5 Costs of Quality Example Vegas Photo Corporation made 10,000photocopying machines last year.Vegas Photo determines the costs of qualityof its photocopying machines using a 7-stepactivity-based costing approach.
6 Costs of Quality (Steps 1 and 2) Identify cost objects.Identify the direct costsof quality of the products.10,000 photocopyingmachinesNo direct costs ofquality
7 Costs of Quality (Step 3) Select the cost-allocation bases to use forallocating indirect costs of quality to the products.PreventionAppraisalInternal failureExternal failureInformation on the totalquantities of each of thesecost-allocation bases usedin all of Vegas operationsis not provided.
8 Costs of Quality (Step 4) Identify the indirect costs of qualityassociated with each cost-allocation base.Information about total (fixed and variable)costs is not provided.
9 Costs of Quality (Step 5) Compute therate per unit.Inspection hours is onecost-allocation base.
10 Costs of Quality (Step 5) Prevention costs:Design engineering (R&D) $80 per hourProcess engineering (R&D) $60 per hourAppraisal costs:Inspection (Manufacturing) $40 per hour
11 Costs of Quality (Step 5) Internal failure costs:Rework (Manufacturing) $100 per hourExternal failure costs:Customer support (Marketing) $ 50 per hourTransportation (Distribution) $240 per loadWarranty repair (Customer Service) $110 per hour
12 Costs of Quality (Step 6) Compute the indirect costs of qualityallocated to the product.
15 Costs of Quality (Step 6) What is the total cost for design engineering?20,000 hours × $80 = $1,600,000What is the total cost for inspection?120,000 hours × $40 = $4,800,000
16 Costs of Quality (Step 6) Cost of Quality andValue Chain Category Total CostsPrevention costs:Design engineering (R&D) $1,600,000Process engineering (R&D) 1,350,000Total $2,950,000Appraisal costs:Inspection $4,800,000
17 Costs of Quality (Step 6) Cost of Quality andValue Chain Category Total CostsInternal failure costs:Rework (Manufacturing) $5,000,000
18 Costs of Quality (Step 6) Cost of Quality andValue Chain Category Total CostsExternal failure costs:Customer support (Marketing) $ 300,000Transportation (Distribution) ,000Warranty repair (Customer Service) 6,600,000Total $7,260,000
19 Costs of Quality (Step 7) Compute the total costs of quality of the product.Prevention costs $ 2,950,000Appraisal costs ,800,000Internal failure costs ,000,000External failure costs ,260,000Total $20,010,000
21 Techniques Used to Analyze Quality Problems 1. Control charts2. Pareto diagrams3. Cause-and-effectdiagrams
22 Control Charts On the basis of experience, Vegas decides that any observation outside the arithmeticmean ± 2 standard deviationsshould be investigated.
23 Control Charts Production Line A + 2 + Defect Rate - - 2Defect RateDays
24 Control Charts Production Line B + 2 + Defect Rate - - 2Defect RateDays
25 Pareto Diagram 600 500 400 300 Number of Times Defect Observed 200 100Copies arefuzzy andunclearNumber of TimesDefect ObservedCopiesare toolight/darkPaper getsjammed
26 Pareto Diagram As a first step, Vegas analyzes the causes of the most frequently occurring failure,fuzzy and unclear copies.Final Draft of aSales ContractFinal Draft of aSales Contract
27 Cause-and-effect Diagrams Human FactorsMethods andDesign FactorsInadequatesupervisionPoor trainingNew operatorFlawed part designIncorrectmanufacturingsequenceInadequate toolsIncorrect speedPoormaintenanceMultiple suppliersIncorrect specificationVariation in purchasedcomponentsMachine-relatedFactorsMaterials andComponents Factors
28 Identify the relevant costs and benefits of quality improvements. Learning Objective 3Identify the relevant costs andbenefits of quality improvements.
29 Relevant Costs Careful analysis of Vegas cause-and-effect diagram reveals that the frame of the copieris often mishandled as it travels from thesuppliers’ warehouses to Vegas’ plant.Mishandling causes the dimensions of theframe to vary from specifications, resultingin fuzzy and unclear copies.
30 Relevant Costs Alternative solutions: Improve the inspection of the framesimmediately upon delivery.Redesign and strengthen the framesand the containers used to transportthem to better withstand mishandlingduring transportation.
31 Relevant Costs What must management do to evaluate each alternative? Additional AdditionalInspection Cost Redesign Cost Difference$200, $230, $30,000Vegas determines the fixed and variablecost component of each activity involved.
33 Comparison Further Redesigning Inspection Frames Relevant savings $995,000 $1,361,000Additional cost , ,000Difference $795,000 $1,131,000What should Vegas do?Redesigning the frames provides a $336,000incremental benefit over further inspection.
34 Provide examples of nonfinancial quality measures of customer Learning Objective 4Provide examples of nonfinancialquality measures of customersatisfaction and internalperformance.
35 Nonfinancial Measures Nonfinancial measures of customer satisfaction:Number of customer complaintsDefective units as a percentage of total unitsshipped to customersPercentage of products that experience earlyor excessive failureOn-time delivery rate
36 Nonfinancial Measures Nonfinancial measures of internal performance:Number of defects for each product lineProcess yield(ratio of good output to total output)Employee turnover(ratio of the number of employees who leftthe company to the total number of employees)
37 Describe the benefits of financial and nonfinancial Learning Objective 5Describe the benefits offinancial and nonfinancialmeasures of quality.
38 Evaluating Quality Performance Financial measures are helpful to evaluatetrade-offs among prevention costs,appraisal costs, and failure costs.Nonfinancial measures help focus attentionon the precise problem areas that needimprovement and also serve as indicatorsof future long-run performance.
39 Describe customer-response time and explain why delays Learning Objective 6Describe customer-responsetime and explain why delayshappen and their costs.
40 Customer-Response Time Order isplacedOrder isreceivedOrder isset upOrder ismanufacturedOrder isdeliveredWaitingTimeMfg.TimeReceiptTimeManufacturingLead TimeDeliveryTimeCustomer-Response Time
41 On-Time Performance On-time performance refers to situations in which the product or service is actually delivered atthe time it is scheduled to be delivered.
42 Time Drivers and Costs of Time 1. Product or serviceorder uncertainty2. Bottlenecks due tolimited capacity
43 Time Drivers and Costs of Time Average waiting time equals:Average number of orders × (Manufacturing time)2÷[[Annual machine Average no. Manufacturingcapacity of orders time of product–×
44 Time Drivers and Costs of Time Fredonia uses one machine to convertsteel bars into a special component (SC).Fredonia expects it will receive 30 orders,but it could actually receive 10, 30, or 40orders for the special component.Each order is for 1,000 units and will take100 hours of manufacturing time.
45 Time Drivers and Costs of Time The annual capacity of the machineis 4,000 hours.What is the expected manufacturingtime required on the machine?(100 × 30) = 3,000 hoursWhat is the average waiting time?
46 Time Drivers and Costs of Time 30 × 1002 = 30 × 10,000 = 300,000300,000 ÷ 2 × [4,000 – (30 × 100)]300,000 ÷ 2 × (4,000 – 3,000)300,000 ÷ 2,000150 hours average waiting time
47 Time Drivers and Costs of Time What is the average manufacturinglead time for an order?150 hours of average waiting time+ 100 hours of manufacturing time= 250 hoursSuppose that Fredonia is consideringintroducing a regular component (RC).
48 Time Drivers and Costs of Time Fredonia expects to receive 10 ordersfor RCs (each order for 800 units).Each order will take 50 hours ofmanufacturing time.The expected demand for specialcomponents will be unaffected.
49 Time Drivers and Costs of Time Assume that introducing RCs would causeaverage waiting time to more than double,from 150 hours to 325 hours.The average manufacturing lead time fora special component order becomes425 hours ( ).Average manufacturing lead time for a regularcomponent order is 375 hours ( ).
50 Relevant Revenues and Relevant Costs of Time The average selling price per order is:Averagemanufacturing Productlead time SC RCLess than 300 hours $22,000 $10,000More than 300 hours $21,500 $ 9,600
51 Relevant Revenues and Relevant Costs of Time Product SC RCAverage number of ordersDirect material costs per order $16,000 $8,000Inventory carrying costs/order/hourShould Fredonia introduce RCs?
52 Relevant Revenues and Relevant Costs of Time Introduce RCsExpected revenues:($21,500 × 30) + ($9,600 × 10) = $741,000Expected variable costs:($16,000 × 30) + ($8,000 × 10) = $560,000Expected other costs: $ 14,625
53 Relevant Revenues and Relevant Costs of Time How was the $14,625 other costs computed?(Average manufacturing lead time for SCs× Unit carrying costs per order for SCs× Expected number of orders for SCs)+ (Average manufacturing lead time for RCs× Unit carrying costs per order for RCs× Expected number of orders for RCs)(425 × $1.00 × 30) + (375 × $0.50 × 10) = $14,625
54 Relevant Revenues and Relevant Costs of Time Do Not Introduce RCsExpected revenues:$22,000 × 30 = $660,000Expected variable costs:$16,000 × 30 = $480,000Expected other costs: $ 7,500
55 Relevant Revenues and Relevant Costs of Time How was the $7,500 other costs computed?Average manufacturing lead timefor SCs without RCs× Unit carrying costs per order for SCs× Expected number of orders for SCs250 × $1.00 × 30 = $7,500
56 Relevant Revenues and Relevant Costs of Time Relevant Introduce Do NotItems RC Introduce RCExpected revenues $741,000 $660,000Expected total costs 574, ,500Difference $166,375 $172,500Falcon Works should not introducethe regular component.
57 Apply the three measures in the theory of constraints. Learning Objective 7Apply the three measuresin the theory of constraints.
58 Theory of Constraints The three main measurements in the theory of constraints are:1. Throughput contribution equal to revenuesminus direct material costs.2. Investments equal the sum of material costsin direct materials inventory, work in processinventory, finished goods inventory, R&Dcosts, and costs of equipment and buildings.
59 Theory of Constraints 3. Operating costs equal to all operating costs (other than direct materials) incurred to earnthroughput contribution.The objective of TOC is to increase throughputcontribution while decreasing investmentsand operating costs.
61 Managing Bottlenecks The four steps in managing bottlenecks are: 1. Recognize that the bottleneck operationdetermines throughput contributionof the system as a whole.2. Search and find the bottleneck operation byidentifying operations with large quantitiesof inventory waiting to be worked on.
62 Managing Bottlenecks 3. Keep the bottleneck busy and subordinate all nonbottleneck operations to thebottleneck operations.4. Take actions to increase bottleneck efficiencyand capacity – the objective is to increasethroughput contribution minus the incrementalcosts of taking such actions.