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Accounting for Quality
Lecture 21



Learning outcomes
At the end of the session, you should be able:

To define quality
To distinguish between the two types of quality
conformance
To identify the four categories of quality costs and
understand their relationship
To outline the implications of quality management to
management accounting

Accounting for Quality: Overview
Recall that to survive and be successful in todays global competitive environment,
companies need to provide quality products or services.
to satisfy customer needs and to meet or exceed customer expectations

Whether a company competes through a strategy of cost leadership or product
differentiation, quality issues permeate every aspect of its operations
A firm choosing to complete on a cost leadership strategy, is not choosing low-
quality products
Similarly a differentiation strategy will fail if the firm fails to build quality into its
products

Focusing on quality of a product can be beneficial
Creates customer satisfaction
Reduces the cost of quality, which can be substantial
Generating higher sales, leading to increased shareholder value

Therefore accounting for quality is an important role of the management accountant
Makes management aware of the magnitude of quality costs
Provides a benchmark against which the impact of quality improvement activities
could be measured.
Quality as a Competitive Tool
Quality is defined as:

The total features and characteristics of a product or a
service made or performed according to specifications to
satisfy customers at the time of purchase and during use.

Ensuring that the technical aspects of the products design
and performance conform to the manufacturers
standards.

Basic Aspects of Quality
Quality may be viewed as hinging on two major factors:
Design Quality- refers to how closely the characteristics of a product
or service meet the needs and wants of customers.
Conformance Quality- refers to the performance of a product or
service relative to its design and product specifications.

Quality of design failure Conformance quality failure

Design Specifications

Actual Performance Customer Satisfaction
Types of conformance
Quality involves conformance with specifications for products
or services that meet or exceed customer requirements and
expectations

Two types of conformance
Goalpost conformance - Conformance to a quality
specification expressed as a specified range around the
target- the target is the ideal or desirable outcome of the
operation
Absolute conformance - Requires all products or services to
meet the target value exactly with no variations

Managing quality to create value
Two major perspectives:
Financial perspective: costs of quality

Non-financial perspective
Customers
Internal processes
Learning and growth
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Financial Perspective: Costs of Quality
The costs of quality (COQ)- refers to costs of activities
associated with prevention, identification, repair, and
rectification of poor quality and opportunity costs from lost of
production time and sales as a result of poor quality.

These costs focus on conformance quality and are incurred in
all business functions of the value chain.

Companies have discovered that they can spend as much as
20% to 30% of total manufacturing costs on quality-related
processes

Yet, traditionally, quality costs only included costs of
inspection and costs of testing the finished products
Cost of Quality Framework
Divides costs into two components:
Conformance costs- prevention and appraisal
costs
Non-conformance costs- internal and external
failure costs.

Assumes a relation between conformance costs and
non-conformance costs
As companies invest more into prevention and
appraisal costs, they will be able to reduce their
failure costs
Prevention is better than cure

Cost of Quality Framework
Conformance costs costs to achieve high quality
Prevention costs
Costs incurred to ensure that the products conform to
quality standards.
E.g., product design and product reviews, employee
training, training and certifying suppliers, quality
engineering, equipment maintenance.

Appraisal costs
Costs incurred in individual product inspection to
make sure they meet both internal and external
customer requirements,
E.g., cost of inspecting incoming materials and parts,
process control monitoring, maintenance of test
equipment.
Cost of Quality Framework
Non-conformance costs: consequences of poor quality
Internal failure costs
Costs incurred when the manufacturing process detects a
defective component or product before it is shipped to
external customers,
E.g., scrap cost, rework cost, re-inspection costs, cost of
downtime due to defective parts

External failure costs
Costs incurred by a non-conforming product detected after
it is shipped to customers,
E.g., cost of repairs, warranty costs, service calls, customer
complaints
Famous external failures
Toyota well known for quality however;
In 2009 in the US
Family died when accelerator pedal got stuck
Enormous media coverage US government got
involved
6 million cars recalled
Production and sales of model suspended
2billion loss in North America alone
Worldwide reputation losses beyond calculation
Non-financial quality indicators
A balanced approach to quality should
include (cf. BSC framework):
Financial indicators (Costs of Quality, above)
Non-financial indicators (see next):
External, customer focused quality indicators
Internal business processes quality indicators
Learning and growth quality indicators
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Non-financial quality indicators
External, customer focused quality indicators
Focused on the two dimensions of quality: design
quality and conformance quality
Indicators include:
Market share; repeat business
Customer complaints
Products with early or repeated failures
Percentage of defective units shipped
Delivery performance
Both lead and lag indicators
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Non-financial quality indicators
Internal business processes quality indicators
Internal dimensions of quality to achieve customer-
relevant quality and avoid failures
Indicators include:
Defective units produced or reworked
Number of quality-driven changes to products and
processes
Development time of new products or services
Order-to-delivery time
On-time performance
Productivity and efficiency measures
15
Non-financial quality indicators
Learning and growth quality indicators
Focus on intangible aspects related to
organizational learning and growth
Indicators include:
Training on quality, of company employees and
from external parties
Employee satisfaction and turnover
Employee empowerment
16
Setting quality targets
External quality targets
Based on other companies in the same industry or
on the industry average
Benchmarks by consultancy firms / associations
The case of ISO benchmarks:
the ISO 900 family of standards
benefits of ISO certification: controversial
insights
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Setting quality targets
Internal quality targets
Based on past performance or internal
benchmarking
The six sigma approach:
improve processes to achieve an
extraordinarily high-conformance quality level,
near perfection
aim to reduce process variability that causes
defects and undermines customer satisfaction
five DMAIC steps
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The five DMAIC steps
19
Define project with strong
business case problem and
objectives
Measure current
performance
using reliable
data
Analyse root
problem and any
cause and effect
relationships
Improve the
process through
generating and
implementing
solutions targeted
at critical process
Control the
process to ensure
sustainable
performance
TQM
TQM: permanent and integrated effort across the
entire organization to excel in all customer-relevant
quality dimensions of products and services

Customer satisfaction: TQMs focus and obsession
Design quality:
Meeting customers expectations + designing
quality into the product and processes to prevent
waste; prevent, rather than detect, defects
Conformance quality
20
TQM
Important tool: plan-do-check-act (PDCA) cycle, a systematic,
interactive approach to continuous improvement and
problem solving
21
Examine what
is causing
problem and
suggest
solution
Experiment with
a solution
Examine results
of different
solutions
Implement
solution if it
works or
return to plan
stage
TQM
Belief: costs of improving quality are more than
compensated by cost reductions from efficiency
improvements and by revenue increases
But still needs to be confirmed!

Return on Quality (ROQ) approach:
Concern that costs of some quality improvement
initiatives, or improving quality beyond a certain
level, may exceed expected benefits

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Quality and management accounting
Potential for significant involvement by management
accounting

Helping to establish the present position of the
organisation in relation to each area of quality chosen
Costing the present performance in order to reveal the
potential for improvement
Through cost reduction
Profit improvement
Carrying out a post audit to demonstrate that savings are
achieved
Regular reporting for management control
Quality and management accounting
Monitoring measures selected in order to check that
improvement is taking place.

Financial measures
Focus managers attention on the costs of poor quality
Assist in problem solving by comparing costs and
benefits of different quality improvement programs
and setting priorities for cost reduction

Non-Financial measures
Direct attention to physical processes and to areas that
need improvement
Provide immediate short-term feedback on whether
quality improvement efforts are succeeding
Provide useful indicators of future long-term
performance