Hansen, Mowen, Elias & Senkow (ITP, 1998)

Week 11 - Quality Costs and

Productivity: Measurement,
Reporting, and Control
Chapter 16

Chapter 16-1

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Learning Objectives
1. Identify and describe the four types of
quality costs.
2. Prepare a quality cost report and explain the
difference between the conventional view of
acceptable quality level and the view
espoused by total quality control.
3. Explain why quality cost information is
needed and how it is used.
4. Explain what productivity is and calculate
the impact of productivity changes on profits.

Chapter 16-2

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Quality Defined
Quality of Design: The degree of excellence, which is a
function of a products specifications

Example: Compare a Cadillac Seville with a Honda Civic. The

Seville is a luxury car with specially designed features and the
Civic is an economy car with standard features. Both are
designed to provide transportation but the design quality are
obviously different

Quality of Conformance: The degree of excellence,

which is a measure of how well the product meets
its requirements or specifications

Example: If the Honda Civic does what it is designed to do and

does it well, quality exists. If an economy car is designed to
provide reliable, low-cost, low-maintenance transportation, the
desired quality exists

Chapter 16-3

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Quality Dimensions

Performance consistently
Aesthetics
Serviceability
Features or quality of design
Reliability
Durability
Quality conformance
Achievement of advertised functions
Chapter 16-4

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Measuring the Costs of Quality

Control activities
Prevention costs
Appraisal costs
Failure activities
Internal failure costs
External failure costs

Chapter 16-5

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Estimating Hidden Quality Costs

The Multiplier Method

The Market Research Method

Chapter 16-6

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Examples of Quality Costs

Prevention costs

Appraisal Costs

Quality engineering
Quality training
Quality planning
Quality audits
Design reviews
Quality circles

Inspection of raw materials

Packaging inspection
Product acceptance
Process acceptance
Field testing
Supplier verification

Chapter 16-7

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Examples of Quality Costs

Internal failure costs

External failure costs

Scrap
Rework
Downtime (defect related)
Reinspection
Retesting
Design changes

Lost sales
Returns/allowances
Warranties
Repair
Product liability
Complaint adjustment

Chapter 16-8

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Reporting Quality Costs

Quality Costs
Prevention costs:
Quality training
Reliability engineering
Appraisal costs:
Materials inspection
Product acceptance
Process acceptance
Internal failure costs:
Scrap
Rework
External failure costs:
Customer complaints
Warranty
Repair
Total quality costs

%of Sales

$35,000
80,000

$115,000

$20,000
10,000
38,000

68,000

2.43

50,000
35,000

85,000

3.04

25,000
25,000
15,000

65,000
$333,000

Chapter 16-9

4.11

2.32
11.90%

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Traditional Quality Cost Graph

Cost of Failures

Cost

Cost of Control

100%
Optional (AQL)
Percent Defects
Chapter 16-10

Hansen, Mowen, Elias & Senkow (ITP, 1998)

ZERO-DEFECT GRAPH
Cost

Total
Quality
Cost

100%
Percentage Defects
Chapter 16-11

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Types of Quality Performance

Reports

Progress with respect to a current-period

standard or goal.
Progress with respect to last years quality
performance.
The progress trend since the inception of the
quality improvement program.
Progress with respect to the long-range
standard or goal.

Chapter 16-12

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Interim Quality Cost Report

Cost Item
Prevention costs:
Quality training
Reliability engineering
Appraisal costs:
Materials inspection
Product acceptance
Process acceptance
Internal failure costs:
Scrap
Rework
External failure costs:
Customer complaints
Warranty
Repair
Total quality costs

Actual Costs

Budgeted Costs

Variance

$35,000
80,000 $115,000

$30,000
$5,000U
80,000 $110,000
0

$20,000
10,000
38,000

$68,000

$28,000
15,000
35,000 $78,000

$8,000F
5,000F
3,000U $10,000F

$85,000

$44,000
36,500 $80,500

6,000U
1,500F $4,500U

$65,000
$333,000

$25,000
20,000
17,500 $62,500
$331,000

$
0
5,000U
2,500F $2,500U
$2,000U

50,000
35,000
25,000
25,000
15,000

Chapter 16-13

$5,000U

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Quality Cost: One-year Trend

Cost Item
Prevention costs:
Quality training
Reliability engineering
Appraisal costs:
Materials inspection
Product acceptance
Process acceptance
Internal failure costs:
Scrap
Rework
External failure costs:
Customer complaints
Warranty
Repair
Total quality costs

Actual Costs
1998

Actual Costs
1997

Variance

$35,000
80,000 $115,000

$36,000
$1,000F
120,000 $156,000 40,000F $41,000F

$20,000
10,000
38,000

$68,000

$33,600
16,800
$39,200

$85,000

$48,000
40,000 $88,000

2,000U
5,000F $3,000F

$65,000
$333,000

$33,000
23,000
16,400 $72,400
$406,000

$8,000F
2,000U
1,400F $7,400F
$73,000F

50,000
35,000
25,000
25,000
15,000

Chapter 16-14

$13,600F
6,800F
$89,600
1,200F $21,600F

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Multiple-Period Quality Costs

Assume the following data:
Quality Costs
1994
1995
1996
1997
1998

$462,000
423,000
412,500
406,000
333,000

Actual Sales
$2,200,000
2,350,000
2,750,000
2,800,000
2,800,000

Chapter 16-15

%of Sales
21.0
18.0
15.0
14.5
11.9

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Multiple-Period Total Quality Costs

Total Quality Costs as a % of Sales
25
20
15
10
5
0
1994

1995

1996
Chapter 16-16

1997

1998

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Multiple-Trend Analysis for

Individual Quality Costs
Assume the following quality cost data:
Prevention
1994
1995
1996
1997
1998

1Expressed

6.0%1
6.0
5.4
5.6
4.4

Appraisal
4.5%
4.0
3.6
3.2
2.4

as a % of sales

Chapter 16-17

Internal
Failure
4.5%
3.5
3.0
3.1
3.0

External
Failure
6.0%
4.5
3.0
2.6
2.3

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Quality Cost Information

For monitoring quality performance

For understanding the relationship between
quality and costs
For suggesting alternative programs
For implementing new programs

Chapter 16-18

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Illustration of Productivity
Improvement
Technical Efficiency:
Condition where no
more of any one input is used than necessary
to produce a given output.
A. Technical efficiency improvement: using less
input to produce the same output or producing
more output using the same input.
B. Price efficiency improvement: using a less
costly input mix to produce the same output.

Chapter 16-19

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Partial Productivity Measures

I. Partial Productivity Measurement: measuring
productivity for one input at a time.
Partial Measure = Output / Input
II. Operational Productivity Measure: partial
measure where both input and output are
expressed in physical terms.

Chapter 16-20

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Productivity: Measurement and

Control
Productivity Measurement Defined - Productivity is the
relationship between output and the inputs used to produce
the output.

Partial Productivity Ratio = Output/Input

Chapter 16-21

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Productivity Measurement
Assume the following data:
1995
Number of heaters produced
Labour hours used
Material used (kgs.)
Unit selling price (heaters)
Wages per labour hour
Cost per pound of material

Chapter 16-22

110,000
11,000
110,000
$25
$10
$5

1996
110,000
10,000
88,000
$25
$10
$5

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Operational Productivity
Measurements
1995a
Labour productivity ratio
Material productivity ratio

10.00
1.00

1996b
11.00
1.25

Ratios do not reveal the value of the improvement

labour:

110,000/11,000; Materials: 110,000/110,000

bLabour: 110,000/10,000; Materials: 110,000/88,000

Chapter 16-23

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Profit-Linked Productivity
Measurement
Profit-Linkage Rule: The measure of value of productivity changes
is the difference between costs of inputs that should be used
in the absence of any productivity change and the cost of inputs
actually used. The difference in costs is the amount by which profits
changed because of productivity changes.

Chapter 16-24

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Profit-Linked Productivity
Input

PQa

PQ x P

Labour
11,000 $110,000
Materials 110,000 550,000
$660,000

labour:

AQ
10,000
88,000

AQ x P
$100,000
440,000
$540,000

(PQ x P) - (AQ x P)
$10,000
110,000
$120,000

110,000/10; Materials: 110,000/1

Profit-linked effect = Total PQ cost - Total current cost

= $660,000 - $540,000
= $120,000 increase in profits
Implications: $10,000 came from labour improvement while $110,000
came from a reduction in material usage.
Chapter 16-25

Hansen, Mowen, Elias & Senkow (ITP, 1998)

In-Class Assignment
Prevention
- quality engineering
- receiving inspection
- quality training
Appraisal
- product inspection
Internal failure
- scrap
- rework
External failure
- net cost of returned products
Chapter 16-26

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Cost of Quality Report

Shortcomings

Information is not explicitly gathered

Budgets are not prepared
Quantitative measures are missing
Responsibility not properly delegated

Chapter 16-27

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Numerical Questions from the

Back of Chapter 16
W16-3, E16-3, E16-7,E16-13.

Chapter 16-28

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Question E16-3
Please return to the textbook to read the
question.

Chapter 16-29

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Question E16-7
Please return to the textbook to read the
question.

Chapter 16-30

Hansen, Mowen, Elias & Senkow (ITP, 1998)

Question E16-13
Please return to the textbook to read the
question.

Chapter 16-31