20%
400
80
30
60
$570
3.04%
700
250
70
360
$1,380
9.20%
$2,045
10.91%
$3,485
23.23%
300
180
60
$540
16-52
16-66 (Continued-1)
5. Data for Trend Analysis (2008 and 2007 Category Results)
Cost of Quality (COQ)Trend Analysis
2008 and 2007
2008
2007
Prevention costs
2.83%
1.47%
Appraisal costs
2.16%
6.37%
Internal failure costs
2.88%
6.20%
External failure costs
3.04%
9.20%
Total cost of quality
10.91% 23.23%
6. Bar Chart: COQ Report, 2008 and 2007
16-53
16-66 (Continued-2)
7. Sensitivity Analysis
Sensitivity Analysis
Sales
Prevention costs
Appraisal costs
Total COQ
Notes:
1
1.05 x $18,750
2
1.06 x $530
2008
Cost as a
Amount
% of Sales
$18,750
$530
2.83%
405
2.16%
540
2.88%
570
3.04%
$2,045
10.91%
2008Revised
Cost as a
Amount
% of Sales
$19,6881
$5622
2.85%
405
2.06%
2163
1.10%
4
285
1.45%
$1,468
7.46%
0.40 x $540
0.50 x $570
3
4
Note: An Excel spreadsheet solution file for this Problem is embedded in this
following:
the Word document.
16-54
16-67 Cost of Quality (COQ) Report (40 Minutes)

1&2
BUSTER COMPANY
For 2008 and 2007
Cost of Quality
(COQ) Category
Prevention costs:
Quality training
Product design
$ 40,000
300,000
$340,000
Appraisal costs:
Testing
$80,000
80,000
Internal failure costs:

Rework
Retesting (defective
products)
Disposal of
defective units
External failure costs:
Product recalls
Field service
2008
Dollar
2007
%
Dollar
5.67
$ 50,000
270,000
$320,000
5.33
1.33
$60,000
60,000
1.00
$200,000
$250,000
50,000
90,000
90,000
340,000
5.67
85,000
425,000
7.08
$360,000
230,000
590,000
9.83
$500,000
350,000
850,000
14.17
$1,350,000
22.50
$1,655,000
27.58
Total Cost of Quality (COQ)
16-55
16-67 (Continued)
There were slight increases in both prevention and appraisal costs from 2007
to 2008. The share of sales dollars consumed by each of these two
categories also increased slightly (0.33 percentage points). These two costs
increased by $40,000 over the two years.
Both internal failure costs and external failure costs decreased substantially
in 2008 as compared to those in 2007. The company experienced a 1.41
percent decrease in internal failure and a 4.34 percent decrease in external
failure costs, which together provided a total savings of $345,000. The
savings was 863 (345,000/40,000) percent of the increase in the sum of
conformance costs (prevention plus appraisal cost).
3. Among nonfinancial measures the firm may want to monitor are:
The number of defects (e.g., per thousand or million opportunities)

Process yield (i.e., ratio of good output to total output)
Percentage first-pass yield (i.e., percentage of output meeting quality
standards upon initial production)
Throughput, in dollar of physical terms (or throughput efficiency, which is a
measure of outputs to resources used)
Average cycle time (i.e., total processing/manufacturing time for all units
produced divided by good units produced)
The percentage of defective units shipped to customers to total units of
products shipped
The number of customer complaints
Difference between delivery date and date requested by the customer
On-time delivery percentage (total units shipped on or before the scheduled
date to the total units shipped)
Surveys of customer satisfaction
Manufacturing lead time (i.e., the sum of order-wait time plus manufacturing/
processing time)
It should be noted that nonfinancial measures by themselves often have limited

meaning. Nonfinancial measures are more informative when trends of the same
measure over time are examined or when they are benchmarked against a relevant
standard, such as best-in-class performance (either internal or external).
16-57
16-68 Ethics (4045 Minutes)

1. COQ provides a general, comprehensive framework for reporting quality-related
costs using a four-category approach: prevention costs, detection/appraisal
costs, internal failure costs, and external failure costs. Thus, the COQ framework
can theoretically be applied to the management and control of environmentalrelated quality costs. That is, it is theoretically possible for an organization to
prepare a Cost of Environmental Quality Report. Such a report would likely be of
use to managers for many of the same reasons that managers see value in a
COQ report:
A Cost of Environmental Quality Report brings together environmental quality

costs into a single number, which can be an effective attention-getter for top
management (e.g., top management could see how much of each sales
dollar is consumed by environmental quality costs).
Such a report, if constructed using activity-cost data, can provide some
direction for controlling environmental costs: eliminate non-value-added
environmental activities and perform value-added activities more efficiently.
Using a category analysis allows decision-makers to assess the value of
spending trade-offs across categories (e.g., do investments in the prevention
area result in decreased environmental failure costs?).
2. Several Standards from the IMAs Statement of Ethical Professional Practice

(www.imaorg.net) relate to the ethical situation faced by Williams. The crux of
the matter, however, is that Williams has an ethical responsibility to take some
action in the matter of GroChem, Inc. and the dumping of toxic wastes. Specific
Standards that relate to the present context are as follows:
Competencemanagement accountants have a responsibility to perform their
professional duties in accordance with relevant laws and regulations.
Confidentialityin general, management accountants are required to keep
information confidential except when disclosure is authorized or legally required;
in this case, Williams may have a legal responsibility to take some type of action
regarding the dumping behavior.
Integritymanagement accountants have a responsibility to abstain from
engaging in or supporting any activity that might discredit the profession.
Credibilitymanagement accountants have a responsibility to disclose all
relevant information that could reasonably be expected to influence an intended
users understanding of reports or recommendations; furthermore, such
accountants have a responsibility to disclose deficiencies in information or
internal controls, in conformance with organization policy and/or applicable laws.
16-58
16-68 (Continued)
3.
In accordance with the IMA Standards, the first alternative (seeking the advice of
her boss) is appropriate. To resolve an ethical conflict, the IMA Standards specify
that the first step is to discuss the problem with the individuals immediate
supervisor, unless it appears that the supervisor is involved in the conflict. In this
case, it does not appear that Williams boss is involved.
Communication of confidential information to anyone outside the company is
inappropriate, unless there is a legal obligation to do so, in which case Williams
should contact the appropriate authorities.
Contacting a member of the Board of Directors would be inappropriate at this
stage. Basically, the IMA Standards specify that Williams should report the
conflict to successively higher levels within the organization and turn only to the
Board of Directors if the problem is not resolved at lower levels.
4.
Jan Williams should follow the established policy of the organization bearing on
the resolution of such conflict. If these policies do not resolve the ethical conflict,
Williams should report the problem to successively higher levels of
management, up to the Board of Directors, until it is satisfactorily resolved.
There is no requirement for Williams to inform her superior of this action
because there is credible evidence that the supervisor is involved in the conflict.
If the conflict is not resolved after exhausting all courses of internal review,
Williams may have no other recourse but to resign from the organization and to
submit an informative memo to an appropriate member of the organization.
16-59
16-69 Cost of Quality (COQ) Reporting (4550 Minutes)

1. Quality Cost Report: 2008 vs. 2007
2008
2007
PREVENTION COSTS
Systems development
Quality engineering
Total
$ 680
1,650
$2,330
$ 120
1,080
$1,200
+ 467
+ 53
+ 94
APPRAISAL COSTS
Inspection
Statistical process control (SPC)
Supplies used in testing
Cost of testing equipment
Total
$2,770
270
40
390
$3,470
$1,700
30
270
$2,000
+ 63
N/A
+ 33
+ 44
+ 74
INTERNAL FAILURE COSTS

Downtime due to quality problems
Net cost of scrap
Rework labor
Total
$1,100
1,300
1,600
$4,000
$ 600
800
1,400
$2,800
+
+
+
+
83
63
14
43
600
2,800
200
$ 3,600
$ 3,500
3,300
3,200
$10,000
83
15
94
64
$13,400
$16,000
16
EXTERNAL FAILURE COSTS

Product recalls
Warranty repairs
Customer returns
Total
TOTAL QUALITY COSTS
% Change
2.
12000
10000
8000
6000
4000
2000
0
Prevention
Appraisal
Internal
Failure
2008
External
Failure
2007
16-60
16-69 (Continued)
3.
The firm increased spending on prevention and appraisal and saw its external
failure cost decrease by 64%. Although the internal failure costs increased from
2007 to 2008, the efforts to improve quality had begun to pay off as indicated by
a decrease of $2,600 (16%) in total quality cost from 2007 to 2008.
The most significant decreases in external failure costs were in costs for product
recalls and customer returns of defective goods. These two costs accounted for
42 percent of the total COQ in 2007. Decreases in these two cost categories in
2008 led to the decrease in the overall COQ. Customers were apparently more
satisfied with the product in 2008 than the year before.
4. No. The company has just started to improve its quality and increase
customer satisfaction. A cut in quality cost will likely jeopardize the improvements
in quality the company has achieved so far. Furthermore, the cut may cast doubt
on the dedication of the company to quality improvements. Continuing the efforts
to improve quality will eventually reduce the total cost of manufacturing and
selling the product, as the company witnessed in 2008. The company most likely
will enjoy increases in sales in the long run as its customers realize the high
product quality of the companys products.
16-61
16-70
1.
Cost of Quality (COQ) ReportingExcel-Generated Solution (4550

Minutes)
LEE ENTERPRISES
COST OF QUALITY REPORT
FOR YEARS 2008 AND 2007
2008
2007
% Change
PREVENTION COSTS
Systems development
Quality engineering
Total
$106
80
$186
$64
56
$120
+ 66
+ 43
+ 55
APPRAISAL COSTS
Inspection
Product testing
Statistical process control (SPC)
Supplies used in testing
Depreciation of testing equipment
Total
$120
160
74
6
34
$394
$ 76
98
4
22
$200
+ 58
+ 63
N/A
+ 50
+ 55
+ 97
INTERNAL FAILURE COSTS

Disposal of defective products
Net cost of scrap
Rework labor
Total
$ 76
124
200
$400
$ 54
86
140
$280
+
+
+
+
41
44
43
43
EXTERNAL FAILURE COSTS

Product recalls
Warranty repairs
Warranty replacements
Field servicing
Total
$ 82
140
18
120
$ 360
$ 340
420
60
180
$1,000
76
67
70
33
64
TOTAL QUALITY COSTS
$1,340
$1,600
16
16-62
16-70 (Continued-1)
2.
3. The report indicates that prevention, appraisal, and internal failure costs have
increased from 2007 to 2008. The external failure cost category decreased by 64%. It is
likely that the intensive efforts to improve quality has begun to pay off as, indicated by a
decrease of 16% in total COQ, from 2007 to 2008.
Lee Enterprises benefits from decreases in its external failure costs. Three external
failure costs (product recalls, warranty repairs, and warranty replacements) have
decreased by approximately 70 percent from what these costs were the year before.
The cost of field services decreased 33%. Some of the field services in 2008 were
likely for sales prior to the launching of the intensive quality-improvement effort. As
the company continues with its quality improvement program, field service costs
should continue to decrease.
4. One of the most effective ways for production workers to be conscientious in their
work is to hold them responsible for mistakes. Holding employees responsible for
their work can include a policy for workers to do rework on their own time and to pay
for costs incurred for rework. Lincoln Electric Company (Harvard Business School
case) has successfully implemented such a policy for years. However, Carrie Lee is
more likely to be successful in adopting this proposal if she can implement the new
procedure gradually over a period of two to three years. The firm also would need to
revise its compensation scheme to reflect the change.
16-63
16-70 (Continued-2)
following:
the Word document.
16-64
16-71 Ethics (45 Minutes)

1. An examination of the IMAs Statement of Ethical Professional Practice
(www.imanet.org) suggests that Maria Sanchez likely violated the following
standards of ethical conduct when she asked Mary Stein to suppress pertinent
information.
CompetenceMaria Sanchez, controller, has a responsibility to:
Provide decision support information and recommendations that are accurate,

clear, concise, and timely.
Perform professional duties in accordance with relevant laws, regulations, and

technical standards.
In this instance, Sanchezs request to Mary Stein, assistant controller, to suppress

information about the component failures is unethical. This action keeps both
Sanchez and Stein from performing their duties in accordance with technical
standards and has a favorable impact on earnings, as requested by Jim March,
vice president of manufacturing. Thus, the reported financial information with the
omission lacks relevance and reliability for decision-making. Management does
not have a clear solution to overcome the component failure.
IntegritySanchez has a responsibility to:
Mitigate actual conflicts of interest. Regularly communicate with business

associates to avoid apparent conflicts of interest. Advise all parties of any
potential conflicts.
Abstain from engaging in or supporting any activity that might discredit the
profession.
Sanchezs request is unethical because she has responsibilities to report all

information of use to decision-makers in the company. Thus, she has a
responsibility to protect the overall interests and goal attainment of the company
by encouraging further study of the problem, informing her superiors of this matter,
and working with others to find solutions.
CredibilitySanchez has a responsibility to:
Disclose all relevant information that could reasonably be expected to influence
an intended users understanding of the reports, analyses, or
recommendations.
Disclose deficiencies in information, in accordance with organization policy
and/or applicable law.
16-65
16-71 (Continued)
The request by Sanchez is unethical because it would suppress information that
could influence an understanding of the results of operations by the company.
Also, by withholding information about the contingent liability, Sanchez is not
communicating information objectively.
2. Resolution of Ethical Conflictthe IMA Standards specify that when an individual
is faced with ethical issues, the individual should follow the policies established by
the organization to deal with (resolve) such conflicts. If these policies do not resolve
the ethical conflict, then the following courses of action are recommended:
The individual should discuss the issue with his/her immediate supervisor
(except when it appears that the supervisor is involved). In this regard, Stein
might want to write a report that provides details regarding the issue, including
the probable economic effects of the situation at hand. As well, she might want to
mention in the memo the request by Sanchez to suppress information regarding
the component failures.
If Stein is not able to achieve a satisfactory resolution of the matter, she should
submit the issue to the next management level. (Note: contact with levels above
the immediate supervisor should be initiated only with the knowledge of the
supervisor, assuming he or she is not involved. Normally, communication of such
problems to authorities or individuals not employed by the organization is not
considered appropriate, unless the employee believes there is a clear violation
of law.
Stein may then proceed to initiating a confidential discussion with an IMA Ethics
Counselor or other impartial advisor, in order to obtain a better understanding of
possible courses of action.
If, after exhausting all other options, the ethical conflict still exists, then Stein
may have no choice but to resign and to write an informative memorandum to
the appropriate organizational representative.
Finally, Stein may want to contact a qualified attorney to more fully determine her
legal obligations and rights concerning this ethical conflict.
16-66
16-72 Relevant Costs and Quality Improvement (2030 min)

1.
Lightening Bulk Company
Cost and Benefit Analysis of the Proposed
Scheduling and Tracking System
Cost of the new system (per year)
Expected benefits each year from the new system:
Contribution margin from sales increase:
5,000 x 10% x $200 x 40% =
Savings from decrease in misplaced items:
5,500 x (12% 1.0%) x $60 =
Savings from decrease in lost items:
5,500 x (3.0% 0.50%) x $300 =
Pre-tax cash flow per year
$ 150,000
$ 40,000
36,300
41,250
117,550
($32,450)
The new scheduling and tracking system will most likely decrease the firms pre-tax
cash flow per year. Thus, from a purely financial point of view the company cannot
justify the purchase of the new system.
2. Among other factors the manager needs to consider are: reliability and accuracy of
the estimates, including contribution margins, cost of tracking misplaced and lost
items (and their behavior patterns), and the estimated decreases in misplaced and
lost items; sales growth; useful life of the new system; changes in technologies (how
soon will a newer system replace the new system); and, training cost, including
possible downtime, for the new system.
3. Cost to handle lost or misplaced items in the country in question:
Misplaced items:
5,000 x 12.0% x 0.8 x $60 =
Lost items:
5,000 x 3.0% x 0.8 x $300 =
Total cost of lost/misplaced items
Expected decrease
Maximum amount to pay for improvements
16-67
$28,800
36,000
$64,800
x
90%
$58,320
16-73 Relevant Costs and Quality Improvement (50 Minutes)

1. Cost of new equipment and installation
Training
Net investment cost of the new process
$12,000,000
3,000,000
$15,000,000
2. Quality cost if no change is made:

Rework
(3,000 x 40%) x $2,000/unit =
Repair
(3,000 x 15%) x $2,500/unit =
Appraisal
Inspection
3,000 x $50 =
Foregone contribution from lost sales:
Contribution margin per unit:
($12,000 x 85%) $2,500 =
$7,700
Lost sales units = (3,000 0.8) 3,000 =
750
Total current cost of quality per year =
Quality cost of the new process:
Warranty repairs
(3,000 0.8) x 5.0% x $1,000/unit =
Savings from the new process each year
Years effective
Savings over Three-Year Period
Appraisal and inspection cost, Year 1($600,000 +
$50/unit x 3,000 units) =
Total savings over 3 years
3.
$ 2,400,000
1,125,000
600,000
150,000
5,775,000
$10,050,000
187,500
$ 9,862,500
x
3
$29,587,500
750,000
$28,837,500
Yes. The cost of the new process is $15,000,000 and the expected benefits total
$28,837,500 over three years. The pattern of pre-tax cash flows for this investment
opportunity is as follows:
Year 0 =
Year 1 =
Year 2 =
Year 3 =
($15,000,000)
$9,112,500
$9,862,500
$9,862,500
(i.e., $9,862,500 $750,000)
Thus, the payback period for this proposed investment is less than two years. Its
internal rate of return (IRR) is approximately 41%, as shown in the following screen
shot from Excel:
16-68
16-73 (Continued)
4. The following factors should be considered before making the final decision:
a. Accuracy of cost estimates, including:
contribution margin per unit
costs of current repair and rework
cost of repair with the new process
cost of the new process
b. Reliability of estimations of
rates of rework and repair
lost sales
amount of time before the current product become obsolete
c. Reaction of competitors
d. Time-value-of-money factor (discount rate) for capital budgeting decisionmaking
5.
The member of the board would be right if we ignore the financial payoff of the new
process and if the company is going to be in business for only three years. Having
high-quality products, especially for a high-end product such as the one the
company is selling, is crucial for a long-term success.
16-69

1. a.
$150
b.
= k x (0.0025)2
k = $24,000,000
L(x = 0.1893) = $24,000,000 x (0.1893 0.1875) 2 = $77.76
2. a. Total quality cost = k x (Tolerance) 2

$6 = $24,000,000 x (Tolerance) 2
Tolerance = 0.0005 inches
b. The specification should be set at 0.1875 0.0005
16-71

1. a.
$200
b.
= k x (5.0)2
k = $8.00
L(x = 122) = $8.00 x (122 125) 2

= $72.00
2. a. Total quality cost = k x (Tolerance) 2

$12.00 = $8.00 x (Tolerance) 2
Tolerance = 1.2247
b. The specification should be set at 125 1.2247
16-72
16-76 Taguchi Loss Function Analysis (60 Minutes)

1.
k = ($50 + $70)/(0.025)2 = $192,000
Measured
Diameter (x)
1.232
1.240
1.250
1.258
1.262
1.270
1.272
1.273
1.274
1.275
1.276
1.277
1.280
1.288
1.292
1.292
1.294
1.298
1.300
1.304
1.320
Totals
Freq.
3
2
2
3
6
6
7
18
8
5
2
2
2
1
4
2
2
1
1
Prob.
f(x)
Loss Function
L(x)
0.0250
0.0375
0.0250
0.0250
0.0375
0.0750
0.0750
0.0875
0.2250
0.1000
0.0625
0.0250
0.0250
0.0250
0.0125
0.0500
0.0250
0.0250
0.0125
0.0125
1.0000
235.200
120.000
55.488
32.448
4.800
1.728
0.768
0.192
0
0.192
0.768
4.800
32.448
55.488
55.488
69.312
101.568
120.000
161.472
388.800
Weighted Loss
L(x) * f(x)
4.4376
5.8800
4.5000
1.3872
0.8112
0.1800
0.1296
0.0576
0.0168
0
0.0192
0.0480
0.1200
0.8112
1.3872
0.6936
3.4656
2.5392
3.0000
2.0184
4.8600
36.3624
16-73
Mean Diameter
x * f(x)
0.015400
0.031000
0.046875
0.031450
0.031550
0.047625
0.095400
0.095475
0.111475
0.286875
0.127600
0.079813
0.032000
0.032200
0.032300
0.016150
0.064700
0.032450
0.032500
0.016300
0.016500
1.2756375
(x xbar)2
f(x) *(x xbar)2
0.001904275
0.000023803
0.001270067
0.000031752
0.000657307
0.000024649
0.000311099
0.000007777
0.000185995
0.000004650
0.000031787
0.000001192
0.000013235
0.000000993
0.000006959
0.000000522
0.000002683
0.000000235
0.000000407
0.000000092
0.000000131
0.000000013
0.000001855
0.000000116
0.000019027
0.000000476
0.000152819
0.000003820
0.000267715
0.000006693
0.000267715
0.000003346
0.000337163
0.000016858
0.000500059
0.000012501
0.000593507
0.000014838
0.000804403
0.000010055
0.001967987
0.000024600
0.000188981
16-76 (Continued)
Mean actual diameter, X-bar = 1.275638
D2 = (1.275638 1.275000) 2 = 0.00000040640625
2 = 0.000188981
EL(x) = $192,000 x (0.000188981 + 0.00000040640625) = $36.36
2.
Allowed tolerance:
Repair Cost = k x (Tolerance) 2
$50 = $192,000 x (Tolerance) 2
Tolerance = 0.016 cm (i.e., specification = 1.291 to 1.259)
Alternative calculation for Tolerance, given Customer Tolerance, T 0:
Tolerance = T0 x (C1/C2) 1/2
= 0.025 cm x ($50/$120) 1/2
= 0.025 cm x 0.645497 = 0.016 cm
document. You can open the spreadsheet object that follows by doing the following:
while you are in the spreadsheet mode. The screen should then return you to the
Word document.
16-74
16-77 Analyzing Cost of Quality (COQ) Reports (50 Minutes)

1.
There is an extensive literature in the area of change management from which

students can draw in order to respond to this question. Based on this literature, the
following factors might be mentioned as being critical for an organization's
successful quality program:
Evidence of top-management support, including motivational leadership and

resource commitments.
Training (including ongoing training and re-education) of those affected,
including employees and suppliers.
A cultural change leading to a corporate culture committed to the customer and
to continuous, dynamic improvement; related to this is the need to develop an
effective reward system (i.e., link performance and compensation).
2.
BERGEN, INC
Quality Cost Report
Most Recent and Most-Distant Quarter
Quality
Cost Category
Prevention
6/30/2007
% of
Amount Quality
(In 000)
Cost
% of
Prod.
Cost
9/30/2008
% of
Amount Quality
(In 000) Cost
% of
Prod
Cost
$240
25
5.83
$270
46
5.99
Appraisal
205
21
4.98
116
20
2.57
Internal failure
188
20
4.56
102
17
2.26
External failure
331
34
8.03
103
17
2.28
$964
100
23.4
$591
100
13.1
Total COQ
From an analysis of the COQ Report (oldest vs. most recent quarterly results) it would
appear that Bergen Inc.'s program has been successful because:
Total COQ as a percentage of total production cost has declined from 23.4% to
13.1%.
External failure costs, those costs signaling customer dissatisfaction, have
declined from 8.03% of total production cost to 2.28%. These declines in
warranty repairs and customer returns should translate into increased sales and
lower costs (and therefore increased profitability) in the future.
The total internal failure cost was 4.56% of the total production cost in 2007, and
is now only 2.26% of the total production cost.
16-77 (Continued)
16-75
Appraisal costs have decreased 48%from 4.98% to 2.57% of production cost.

Higher initial quality (via Prevention expenditures) is likely reducing the demand
for testing.
Quality costs have shifted to the area of prevention where problems are solved
before the customer becomes involved. Prevention costs, such as maintenance,
training, and design reviews, have increased from 5.83% of total production to
5.99% and from 25% of total quality costs to 46%. This $30,000 increase was
more than offset by decreases in other quality costs.
3. Tony Reese's current reaction to the quality-improvement program is more favorable

as he is seeing the benefits of having the quality problems investigated and solved
before they reach the production floor. Because of improved designs, quality
training, and additional preproduction inspections, scrap, and rework costs have
declined. Production does not have to spend an inordinate amount of time with
customer service since those individuals are now making the product right the first
time. It is plausible that throughput has increased and that throughput time has
decreased: work is now moving much faster through the department. (Of course,
this last assertion can be tested through the collection of relevant nonfinancial
quality indicators.)
4. To measure the opportunity cost of not implementing the quality program, Bergen
Inc. could assume that:
a.
b.
Sales and market share would continue to decline and then estimate the
revenue and income lost.
The company would have to compete on price rather than quality and calculate
the impact of having to lower product prices to do so.
5. This question is designed to make students think about a proper role of a COQ
reporting system as part of a comprehensive framework for managing and
controlling quality, such as the framework presented in Exhibit 16.3. The main point
is that COQ data can be a valuable attention-director. For example, many
organizations (confirmed by our own in-class discussions with MBA students) are
surprised to see how much spending (i.e., portion of each sales dollar) is consumed
by spending on quality. For many organizations, a reduction in overall quality costs
can be a key to significantly increasing financial performance (a point substantiated
by the empirical evidence referenced early in the chapter). Therefore, if COQ
reports are accessible, comprehensible, and viewed as reliable, they can inform
managers and operating personnel alike that quality failures can be exceedingly
expensive to the organization.
However, COQ measures are not diagnostic in nature. That is, these financial
measures do not point to ways to eliminate quality problems; however, it does
quantify in financial terms the impact of these failures on profitability. In short,
diagnostic control of quality is probably better achieved through the application of
techniques borrowed from operations management (cause-and-effect diagrams,
Pareto charts, etc.) applied to nonfinancial measures of quality. This suggests,
therefore, that one characteristic of a comprehensive framework for managing and
controlling quality is the use of both financial and nonfinancial quality indicators.
16-76
16-78 Expected Quality Cost, Confidence Intervals, and Sample Size

(30-40 Minutes, requires some material from Chapter 6: Cost Estimation)
1.
Paragon Manufacturing would be willing to spend $509,000 annually to implement

quality control inspection of the housings before assembly begins. This amount is
equal to the expected cost of rejections and repairs without quality control
inspection, calculated as follows.
Expected Value of Housings
Rejected During Assembly
(1)
(2)
(1) x (2)
Quantity
Probability
Outcome
90
0.40
36
70
0.30
21
50
0.20
10
30
0.10
3
70
Expected Value of Housings
Rejected During Performance Testing
(1)
(2)
(1) x (2)
Quantity
Probability
Outcome
50
0.50
25
40
0.15
6
20
0.15
3
10
0.20
2
36
Cost/direct labor hour = $12.00 + 18.00 = $30.00 per hour

Cost of repair material = $7.00 x 0.5 = $3.50 per housing
Rejection/repair cost per production lot
= Cost of assembly rejections + Cost of performance test rejections
= (70 x $3.50) + (70 x 0.15 x $30) + (36 x $3.50) + (36 x 1.25 x $30)
= $245 + $315 + $126 + $1,350
= $2,036 per lot
Number of lots
Annual cost
= Demand Lot size

= 200,000 800
= 250 lots
= Cost per lot x Number of lots
= $2,036 x 250
= $509,000
16-77
16-78 (Continued)
2. The sample size that Ross Webster should select from a lot of 800 housings is 265
units, calculated as follows:
nc = (2.00)2 (0.01) (0.99)
(0.01) 2
= 0.0396 0.0001
= 396
nf
3.
= 396 (1 + (396 800))

= 396 1.495
= 264.88 or 265 units in sample
a. Two defective housings in a sample of 240 is a 0.0083 rejection or error

rate (2/240). Thus, this lot should be accepted as the error rate is less
than one percent, the acceptable rate.
b. Three defective housings in a sample of 240 is a 0.0125 rejection or error
rate (3/240). Thus, this lot should be rejected as the error rate exceeds
one percent, the acceptable rate.
16-78
16-79 Benefits of Switching to JIT (50-60 Minutes)

1. A JIT manufacturing approach is considerably different from a conventional
manufacturing system. Under JIT, an output is produced only when
demanded by the customer (internal or external). At the core of JIT is a
strong commitment to quality (i.e., eliminating or reducing processing
delays, eliminating or reducing inventory holdings, reductions in operator
errors and production waste). The conceptual goal is a manufacturing cycle
efficiency ratio equal to 1.0 (i.e., elimination of all non-value-added
activities).
Under conventional manufacturing, outputs are produced according to a
production schedule that may or may not be tied directly to customer
delivery demands. Inventories of materials, WIP, and finished goods are
kept on-hand as a cushion to compensate for error, waste, and
inefficiencies, or for unforeseen circumstances. Normal inefficiencies, in
fact, are built into overhead application rates.
2. The response to this question can be crafted around an examination of
Exhibit 16.3. As indicated in this exhibit, the management accountant,
because of expertise in the area of measurement, can supply to
management relevant cost information and relevant nonfinancial
performance indicators associated with a change in manufacturing process,
such as a move to JIT.
Specifically, the management accountant can help estimate the financial
savings associated with inventory reductions and with manufacturing
efficiencies associated with JIT (e.g., reduction of scrap and rework costs),
as illustrated in this problem. However, the management accountant can
also assist in the development of nonfinancial quality indicators associated
with the move to JIT. Thus, manufacturing cycle time information, process
yields, and percentage first-pass yield data can all be collected to help
assess the overall benefits associated with the move to JIT. These
characteristics of the manufacturing process are important to monitor
because they can be leading indicators of future financial performance.
3. Annual benefits associated with the proposed move to JITin general,
improvements in quality, such as those associated with the adoption of JIT,
result in two separate benefits: increases in revenues (or, contribution
margin), and decreases in costs.
Estimated annual increase in contribution margin
= [($65 $35) x 52,000 units] + [($65 $50) x 40,000 units]
= $1,560,000 + $600,000 =
$2,160,000
Estimated decrease in inventory carrying costs:
Pre-JIT Inventory Holdings:
Raw materials = 40,000 x $15 x 4/12 =
WIP Inventory = 40,000 x $25 x 3/12 =
Finished Goods = 40,000 x $40 x 2/12 =
16-79
$200,000
$250,000
$266,667
Average Inventory Holdings = $716,667

16-79 (Continued)
Post-JIT Inventory Holdings:
Raw Materials = 52,000 x $12 x 2/12
WIP Inventory = 52,000 x $20 x 1.5/12
Finished Goods = 52,000 x $30 x 1/12
Average Inventory Holdings
=
=
=
=
$104,000
$130,000
$130,000
$364,000
Difference in Average Inventory Holdings

x Inventory Holding Cost Rate
Estimated Decrease in Inventory Holding Costs
=
=
=
$352,667
x 15%
$52,900
$1,500,000
Increase in annual lease cost

= $2,000,000 $500,000
Annual Cost/Benefit of Switch to JIT
=
$2,160,000 + $52,900 $1,500,000
= $712,900
4. Based solely on the short-term financial effect, ABC should replace the
equipment and move to JIT. The annual pre-tax net benefit ($712,900)
greatly exceeds the one-time penalty the company would have to pay to
break its existing lease.
5. Additional considerations:
This decision is technically a capital budgeting decision; as such, the

future cash flows should be stated on an after-tax basis and discounted
(at the weighted-average cost of capital) back to present value.
Is the assumption regarding a constant sales price between the two
alternatives realistic? That is, could the company increase its selling
price, post-JIT, if it realizes a significant increase in the quality of its
product?
JIT places significant pressures on employees and managers alike, to
constantly improve: is there an appropriate change agent in the
organization to lead this effort? Does the change have the full, and
visible, support of top management? Will appropriate incentives and
rewards be instituted to compensate employees for their efforts? Does
the company plan to include appropriate training programs to support
the move to JIT?
Since JIT involves smooth and efficient flows throughout the entire value
chain, have suppliers and customers been consulted and included in
any planning efforts regarding the implementation of JIT?
Has the cost of collecting, reporting, and interpreting key nonfinancial
quality indicators been factored into the analysis?
16-80

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CHAPTER 16: THE MANAGEMENT AND CONTROL OF QUALITY

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

inspection and testing, installation, and servicing of products, services, and

The McGraw-Hill Companies 2008

(i.e., a measure of dispersion around a mean value). On a standard normal bell

Provide necessary leadership and resourcesfor Six Sigma to succeed,

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Make training ongoingavoid one-time-event training by providing

16-11 Goalpost conformance is conformance to a quality specification expressed as a

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

To be relevant for decision-making, financial information (i.e., costs and

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Manufacturing cycle efficiency is defined as the ratio of value-added time to

Manufacturing cycle efficiency = ratio of actual processing (manufacturing)

The estimated cost coefficient, k, in the Taguchi loss function is calculated as

Total prevention cost = equipment maintenance = $1,154; total appraisal cost =

Customer Response Time (CRT) = elapsed time between when a customer

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Manufacturing wait time = time between when manufacturing receives an

Manufacturing (processing) time = time between when manufacturing

Each TV set contains 100 components; thus, if each component is produced

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

16-42 Interpretation of Six-Sigma quality expectations (ppm) (30 minutes)

Excel formula: = 1 - NORMSDIST(n), where n = sigma level (1, 2,...)

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

16-43 Quality RatingsGraduate Business Programs (30 Minutes)

Recruiter Assessment Score (15%)In the fall of 2005, corporate recruiters

Placement Success (weight = 35%):

Employment Rates for Full-time Master's Program in Business Graduates

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Mean GMAT Scores (16.25%)The average Graduate Management Admission

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

16-44 Spotting Quality in Business Programs (30 Minutes)

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

16-45 Management Accountings Role in Six Sigma (20-30 Minutes)

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

Blocher, Stout, Cokins, Chen, Cost Management, 4/e

The McGraw-Hill Companies 2008

16-46 Applying Six-Sigma Principles to the Accounting Function (30 Minutes)

Blocher, Stout, Cokins, Chen, Cost Management, 4/e