Professional Documents
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CHAPTER 26
MANAGING ACCOUNTING IN
A CHANGING ENVIRONMENT
I. Questions
1. The American Heritage Dictionary defines quality as “1. a characteristic
or attribute of something; property; a feature. 2. the natural or essential
character of something. 3. excellence; superiority.”
Quality for a product or service can be defined as a “product or service
that conforms with a design which meets or exceeds the expectations of
customers at a price they are willing to pay.”
2. Procter & Gamble defines TQM as “the unyielding and continually
improving effort by everyone in an organization to understand, meet, and
exceed the expectations of customers.” Typical characteristics of TQM
include focusing on satisfying customers, striving for continuous
improvement, and involving the entire workforce.
TQM is a continual effort and never completes. Global competition,
new technology, and ever-changing customer expectations make TQM a
continual effort for a successful firm.
3. The core principles of TQM include (1) focusing on satisfying the
customer, (2) striving for continuous improvement, and (3) involving the
entire work force.
4. Continuous improvement (Kaizen) in total quality management is the
belief that quality is not a destination; rather, it is a way of life and firms
need to continuously strive for better products with lower costs.
In today’s global competition, where firms are forever trying to
outperform the competition and customers present ever-changing
expectations, a firm can never reach the ideal quality standard and needs
to continuously improve quality and reduce costs to remain competitive.
5. The Institute of Management Accountants (IMA) believes an effective
implementation of total quality management will take between three and
five years and involves the following tasks:
Year 1
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II. Exercises
d. Contribution margins
of lost sales x
e. Tuition for quality
courses x
f. Raw materials
inspections x
g. Work-in-process
inspection x
h. Shipping cost for
replacements x
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Managing Accounting in a Changing Environment Chapter 27
i. Recalls x
j. Attorney’s fee for
unsuccessful defense of
complaints about quality x
k. Inspection of reworks x
l. Overtime caused by
reworking x
m. Machine maintenance x
n. Tuning of testing
equipment x
Requirements 1 & 2
Bali Company
Cost of Quality Report
For 2005 and 2006
a. There were slight increases in both prevention and appraisal costs from
2005 to 2006. Each of these two cost of quality increased by
approximately 0.33 percent of the total sales. These two costs increased
by P40,000 over the two years.
b. Both internal failure costs and external failure costs decreased
substantially in 2006 as compared to those in 2005. The firm
experienced a 1.41 percent decrease in internal failure and a 4.34 percent
decrease in external failure costs with the total savings of P345,000. The
savings was 863 percent of the increases in prevention and appraisal
costs.
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Chapter 27 Managing Accounting in a Changing Environment
Requirement 3
Requirement 1
Internal External
Costs of Quality Prevention Appraisal Failure Failure
Rework P 6,000
Recalls P15,000
Reengineering efforts P 9,000
Repair 12,000
Replacements 12,000
Retesting 5,000
Supervision P18,000
Scrap 9,000
Training 15,000
Testing of incoming
materials 7,000
Inspection of work in
process 18,000
Downtime 10,000
Product liability
insurance 9,000
Quality audits 5,000
Continuous 1,000
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improvement
Warranty repairs 15,000
Requirement 2
Total spent by
category P25,000 P48,000 P42,000 P51,000
Requirement 3
Requirements 1 and 2
2006 2005
Revenues P12,500,000 P10,000,000
Percentage Percentage
of Revenues of Revenues
Cost (2) = (1) Cost (4) = (3)
Costs of Quality (1) P12,500,000 (3) P10,000,000
Prevention costs
Design engineering P240,000 P100,000
Preventive
maintenance 90,000 35,000
Training 120,000 45,000
Supplier evaluation 50,000 20,000
Total prevention
costs 500,000 4.0% 200,000 2.0%
Appraisal costs
Line inspection 85,000 110,000
Product-testing
equipment 50,000 50,000
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Chapter 27 Managing Accounting in a Changing Environment
Incoming materials
inspection 40,000 20,000
Product-testing labor 75,000 220,000
Total appraisal costs 250,000 2.0% 400,000 4.0%
Internal failure costs
Scrap 200,000 250,000
Rework 135,000 160,000
Breakdown
maintenance 40,000 90,000
Total internal failure
costs 375,000 3.0% 500,000 5.0%
External failure costs
Returned goods 145,000 60,000
Customer support 30,000 40,000
Product liability claims 100,000 200,000
Warranty repair 200,000 300,000
475,000 3.8% 600,000 6.0%
Total costs of quality P1,600,000 12.8% P1,700,000 17.0%
Between 2005 and 2006, Gabriel’s costs of quality have declined from 17%
of sales to 12.8% of sales. The analysis of individual costs of quality
categories indicates that Gabriel began allocating more resources to
prevention activities – design engineering, preventive maintenance, training
and supplier evaluations in 2006 relative to 2005. As a result, appraisal
costs declined from 4% of sales to 2%, costs of internal failure fell from 5%
of sales to 3%, and external failure costs decreased from 6% of sales to
3.8%. The one concern here is that, although external failure costs have
decreased, the cost of returned goods has increased. Gabriel’s management
should investigate the reasons for this and initiate corrective action.
Requirement 3
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Requirements 1 and 2
Percentage of
Revenues
Costs (2) = (1)
Costs of Quality (1) P20,000,000
Prevention costs
Design engineering (P75 x
6,000 hours) P 450,000 2.25%
Appraisal costs
Testing and inspection (P40 x
1 hour x 10,000 units) 400,000 2.00%
Internal failure costs
Rework (P500 x 5% x 10,000
units) 250,000 1.25%
External failure costs
Repair (P600 x 4% x 10,000
units) 240,000 1.20%
Total costs of quality P1,340,000 6.70%
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Percentage of
Revenues
Costs (2) = (1)
Costs of Quality (1) P7,500,000
Prevention costs
Design engineering (P75 x
1,000 hours) P 75,000 1.00%
Appraisal costs
Testing and inspection (P40 x
0.5 x 5,000 units) 100,000 1.33%
Internal failure costs
Rework (P400 x 10% x 5,000
units) 200,000 2.67%
External failure costs
Repair (P450 x 8% x 5,000
units) 180,000 2.40%
Estimated forgone
contribution margin on
lost sales [(P1,500 –
P800) x 300] 210,000 2.80%
Total external failure
costs 390,000 5.20%
Total costs of quality P765,000 10.20%
Requirement 3
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III. Problems
Requirement 1
Requirement 2
Requirement 3
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Chapter 27 Managing Accounting in a Changing Environment
Yes. The cost of the new process is P15,000,000 and the expected benefits is
P28,837,500 over three years. The firm can expect to earn a return of over
90%.
Requirement 4
The following factors should be considered before making the final decision:
Requirement 5
The member of the board would be right if we ignore the financial payoff of
the new process and if the firm is going to be in business for only three
years. Having high quality products, especially for a high-end product such
as the one the firm is selling, is crucial for a long term success.
Increase
Costs Categories 2005 2006 (Decrease)
Prevention costs:
Training P 75,000 P 100,000 P 25,000
Product design 150,000 175,000 25,000
Total prevention 225,000 275,000 50,000
Appraisal costs:
Testing 50,000 150,000 100,000
Calibration 75,000 100,000 25,000
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Requirement 1
Incremental
Costs under Incremental
Current Costs under JIT
Production Production
Relevant Items System System
Annual tooling costs – P150,000
Required return on investment
12% per year x P900,000 of average
inventory per year P108,000
12% per year x P200,000 of average
inventory per year 24,000
Insurance, space, materials
handling, and setup costs 200,000 140,000a
Rework costs 350,000 280,000b
Incremental revenues from higher
selling prices – (90,000)c
Total net incremental costs P658,000 P504,000
Annual difference in favor of JIT
production P154,000
a
P200,000 (1 – 0.30) = P140,000
b
P350,000 (1 – 0.20) = P280,000
c
P3 x 30,000 units = P90,000
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Chapter 27 Managing Accounting in a Changing Environment
Requirement 2
Requirement 1
Incremental
Costs under Incremental
Current Costs under JIT
Purchasing Purchasing
System Policy
Required return on investment
20% per year x P600,000 of
average inventory per year P120,000
20% per year x P0 of inventory
per year P 0
Annual insurance costs 14,000 0
Warehouse rent 60,000 (13,500)a
Overtime costs
No overtime 0
Overtime premium 40,000
Stockout costs
No stockouts 0
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Note that the incremental costs of P40,000 for overtime premiums to make
the additional 15,000 units are less than the contribution margin from losing
these sales equal to P97,500 (P6.50 x 15,000). Josefina would rather incur
overtime than lose 15,000 units of sales.
Requirement 1
Zashi should invest in the modern jigs and tools because the benefit of
higher throughput contribution of P40,000 exceeds the cost of P30,000.
Requirement 2
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Requirement 1
Requirement 2
Requirement 1
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Requirement 2
Alternatively, the cost of 2,000 defective units at the finishing operation can
be calculated as the lost revenue of P72 x 2,000 = P144,000. This line of
reasoning takes the position that direct materials costs of P32 x 2,000 =
P64,000 and all fixed operating costs in the machining and finishing
operations would be incurred anyway whether a defective or good unit is
produced. The cost of producing a defective unit is the revenue lost of
P144,000.
Problem 8
Requirement (a)
Anthony Foods
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Chapter 27 Managing Accounting in a Changing Environment
Quality Costs
2005-2006
(Millions)
2005 2006
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Quality assurance
administration P 6.20 P 6.52 P 6.86 P 7.19 P 7.93 P 8.74 P 9.61 P10.53
Training 13.10 14.39 15.90 17.46 21.12 25.50 30.37 36.35
Process
engineering 2.20 2.46 2.76 3.11 3.87 4.86 6.13 7.58
Prevention 21.50 23.37 25.52 27.76 32.92 39.10 46.11 54.46
Inspection 1.40 1.56 1.75 1.95 2.39 2.96 3.63 4.46
Testing 1.60 1.72 1.85 1.99 2.29 2.62 3.01 3.45
Appraisal 3.00 3.28 3.60 3.94 4.68 5.58 6.64 7.91
Rework 15.80 12.65 10.03 8.49 7.25 6.16 5.56 5.00
Scrap 17.60 14.48 11.92 10.32 8.92 7.72 7.00 6.34
Internal failure 33.40 27.13 21.95 18.81 16.17 13.88 12.56 11.34
Returns 26.90 21.09 16.35 13.53 11.32 9.50 8.43 7.52
Customer
complaint dept. 3.90 3.45 3.03 2.76 2.50 2.27 2.14 2.01
Lost sales 49.20 40.31 33.11 28.42 24.45 21.08 19.20 17.44
External failure 80.00 64.85 52.49 44.71 38.27 32.85 29.77 26.97
Total costs P137.90 P118.63 P103.56 P95.22 P92.04 P91.41 P95.08 P100.68
Requirement (b)
From the preceding data we see that prevention and appraisal costs are
increasing while internal and external failure costs have been decreasing.
The following graph plots three series: prevention and appraisal costs,
failure costs, and total quality costs.
140
120
100
80
60
40
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20
0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
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Chapter 27 Managing Accounting in a Changing Environment
1. C 11. C
2. B 12. A
3. C 13. C
4. D 14. B
5. D 15. C
6. A 16. D
7. C 17. D
8. C 18. D
9. D 19. A
10. D 20. A
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