CH 14

CHAPTER 14 SOLUTIONS
Solutions to Questions for Review and Discussion
1. Prevention costs are incurred to prevent the production of products or services that do not meet
specifications.
Job training Quality training

Supplier evaluation and approvals Preventive maintenance
Appraisal costs are incurred to monitor and inspect production. These costs are intended to
detect products or services that do not meet specification during the production process.
Inspections of materials Quality control activities

Inspections during production Production testing
Internal failure costs are incurred after defective or substandard product or service is detected
but before it leaves the plant.
Rework, retesting, and rescheduling Scrap

Lost production Downtime
External failure costs are incurred when the defective product or service gets to the customer.
These costs include costs of handling customer complaints and costs of future lost sales
because of poor quality and customer dissatisfaction.
Repairs Complaint departments

Warranties (estimated and actual) Product service departments
Lost contribution margin from damaged product reputation
2. An internal failure cost is incurred before the product leaves the firm. The costs recognized
reflect the costs of damaged and/or wasted product. External failure is cost incurred after the
product reaches the customer. The impact of these failures includes both the costs of
replacement and repair and the costs of damaged customer relations. The internal failure costs
and the replacement and repair external failure costs can be itemized in accounting records.
The customer relations costs are impossible to measure accurately. Monitoring these costs
separately helps management to trace responsibility, to monitor the impact of preventative and
appraisal actions, and to assess the need for changes in quality activities.
3. Greg is correct in part. Clearly, appraisal activities are undertaken to reduce failure costs. It is
better to find the product problem through inspection and testing than for the customer to find
the problem. Finding failures internally is better than having customers find the failure. Perhaps
more importantly, prevention costs become the ultimate substitute for appraisal and failure costs.
If training and better prepared workers can eliminate the causes of failures and defective work,
these costs will decrease.
Substitution is rarely one to one. And as a firm approaches the higher quality levels, prevention
costs may be incurred in greater proportions relative to the reduction of failure costs. Yet ideally,
when prevention costs incurred have the desired effects, total costs do decline.
Managerial Accounting Solutions, Schneider/Sollenberger, 4th Edition, Chapter 14, Page 14-1
4. As prevention costs have an impact through better training and through investments in improved
equipment, failure costs may decline. Thus, costs incurred in this period in prevention will have
a benefit in later periods. Eventually, with a highly trained and quality sensitive workforce, total
quality costs may actually decline over time. Theoretically, a new lower optimal quality cost point
could be created each succeeding period.
5. The missing cost in many costs of quality systems is lost sales due to the dissatisfaction of
customers because of product failures. How many customers are disgruntled? How many lost
sales resulted from one product failure? What negative opinions were formed by how many
people from one visible product problem? Answers to these questions are very difficult to
measure. These are costs unlike the ones that can be tracked within cost accounting systems.
Customer surveys may be able to give rough estimates, but these estimates are far more
subjective (but perhaps even more important) than the other measurable quality costs.
6. The definitions of prevention, appraisal, and failure costs are not clear. Different firms use
different definitions, making benchmarking difficult. Also, cost accounting systems were probably
not designed to capture and report costs of quality. Only systems that have been redesigned
recently, perhaps using activity-based costing, are equipped to measure costs of quality
consistently. Even here difficult measurements must be made that allow subjectivity to muddy
the waters. Early efforts to measure these costs were not well grounded in strong accounting
logic and definitions.
In spite of these problems, significant progress has been made in defining terms, measuring
relevant costs, and reporting quality costs. Benchmarking within firms (among departments and
plants for example) seems logical if firm-wide definitions can be determined. Benchmarking
across firms is more difficult but offers real insights into how other high-performing firms track
and report these costs.
7. Both sets of measures are important to the quality monitoring process. Non-financial measures
give direct assessment of key elements in quality programs. Customer-related performance
indicators are perhaps more objective evidence of external quality performance than lost sales
estimates. Internally, non-financial performance measures are often very explicit indicators of
the success certain activities are having.
The measurement of costs of quality brings money realities to bear on quality problems. The
costs of quality may be stronger overall assessments of quality progress. The trends of these
costs, the tradeoffs found, and the total costs as a portion of sales or profits are key managerial
performance indicators.
Which is more important? It depends! Both are important and are complementary of each other.
8. Since spending on prevention costs typically creates benefits in the future by reducing future
failure costs and even replacing appraisal costs, the optimal long-run spending level may be
different than optimal spending for the current period. In other words, spending more than
optimal now (if that spending is on prevention activities) will reduce total quality costs in the
future.
9. In all probability, it is very unlikely that failure costs can be eliminated entirely. This ultimate level
of perfection may always remain too expensive to attain. Also, prevention spending on training,
for example, is ongoing. To stop training and other prevention activities would drop the firm's
defense against failures and require more spending on appraisal and failure corrections.
10. Service organizations have the same costs of quality categories as manufacturing firms. Since
many services are provided by people, increasing the quality level of services requires training.
These prevention costs typically represent a much higher portion of quality costs than in other
firms. Internal failures may not be as large a portion since a service is created and received by
the customer. Reducing and eliminating external failures are of critical concern in service
organizations.
11. The traditional approach adds profit margins to the costs of already designed products. Target
costing reverses this process. After a target selling price and a target profit are established, an
allowable cost consistent with these targets is obtained for the product. The company then
designs the product based on the allowable costs.
12. Kaizen costing is a system to support cost reduction in the manufacturing stage; target costing
applies to the design and development stages.
13. Any resource-using activity that does not add value to the product or service is a nonvalue-
added activity. This is often called waste. Any cost incurred for these activities is a nonvalue-
added cost. Examples of such activities and costs can be found in inspection time, move time,
waiting time, and storage time.
14. The time classification is process time, inspection time, move time, waiting time, and storage
time.
Process time is the time during which a product is undergoing conversion activities which
transform raw materials into finished products. Any inefficiency or other nonproductive time
represents nonvalue-added activities.
Inspection time is the amount of time spent assuring that the product is of high quality. It is
difficult to say whether inspection procedures result in nonvalue-added costs without detailed
knowledge of the production technology and inspection procedures. However, in an
environment of zero defects and total quality control, managers attempt to build quality into and
not inspect it into the product.
Move time is the time spent moving raw materials, work in process, or finished products between
operations within the plant. This includes the activities associated with:
 Receiving materials.
 Moving materials into storage.
 Moving materials and components to the first production operation.
 Moving partially completed products from one work center to the next or from one
department to another.
 Moving the completed product to the finished goods storage area to await shipping.
Move time is a nonvalue-added activity.
Wait time is the amount of time that materials or work in process are held for the next operation.
This includes the time that materials, components, and partially completed products spend in
queues immediately preceding an operation and in holding areas located near or next to each
department waiting for the next production operation. Wait time is a nonvalue-added activity.
Storage time is the time during which finished products are held in stock before shipment to
customers. It includes the time products spend in storage and the time spent preparing final
products for shipment packaging activities. Storage time is a non-value-added activity.
15. Manufacturing cycle efficiency (MCE) is a measure of the amount of throughput time which
consists of process time. It is the following ratio:
MCE = Processing time Throughput time
MCE represents the ratio of value-added time to total throughput time.
16. The value-added labor ratio is the ratio of value-added direct labor to total direct and indirect
labor. The ratio may be computed in terms of number of employees or payroll. It provides a
measure of the number of supervisors, managers, clerical staff, accountants, engineers,
inspectors, and all others who are nonvalue-added workers. Therefore, the goal is to increase
the percentage of direct labor to total labor.
17. Costs of quality valuation enables one to aggregate various aspects of quality by using a
common unit of measure - dollars. Furthermore, it allows one to assess the impact of quality on
the company's profits. However, knowing the costs of quality does not enable pinpointing
specific sources of quality problems. To diagnose and correct specific problems relating to
quality, it is necessary to have a variety of nonfinancial measures of quality.
18. The first one, customer acceptance measures, focuses on the extent to which a company's
customers perceive its product to be of high quality. Design quality assesses how well a product
has been designed. In-process quality measures look at product quality during production. A
fourth area of quality relates to purchased materials and parts.
19. Examples are unscheduled machine downtime, equipment repair time, tooling turnaround time,
engineering change times, machine availability, and adherence to maintenance schedules.
20. A piece of information often impossible to measure is business lost because of delivery failure.
21. Common external sources are trade and business publications, electronic databases,
professional conferences and trade conventions, commissioned studies, and site visits to
companies.
22. Downsizing can involve outsourcing one or more functions, consolidation of certain functions,
across-the-board cuts in personnel, or elimination of business segments such as product lines or
geographical territories.
23. Business process reengineering refers to changes made in management, organizational

structure, and work practices to achieve significant improvements in quality, cost, speed, and
service. It is not merely a marginal changing of processes; rather, it involves major restructuring
of organizational forms, management procedures, job descriptions, work flows, control systems,
and organizational cultures.
Solutions to Exercises
14-1.
(1) and (2) Costs of quality classification: Percentage
Total of Sales
Prevention costs:
Customer design verification $5,000
Machine testing after machine setup 10,000
Routine machine maintenance 25,000
Employee training 40,000 $80,000 1.74%
Appraisal costs:
Raw materials testing $12,000
Final product testing 20,000
In-process inspection 45,000 77,000 1.67
Internal failure costs:

Scrap loss net of scrap sales $30,000
Materials reprocessing 28,000
Idle labor-downtime due to machine repairs 37,000
Nonroutine machine repairs 50,000 145,000 3.15
External failure costs:

Customer complaints and returns $40,000
Discounts for missed delivery dates 33,000
Price reductions for product quality downgrades 68,000 141,000 3.07
Total $443,000 9.63%
14-2.
(a) The concept is based on the idea that when the total costs of poor quality are added together
they sum to a much larger total that expected. When quality is improved by spending more on
prevention, the failure costs will decrease. The total quality costs are lower when quality is
higher. Thus, quality is 'free."
(b) This comment needs two responses. First, it is very difficult to measure quality costs accurately
and completely. Therefore, finding the "true" optimal point is almost impossible. Second, as the
chapter discusses, spending on quality costs in one time period can cause the quality cost
patterns in the next time period to change. Prevention costs should impact future failure costs.
Thus, an optimal spending level in this period will differ from last period and from the next period.
(c) The problem is whether the new chart of accounts and cost center definitions considered costs
of quality and their cost drivers. Many traditional accounting systems fail to separate activities
that cause quality costs from other activities. Costs of quality should be reported routinely and
consistently over time to allow tracking of progress. Most accounting systems are not able to
identify these costs easily.
(d) Internal benchmarking implies several comparisons: comparisons to past performance and to
targets and comparisons to other similar operations within the firm. These comparisons have the
advantage of using common definitions and perhaps having similar activities. External
benchmarking means comparing our data to other firms' data. This is particularly helpful in
measuring a firm's quality and costs of quality levels with other firms which are superior
performers.
14-3. Analysis of Haber & Killian costs of quality:
2007 2008 2009

Costs: 1st Half 2nd Half 1st Half 2nd Half 1st Half 2nd Half
Prevention costs $5,000 $20,000 $50,000 $60,000 $50,000 $55,000
Appraisal costs 40,000 60,000 65,000 70,000 72,000 70,000
Internal failure costs 120,000 130,000 120,000 123,000 110,000 105,000
External failure costs 43,000 30,000 25,000 26,000 18,000 15,000
Total $208,000 $240,000 $260,000 $279,000 $250,000 $245,000
Percentage of total costs:
Prevention costs 2.4% 8.3% 19.2% 21.5% 20.0% 22.4%
Appraisal costs 19.2 25.0 25.0 25.1 28.8 28.6
internal failure costs 57.7 54.2 46.2 44.1 44.0 42.9
External failure costs 20.7 12.5 9.6 9.3 7.2 6.1
Comments:
 The mix of costs has changed dramatically over the three years. External failure costs have
decreased in total and as a percentage of the total costs of quality.
 The distribution of higher costs has changed from external failure to prevention.
 Internal failures is still the highest cost category but is decreasing as a percentage.
 The full benefits of the quality effort have yet to be received. The next year or two should
capitalize on the prevention cost spending.
14-4.
(a) Certainly the external failure costs are at a very low level. Possibly, the accounting system
cannot capture the true external failure costs. Or, prevention and appraisal activities have kept
customer problems very low as implied in the comment.
(b) Perhaps, but the trends of spending and the impacts of the spending patterns must be examined
over time to find relationships. The need to equalized spending has little to do with the relative
effectiveness of the spending. One could argue that the internal failure costs are very high and
might be reduced with more and wiser spending on prevention and appraisal activities.
(c) Certainly, reduced spending for costs of quality may be a reasonable goal. But increased
spending on prevention costs may be needed to reduce the appraisal and internal failure costs.
Increased spending on prevention activities next year may reduce failure costs by much more in
succeeding years.
(d) This would be an improvement, but the goal is to reduce the total costs of quality as a
percentage of sales substantially. In early stages of quality efforts, total costs as a percentage of
sales may actually increase. Current prevention spending hopefully reduces total spending in
the future.
14-5.
(1) Production cost analysis: Total
Stage 1 Stage 2 Stage 3 Stage 4 Costs 5% Scrap Rework
Materials £88,000 £22,000 £110,000 £1,000
Labor 66,000 44,000 £33,000 £44,000 187,000 2,000
Variable overhead 66,000 88,000 99,000 44,000 297,000 2,000
Total costs £594,000 £29,700 £5,000
Minus 10% 59,400
Cost of goods units £534,600
Plus:
Cost of scrap 29,700
Cost of rework 5,000
Lost revenue:
(£100 – £54) x 550 25,300
£100 x £550 55,000
Total actual costs & opportunity costs £649,600
(2) Total costs under the revised inspection system:
Stage 1 Stage 2 Stage 3 Stage 4 Total

Materials £88,000 £22,000 £110,000
Labor 66,000 44,000 £33,000 £44,000 187,000
Variable overhead 66,000 88,000 99,000 44,000 297,000
Additional inspection 11,000 11,000 11,000 33,000
Total costs £627,000
Mr. Spero’s proposal will reduce costs by £22,600. The higher inspection costs are more than
offset by the reduced opportunity costs.
Advantages:
 Walle sells 1 1,000 units at full price instead of 9,900 units at full price and 550 units at cost.
 Each stage knows that it is passing good units to the next stage. Likewise, each stage
knows that it is getting good units from the preceding stage.
 No substandard products are being sold “out the side door."
 All efforts are being put into good units.
14-6.
(1) Several problems could be hiding in the data reported:
 Since the records are created largely at the plant level, little control exists over the
classification of costs, the validity of the data reported, and the consistency of reporting over
several time periods.
 Without controls on accounting processes, the data have little validity for managerial use at
higher levels, much less for determining bonuses and promotions of operating managers.
 Actions by certain managers in certain time periods could temporarily shift the apparent
direction of performance in key areas such as quality and product yields.
 A bonus system emphasizing a 'bottom-line result" may lead to actions by managers that
yield short-run benefits to them but fail to achieve the long-run goals of the firm.
 Lack of an emphasis on trend analysis allows year-to-year changes to be evaluated
independently.
(2) Several approaches could be used:
 Benefit payments could be based on a moving average approach. Thus, strong gains in one
year are averaged with quality losses the next year. If the average shows no gain, then no
bonus is paid.
 A vigorous internal audit program that focuses on costs of quality could check the gains for
validity and consistency with the goals of the firm.
 Vigorous examination of quality successes by supervisors could detect unreal successes and
halt the creation of false gains.
14-7. Target cost:
$3.50 – Target cost = 0.2 x $3.50

Target cost = $3.50 – $0.70 = $2.80
14-8. Target cost for new software:
Let x = target cost

x + 0.25x = $450
1.25x = $450
x = $360
14-9. Kaizen cost targets:
2006 2007 2008 2009 2010

$600 $600 0.98 ($600) = $588 0.98 ($588) = $576 0.98 ($576) = $564
950 950 0.98 ($950) = 931 0.98 ($931) = 912 0.98 ($912) = 894
820 820 0.98 ($820) = 804 0.98 ($804) = 788 0.98 ($788) = 772
980 980 0.98 ($980) = 960 0.98 ($960) = 941 0.98 ($941) = 922
Note: Numbers are rounded to the nearest whole dollar.
14-10. Cycle efficiency: 18 + 63 + 230 + 15 + 22 = 348

230  348 = 66%
14-11.
(1) Classification of activities:
Process time:
Cutting material into patterns.
Sorting of pieces to jeans.
Sewing of jeans.
Adding thread, zippers, and snaps.
Reworking defective jeans.
Adding brand labels.
Inspection time:
Inspect in Inspection and Finishing Department.
Move time:
Move from storeroom to Cutting Department.
Move from Cutting Department to Stitch and Form Department.
Move from Stitch and Form Department to Inspection and Finishing Department.
Move from Inspection and Finishing Department to finished goods inventory.
Wait time:
Bales wait in Cutting Department until ready.
Pieces wait to be sorted.
Sets of jeans wait to be sewn together.
Sewn jeans wait at stations for zippers and snaps.
Completed jeans wait for inspection.
Jeans passing inspection wait at labeling tables for brand labels.
Final product waits for movement to finished goods warehouse.
Storage time:
Dyed denim cloth bales held until released to production.
Finished goods inventory.
(2) Nonvalue-added activities:
The candidates for nonvalue-added activities are all activities in inspection time, move time, wait
time, and storage time. In addition, any activities associated with sorting pieces, scrapping
pieces, and reworking defective jeans are also nonvalue-added activities.
These activities are nonvalue-added because they add nothing to the product. With a properly
designed system that eliminates these activities, costs of production would be substantially
reduced.
14-12.
A key to classifying activities is to identify the product (or, in this case, the service). The service
is not processing of patients in the minimum amount of time. Rather, the service is identifying
the physical condition of the diabetic and what needs to be done for the patient to control the
diabetic condition.
Process time:
Check in with receptionist.
Weigh in (weight is a factor in determining insulin needs).
Take blood sample.
Take blood pressure.
Confer with doctor.
Take additional blood samples.
Confer with dietician (diet influences blood sugar levels and relates to insulin needs).
Inspection time:
Does not occur.
Move time:
Move from waiting room to inner office.
Return to receptionist.
Wait time:
Spend time in waiting room until moved to office area.
Gather data for updating medical records (Much of the information is already in the files the
nurse is holding. Whatever necessary function is needed here could be done in
combination with something else.)
Wait for the doctor to arrive.
Wait for the dietician.
Pay bill.
Schedule next appointment.
Storage time:
Does not occur (However, many patients feel their wait behind closed doors is much like
storage time.)
(2) Nonvalued-added activities.
All activities that are not included in process time are nonvalue-added activities. None add to the
service for which the patient sees the doctor. These activities increase the overhead costs and,
thus, the rates paid.
Note: Since most of us are patients, we see the obvious wait time as nonvalue-added – in fact,
a major cost to us. But from the doctor's side, these waiting times are too often viewed
as cost free.
14-13.
(1) Classification of labor:
(a) Three fabricators: value-added labor.
(b) One parts inspector: nonvalue-added labor.
(c) One warehouse stocker: nonvalue-added labor.
(d) One molder: value-added labor.
(e) Two assemblers: value-added labor.
(f) One product inspector: nonvalue-added labor.
Summary: 6 value-added workers; 3 nonvalue-added workers.
(2) Value-added labor ratio (VALR) = 6 value-added workers  11 total workers = 0.55
14-14. Value-added employees:
(1) Value-added labor ratio in terms of employees:

Lead disk jockeys 8
News and weather staff 3
Account executives 6
Total value-added employees 17
Total employees  40 = 42.5%
(2) Value-added labor ratio in terms of compensation:

Lead disk jockeys $16,000
News and weather staff 5,000
Account executives 7,200
Total value-added employees $28,300
Total employees  $68,200 = 41.5%
14-15.
(1) Measures for manufacturing productivity:
Manufacturing-cycle efficiency.
Total setup time.
Overtime hours.
Power consumption.
(2) Measures for product quality:

Number of defective units in raw materials orders.
Number of defective units in process.
Number of defective units in finished goods.
Number of products returned by customers.
(3) Measures for delivery performance:

Percentage of customer orders filled.
Percentage of on-time orders delivered.
(4) Measures for inventory control:

Inventory value  sales revenue.
(5) Measures for machine maintenance:

Machine downtime.
Number of unscheduled machine maintenance calls.
14-16. Neither subsidiary is superior to the other in all delivery performance measures. The
Malaysian subsidiary has a slightly better percentage of orders filled, as follows:
Malaysian subsidiary: 2,895  3,000 = 0.97

Indonesian subsidiary: 5,250  5,500 = 0.95
The Malaysian subsidiary also has a better time from order to delivery (3 weeks as opposed to 4
weeks). However, the Indonesian subsidiary has a better percentage of orders delivered on
time, as follows:
Malaysian subsidiary: 2,540  3,000 = 0.85

Indonesian subsidiary: 5,100  5,500 = 0.93
14-17. Classification into the four categories contained in a balanced scorecard:
a. Percentage of pizzas delivered on time – Customer

b. Percentage of sales growth – Financial
c. Pounds of pizza scrapped – Internal Business Process
d. Production cost per pizza – Financial
e. Packaging materials cost per month – Financial
f. Percentage of repeating customers – Customer
g. Employee turnover percentages – Learning and Growth
h. Response time to customer inquiries – Customer
i. Number of customer complaints – Customer
j. Number of pizzas per labor hour – Internal Business Process
k. Hours of community volunteer work – Learning and Growth
l. Return on invested capital – Financial
m. Cost per delivery – Financial
n. Throughput time – Internal Business Process
o. Suggestions per employee – Learning and Growth
p. safety incident index – Learning and Growth
14-18. Gail Norman's dilemma is caused by the fact that an entire $200,000 cost reduction
becomes incorporated into a new kaizen cost target. So that her future performance evaluation
is not jeopardized, she decides to cut only $40,000 during 2004. Presumably, she plans similar
cuts over the next few years. The ethical dimension is that Ms. Norman may not be serving the
company's best interest. If cutting $200,000 in payroll costs during 2004 is truly the best
financial decision for the company, then by cutting only $40,000 in the current period, Ms.
Norman is placing her personal interests above those of the company.
Solutions to Problems
14-19.
(1) Kal Held Properties costs of quality analysis:
2001 2003 2005 2007

Prevention costs $100,000 $300,000 $300,000 $200,000
Appraisal costs 300,000 400,000 400,000 200,000
Internal failure costs 400,000 360,000 252,000 151,200
External failure costs 300,000 270,000 121,000 39,930
Total quality costs $1,100,000 $1,330,000 $1,073,000 $591,130
Sales $10,000,000 $11,000,000 $12,100,000 $13,310,000

Costs as a percentage of sales 11% 12.1% 8.87% 4.4%
(2) No. By 2007, the costs as a percentage of sales will drop to 4.4 percent. This misses the target
of 4 percent slightly Further improvements must be made if the goal of 4 percent is to be
achieved. Quality costs will be cut nearly in half. But sales are forecast to grow by over 13
percent since 2001.
(3) Assumptions that must be examined carefully:
a. That external costs will be reduced from 3 percent of sales to 0.3 percent of sales in six
years. This is a dramatic reduction that will take significant attention of management.
b. That the increase in prevention costs and higher appraisal costs will cause the failure costs
to drop as fast as forecast. Merely spending more in these prevention and appraisal areas
will not cause the failure costs to drop. Management must take the task very seriously and
create a team of management and employees to attack the quality problems.
c. That sales will increase at a steady 10 percent, which is an orderly and safe growth rate.
Unusual growth rates or lack of growth could cause the gains in cost reduction to disappear
or to be limited.
d. That other changes in operations will not affect the forecast relationships. Rarely is a
situation steady. New production processes, new products, changes in customer demands,
and many other issues could disrupt the total quality program.
14-20. Software quality costs: Costs After
Current Costs Installation
Annual costs of quality:
.Internal failure costs:
$100 x 50 x 12 months $60,000
$100 x 10 x 12 months $12,000
$50,000 x 12 600,000
$10,000 x 12 120,000
Appraisal costs:
$40,000 x 3 120,000
Software updating 30,000
Total annual costs of quality $780,000 $162,000
Three-year total operating costs $2,340,000 $486,000

One-time software acquisition 300,000
Total costs $2,340,000 $786,000
The net savings from using the software is $1,554,000 over the three-year period or an annual
savings of $518,000 per year. The vast majority of the savings comes from the reduced costs
incurred from customer legal problems.
14-21.
(a) Manager A:
The approach will compare the net cost of scrap with the cost of improvement. The time value of
money should be considered since the costs occur at different times.
Costs of scrap (500 x $10) $5,000

Minus scrap recovery (500 x $4) 2,000
Net cost of scrap $3,000
Years of service x 5
Total scrap costs over 5 years $15,000
Cost of improvement $50,000
The only reason to make the equipment modification is if the quality of all units is improved in
some way, if other costs can be reduced, or if the current problem affects customer satisfaction
negatively
(b) Manager B:
The approach will compare the cost of added good units to the cost of reducing the units needed
to be reworked.
Cost to produce an additional 1,000 saleable units $120,000

Cost to train employees 80,000
Cost savings from training $40,000
The difference between the two alternatives is the amount of capacity for saleable units created.
Manager B appears to have a market for 1,000 additional units, but the training generates 2,000
(0.4 x 5,000) of additional good units. The training is, therefore, better for two reasons – cost
savings and greater capacity.
(c) Manager C:
The approach will need to compare "apples with apples." The inspection and lab costs must be
compared to the costs that will be reduced by the added people and equipment. The
engineering change costs and process testing will likely not change because of the added
inspectors and lab work.
14-22.
(1) Cost of quality categories:
2003 2005
Prevention costs:
Design documentation standards development $0 $100,000
Documentation of customer training process 0 20,000
Documentation of changes to software 5,000 20,000
Customer training 100,000 130,000
Software testing – prerelease 50,000 140,000
Training for systems designers/programmers 100,000 250,000
Training for sales staff 10,000 80,000
Total prevention costs $265,000 $740,000
Appraisal costs:
Software testing – customer site $130,000 $80,000
Failure costs:
Telephone "on-line" customer problem support $90,000 $60,000
Field "trouble shooting" for customer support 140,000 80,000
Software corrections and redesign 50,000 20,000
Costs of contract cancellations 180,000 30,000
Revenues lost due to delivery date delays 0 120,000
Total failure costs $460,000 $310,000
A number of these costs might be classified in different categories. Also, some failure costs may
be either internal or external. The majority of the failure costs appears to be external failure
costs.
(2) There is good news and bad news. The bad news appears as:
 All the quality training and documentation has reduced the productivity of the systems staff
and caused serious delays in getting good product out the door.
 The training and documentation processes have been very expensive, increasing prevention
costs by nearly $500,000.
 The benefits from the additional training and documentation have yet to recover the added
costs. Appraisal and failure costs have decreased by $200,000.
The good news appears as:
 Failure costs other than the delivery delay lost revenues have been reduced, particularly the
contract cancellation costs.
 The only appraisal cost has been reduced also.
Perhaps the timing of the 2005 report is too soon to see the true impact of the quality changes.
But, carefully monitoring of these costs and reviewing of the training and documentation
processes must be done to se e if, in solving one problem, another problem has been created.
Perhaps, the documentation process is so complex that new products cannot be finished and
delivered to the customers.
(3) Perhaps. The change from a loss to a profit when tied to the growth in total quality costs implies
that sales increased between the two points in time. Obviously, other operating costs, sales mix,
and a host of other factors must be considered before the answer to Part.(2) would change. But
a major jump in sales might imply that customers appreciate the new higher quality control level
and are attracted to the firm's software products.
14-23.
(1) Meta Medical costs of quality classification:
Prevention costs:
Training of repair technicians (time and travel) $196,000
Testing and certifications of calibration equipment 15,000
Development of client testing processes and diagnostics 31,500
Appraisal costs:
Inspection of finished repairs $45,000

Parts warranty, including replacement labor $92,000
Emergency trips to service client machines 86,000
Rental of substitute equipment to cover client downtime 43,000
Lost revenues on cancelled contracts 60,000
(2) Problems in analyzing costs of quality:
a. The accounting system may not be classifying these cost accurately. Costs may be missed,
and other costs that do not really impact quality issues may be included in the accounts
reported.
b. Other intangible costs may not be captured in normal accounting reports such as additional
lost future revenues from the cancelled contracts.
c. As he gains more experience, the definitions of costs of quality will likely change over time.
This means that year-to-year comparisons may not be valid bases for evaluation of
improvement.
d. As operations change, the bases of comparison also change.
e. Much effort must be put into measuring and reporting these costs to provide accurate
measures of costs and of benchmarks of performance.
14-24. The cost savings provided by the centralized Purchasing Department are $4,135,200, as
follows:
Savings from decrease in defective newsprint (0.6 x $7,200) $4,320

Savings from quantity discounts (0.028 x $980,000) 27,440
Reduction in salary and other purchasing costs ($365,000 – $190.,000) 175,000
Savings at one paper $206,760
Number of papers x 20
Estimated total savings $4,135,200
This is far more than the $1.8 million additional annual costs incurred for the centralized
Purchasing Department. Also, the reengineering improved on-time delivery of newsprint from 70
percent to 85 percent. Therefore, it appears that reengineering the purchasing process was
worthwhile.
14-25.
(1) Target cost:
Net profit margin percentage = [($1,200,000 – $875,000 – $145,000)  $1,200,000] = 15%
2003 revenues = $90 x 11,000 = $990,000
To obtain the 2005 target cost:

($990,000 – Target cost)  $990,000 = 0.15
$990,000 – Target cost = $148,500
Target cost = $841,500
(2) Percentage reduction in direct labor: Existing Variable Cost Per Set
Direct materials ($120,000  12,000) $10.00
Direct labor ($210,000  12,000) 17.50
Energy costs ($144,000  12,000) 12.00
Other overhead ($96,000  12,000) 8.00
Total variable cost per set $47.50
Total variable cost for 11,000 sets = $47.50 x 11,000 = $522,500

Total fixed cost for 11,000 sets = $130,000 + $175,000 + $145,000 = $450,000
Total cost for 11,000 sets = $972,500
To achieve the target cost of $841,500, direct labor cost will have to be reduced by $131,000
($972,500 – $841,500).
Percentage reduction in direct labor workforce = $131,000  $210,000 = 62.4%.
14-26.
(1) Identification of activities in the production process
Process time:
Blending of ingredients into a dough mix.
Rolling out dough on large boards.
Cutting donuts and holes.
Processing of leftover dough.
Deep-frying/cooking of donuts and donut holes.
Coating of products.
Packing completed product in boxes.
Inspection time:
Inspecting ingredients at receiving.
Inspecting cooked product during drying stage and removing defectives.
Move time:
Moving ingredients to storeroom.
Moving requisitioned ingredients to Mixing Department.
Moving raised dough to cutting machines.
Moving cut product to deep fry area.
Disposing of leftover dough at end of day.
Moving cut donuts and donut holes to cooking area.
Moving cooked product to drying area.
Disposing of cooked product to be scraped.
Moving dried product to finishing area.
Moving boxes to shipping area.
Wait time:
Holding ingredients in storeroom until requisitioned.
Staging time at Mixing Department.
Raising time in holding area.
Waiting time for cutting machines.
Waiting to cook donuts and holes.
Drying time.
Waiting to be coated.
Settling or drying time for coatings.
Storage time:
Packed boxes waiting for trucks to deliver to stores.
Once products are on the shipping docks, the production process is completed. The remaining
activities are not related to production.
(2) Nonvalue-added activities.
Activities in the inspection time, move time, wait time, and storage time are candidates for
nonvalue-added activities. Some exceptions in these categories may exist. For example, the
raising time is essential for the final product. (No one will buy donuts that are not raised.) Also, a
need exists for drying after cooking to remove the excess oil. One can legitimately argue that
both of these activities should be processing time because they may be considered value-
added.
Any of the activities related to day-old and second day-old donuts are nonvalue activities for the
company, even though such activities are not production related.
14-27.
(1) Nonvalue-added activities:
Moving of raw materials to storeroom.
Holding raw materials in storeroom until needed.
Moving metals to stamping operation.
Waiting in front of stamping machine,
Inspecting stamped product.
Waiting to be moved to finishing and assembly
Moving stamped product to finishing and assembly.
Moving materials to molding operation.
Waiting in front of molding operation.
Inspecting molded product.
Waiting in molding for movement to finishing and assembly.
Moving knobs and screws to assembly area.
Waiting in front of finishing and assembly operations.
Inspecting at end of finishing and assembly.
Waiting to move product to finished goods inventory.
Storaging in finished goods inventory.
Reworking operations.
(2) Nonvalue-added activities always increase costs of the product. Most of the time, scrap,
spoilage, and rework are due to lack of quality and inefficiency. Although differences occur in
specific circumstances, the common places to find the costs of scrap, spoilage, and rework are:
 Scrap cost is in direct materials.
 Spoilage cost is included in factory overhead; or the (direct materials, direct labor, and
factory overhead) elements cost to spoiled units are simply left as part of the direct materials,
direct labor, or factory overhead costs.
 Defective unit cost is factory overhead.
(3) Eliminating nonvalue-added activities usually means redesigning the production system and the
product and adopting a new manufacturing philosophy. Other than that general comment, other
suggestions would include the following:
 Implement a just-in-time production philosophy (eliminates waiting time).

 Have raw materials by-pass the storeroom and be delivered directly to the production floor
where needed.
 Redesign the plant layout to minimize the distances between the stamping operation and
finishing and assembly and between the molding operation and finishing and assembly.
 Adopt a quality philosophy at the individual activity level so that spoilage and defects
are eliminated or significantly reduced.
14-28.
(1) Estimate of losses from late shipments:
Two hours late (3% x B6,420,000 x 10%) B19,260
One day late (2% x B6,420,000 x 20%) 25,680
Two days late (1% x B6,420,000 x 40%) 25,680
Total loss from late shipments B70,620
(2) Estimate of the cost of shipments with breakage:

Damaged shipments (1% x 642 x B8,000) B51,360
Summary of costs:
Replacement of damaged goods B51,360
Reshipping costs (1% x B6,420,000 x 70%) 44,940
Refunded shipping costs (1% x B6,420,000) 64,200
Surcharge for business interruption (30% x B51,360) 15,408
Total cost of shipments with breakage B175,908
(3) Maximum cost for system changes and training programs:

Two hours late (2% x B6,420,000 x 10%) B12,840
One day late (1% x B6,420,000 x 20%) 12,840
Two days late (0% x B6,420,000 x 40%) 0
Total loss B25,680
Total cost of breakage (0.5 x Bl75,908) 87,954
Revised total loss B113,634
Loss without change [see Parts (1) and (2) above] (246,528)
Maximum amount the company is willing to pay B132,894
14-29. Value-added labor concept:
In determining who the value-added workers are, one must consider what the real product or
service is. Anyone who does not add value to that product or service is nonvalue-added.
(a) Airline – Pilots and flight attendants.

(b) CPA firm – Professional staff and partners.
(c) Radio station – Disk jockeys, news and weather people, sports announcers, any others who
are heard on the air, and account executives who bring in advertising.
(d) Clinic specializing in sports injuries – Doctors, nurses, physical therapists, and others working
directly with patients.
(e) Rehabilitation and therapy center – Staff who work with patients.
(f) Motel chain – People who make up the room and attendant assigning rooms.
(g) Travel agency – Travel agents.
(h) Retail department store – Salespeople on the floor.
(i) Automobile garage for repairs and servicing – Service managers (people who take orders
and interface with customers) and mechanics.
(j) Funeral home – Funeral directors.
14-30.
Processing:
Blood is drawn from a donor at a clinic.
Blood is placed into proper blood group.
Blood is separated into red cell concentrate and plasma.
Plasma is pooled into batches, prepared, and centrifuged.
Solids (cryoprecipitate) are processed further.
Cryoprecipitate is frozen.
Heat treatment is given.
Packaging is done.
Inspection:
Blood is tested.
Cryoprecipitate is inspected.
Moving:
Product is transported to fractionation plant.
Incoming plasma is shelved.
Plasma is taken to centrifugation center.
Cryoprecipitate is moved to packaging center.
Completed coagulant is taken to storage area.
Waiting:
Plasma waits for delivery to fractionation plant.
Cryoprecipitate waits for inspection.
Storage:
Plasma sits on shelf.
Coagulant waits for delivery to hospital.
(2) Processing cycle efficiency:
The total time for the eight activities classified as processing time in Part (1) is 335 minutes (20 +
10 + 45 + 90 + 120 + 25 + 10 + 15). The total time for all five categories of activities is 805
minutes. Therefore, the processing cycle efficiency is 41.6 percent (335  805).
(3) First-pass yield:
Weight of cryoprecipitate = 0.5 x 80 kg. = 40 kg.

First-pass yield = (40 – 2)  40 = 95%
14-31. Analysis of product quality performance:
The Columbus plant appears to have superior design quality. Its pens have fewer parts (5 vs. 7)
and a lower ratio of unique parts (1  5 = 20% vs. 3  7 = 43%).
The Cleveland plant had a better performance with respect to customer acceptance. It had
fewer returns (2% vs. 5%) and fewer warranty claims (22 vs. 39).
The in-process quality measures are better at the Cleveland plant. It had lower scrap costs
($250 vs. $370) and fewer pens that needed rework (950 vs. 1,400).
For materials and parts quality, there is no clear winner. While the Cleveland plant had fewer
defects in parts received (3% vs. 4%), it had a higher percentage in terms of dollars (3.5% vs.
3.2%).
14-32.
(1) Product quality decreased from 2002 to 2004, as evidenced by five of the six measures of
product quality (number of failures at customer locations, number of returned transducers,
amount of scrap, amount of rework, percentage of defects in delivered components). The only
product quality measure that improved was the number of engineering change orders.
(2) There are three measures indicative of manufacturing productivity. Two of them improved--
transducers produced per day per employee and manufacturing cycle efficiency. The
improvement largely occurred between 2002 and 2003. In contrast, the first-pass yield declined
steadily from 2002 to 2004.
(3) The only inventory control measure shown was the average time inventories are held. This
measure worsened from 2002 to 2004 (largely between 2002 and 2003).
(4) Delivery performance improved from 2002 to 2004. The time from customer order to delivery
decreased, and the percent of customer orders filled increased.
14-33. The Golden Age Nursing Homes bonus plan does not use a balanced scorecard approach to
incentive compensation. The existing bonus plan is based exclusively on return on invested
capital, which relates to only one of the four dimensions of a balanced scorecard – Financial.
The initiatives designed to enhance the quality of service yielded:
 the highest satisfaction indices compiled in the history of that location;

 improved morale for the nurses and other health care workers;
 a decline in absenteeism;
 a reduction in employee turnover; and
 employee suggestions that were implemented and led to improved profits.
These measures relate to the other three dimensions of a balanced scorecard and should
positively affect the longer-term success of the organization. In contrast, the return on invested
capital measure used alone, ignores the longer-term benefits of the quality improvements that
resulted from the added investment. By utilizing all four dimensions of the balanced scorecard,
these longer-term benefits would have been reflected in the administrator’s performance
measurement.
Solution to the Case
CASE 14 – Pare-Ott Hospital
(1) "Customer" groups include:

 Patients.
 Contract physicians.
 Third-party payers such as insurance companies, HMOs, Medicare, and Medicaid.
 Other hospital departments that use the Respiratory Therapy Department's services
(including in-house physicians).
Different types of customers may have different perspectives on the quality of services they
receive and may react differently to a given level of performance. Often, a patient cannot
evaluate the quality of clinical treatment received. Most patients can only assess the quality of
their treatment based on their contact with the hospital's staff. For instance, even if a therapist is
highly skilled, if the therapist is abrupt or rushed during therapy, the patient may evaluate the
quality of treatment as low. Perceptions may also differ for different treatments. For instance,
while customer relations may be important for the bronchodilator treatment, it will be relatively
unimportant for the emergency intubation treatment.
As for contract physicians, hospitals must compete for their patronage by providing to them high
quality for the services they consider important. Also, the contract physicians usually are the
ones who choose the hospital that the patient will go to for treatment.
Currently, third party payers typically pay standard rates for many of the procedures that would
be performed in Respiratory Therapy. Hence, the rates they pay are not as affected by poor
quality. However, while teaching institutions such as Pare-Oft Hospital generally have very good
clinical reputations, they are notoriously inefficient. Consequently, third-party payers tend to try
to limit or exclude services from these institutions. Thus, Pare-Ott would not only be facing
normal competition from area hospitals, but would have to deal with efficiency issues directly
with third-party payers.
Other hospital departments that use Respiratory Therapy's services might be concerned that
lack of quality in Respiratory Therapy may affect the perceived quality in their own department.
Poor quality in Respiratory Therapy may adversely affect customer perceptions about other
departments.
(2) Measurement of costs for:
Quality Planning – prorate the monthly salaries of those involved in the monthly meeting;
also, assign 10 hours of the Program Instructor's weekly wages.
Write-ups – for intubations, multiply 0.25 hours by the number of intubations, and then
multiply by the therapist's hourly wage; for bronchodilator treatments, multiply 0.167
hours by the number of treatments, and then multiply by the therapist's hourly wage.
Improper Installation – Multiply the time spent after two attempts by the hourly wages of the
personnel involved: also, add the extra supplies consumed for more than two attempts.
(3) Categorization:
Prevention Costs – Quality Planning, Training, Forecasting and Budgeting, Patient Relations.
Appraisal Costs – Quality Audits, Write-ups, Performance Audits, Appraisal Support.
Internal Failure Costs – Improper Installations, Overtime, Rework, Retraining Therapists,
Absenteeism and Turnover.
External Failure Costs – Malpractice Suits, Malpractice Insurance, Customer Service,
Administrative Measures.
Some of these are subject to debate. One could argue that, although Administrative Measures
and Retraining Therapists resulted from failures, they should be classified as prevention costs
since the purpose of these expenditures is to improve future quality. Another item, Write-ups,
may be questioned as to why it is considered a quality cost. A response to this is that it is
analogous to a 100 percent inspection.
(4) Other costs of quality:

 Hiring and retention of employees (Prevention Cost)
 Unneeded bronchodilator treatment (Internal Failure Cost)
 Loss of future customers (External Failure Cost)
 Research and development (Prevention Cost)
 Patient follow-ups to evaluate their satisfaction (Appraisal Cost)

CH 14

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CH 14

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CHAPTER 14 SOLUTIONS

Solutions to Questions for Review and Discussion

Job training Quality training

Inspections of materials Quality control activities

Rework, retesting, and rescheduling Scrap

Repairs Complaint departments

Move time is a nonvalue-added activity.

23. Business process reengineering refers to changes made in management, organizational

Internal failure costs:

External failure costs:

14-3. Analysis of Haber & Killian costs of quality:

2007 2008 2009

(2) Total costs under the revised inspection system:

Stage 1 Stage 2 Stage 3 Stage 4 Total

(2) Several approaches could be used:

$3.50 – Target cost = 0.2 x $3.50

14-8. Target cost for new software:

Let x = target cost

14-9. Kaizen cost targets:

2006 2007 2008 2009 2010

Note: Numbers are rounded to the nearest whole dollar.

14-10. Cycle efficiency: 18 + 63 + 230 + 15 + 22 = 348

(2) Nonvalue-added activities:

(2) Nonvalued-added activities.

Summary: 6 value-added workers; 3 nonvalue-added workers.

14-14. Value-added employees:

(1) Value-added labor ratio in terms of employees:

(2) Value-added labor ratio in terms of compensation:

(2) Measures for product quality:

(3) Measures for delivery performance:

(4) Measures for inventory control:

(5) Measures for machine maintenance:

Malaysian subsidiary: 2,895  3,000 = 0.97

Malaysian subsidiary: 2,540  3,000 = 0.85

14-17. Classification into the four categories contained in a balanced scorecard:

a. Percentage of pizzas delivered on time – Customer

2001 2003 2005 2007

Sales $10,000,000 $11,000,000 $12,100,000 $13,310,000

(3) Assumptions that must be examined carefully:

Three-year total operating costs $2,340,000 $486,000

Costs of scrap (500 x $10) $5,000

Cost to produce an additional 1,000 saleable units $120,000

The good news appears as:

External failure costs:

(2) Problems in analyzing costs of quality:

Savings from decrease in defective newsprint (0.6 x $7,200) $4,320

To obtain the 2005 target cost:

Total variable cost for 11,000 sets = $47.50 x 11,000 = $522,500

(2) Nonvalue-added activities.

 Implement a just-in-time production philosophy (eliminates waiting time).

(2) Estimate of the cost of shipments with breakage:

(3) Maximum cost for system changes and training programs:

(a) Airline – Pilots and flight attendants.

(3) First-pass yield:

Weight of cryoprecipitate = 0.5 x 80 kg. = 40 kg.

14-31. Analysis of product quality performance:

 the highest satisfaction indices compiled in the history of that location;

Solution to the Case

CASE 14 – Pare-Ott Hospital

(1) "Customer" groups include:

(4) Other costs of quality:

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