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Statements on Management Accounting

B U S I N E S S P E R F O R M A N C E M A N A G E M E N T

T I T L E

Managing Quality Improvements

C R E D I T S

The Institute of Management Accountants is indebted toThe Society of Management Accountants of Canada for per-mitting reproduction of the Society’s ManagementAccounting Guideline 14, “Managing Quality Improvements,”as a Statement on Management Accounting.

Statements on Management Accounting

T A B L E O F C O N T E N T S

I. Rationale . . . . . . . . . . . . . . . . . . . . . . . 1

II. Scope . . . . . . . . . . . . . . . . . . . . . . . . . 1

III. Defining Quality . . . . . . . . . . . . . . . . . . . .2

IV. Total Quality Mangement

V. The Role of Management Accountanting . .4

VI. TQM Implementation Guidelines . . . . . . . .7

VII. Management Processes, Tools and Measures . . . . . . . . . . . . . . . . . . . . .9

VIII. TQM Implementation Example . . . . . . . .13

IX. Cost of Quality . . . . . . . . . . . . . . . . . . .15

X. Cost of Quality in Service Industries . . . . .16

XI. Quality Cost Relationships . . . . . . . . . . .17

XII. Management Accounting Challenges . . .17

XIII. Summary and Conclusions . . . . . . . . . .20

Bibliography . . . . . . . . . . . . . . . . . . . . . . . .30

ExhibitsExhibit 1: Quality Lever . . . . . . . . . . . . . . . . .2

Exhibit 2: Total Quality Management . . . . . . .4

Exhibit 3: TQM for a Manufacturing Company . .5

Exhibit 4: Policy Deployment . . . . . . . . . . . .11

Exhibit 5: Quality Education Matrix . . . . . . .13

Exhibit 6: Optimal Quality Cost . . . . . . . . . .18

Exhibit 7: Cost of Quality Proporations . . . .19

Exhibit 8: Quality Cost Process Summary . .21

Exhibit 9: Cost of Quality Report . . . . . . . . .24

Exhibit 10: Cost of Quality Graph . . . . . . . . .25

Exhibit 11: Rework and Reject Costs by Product Analysis . . . . . . . . . . .26

Appendix 1: Case Study . . . . . . . . . . . . . . . . .23

Appendix 2: Statistical Tools and Processes Measures . . . . . . . . . .27

Appendix 3: Additional Quality Measures . . . . .29

Managing Quality Improvements


I . RAT IONALEThe world economy has changed. Enterprises inmany countries now have the ability to competeglobally. In many sectors, supply exceedsdemand. Consumers faced with greater choiceshave become more cost- and value-conscious,and are turning to alternative sources for prod-ucts and services. Consumers are also demand-ing improved quality. A customer lost because ofa quality problem may never return but, moreimportantly, may take other customers with himor her.

In the economic marketplace, every enterprise isrequired to define its chosen battlefield and competitive weapons. Today, quality, cost,innovation and response times to customers are the competitive weapons of choice for thesuccessful enterprise.

In the 1970s and ‘80s, traditionally managedbusinesses that competed with those that mastered total quality management lost marketsthat they previously dominated. The successfulcompanies proved that a better quality productor service, produced and delivered in a timely manner, can be less, not more, expensive for theproducer.

Quality, cost and time frequently seem to conflictwith one another, necessitating trade-offs. Theseconflicts exist because traditional cost account-ing practices do not always consider the hiddencosts of (poor) quality. For example, an executivein the computer industry once observed, “If youcatch a faulty two cent resistor before you use itand throw it away, you lose two cents.” However,if you don’t find it until it has been soldered intoa sub-assembly, it may cost $10 to repair thepart. And if you don’t catch it until it is in thecomputer, the expense may be well in excess ofthe manufacturing costs.

This is illustrated by the Quality Lever for a manufacturing company (see Exhibit 1).

Traditional accounting practices measure productcosts at the end of the manufacturing process.This process identifies and captures a limitedamount of savings by focusing on scrap, rework,testing, etc. But if the quality cost opportunitieswere identified in the inspection stage before themanufacturing process was finalized, the savingswould be greater.

Similarly, the savings would be even greater ifquality and cost opportunities were identified inthe product design phase.

Unfortunately, the “fire fighting” mode of problemsolving at the production stage frequentlyoccurs. Enterprises tend to focus on solvinginstead of preventing problems. While they maynot have consciously decided to do this, enter-prises fall into a pattern of behavior that favorsthe “find and fix” approach. Hence, there is aneed for a disciplined quality management thatwill redirect all efforts to improving quality in allstages, from the concept of the product or servicethrough to its delivery to the customer.

I I . SCOPEThis guideline provides practical operating princi-ples and recommended approaches for imple-menting Total Quality Management (TQM). It isaddressed to management accountants so theycan fully employ their unique skills in the qualitymanagement process. It is designed to:

l help make the management accountant a keycontributor to the achievement of qualitythrough the use of Cost of Quality, statisticalmeasures, and other quality managementtools and processes.

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l help in implementing the initial process of aTQM system and the on-going continuousimprovements in the enterprise.

This guideline assumes an organization wherethe decision to implement a TQM process hasalready been made.

The guideline is, of necessity, both descriptiveand prescriptive. The descriptive parts shape avision of the future, build commitment for thechange, and define quality concepts and tech-niques. The prescriptive part addresses how tolead, plan, and implement TQM.

The concepts, techniques, and the case studyincluded in the guideline are all structured to beapplicable to:

l businesses that produce a product or a service;l all levels of an enterprise, from the CEO down;l all functions in an enterprise; andl enterprises in all business sectors.

I I I . DEF IN ING QUALITYQuality, like excellence, is a concept that is easyto visualize but exasperatingly difficult to define.It remains a source of confusion to managers.Quality improvement is unlikely in such settings.Even when quality has been precisely defined, ithas been focused narrowly on the factory floor orhas relied primarily on traditional methods ofquality control. Little attention has been paid tothe underlying sources of superior quality, suchas contribution of product design, vendor man-agement and selection, production and work-force management.

Quality remains a difficult concept because ithas undergone a significant evolution since the1950s. Quality methods have expanded in ever-widening circles, each incorporating the elementsof the preceding method.

During the evolution of quality, five principalapproaches to defining quality have been tried.These are:

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B U S I N E S S P E R F O R M A N C E M A N A G E M E N TEXHIBIT 1: QUALITY LEVER

PREVENTION

(e.g., Product Design)INSPECTION

(e.g., Manufacturing Process)REACTION

(e.g., Manufacturing Operations)

COST SAVINGS

GreatestLeverage Good

LeverageLeast

Leverage

EXHIBIT 1. QUALITY LEVER

l Transcendent: Neither mind nor matter. I knowit when I see it.

l Product-based: Quality of product ingredient or attributes, such as performance, features,reliability, durability, serviceability and aesthetics.

l User-based: Ability to satisfy wants.l Manufacturing-based: Conformance to specifi-

cation.l Value-based: Quality at an acceptable price.

These differing approaches co-exist because ofthe competing views of quality held by members ofthe marketing, engineering and manufacturingdepartments. Despite the potential for conflict, anenterprise can benefit from such multiple perspec-tives. Reliance on a single definition can causeproblems. For example, a company may discoverthat its product does not meet customer require-ments, even though it conforms to all the specifi-cations. Conversely, the customer satisfaction rat-ing may be very high, but at a high cost of rejects,scraps, rework, and warranty costs.

In both cases, managers thought that they wereproducing high-quality products. And they were,but according to only one of the approaches toquality described above. Because each approachhas a blind spot, TQM encourages multiple per-spectives on quality, actively shifting the meas-ures of products more from design to quality.

The TQM concept is the most comprehensivequality concept to date. It is no longer an isolat-ed, independent function dominated by technicalexperts. It has entered the corporate main-stream, becoming an activity as worthy of atten-tion as marketing or production.

IV. TOTAL QUALITY MANAGEMENTTQM, as discussed in this guideline, integratesthe contributions of major quality masters suchas Deming, Juran, Taguchi, Ishikawa and Crosby.

The TQM approach starts with identifying thecustomers and their requirements.

Every function, and every individual within a function, has a set of customers. Each of thesecustomers has a set of spoken and/or latentneeds or requirements.

The focus on the customer-supplier relationshipis crucial to any attempt to improve quality. Thisrecognizes that everyone in a process is at somestage a customer or supplier of someone else,either inside or outside the organization.

At an enterprise level, TQM starts with the exter-nal customer requirements, identifies the internalcustomer-supplier relationship and require-ments, and continues with the external suppliers.In a chain of operations to produce a product orservice, there are many internal customer-supplierlinks. The ultimate, external customer is betterserved if each internal customer is also servedto the fullest–in terms of timeliness, complete-ness, and accuracy (See Exhibit 2).

Understanding and meeting these customerrequirements completely is the premise of TQM.See Exhibit 3 for an example using a manufactur-ing company.

The implementation of TQM requires carebecause the various customer requirements arenot always translated properly. The traditionalstructure of large organizations and the complexityof the product/service delivery processes oftenstand in the way.

For example, most companies are organized, out ofnecessity, along vertical reporting hierarchies. Butthe delivery of a product or a service requires a greatdeal of cooperation among horizontal linkages.

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The horizontal linkages in large organizationstend to be weak and lead to differences in inter-pretation and conflicting priorities. If the productdevelopment cycles are long, several key playersmay also change or be promoted before comple-tion of the output.

Because of these complexities, TQM needs to beformally articulated and understood across all horizontal and vertical linkages. Ford utilized thisconcept to develop the Ford Taurus and MercurySable. To bring these cars to market, a cross-function “Team Taurus” was organized to strengtheninternal linkages and to ensure that quality wasdesigned into the new cars at every stage.

V. THE ROLE OF MANAGEMENTACCOUNTINGTraditionally, the management of quality has beenseen as the exclusive domain of the quality man-agement staff, manufacturing and production engi-neering department personnel, and productdesign and engineering department personnel.

On the other hand, the modern concept of TQMis seen as a company-wide function and needthat requires many new players.

Most existing quality information gathering,measurement and reporting systems have beendeveloped and operated by non-accountants.The problem with these systems is that qualitydata are seldom accumulated and reported in a manner that emphasizes quality costs and clearly indicates the impact of quality on finan-cial performance. Instead, these cost/benefitrelationships are buried in a variety of productcost, marketing, engineering, and service department accounts.

Since management accountants are trained inanalyzing, measuring, and reporting informationfocused on user needs, their expertise can be ofassistance in the design and operation of comprehensive quality information gathering,measurement, and reporting systems.

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EXHIBIT 2: TOTAL QUALITY MANAGEMENT

EXTERNALCUSTOMERS

REQUIREMENTS REQUIREMENTS

DELIVERABLESDELIVERABLES

Internal Customer/Supplier



EXTERNALSUPPLIERS

EXHIBIT 2. TOTAL QUALITY MANAGEMENT

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EXHIBIT 3: TQM FOR A MANUFACTURING COMPANY

Source:

Identify customers’ requirements and translate these to supplier specifications

for each successive customeras shown below

Identify Customers

Design Requirements

Part Characteristics

Manufacturing Operations

Production and External Vendor Requirements

Selling Requirements

Customer Requirements

EXHIBIT 3. TQM FOR A MANUFACTURING COMPANY

To leverage this advantage, managementaccountants should integrate quality cost sys-tems into the existing management reportingand measurement systems. With full knowledgeof cost concepts and allocation procedures, theycan measure and report quality costs in a man-ner that will contribute to the solution of qualityproblems. (The case study in Appendix 1 high-lights this further.)

These efforts will enhance the role and responsi-bility of the management accountant in the enter-prise. He or she can highlight the fact that poorquality can be a significant cost driver. Theabsence of good materials, trained labor, well-maintained equipment, and well-conceived man-agement processes can dramatically increasequality costs. These include scrap, rework, excessinventories, process and equipment breakdowns,field service, and product warranty claims.

As an example, the material management func-tion in some organizations is evaluated on a pur-chase price variance from standard cost. Thisencourages the acquisition of materials on aprice basis alone rather than on the merits ofdesign quality and price. If low-cost materials donot possess the right quality, this accountingprocess results in high manufacturing costs.Such costs include scrap, rework, schedule dis-ruptions, etc., all downstream functions forwhich the material management function is notaccountable. If not managed, the downstreamcosts of this lack of quality could exceed theprice savings achieved.

The management accountant should be totallyinvolved in all activities of the enterprise. The fol-lowing activities illustrate the role of the involvedmanagement accountant.

l ensure that he or she is well represented onthe main quality control committees andemployee involvement teams;

l ensure that the company knows the competi-tive benchmarks, competitive gaps, customerretention rate, and the Cost of Quality;

l help identify areas of greatest quality opportunities;

l create a system of quality measures to monitor on-going progress against qualitygoals. The existing reporting systems mayneed extensive reworking;

l ensure that accounting is involved intimately invendor rating decisions;

l ensure that he or she takes part in selectionprocedures for new manufacturing equipmentby attending outside trials and viewings;

l discuss quality control effectiveness and thevalue of training courses for quality control per-sonnel and operators with the humanresources department;

l continually review scrap and recovery costsand the basis of their evaluation.

In service industries, some adjustment from themanagement accountant’s role may be required if:

l services are delivered away from headquar-ters, at customer premises, and in direct inter-face with customers; and

l operating personnel (i.e., repair technicians)are away from headquarters.

The management accountant should beinformed and willing to be an active participant inthe TQM process. The management accoun-tant’s training and field of expertise will be ofvalue in this process but the achievement ofquality goals will not be driven, only aided by theapplication of such expertise.

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VI . TQM IMPLEMENTAT IONGUIDEL INESThe overriding lesson to be learned from the evo-lution of quality in Japan is that there are noeasy answers. TQM cannot be reduced to a cook-book. Many early converts to the qualityapproach implemented quality circles, workteams, and other faddish techniques that mere-ly copied the Japanese style while missing itssubstance. Each enterprise that has implement-ed TQM has developed its own implementationplans. TQM does not occur overnight; there areno shortcuts. It took the Japanese more than 15years to approach and then surpass the qualitylevels of the West.

In general, the movement within an enterprisefrom traditional management to TQM will takebetween three to five years and will be difficultas well as time consuming. Many specific projects along the way, however, can yield highreturns quickly.

While there is no one perfect implementationprescription for TQM, the following 11 phaseshave been used by the winners of the U.S.Malcolm Baldrige awards for effectively managing quality.

Year 1l Create CEO/Quality council and staffl Conduct executive quality training programsl Conduct quality auditl Prepare gap analysisl Develop strategic quality improvement plans.

Year 2l Conduct employee communication and training

programsl Establish quality teamsl Create measurement system and set goals.

Year 3l Revise compensation/appraisal/recognition

systemsl Launch external initiatives with vendorsl Review and revise.

Create CEO/Quality Council and StaffMost companies seeking to implement TQMhave found the transition impossible to achievewithout the direct involvement of the most seniormanagers, including the chief executive/presi-dent. Leadership for such a change cannot bedelegated. It requires active, unwavering leader-ship from the CEO. If it means no more than afew speeches and a lapel pin, quality will notwork. CEOs must lead this change. Most TQMcompanies establish an executive-level qualitycouncil to oversee the change process, chairedby the CEO or president and composed of the topmanagement team. The council develops qualitymission and vision statements, the company’slong-range quality strategy, and company-widequality goals. To support the council, some TQMcompanies develop a small quality staff to coor-dinate and track the quality improvementprocess, provide technical guidance and over-sight to improvement teams, develop the contentof quality training, and assist professional train-ers. Other TQM companies look to major seg-ments of the total organization to manage thisactivity and provide the required information tothe corporate offices.

Conduct Executive Quality TrainingProgramsMost TQM companies invest considerable time andeffort raising senior management’s awareness ofthe need for a systematic focus on quality improve-ment, creating a common knowledge base concern-ing total quality, establishing reasonable expecta-tions, and avoiding misunderstandings and mis-communications as the change effort progresses.

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Conduct Quality AuditThe quality audit assesses the effectiveness ofefforts to provide background information to sup-port the development of a long-term strategicquality improvement plan. It may include ananalysis of the quality improvement initiativesand quality performance levels of “best-in-class”competitors to identify the company’s strengthsand weaknesses versus the competition. Itshould also identify improvement opportunitiesthat are likely to provide the greatest return tothe company in both the short and long term.

Prepare Gap AnalysisA gap analysis against the “best-in-class” com-petitors tells a company what it lacks to movefrom one point to the other or to “leap-frog” thecompetition to become the new industry leader.It identifies strengths, weaknesses, and targetareas for improvement, which are then fed backto managers and employees. The purpose of thegap analysis is to provide a common objectivedata base from which a strategic quality improve-ment plan can be developed.

Develop Strategic Quality Improvement PlansNext, the quality council sets priorities for quali-ty improvement by developing a one-year short-term strategic quality plan and a five-year long-range plan based on the gap analysis and targetcriteria. Successful TQM plans need to have thesupport and participation of every group in thecompany—including unions, where they exist.

Conduct Employee Communication and Training ProgramsTraining is used both to communicate manage-ment’s commitment to total quality and to pro-vide employees with significantly enhanced skillsin data analysis and problem solving. Trainingshould be done from the top down: managers

who actively participate in staff training reinforcethe importance the company attaches to qualityimprovement.

Establish Quality TeamsMost successful TQM companies use a widevariety of employee and management teams. Inaddition to work-unit and self-managed teams,companies have devised quality managementboards to oversee the continuous improvementeffort for their line of business and quality taskforces. These are temporary teams that addresscross-functional quality teams.

TQM coordinators should serve as monitors forquality teams. But if the workforce has been pro-vided with proper TQM training, then the teamsshould be able to structure themselves and han-dle problems on their own.

Unique quality teams, including representativesfrom the areas involved and a chairperson froman unrelated area, should be assembled to han-dle specific problems. Involving people fromunrelated areas gives everyone a chance toshare their experiences on how the TQM processhas worked elsewhere.

A target should be established at the outset ofthe company’s TQM process as to the number ofquality teams and issues that will be dealt withat any one point in time. This will ensure thatresources are not being spread too thin and thatissues are being resolved before new topics areadded to the process.

Create Measurement System and Set GoalsCrucial to the success of TQM implementation isthe ability of quality teams to develop a betterunderstanding of their internal and external cus-tomer needs and expectations, and to developmeasures that truly reflect these expectations.

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Frequently, TQM companies find that traditionalmeasures are not only inadequate, but mislead-ing, and must be overhauled or discarded. Theyadopt high goals that call for improvements bytenfold or more over the span of a few years.They also measure their performance againstnot just the “best-in-class” among their competi-tors but the “best-in-class” for a function or busi-ness process.

Revise Compensation, Appraisal andRecognition SystemsAs TQM companies revise their measurementsystems, they also revise their compensation,appraisal, and recognition systems to reflect theemphasis on quality.

Launch External Initiatives with VendorsIt is important that quality management beextended beyond the firm. Some of the most sig-nificant benefits of a quality program come aboutwhen the concept is also adopted by the firm’ssuppliers. In general, TQM efforts shouldbecome part of the entire business system thatextends from raw materials to the final customer.

Review and ReviseQuality progress is constantly reviewed by quali-ty teams and the entire quality improvementeffort should be reassessed at least annually.There is no finish line in the race for quality.

V I I . MANAGEMENT PROCESSES,TOOLS AND MEASURESImplementing quality is not easy. It requiresactive, unwavering leadership, firm goals, andtime from the CEO. Many quality initiatives failbecause top management often has other priorities. If all an enterprise has is symbolism,nothing happens.

All enterprises have general access to the sameequipment, technology, financing, and people.The real difference lies in how these resourcesare developed and deployed. In addition to thegeneral implementation guidelines describedearlier, the following management processes,tools and measures need to be adopted by anenterprise embarking on the road to quality:

l Policy Deploymentl Quality Function Deploymentl Kaizenl Employee Involvementl Suppliers’ Managementl Competitive Benchmarkingl Quality Trainingl Reward and Recognitionl Customer Retentionl Statistical Methods.

Policy DeploymentPolicy Deployment is a system for planning cor-porate objectives and the related means formeeting them. The Japanese quality commenta-tors describe it as the key to the TQM system.This reflects its primary characteristic: that ofproviding a measurable link between a compa-ny’s strategic vision and plans, and the detailedmeans by which each level within the companywill move toward achieving its related objectives.Policy Deployment is thus the method that TQMcompanies use to ensure goal congruencethroughout the organization.

Policy Deployment evolved as the linking orumbrella TQM system in Japan over the lastdecade. It followed years of quality effort that hadalready resulted in a process-centered businessenvironment where the use of the Plan–Do–Check–Act cycle and statistical performancemeasurement was common at all levels. ThePlan–Do–Check–Act process is:

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l Plan for improvementsl Search for problemsl Search for causesl Attempt corrective actionl Verify if it succeededl If successful, incorporate into the processl Continue the cycle.

As a result, when Japanese companies refinedtheir strategic planning processes to improvetheir long-term competitive advantage, they hadthe considerable advantage of already knowingtheir business process capability. They werealready able to “manage by fact” on a day-to-daybasis. As a result, Policy Deployment offeredJapanese companies two major business bene-fits. The first was a method of developing strate-gic plans that were not only customer-centered,but incorporated detailed means and relatedmeasures for implementing the plans over theplan period. The second was a method of focus-ing each organizational level on common, vitalbusiness objectives and testing the capability ofthe business entities to achieve the required performance.

Policy Deployment is deliberate, time consumingand, at times, difficult. It requires organizationaldiscipline to be sustained in the face of day-to-day pressures. However, there is a greatlyimproved chance for TQM by using PolicyDeployment (see Exhibit 4).

Quality Function Deployment (QFD)QFD is a means of ensuring that customerrequirements are accurately translated into rele-vant design requirements throughout each stageof the product development process. This meansthat the ends and means are linked at eachstage. The process, like Policy Deployment, issimple but very detailed and disciplined. Therewards of QFD are well worth the extra up-front

effort in planning. Toyota reports that, with QFD,its design cycle was reduced by one-third and thecustomer requirements were better reflected inthe end product.

KaizenThis is a Japanese term for ContinuousImprovement in all aspects of a company’s oper-ations at every level. The process is oftenthought of as a staircase of improvement. As youmove from step to step, you follow an improve-ment, maintain the improvement, follow animprovement, maintain an improvement, etc.Each step is a small upward movement (the ver-tical part of the step). While the steps are small,the staircase continues to move you upwards.

Employee Involvement (El)There is little chance that a firm’s customers willbe excited about its products and services if itsworkers are not. El results in excited and com-mitted workers. El is more than simply organizinga few quality control circles or worker teams.Teams are only part of the picture. The creativeenergies of all employees must be used for prob-lem solving and continuous improvement. Thismeans that employees must be trained in newskills and encouraged to apply them on the job.Eventually, the number of ideas generated andthe percentage of these ideas implementedbecome important measures of both individualand team performance.

As the El process is absorbed, many of the roles,responsibilities, and activities of departmentsand individuals begin to overlap. The organizationwill de-layer and decompress. Responsibility forjudgments, decisions, and problem resolutionswill shift downward to those closest to the pointof activity.

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Suppliers’ ManagementA supplier is an extension of a company’s ownprocess. An enterprise’s ability to serve its cus-tomers and to create a perception of value dependson the suppliers’ ability to serve the enterprise’sneeds. Building a quality supplier base requires:

l reducing the supplier base to reduce variationand to increase supplier commitment and theefficient use of a buyer’s resources;

l selecting suppliers not only on price but ontheir capability to improve quality, cost, deliv-ery, flexibility, and their willingness to becomeworld class;

l forming new and long-term relationships withsuppliers as working partners; and

l specifying precise customer and supplierexpectations and agreeing to their consistentdelivery.

Competitive Benchmarking (CB)Most organizations do not really know who orwhat is best in their industry. Consequently,most quality improvement targets are set inter-nally based upon past performance. This resultsin conservative estimates of further expectedimprovements. CB is the creative tool thatenables enterprises to break free of these self-imposed limits and focus on the competitors andhow to exceed their performance.

CB is the continuous process of measuring anenterprise’s products, services, and practicesagainst its toughest competitors. Benchmarksshould include a measure of the results as well asan analysis and the appropriate measures of theprocess used to achieve those results. Commonbenchmarks used are: cost, staffing, yield, cycletime, on-time, inventory level, and rework.

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EXHIBIT 4: POLICY DEPLOYMENT

Source:

Top Management

Middle Management

Front Line Management

Policy

Targets Plans/Measures(Means)



EXHIBIT 4. POLICY DEPLOYMENT

Of all the benchmarks, the most important maybe customer satisfaction. Quality is only as goodas the customer says it is, not what the numberson the quality control chart show. In fact, cus-tomer satisfaction shows up as the most impor-tant criterion of the U.S. Malcolm BaidrigeQuality Award.

CB emerged as a management tool with Xerox in1979. Several other corporations such as IBM,General Motors and Motorola - all MalcolmBaldrige Quality Award winners in the UnitedStates—have since adopted it. It helps facilitatea culture that values continuous improvement,increases sensitivity to changes in the externalenvironment, and prioritizes the areas to beworked on first.

To make CB easier, several best practices databases are being developed. One of these is theErnst & Young and the American QualityFoundation data base. This is based upon astudy of 500 companies in the automotive, bank-ing, computer, and health care industries in fourcountries.

Quality TrainingAn important development tool is quality train-ing. All employees must be familiar with the toolsfor preventing, detecting, and eliminating non-quality.

The education process needs to be customizedfor the various audiences: executives, middlemanagers, supervisors, and workers. A suggest-ed quality education matrix for these target audi-ences is provided in Exhibit 5.

Reward & RecognitionReward and Recognition are the best means ofillustrating the emphasis on TQM. Recognitioncan range from public acknowledgement of team

accomplishments to rewards such as mugs, jack-ets, or monetary bonuses. Rewards should begroup-oriented rather than individual. For exam-ple, “TQM DAY” would involve all employees andwould be used to mark a major milestone in thecompany’s effort to attain Total Quality. “TQMImprovement Team of the Week” would honor agroup effort.

A Reward and Recognition structure based uponquality measures can be a very powerful stimu-lus to promote TQM in a company.

Customer RetentionProgressive service companies use an integrat-ed measure of service quality (i.e., customerretention). This is the yardstick that all servicecompanies need to measure their quality. Inmost industries, boosting customer retentioncan have the same effect on profits as cuttingcosts by 10%. Loyal customers spend more,refer new clients, and are less costly to do busi-ness with.

Organizations must make it easy for customersto respond to both what is right and what iswrong. The response must address issues key tothe quality of product or service delivery.

Some customers will complain that the compa-ny’s product or service does not meet theirexpectations. But many find it too easy to simplygo somewhere else the next time. It is these cus-tomers that the firm must address.

As well, customers rarely make the effort to say“yes, you gave me exactly what I wanted.” This isfair; they should not have to. But the feedbacksystem should actively pursue this informationso that the organization knows it is proceeding inthe right direction.

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Statistical MethodsOrganizations should have the ability to applystatistical concepts and methods if they intendto implement quality improvement programs.Useful statistical concepts for implementingTQM are described in Appendix 2.

V I I I . TQM IMPLEMENTAT IONEXAMPLEIn a manufacturing setting, the following is a summa-ry of the approach used by Motorola, a winner of theU.S. Malcolm Baldrige Quality Award, to implementTQM. This approach is similar to the eleven-pointTQM implementation process discussed earlier.

The Company was a successful multinational inthe 1960s and 1970s. It had such a strangle-hold on the market that it hardly paid attentionwhen Japanese competitors first entered themarketplace in the late 1970s. It had grown upto be a bureaucratic company in which one functionbattled another and operating people constantlybickered with corporate staff. Disputes overissues as minor as the color scheme of productshad to be resolved by the CEO. The result waspainfully slow product development, high manufac-turing costs, and unhappy customers.

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EXHIBIT 5: QUALITY EDUCATION MATRIX

Source:

Executives Middle Supervisors WorkersManagers

Quality improvement overview X X X XEmployee involvement X X X XLeadership/facilitator workshop X X X Team building X X X XCreative thinking X X X XProblem solving — basic X X X XProblem solving — advanced X X X XStatistical Process Control X XProblem solving — train the trainer X X X Design of experiments X X XTotal quality control audit X X Competitive benchmarking X X Statistical thinking (how to understand X X X X variability and the correct approach

to reducing it) Quality function deployment X X X Total productive maintenance X X X XGeneral business prespective X XParameter design using Taguchi methods X Policy deployment X X X

EXHIBIT 5. QUALITY EDUCATION MATRIX

The Japanese exploited this weakness withaggressive pricing and proceeded to gain a sizablemarket share. By the early 1980s, the companyrecognized that it had to evolve rapidly into aworld-class organization if it was to survive.

The company began by assessing its corporatestrengths and weaknesses as well as those ofits competitors. An important management stepwas taken in the early ‘80s when the companyinitiated a formal benchmarking process to iden-tify the successful practices of top competitors.

The competitive benchmarking revealed that, tocompete successfully, the company had to be drivenby its customers and competitors. It instituted sev-eral changes in organizational structure, productdevelopment processes, and supplier relations. Italso set out on a quest for quality.

The quality practices and results were studied atleading-edge U.S. and Japanese corporations.The study convinced management that the efforthad to appear more lasting and convincing thanmere symbolism. A high-level quality council,staffed by senior executives, was created for aperiod of a year to study the quality gap, compet-itive practices, and to recommend company-spe-cific quality vision, goals, and action plans.

The quality council recommended the following:

l TQM needs to be a strategic imperative.l TQM means meeting market and customer

requirements.l The quality responsibility lies with everyone,

with top management exercising strong leader-ship.

l The quality journey would take approximatelythree years. The implementation steps included:extensive training, reengineering of workprocesses, employee involvement, quality audits,

gap analysis, quality teams, measurement sys-tems, and reward structure. Some of thesewere to be extended to the vendors as well.

l To support the three-year implementationprocess, a small quality staff needed to beestablished. It would coordinate and track thequality improvement process, provide technicalguidance and oversee the improvementteams, develop the content of quality training,and assist professional trainers.

These recommendations were accepted. Overthe following two years, the company investedconsiderably in quality training — particularly inEmployee Involvement, Team Building, ProblemSolving, Design of Experiments, StatisticalAnalysis, Quality Function Deployment, and PolicyDeployment. The training began with the CEOand his staff and cascaded in groups across thecompany and its suppliers.

The above training and accompanying workprocess changes began to transform the company.Within three years the quality and cost competi-tive gaps were reduced by more than 50%.Encouraged by this progress, the company set aneven more aggressive goal — to apply for andwin the U.S. National Quality Award in the follow-ing three years. This required further intensiveTQM efforts. At the end of the period, the compa-ny had increased its customer satisfaction indexby 50%, reduced costs by an additional 20%,improved product quality, as measured by thecustomers, by 50%, and had begun to win backmarket share from competitors. These results,and the quality journey that had made them possible, were recognized by the U.S.Department of Commerce which awarded thecompany the National Quality Award.

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IX . COST OF QUAL ITYConverting the language of quality into some-thing that management is familiar with, such asdollars, gives everyone a common language andalso facilitates measuring, tracking and analyz-ing. Dr. Juran first proposed the concept in theQuality Control Handbook published in 1951 andit has been greatly refined since.

The Cost of Quality is a measure of what an organ-ization is spending for its overall quality. It can beviewed as the difference between the actual costof making and selling products and services andthe cost if there were no failures of the productsand services during manufacture or use.

Unfortunately, the term “Cost of Quality” can leavea negative impression that reflects the thinkingof the 1960s when it was believed that betterquality products cost more to produce. But Costof Quality can provide a very useful tool to changethe way the enterprise thinks about errors.

Examples include:l getting management attention by taking quali-

ty out of the abstract and into dollar terms,thereby competing with other cost and sched-uling priorities

l changing the way employees think about errorsl identifying and prioritizing areas for corrective

actionsl measuring the effect of corrective actions and

changesl providing new emphasis on doing the job right

the first time, every time.

The Cost of Quality has two basic components:A) Cost of conformance, i.e.,

l cost of preventionl cost of appraisal

B) Cost of non-conformance or failures, i.e.,l cost of internal failurel cost of external failure or lost opportunity.

Leading companies supplement these Cost ofQuality measures with other non-financial meas-ures depending upon the nature of the enter-prise. Examples of additional quality measuresare illustrated in Appendix 3.

Most enterprises accept that poor quality is cost-ing them a great deal of money, but they areshocked when they find out how much. In the1980s, the cost of poor quality was estimated tobe 10 to 20% of sales dollars or two to fourtimes the profit for an average company.

Cost of PreventionThe cost of prevention is the cost to ensure thatcustomer requirements are met. It is associatedwith maintaining quality systems, such as quali-ty control systems. These are incurred prior to orduring production to prevent defective units ofoutput.

This is a necessary cost for error prevention. Byfar the best way an enterprise can spend its Costof Quality dollars is to invest in preventiveactions. Unfortunately, many companies haveneglected this valuable investment because ofdifficulties in identifying the downstream returns.

Examples of preventive actions include:l quality planningl quality engineeringl training to improve qualityl maintenance and calibration of production and

inspection of equipmentl supplier assurance.

15


Cost of AppraisalThe cost of appraisal is the cost to ensure thework processes are producing outputs that meetcustomer needs or requirements, such as theinspection of raw materials. Here the term refersto both internal and external customers. Theseare incurred after production, but before sales,to identify defective items.

Examples include:l quality data acquisition and analysisl quality measurement criterial quality auditsl laboratory acceptance testingl field evaluation and testingl inspection and testingl raw materials testingl in-process testingl review of test and inspection data.

Unlike preventive actions, appraisal actions donot reduce the number of errors; they only detecta higher percentage of errors in output before itis delivered to the customer.

Cost of Internal FailureThese are costs of not meeting customerrequirements, such as the cost of having to dowork again (rework). These are easy to identifybecause many accounting systems already trackthem. They are incurred to fix or dispose of thedefective items before they are sold.

Unlike the cost of prevention and appraisal, thesecosts are not value added and never necessary.

Examples include:l scrapl rework or repairl trouble shootingl re-inspect and re-test.

Cost of External Failure or Lost OpportunityThese costs represent the lost profits associat-ed with not meeting external customer needs orrequirements. If the external customers becomedissatisfied with an enterprise’s offerings, theyare likely to return the product, not buy from thefirm again and, more importantly, tell otherpotential customers about their experience. Thecost of lost opportunity, therefore, includes lostprofits from order cancellations and marketshare loss.

Examples include:l customer service faultsl products or services rejected and returnedl products or services recalled for modificationl repairs and replacements or added service

provided under warrantyl admitted repairs beyond warrantyl product liabilityl customer losses due to poor quality.

X . COST OF QUAL ITY IN SERVICE INDUSTRIESCosting quality in service industries is similar tocosting quality in manufacturing. External fail-ures, however, are a more important quality costin service industries. Errors in service are notamenable to rework. In manufacturing indus-tries, customers can call and demand warrantyrepairs on a faulty product. In the service indus-try, it does not always work that way. The servicefailure can result in the company’s losing thecustomer—even without knowing it.

For example, an airline that is either tardy or haspoor in-flight service may not win the loyalty offrequent business travelers and thereby will losemarket share.

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Management accountants should be aware that aservice company’s profit has more to do with cus-tomer defections than with unit costs, economy ofscale, and other factors traditionally tracked bycost accounting. For example, in some industries,companies can boost profits by 50% just by retain-ing 10% more of their customers.

The cost of lost opportunity in a service industry,therefore, needs to be strengthened to include theprobability of market damage done by poor service.

Another major difference between service indus-tries and manufacturing is that labor costs takeup a far greater proportion of operating costs.This can lead to several challenges. For example,time cannot be reworked or reclaimed. In a man-ufacturing organization, raw material can bereclaimed. But when the material is people’stime it cannot. This means that, by looking at thepercentage of time spent on various activities,Cost of Quality data may equate a reduction infailure costs with job losses, and cooperationmay diminish.

X I . QUAL ITY COST RELAT ION-SHIPSSince prevention and appraisal costs are a func-tion of managerial discretion, they are referred toas voluntary costs. Management makes directdecisions about the current funds to be budgetedfor these voluntary costs. In contrast, invest-ments to manage non-conformance or failurecosts may not be directly controllable by man-agement. For example, the cost of customer dissatisfaction, while not easily measurable, maytrigger a cost for management to contain.

Even though non-conformance costs may not bedirectly controllable, they are definitely related tovoluntary costs. When additional resources areallocated for prevention and appraisal activities,

quality improves and non-conformance coststend to decline. Conversely, when quality confor-mance efforts are reduced across the supplier,manufacturer and distribution chain, non-confor-mance costs increase. Accordingly, voluntarycosts and failure costs move in the oppositedirection.

Therefore, the minimum amount of total qualitycost is located at the point where the marginalvoluntary expenditures are equal to the marginalsavings on non-conformance costs (see Exhibit 6).

From Exhibit 6, it is clear that the minimum totalquality cost per unit is located at a level of qual-ity assurance that is less than 100%. At very lowlevels of assurance, significant internal andexternal failure costs outweigh any cost savingsthat could be attained by avoiding voluntarycosts. In contrast, extremely high levels of qualityassurance result in voluntary cost expendituresthat cannot be offset by non-conformance costsavings.

For an organization not steeped in TQM, thecosts of internal failures and lost opportunitieswill comprise the biggest part of the total Cost ofQuality. As these non-conformance costs areidentified and managed, the relative balancebetween conformance and non-conformancecosts shifts. In a steady state, both the confor-mance and non-conformance costs decline,though as a percentage of total Cost of Quality,the conformance costs increase as shown inExhibit 7.

X I I . MANAGEMENT ACCOUNTINGCHALLENGESManagement accountants require a clear under-standing of TQM methodology. They should alsobe able to create a system of quality informationmeasurement and to evaluate exactly what is

17


required by each organizational unit and by thetotal enterprise.

The management accountant may need to exten-sively rewrite existing product costing and report-ing systems. The costs associated with lostopportunities or loss of market prominence asquality falls below customer expectations mayrequire more subjective reasoning than normal.These costs may have to be subjectively estimat-

ed before managers have an idea of their totalquality costs.

Most accounting systems don’t reflect all thespecific quality cost categories that are requiredfor quality management purposes. The manage-ment accountant, therefore, must:

l determine which accounts contain valid infor-mation for TQM;

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EXHIBIT 6: OPTIMAL QUALITY COST

Source:

Quality Costper Unit

Level of QualityAssurance

Total Quality Control Cost

Non-Conformance Costs

Conformance Costs

**

*

*

*

*

250

$300

200

150

100

50

00 60 64 68 72 78 80 84 88 92 96 98%

EXHIBIT 6. OPTIMAL QUALITY COST

l reorganize and restructure the existingaccounting system to provide accurate qualitycost data; and

l revise the chart of accounts to reflect eachquality cost category.

Another shortcoming of most accounting sys-tems is their failure to associate costs with activ-

ities. The systems do not provide individual man-agers and employees with the information theyrequire to make improvements. Therefore, quali-ty teams will not have the information necessaryto focus on the most important quality problems.

The management accountant needs to relatequality costs to activities to help quality improve-

19

B U S I N E S S P E R F O R M A N C E M A N A G E M E N TEXHIBIT 7: COST OF QUALITY PROPORTIONS

Source:

QualityCosts

Period

Current Interim Maturity

OpportunityLost

InternalFailure

AppraisalPrevention

OpportunityLost

InternalFailure

Conformance

OpportunityLost

InternalFailure

Conformance

EXHIBIT 7. COST OF QUALITY PROPORTIONS

ment teams focus their efforts appropriately inorder to assure the success of the TQM effort.

The solution lies in applying techniques fromactivity-based costing to TQM. Activity-based cost-ing yields improved information because of its useof an extensive cost driver identification processto relate activities to products or services.

Cost drivers (such as the number of differentparts used or the effort expended by a product)reflect the consumption activities of a product orservice. Examples of activities include:

l Tapping threads in a hole in a metal partl Issuing a purchase order.

Cost drivers allow quality teams to pinpoint activities which are the result of not doing thingsthe right way.

Since no standard format has been developedfor Cost of Quality reporting, the types of itemsincluded vary within and among companies. Forexample, some Cost of Quality reports includeoverhead related to internal failure costs whileothers do not. These differences make it difficultto compare the performance of organizationalunits. If managers are to be evaluated on thequality cost performance of their units, the man-agement accountant should ensure that the Costof Quality reports are standardized.

In addition to these challenges, the managementaccountant must recognize that the quality costperformance measures will vary widely depend-ing upon the organization. Nevertheless, he orshe should ensure that the measurement andreporting process meets the following criteria:

l directly relates to the requirements of the internalcustomer using these measures and reports;

l uses Cost of Quality measures as well asother non-financial measures;

l uses measures that vary between locationsdepending upon quality and business chal-lenges;

l uses measures that change over time as theneeds change;

l is simple and easy to use, implement andmonitor;

l provides fast feedback to users and man-agers;

l is intended to foster improvement rather thanjust to monitor;

l motivates people to achieve quality gains.

Management accountants will need to be awarethat, although Cost of Quality data can be anattention-getter for senior management, precisionmeasurement may be redundant. Arguments canarise over the correct classification of costs. If theCost of Quality runs as high as 20% of revenue,greater precision in calculating cost seems to beof little value and perhaps very expensive toachieve. Therefore, techniques such as periodicaudits of Cost of Quality may suffice if theaccounting system changes prescribed earlierare prohibitively expensive. The primary benefitsof the Cost of Quality are its initial shock valueand its function as a means to measure improve-ment over time.

Based upon these challenges, a proposed sum-mary of the quality cost process is described inExhibit 8.

SUMMARY AND CONCLUSIONSExamining the Cost of Quality allows the enter-prise to identify, prioritize and monitor qualityimprovements. Other measures and processes(such as statistical analysis, Quality FunctionDeployment, Policy Deployment, quality circlesand benchmarking) will also be required.

20


The leadership for a company-wide quality transi-tion has to start at the top. It cannot be delegat-ed. The companies that have successfully movedto the quality paradigm established an executive-

level quality council to oversee and propel thechange process. The council must be chaired bythe CEO or the president and composed of thetop management team.

21


EXHIBIT 8: QUALITY COST PROCESS SUMMARY

Source:

The CEO is a major player in the process of identification of cost of quality, quality control, controller’s office

establishes cost of quality accounts, source documents, e.g., time sheets and labor accounts, may need to be restructured to identify quality cost categories.

CEO/quality council become the numberone quality implementors

User-oriented cost of quality reports developed.

Significant areas of quality improvement identified.

Problem-solving groups formed and quality tools applied,e.g., pareto analysis, force field analysis

statistical quality control.

Corrective actions identified and implemented.

Quality becomes a fundamental way of managing the company.

EXHIBIT 8. QUALITY COST PROCESS SUMMARY

The management accountant has the skillsrequired to be a valuable contributor to the exec-utive quality council, advising on quality opportu-nity areas and the measures and reportsrequired to monitor progress.

The journey on this quality path is difficult. It cantake several years to make significant progress.Several behavioral factors common to largeorganizations can become inhibitors. For exam-ple, some functions may be identified as con-tributing to the Cost of Quality. The managers ofthese functions may not cooperate. There mayalso be debates about what should be consid-ered as opportunities for managing the Cost ofQuality. Finally, change at one step of the produc-tion process may cause unexpected or hiddenchanges in subsequent processes.

A company that has successfully implementedTQM can expect improved market share or prof-its or both. Cost reductions of 5 to 10%, out of apotential 20% of sales, are not uncommon.

Companies near the end of their transition toTQM appear very different from when they start-ed. The differences show up, for example, in thefollowing areas:

l the organizational structure becomes moreefficient and flexible. Internal communicationimproves as some non-value-added or “findand fix” functions are reduced;

l internal measures of performance arereplaced or supplemented by customer-orient-ed quality measures. Several new financialand non-financial measures (such as customersatisfaction) are added;

l all employees in all departments are intro-duced to the basic tools and philosophy ofTQM. Decision making becomes more broadlydistributed;

l there are many cross-functional improvementefforts;

l suppliers become heavily involved and “buy in”to programs related to the quality quest;

l key products/services and markets are reorganized;

l several management processes are institu-tionalized, such as benchmarking, continuousimprovement, elimination of waste, preventionnot detection, JIT, reduction of variation,statistical thinking, and consistent manage-ment practices.

While many companies can expect a successfultransition, others will falter or achieve only par-tial benefits. They fail because they do not recog-nize that the total journey can take several years.Over this time there can be changes in the keyplayers or competing management priorities.This guideline is designed to alleviate some ofthese pitfalls.

22


APPENDIX 1 : CASE STUDYIt is impossible to provide a general model ofquality costing for all companies.

Since a standard format for Cost of Qualityreporting has yet to be developed, managementaccountants may not be aware of the analyticalmethodologies. Various types of analysis,reports and graphs can be developed once thedata has been gathered, surveyed by question-naires, or estimated by knowledgeable person-nel. A case study in a manufacturing environ-ment is described below to highlight the analyti-cal methodologies used to identify the areas forquality improvement.

Manufacturing ExampleManufacturing company X operates in a highlycompetitive environment and has been experi-encing increasing cost and quality pressuresfrom new Japanese entrants. By Year 1, theexternal failure costs as measured by warrantyclaims, customer dissatisfaction, and share losshad increased to 60% of the total Cost of Quality.

Realizing this, the company instituted a corporate-wide quality program, using a three-year TQMprocess, to win customers back. This required considerable investments in voluntary preventionand appraisal costs.

In the first year, the company increased the vol-untary prevention and appraisal costs by approx-imately 50%. In the second year, the investmentbegan to pay dividends.

The management accountant gathered and sum-marized the quality costs in the following Cost ofQuality report. The purpose of the report was tocommunicate to management the magnitude ofthe Cost of Quality and provide a baseline formeasuring the impact of future improvement

activities (see Exhibit 9).

The report indicated that prevention and apprais-al investments had begun to pay off in Year 2.The internal failure, external failure, and totalcosts had all decreased.

Increase/Decreasel Prevention Costs +45%l Appraisal Costs +55%l Internal Failure Costs –31%l External Failure Costs –47%l Total Quality Costs –26%

A decrease in the warranty costs resulted from adecrease in defective products delivered to cus-tomers. The market share, however, did not yetshow a gain. This can be expected when a com-pany first begins to emphasize quality. It takestime for quality to work its way through to themarket share. Increased quality should show uplater as the customers experience it and thecompany re-establishes itself.

Year 1 and 2 quality costs were further summa-rized (see Exhibit 10). This graph showed themagnitude of the quality costs and compared thecurrent period’s costs with the prior year’s. AsTQM is fully implemented by company X, totalquality costs will decline. Prevention and apprais-al costs, however, will increase in proportion.

The quality cost data provided by the manage-ment accountant pointed to the areas that need-ed quality improvement. The problem areas wereaddressed through quality circles and problemsolving groups. Several times, further analysis ofthe data through statistical analysis techniqueswas necessary.

Rework and reject was the biggest line item inthe internal failure costs. The company found it

23


24


EXHIBIT 9: COST OF QUALITY REPORT

Source:

Year 2 Year 1 % Change

PREVENTION COSTSTraining $ 90,000 $ 50,000 +80

Processes/Procedures 50,000 35,000 +42 Quality Planning 86,000 65,000 +32 Other Quality Improvement Efforts 60,000 45,000 +33 Data Analysis 40,000 30,000 +33

Total $326,000 $225,000 +45

APPRAISAL COSTSTesting 140,000 90,000 +55

Performance Measurement 75,000 50,000 +50 Supplier Monitoring 65,000 40,000 +62 Customer Surveys 30,000 20,000 +50

Total $310,000 $200,000 +55

INTERNAL FAILURE COSTSRework and Reject 55,000 100,000 –45

Reinspection and Testing 35,000 40,000 –13 Equipment Failure 30,000 35,000 –14 Other Failures 20,000 30,000 –33

Total $140,000 $205,000 –31

EXTERNAL FAILURE COSTSWarranty 70,000 200,000 –65

Cost of Warranty 100,000 120,000 –16 Customer Losses (estimated) 600,000 1,140,000 –47

Total $ 770,000 $1,460,000 –47

TOTAL QUALITY COSTS $1,546,000 $2,090,000 –26

EXHIBIT 9. COST OF QUALITY REPORT

necessary to break it down by product. One ofthe most powerful analytical tools is ParetoAnalysis. This technique was used to identify theproducts requiring further root cause analysis.Exhibit 11 showed that three product lines out offourteen accounted for 70% of the total scrap.

Further root cause analysis explained that theparts on these three product lines werescrapped because of the overall sub-system tol-erance requirements. With this information, man-agement investigated the reasons for the lowpart tolerance parameters and formulated a planto correct the situation.

25


EXHIBIT 10: COST OF QUALITY GRAPH

COST OF QUALITY($000)

External Failure

20,000K

$1,460K

205K

200K

225K

$770K

140K

310K

326K

$200K

100K

250K

250K

1,600

1,200

800

400

Year 1 Year 2 Desired State

0

InternalFailure

Appraisal

Prevention

EXHIBIT 10. COST OF QUALITY GRAPH

26


EXHIBIT 11: REWORK AND REJECT COSTS BY PRODUCT ANALYSIS

Source:

PRODUCT LINES

Product A B

20

15

10

5

0C D Other

(10)

108

12

15

20

COST

EXHIBIT 11. REWORK AND REJECT COSTS BY PRODUCT ANALYSIS

APPENDIX 2: STATISTICAL TOOLSAND PROCESSES MEASURESTraditional accounting systems do not provide sufficient information to personnel responsiblefor observing the production process, chartingquality performance, or identifying special causes of variation.

Management accountants need to understandthe use of statistical tools and processes meas-ures so that they can actively participate in andcontribute to the TQM process. A sample listingis presented below.

Closed loopIn a closed loop process, feedback providesinformation about the process output. When thisinformation shows the need for correction, theprocess output is corrected automatically. Aclosed loop can be effective in reducing variabil-ity and centering a process if the process feed-back is correctly analyzed and if process adjust-ments are appropriate.

ErrorsThe result of failing to correctly perform an action. Errorsresult in non-conforming outputs if left uncorrected.

Error ReductionThe reduction of errors,measured in terms of error rate.Improvement efforts should be directed to reducingerrors rather than correcting non-conforming outputs.

Non-random VariationsA term referring to variation in a process output,sometimes used in analyzing control charts. Thisvariation is the result of “special” causes and canoften be improved by the employees (supportedby their managers) who use the process beingmeasured. Usually these variations show up oncontrol charts as points outside the control limits,or as trends, shifts or periodic changes.

Process Capability MeasurementA measurement to determine if a process can pro-duce output that is both centered on the targetand well within the specifications limits. A processis “capable” if it fully conforms to customerrequirements; meets predetermined levels of cen-tering on the target value and variability within thespecifications limits; and is in control.

Process Quality AssuranceA system that verifies that the process is beingfollowed, that the enablers for the process are inplace, and that the process is consistently capa-ble of achieving specified outputs.

Random VariationA term referring to inevitable variation in a processoutput, sometimes used in analyzing controlcharts. Random variation is usually the result of“common” causes that can often be improvedonly by management (in contrast to “special”causes that the employee using the process mayoften address). While the causes may appear tohave a small effect, a single cause may substan-tially influence the size of the variation.

Six Sigma QualitySigma is a measure of variation in a product orprocess. It is a symbol for a statistical parame-ter known as standard deviation. In a typicalprocess, X represents the process average andsigma its standard deviation. Generally, theprocess width is defined as X ± 3 sigma. If thespecification width was the same, the processused to be considered in control. But in realterms, such a process would have a defect rateof 0.27 percent or 2,700 defects per millionunits. If, however, the process width is halvedand the specification width remained the same,the latter’s boundaries would be at X ±6 sigma.In such a case, the defect rate would be only 2defects per million units. And even if the process

27


average shifted by 1.5 sigma to one side, thedefect rate would only be 3.4 defects per millionunits. This is the statistical meaning of ±6 sigma.

In product terms, Motorola’s goal is for everyimportant parameter to be designed, built, andbrought to ±6 sigma; that is, the process widthwould be no more than half the specificationwidth. In administrative terms, ±6 sigma is sim-ply perfection; that is, having a defect rate of nomore than 3.4 errors per one million opportuni-ties for error. Motorola is dedicated to achievingthis state of perfection by 1992.1

StandardizationThis ensures the consistent use of a process orprocedure across all applicable areas. After aprocess improvement has been tested and veri-fied, the improved process must be standardizedto maintain the benefit across the corporation.

Statistical Process Control (SPC)The application of statistical techniques for meas-uring and analyzing the variation in processes.

Statistical Quality Control (SQC)The application of statistical techniques formeasuring and improving the quality of process-es. SQC includes SPC, diagnostic tools, sam-pling plans, and other statistical techniques.

Statistical ToolsGraphical and/or numerical methods that assistin the analysis of a process or population ofevents. Often the tools use a sampling of thepopulation to make a judgment and decisionabout the entire population.

Listed below are the seven most commonly usedstatistical tools for analytical problem solving.

1. Check Sheets2. Cause and Effect Diagrams3. Histograms4. Pareto Diagrams5. Control Charts6. Scatter Diagrams7. Graphs.

StratificationThe process of classifying data into two or moresub-groups based on categories or characteris-tics. This is a powerful and frequently used tool.When the data are stratified according to the vari-ables, which are thought to cause variation, thecauses of variation can be detected more easily.

10X Improvement(Also known as “tenfold reduction”.) lOXimprovement means reducing the process’s erroror non-conforming output rate to 10% of its existing rate. Improvement is measured by examining on-going quality in terms of error andnon-conforming output rates.

VariabilityThe inevitable changes in the measured values ofa process output. Changes are due to randomcauses (natural or common causes) or non-randomcauses (special causes). Variability can be meas-ured. It describes the spread of the measured out-put values around the average. Sigma (standarddeviation) is an often used numerical measure ofvariability. Variation can be visually representedthrough the use of graphical techniques.

Variability ReductionThe process of reducing the spread of values ofa process output. To reduce variability, you sepa-rate the random from the non-random variationbefore you develop corrective action plans. Youthen use different corrective actions for the ran-dom and non-random causes.

28


1 Bhote, K.R. Motorola’s Long March to the Malcolm BaldrigeNational Quality Award. National Productivity Review. Vol. 8(Autumn 1989).

APPENDIX 3 : ADDIT IONAL QUAL ITY MEASURESCost of Quality by itself cannot resolve qualityproblems. It is only designed to help manage-ment understand the magnitude of the problem,identify opportunities, and measure progress. Itmust be accompanied by an effective improve-ment process to reduce the errors in an enter-prise. An enterprise should supplement the Costof Quality measures with additional measures tomaintain focus on unique quality elements. Themanagement accountant must achieve a workingknowledge of these measures to help quantifythe Cost of Quality.

Some of these measures are common to mostorganizations. Others may be unique to thenature of an enterprise, i.e., industry, competi-tion, current and desired state of quality, etc.

An exhaustive list of quality measures for manu-facturing and service industries is impossible tocreate. Many of these measures have to bedeveloped specifically for the industry, companyor quality need. A sample listing is presentedbelow.l Installation failuresl Scrap and reworkl Reinspection and retestl Redesign and engineering changesl Soft toolingsl Abandoned programsl Billing errorsl Bad debtsl Premium shipping costsl Supplier cancellation costsl Overdue accounts receivablel Off-spec/waiversl Excess inventory

29


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