INTEGRATING THE QUALITY COST REPORT AND TQM TOOLS TO ACHIEVE COMPETITIVE

ADVA
Wang, Geng;Gao, Zhongming;Lin, Thomas W
Cost Management; Jan/Feb 2007; 21, 1; ProQuest
pg. 42

INTEGRATING THE
QUALITY COST This paper reports a study on the quallty cost

REPORT
mana1ement situation of a Chinese firm over three
years as It attempts to Identify how to use TQM tools
and the quallty cost report for Its bu1lne11 to
1tren1then quallty
cost mana1ement and raise Its

AND TQM TOOLS TO

competitive advantaie.

ACHIEVE COMPETITIVE
ADVANTAGE GENG WANG, ZHONG MING GAO. and THOMAS W. LIN
ver since China entered the worked for include Formosa
Plastics Group and KPMG. A
WTO at the end of 2001, CMA and a member of the
Chinese frms have faced Institute
Accountants
of Management
and the
severe competition from American Accounting
other multinational com• Association, he published
two co-authored books in
panies. Many Chinese 2005: Cost Management: A
frms have Strategic Focus, srd edition,
and Cases and Readings in
realized that the implementation Cost Man• agement, srd
of total quality management (TQM) edition.
is one of the key success factors in
international competi• tion. The
core principle of TQM follows a
simple customer-focused line of
reason• ing: Because customers
value high quality, businesses
producing high quality prod• ucts
and services can raise product price
and expand market shares. High
value and mar• ket share foster
high sales revenue. Qual-

GENG WANG is Professor of Accounting in the

Antai School of Management, Shanghai
Jiaotong University, China. She is a Council
Member of the Accounting Society of China,
and an Advisor of the Chinese Accounting
Standard Committee.

ZHONGMIN GAO is the Deputy General

Manager at Shang·
hai Urban Marketing
Management Co., Ltd.

THOMAS W. LIN is Professor of Accounting

and Leventhal International Faculty Fellow in
the Leventhal School of Account• ing, University
of Southern California. Previous companies
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permission.
ity improvement helps a firm to reduce sales agement practices incur upfront
returns and allowances, lower manufac• costs. Advantages come only
turing costs, and shorten the production through increasing product quality
cycle. Reductions in sales returns decrease while decreasing non-value• added
warranty costs and repair expenses. Reduc• tion operation quality costs.
in the production cycle speeds prod• uct Therefore, a study on quality cost
output, which in turn increases customer control under TQM becomes a
satisfaction, generates new demand, and great challenge in contempo•
expands market share. Increases in sales rary businesses, especially for
revenue and decreases in cost raise the net China's busi• ness firms. This
income and return on investment. article reports on how one Chinese
The business that explores its market healthcare product-manufactur•
opportunities through quality management ing firm in the Shanghai area
enters the international quality playing increased the benefits and core
field and may achieve a competitive advan• competencies of its busi• ness by
tage, but improvements on quality man• increasing product quality while effec-

COST MANAGEMENT JANUARY/FEBRUARY 2007

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 EXHIBIT 1 Quality Cost Report
YEAR 1 YEAR 2
YEAR 3
% of % of
% of
Categories Activities Amounts Sales Amounts Sales
Amounts Sales
-·--· -··- ---- --

1 Prevention Quality
Costs Management
Training 202,300 301,10 443,5
0 00
Production Supplier
Preparation Auditing 29,200 48,60 40,20
Stage
New Product
Inspection 14,400 18,00 22,00
0 0
Sub-total 245,900 0.66% 367,70 0.66% 505, 0.45
0 700 %
2 Appraisal New
Costs
Material Inspection 12,800 18,92 21,60
0 0
Production Arrival
Stag
Material Inspection 3, 120 5,070 11 ,060
e
Work-in-process 27,000 48,90 101,700
Inspection 0

Finished
Product
Inspection 22,500 55,80 144,200
0
Chemical 180,000 226,00 638,000
0
Test Instrument 2,220 4,380 5,
120
Correction of
Test Instrument 11,000 18,90 21,800
0
Verification of
TestInstrument 2,240 40,05 32,100
0
Maintenance of
Test 36,000 51,80 58,300
Instruments 0
Sub-total 296,880 0.80% 1,033,880
469,820 0.84% 0.91% -
-·- -·- - - - - - - Disposal
3 In-ternal - - - -·- - of
- - - - - - - - - - - - - - - - - - - - - - - - - -
Failure Defective
Costs Products 48,000 60,400
98,200

Production Rework 7,200 9, 100

1,350
Stage
Loss due
to work 8,600 8,010 10, 100
interruptions
Sub-total 63,800 0.17% 77,51 0.14% 109,65 0.10
0 0 %
4 Customer
Failur
External Complaints 9,600 9,440 14,600
e
Costs
Sales Returns
Marketin and Allowance 36,000 8,800 11, 100
gand After-
sale Customer Service
Servic Expense 5,200 4,280 5,800
e
Sub-total 50,800 0.14% 22,52 0.04% 31,500 0.03
0 %
5 Total Quality
Costs 1 + 2 + 3 657,380 937,550 1,680,7
+ 4 30
6 Sales 37,000,000 55,800,000 113,366,0
00
7 Proportion of
total quality
costs to sales 5 + 1.78% 1.68% 1.48%
6
(Unit: RMB where $1 U.S. = 8.1 RMB)

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 TOTAL OUAllTY MANAGEMENT JANUARY/FEBRUARY 2007 COST MANAGEMENT

43

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 EXHIBIT 2 Year 1 Defect Incidence and Cause & Efect Map

25.00% �-------------------
19.20%
20.00%

+-----------------
--
15.00% +------------------
10.00% +-8-9--%-�=-------------
s.oo
s 0 0.43% 0.22%

People Equipment

Material Method Environment

EXHIBIT 3 Year 2 Defect Incidence Pareto Chart

16.00% 14.80%
..--�����������������-,
14.00% +------------------
12.00% +------------------
10.00% +------------------
8.00% +-----------------
6.00
%
4.00
%
2.00
%
0.00
%

tively decreasing the a large-

percentage of total product scale
quality costs to sales revenue. healthcare
product-
manufactur
Integrating quality costs and TOM ing firm that
tools SK Shanghai Company is is located in
China.
 During the past five years, the firm
benefited from implement-
ing TQM by gradually increasing
product quality, fully satisfying
customer demand, and continually
expanding its market share. Both
the firm's CEO and other top man•
agement have fully committed to
support• ing and participating in
various TQM activities. The
responsibilities of quality cost data
collection are led by the Quality
Assur• ance Department but
shared by the Sales

44 COST MANAGEMENT JANUARY/FEBRUARY 2007 TOTAL

OUALITY MANAGEMENT
 Department, Purchasing
Department, and
Production
Department.
From a value-chain perspective,
the firm has only middle-and-down
stream produc• tion, marketing,
and after-sale service with no
design or R & D stages. The process
analy• sis method was used to
determine key qual• ity activities.
Exhibit I shows a detailed
Quality Cost Report with the total
quality costs of three successive
years in category 5 of Exhibit 1.
The firm's management focuses on
controlling costs of
nonconformance, i.e., internal
failure costs and external fail• ure
costs. The frm's Quality Cost Report
shows that the internal failure
cost has a higher percentage than
the external failure cost. Pareto charts
and cause-and-effect diagrams
were used to analyze internal
failure costs of the SK Shanghai
Company.
Internal failure cost analysis for
year one Of RMB63,800 total
internal failure costs in year one,
more than seventy-five percent
were incurred during disposal of
defective products with the
remaining costs distrib• uted
evenly between rework and work
inter-
EXHIBIT 4 Year 3 Defect Incidence and Cause & Efect Map
material quality
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ruptions. Therefore, it was
imperative to characterize the
disposal of defective prod• ucts to
control internal failure costs.
Data on disposal of defective
products in year one revealed the
different defect causes and rates
of defects for each cause. Pareto
chart• ing and cause-and-effect
mapping was used to analyze the
internal failure cost.
As shown in Exhibit 2, the key
factor is "dyeing defect," which
accounts for 8.9 l percent of the
total defects. The cause and
effect map shows that five factors
lead to dye• ing defects are:
people, equipment, mater• ial,
mixture, and environment.
However, due to high automation
and closure of the dying
operation, many of the impacts
from people and the
environment could be ignored.
Equipment related defects are
deter• mined by temperature,
timing, and dosage of dyeing
solution. The firm estimated the
cost of correction and verifcation of
the dye• ing machine and dosing
equipment to be RMB4,935.60.
Dye and catalyzer are mate• rial
factors that infuence defect
rates. The cost of inspection both
to dye and catalyzer was
estimated to be RMB246.80.
Mixture defects can be
infuenced by mix propor-
vacuum forceps jacket
 Material Environment
Method

TOTAL QUALITY MANAGEMENT JANUARY/FEBRUARY 2007 COST MANAGEMENT

45

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 EXHIBIT 5 Percentage Changes of Quality Costs and Sales

�
1 20..0%..---------
_---,,,,,...,.,,.,....-------------------- --,
100.0% _
80.0%--=-�----,:==-=::-:-
60.0% t---====-=-:::-:----''i=-;.;.
40.0%
20.0%
0.0%
·20.0%.i-:-====c.......;_==:.=.:;.;;;.. ---l
-40.0"4+------------'=="""-"="-="'=-i
-60.0"%4.....-..-_--------------- ....::,......-_-------------
1.
External Fellure Coats
DYear 1 To Year 2
•Year 2 to Year 3

tion and timing, but they could be reached

addressed through proper 8.65
training. The cost of qual• ity percent.
management training for mixing In light of
processes was estimated as RMB the
1,200. The total estimated identifiable
additional prevention cost was sources of
RMB6,382.40. After implementing impurity, it
pre• vention measures, the costs of was
dyeing defects were reduced from unnecessary
RMB24,502 in year one to to use a
RMB3,038 in year two with the cause•
increased benefit of RMB2 l , and-effect
464. The cost control appears map to
to be effective because the analyze data
benefit from the cost reduction in year two
exceeded the addi• tional because the
prevention cost. main cause
was the
impurity of
Internal failure cost analysis for imported
year two The same methods raw
were used to analyze internal materials.
failure costs of year two. As To solve the
illus• trated in Exhibit 3, Pareto
charting demon• strated that the
dying defects had dropped to 0.
78 percent, and impurities,
now accounted for 6.94 percent
of cost for dis• posal of
defective products. After further
analysis, the impurity was found
to come from two sources:
• The main raw materials were
imported from the U.S. and
molded by the sup• plier.
Therefore, the local factory
can• not control hidden
impurities.
• The imported raw materials
were exempted from
inspection in the past.
Through random inspection of
mate• rials in stock, it was
found that the impurity rate
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impurity problem, the firm decided to con• duct an audit dis• posal of defective products
of its raw material suppliers and required each (see Exhibit 4).
supplier to provide tech• nical procedures to reduce The analysis of the cause-and-
the impurity rate to less than three percent. This effect map shows once again that
action incurred the additional cost of RMB3,508. The people, equipment, material,
firm also developed and implemented a new method and environment infuence
inspection standard to reinforce material face defects. The environmental
inspection and random inspec• tion, which incurred a factor is uncontrollable in this
cost of RMB246.80. The total new prevention case. The equipment factor is
cost was RMB3,754.80. After implementing pre• primarily infuenced by the plas•
vention measures, the costs of impurity have tic forceps jacket and vacuum
reduced from RMB36,346 in year two to RMBO in year forceps jacket. As a result,
three. Once again, the cost control appears to be verification of the quality of the
effective because the benefit of RMB36,346 greatly forceps jackets and use of the
exceeds the additional prevention cost of RMB3,754.80. vacuum forceps jacket to unpack
the material are required to
reduce scraping and face defects,
Internal failure cost analysis for year three Finally, the which generate costs of RMB 180.
same methods were used to ana• lyze internal failure The mate• rial factor is
costs of year three when face defect became the new infuenced by the quality of
major failure fac• tor accounting for 5. 79 percent of cost for

48 COST MANAGEMENT JANUARY/FEBRUARY 2007 TOTAL

QUALITY MANAGEMENT

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 purchased material on arrival. Internal failure costs increase
Arriving material inspection, every year,
random inspection, and quality but the sales still exceed them.
assurance of material in stock are The exter•
required to address material nal failure costs decrease in
infuences, which generate costs of year two and increase in year
RMB246.80. Unpack• ing the three, but their ratio to sales
material and the fact that it is decreases. Exhibit 5 also shows
easy to scrape products during the that the increasing
finished prod• ucts inspection percentages of sales rev•
infuences the method fac• tor. enues are higher than total
Improved methods of quality costs
conducting finished product
inspection are required to reduce
the possibility of face scraping.
Fingernail length and jewelry
infuence the people factor. Thus,
employees are required to trim
their nails and remove the
orna• ments on their hands. The
total cost of elim• inating method
and people factors will be RMB
1,200. The additional prevention
cost reaches RMB 1,626.80, and
the actual data of prevention
measure results is not currently
available.

Analysis of quality cost

versus sales in three
recent years
The following general analysis
of quality costs serves as the
benchmark for overall per•
formance evaluation. Exhibit 5
shows per• centage changes in
prevention costs, appraisal costs,
internal failure costs, external
fail• ure costs, total quality costs,
and sales rev• enue from year one
to year two and from year two to
year three.
In three recent successive years,
appraisal costs increase 58.3
percent from year one to year two
and 120 percent from year two to
year three because of the
continuous increase in the
company's market share and
sales. In contrast, during the same
time period, pre• vention costs
reduce the increasing speed from
49.5 percent to 27 .5 percent due
partly to
the increase of prevention
costs lagging behind sales, and
due chiefy to supplier auditing
efforts in year two that contributed
to the decreases of prevention
costs to sales percentage in year
three.
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percentages in both years. The quality inputs and product
field study data also demonstrate improvements and gain higher
that the frm achieved satisfactory profitability. To effectively
results by introducing TQM and reduce internal and external
quality cost control characterized failure costs in implementing
by stable product quality, fewer quality cost control under TQM,
customer com• plaints, the company can invest
improvement in the company's more on prevention and
goodwill, increases in the appraisal costs and improve
company's core competency, and key problems careful analysis
expansion of the com• pany's of contributing factors.
market share. 3. Quality cost control
establishes and raises
company goodwill, which leads
Practical guidelines for quality to a higher return on
costing investments. The decrease in
As a way to evaluate the external failure costs
effectiveness of a company's demonstrates that products
quality system, quality costing satisfy the customer
can discover problems, develop demands, and the company
measures, and improve the overall gains competitive advantage
system. The appli• cation of basic as well as
Pareto charts and thought• ful expands its market share.
Although the investments on
cause-and-effect maps in this
prevention and appraisal may
case of quality cost control exceed the decreases in
suggests three practi• cal internal and external failure
guidelines. costs, they contribute to the
1. The satisfactory performance
increase in sales and
of qual• ity cost control not
decreases in the ratio of total
only depends on the efforts of
quality cost and sales.
accounting profession• als, but
Therefore, quality cost
also on the support and
management and control play a
involvement of top management, espe•
cially the CEO and president. signifi• cant role in a
2. Quality cost control supports company's strategy. •
company decision making on

TOTAL QUALITY MANAGEMENT JANUARY/FEBRUARY 2007 COST

MANAGEMENT 47

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