Wayne Johnson, president of Banshee Company, recently returned from a conference on quality and productivity. At the conference, he was told that many American firms have quality costs totaling 20 to 30 percent of sales. He, however, was skeptical about this statistic. But even if the quality gurus were right, he was sure that his company’s quality costs were much lower—probably less than 5 percent. On the other hand, if he was wrong, he would be passing up an opportunity to improve profits significantly and simultaneously strengthen his competitive position. The possibility was at least worth exploring. He knew that his company produced most of the information needed for quality cost reporting—but there never was a need to bother with any formal quality data gathering and analysis.
This conference, however, had convinced him that a firm’s profitability can increase significantly by improving quality—provided the potential for improvement exists. Thus, before committing the company to a quality improvement program, Wayne requested a preliminary estimate of the total quality costs currently being incurred. He also indicated that the costs should be classified into four categories: prevention, appraisal, internal failure, or external failure. He has asked you to prepare a summary of quality costs and to compare the total costs to sales and profits. To assist you in this task, the following information has been prepared from the past year, 20x5:
- a. Sales revenue, $15,000,000; net income, $1,500,000.
- b. During the year, customers returned 90,000 units needing repair. Repair cost averages $1 per unit.
- c. Four inspectors are employed, each earning an annual salary of $60,000. These four inspectors are involved only with final inspection (product acceptance).
- d. Total scrap is 150,000 units. Of this total, 60 percent is quality related. The cost of scrap is about $5 per unit.
- e. Each year, approximately 450,000 units are rejected in final inspection. Of these units, 80 percent can be recovered through rework. The cost of rework is $0.75 per unit.
- f. A customer cancelled an order that would have increased profits by $150,000. The customer’s reason for cancellation was poor product performance.
- g. The company employs three full-time employees in its complaint department. Each earns $40,500 a year.
- h. The company gave sales allowances totaling $45,000 due to substandard products being sent to the customer.
- i. The company requires all new employees to take its three-hour quality training program. The estimated annual cost of the program is $30,000.
Required:
- 1. Prepare a simple quality cost report classifying costs by category.
- 2. Compute the quality cost-to-sales ratio. Also, compare the total quality costs with total profits. Should Wayne be concerned with the level of quality costs?
- 3. Prepare a pie chart for the quality costs. Discuss the distribution of quality costs among the four categories. Are they properly distributed? Explain.
- 4. Discuss how the company can improve its overall quality and at the same time reduce total quality costs.
- 5. By how much will profits increase if quality costs are reduced to 2.5 percent of sales?
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Chapter 14 Solutions
Cornerstones of Cost Management (Cornerstones Series)
- Danna Wise, president of Tidwell Company, recently returned from a conference on quality and productivity. At the conference, she was told that many American firms have quality costs totaling 20 to 30% of sales. The quality experts at the conference convinced her that a company could increase its profitability by improving quality. However, she was of the opinion that the quality of Tidwell Company was much less than 20%probably more in the 4 to 6% range. However, because the potential for increasing profits was so great if she was wrong, she decided to request a preliminary estimate of the total quality costs currently being incurred. She asked her controller for a summary of quality costs, with the costs classified into four categories: prevention, appraisal, internal failure, or external failure. She also wanted the costs expressed as a percentage of both sales and profits. The controller had his staff assemble the following information from the past year, 20X1: a. Sales revenue, 37,240,000; net income, 4,000,000. b. During the year, customers returned 40,000 units needing repair. Repair cost averages 9 per unit. c. Twelve inspectors are employed, each earning an annual salary of 80,000. The inspectors are involved only with final inspection (product acceptance). d. Total scrap is 200,000 units. Of this total, ninety percent is quality related. The cost of scrap is about 10 per unit. e. Each year, approximately 800,000 units are rejected in final inspection. Of these units, seventy-five percent can be recovered through rework. The cost of rework is 1.80 per I unit. f. A customer cancelled an order that would have increased profits by 600,000. The customers reason for cancellation was poor product performance. g. The company employs 10 full-time employees in its complaint department. Each earns 48,600 a year. h. The company gave sales allowances totaling 180,000 due to substandard products being sent to the customer. i. The company requires all new employees to take its 4-hour quality training program. The estimated annual cost of the program is 120,000. Required: 1. Prepare a simple quality cost report classifying costs by category. 2. Compute the quality cost-sales ratio. Also, compare the total quality costs with total profits. Should Danna be concerned with the level of quality costs? 3. Prepare a pie chart for the quality costs. Discuss the distribution of quality costs among the four categories. Are they properly distributed? Explain. 4. Discuss how the company can improve its overall quality and at the same time reduce total quality costs. 5. By how much will profits increase if quality costs are reduced to 3% of sales?arrow_forwardDana Wise, president of Tidwell Company, recently returned from a conference on quality and productivity. At the conference, he was told that many firms have quality costs totaling 20 to 30% of sales. The quality experts at the conference convinced him that a company could increase its profitability by improving quality. However, he was of the opinion that the quality of Tidwell Company was much less than 20% - probably more in the 4 to 6% range. However, because the potential for increasing profits was so great if he was wrong, he decided to request a preliminry estimate of the total quality costs currently being incurred. He asked his controller for a summary of quality costs, with the costs classified into four categories: prevention, appraisal, internal failure, or external failure. He also wanted the costs expressed as a percentage of both sales and profits. The controller had his staff assemble the following information from the past year, 20x1: a. Sales revenue,…arrow_forwardBerwin Inc. is a small industrial equipment manufacturer with approximately $3.5 million in annual sales.Berwin can always compete with other small appliance manufacturers. However, the market expandsonly when there is product innovation. The following is information on Berwin Inc's performance report:Required : Compute and analyze if the variance is favorable or unfavorable! Identify the strengths and weaknesses of the performance report and give your explanation! How should the report be revised to eliminate these weaknesses? Please explain!arrow_forward
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- In 20X1, Don Blackburn, president of Price Electronics, received a report indicating that quality costs were 31% of sales. Faced with increasing pressures from imported goods. Don resolved to take measures to improve the overall quality of the companys products. After hiring a consultant in 20X1, the company began an aggressive program of total quality control. At the end of 20X5, Don requested an analysis of the progress the company had made in reducing and controlling quality costs. The accounting department assembled the following data: Required: 1. Compute the quality costs as a percentage of sales by category and in total for each year. 2. Prepare a multiple-year trend graph for quality costs, both by total costs and by category. Using the graph, assess the progress made in reducing and controlling quality costs. Does the graph provide evidence that quality has improved? Explain. 3. Using the 20X1 quality cost relationships (assume all costs are variable), calculate the quality costs that would have prevailed in 20X4. By how much did profits increase in 20X4 because of the quality improvement program? Repeat for 20X5.arrow_forwardIn 2011, Milton Thayne, president of Carbondale Electronics, received a report indicating that quality costs were 31 percent of sales. Faced with increasing pressures from imported goods, Milton resolved to take measures to improve the overall quality of the companys products. After hiring a consultant in 20x0, the company began an aggressive program of total quality control. At the end of 20x5, Milton requested an analysis of the progress the company had made in reducing and controlling quality costs. The Accounting Department assembled the following data: Required: 1. Compute the quality costs as a percentage of sales by category and in total for each year. 2. Prepare a multiple-year trend graph for quality costs, both by total costs and by category. Using the graph, assess the progress made in reducing and controlling quality costs. Does the graph provide evidence that quality has improved? Explain. 3. Using the 20x1 quality cost relationships (assume all costs are variable), calculate the quality costs that would have prevailed in 20x4. By how much did profits increase in 20x4 because of the quality improvement program? Repeat for 20x5.arrow_forwardMercury, Incorporated, produces cell phones at its plant in Texas. In recent years, the company's market share has been eroded by stiff competition from overseas. Price and product quality are the two key areas in which companies compete in this market. A year ago, the company's cell phones had been ranked low in product quality in a consumer survey. Shocked by this result, Jorge Gomez, Mercury's president, initiated an intense effort to improve product quality. Gomez set up a task force to implement a formal quality improvement program. Included on this task force were representatives from the Engineering, Marketing, Customer Service, Production, and Accounting departments. The broad representation was needed because Gomez believed that this was a companywide program and that all employees should share the responsibility for its success. After the first meeting of the task force, Holly Elsoe, manager of the Marketing Department, asked John Tran, production manager, what he thought of…arrow_forward
- Mercury, Incorporated, produces cell phones at its plant in Texas. A year ago, a consumer survey ranked the company's cell phones low in product quality. Shocked by this result, Jorge Gomez, Mercury's president, set up a task force to implement a formal quality improvement program. Included on this task force were representatives from the Engineering, Marketing, Customer Service, Production, and Accounting departments. After working together for a year, the task force prepared the quality cost report shown below: Prevention costs: Machine maintenance Training suppliers Quality circles Total prevention cost Appraisal costs: Incoming inspection Final testing Total appraisal cost Internal failure costs: Rework Scrap Total internal failure cost External failure costs: Warranty repairs Customer returns Mercury, Incorporated Quality Cost Report (in thousands) Total external failure cost Total quality cost Total production cost Prevention costs: Machine maintenance Training suppliers Quality…arrow_forwardRockness asked, "Do you see any problems here? Should we drop any of these products? Should we reprice any of these products?" He said, "I am suspicious of these cost data, Rocky. Here we are assigning indirect costs to these products using a 260 percent rate. I really wonder whether that rate is accurate for all products. I want you to dig into the indirect cost data, figure out what drives those costs, and see whether you can give me more accurate cost numbers for these products." Rocky first learned from production that the process required four activities: (1) setting up production runs, (2) managing production runs, and (3) managing products. The fourth activity did not require labor; it was simply the operation of machinery. Next, he went to the accounting records to get a breakdown of indirect costs. Here is what he found: ---------------------------------------------------IMAGE 2----------------------------------------------------------------- Then, he began a series of…arrow_forwardThe XYZ Manufacturing Company is evaluating options for spending on product quality and wants to find the optimal amount to spend on changing its processes to further prevent defects. Its engineers have developed the following estimates: 1. Defects The current defect rate is 10%. If it invests an additional $10 per unit in prevention costs, the defect rate will drop to 6%; spending $20 per unit on prevention drops the defect rate to 3%; spending $30 per unit drops the defect rate to 1.5%; and investing $40 per unit on prevention reduces the defect rate to 1%. 2. Inspection Inspection costs are $5 per unit. Inspection is successful at detecting 98% of defective units; the remaining 2% of defective products are sold and eventually returned for warranty repairs or replacement at no cost to the customer. 3. Internal failure costs are $400 per defective unit that is detected. 4. External failure costs are $1000 per unit returned. 5. Current production level is 1 million units. REQUIRED: A.…arrow_forward
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