EXERISES -Cost of Quality

Reporting quality costs

The purpose of reporting quality costs is to make management aware of the
magnitude of quality costs and to provide a baseline against which the impact of
quality improvement activities could be measured.

Example:
The Black Company manufactures custom-designed milling machines and
incurred the following costs of quality for 2021 and 2022:
2022 2021
Rework P 200,000 P 250,000
Quality manual 40,000 50,000
Product design 300,000 270,000
Testing 80,000 60,000
Retesting 50,000 90,000
Product recalls 360,000 500,000
Field service 230,000 350,000
Disposal of defective units 90,000 85,000

The total sales in each of the two years were P6,000,000. The firm’s cost of goods
sold is typically one -third of the net sales.
Required:
1. Prepare a cost-of-quality report that classifies the firm’s cost under the proper
cost-of-quality category.
2. Calculate the ratio of each cost-of -quality category to sales in each of the two
years. Comment on the trends in cost of quality between 2021 and 2022

Solution:
1.
Black Company
Cost of Quality Report
For 2021 and 2022
Cost of quality Percent Percent
category of total of total
sales sales

2022 2021

Prevention costs

Quality manual P 40,000 P 50,000

Product design 300,000 P 340,000 5.67% 270,000 P320,000 5.33%

 Appraisal costs

Testing 80,000 80,000 1.33% 60,000 60,000 1.00%

Internal failure costs

Rework 200,000 250,000

Retesting 50,000 90,000

Disposal of 90,000 340,000 5.67% 85,000 425,000 7.08%

defective
units

External failure costs

Product recalls 360,000 500,000

Field service 230,000 590,000 9.83% 350,000 850,000 14.17%

Total costs of quality P1,350,000 22.50% P1,655,000 27.58%

A. Classify these following items into types of cost of quality:

1. Warranty repairs EXTERNAL FAILURE
2. Scrap INTERNAL FALURE
3. Allowance granted due to blemish EXTERNAL FAILAURE
4. Contribution margin of lost sales EXTERNAL FAILURE
5. Tuition for quality courses PREVENTION
6. Work in process inspection APPRAISEAL
7. shipping costs for replacements EXTERNAL FAILURE
8. Recalls EXTERNAL FAILURE
9. Inspection of reworks INTERNAL FAILURE
10. Tuning of testing equipment PREVENTION

B. The Gabriel Corporation manufactures and sells industrial grinders. The following table
presents financial information pertaining to quality in 2021 and 2022 (in thousands)
2022 2021

Revenues P 12,500 P10,000

Line inspection 85 110

Scrap 200 250

Design engineering 240 100

Cost of returned goods 145 60

Product-testing equipment 50 50

Customer support 30 40

Rework cost 135 160

Preventive equipment maintenance 90 35

Product liability claims 100 200

Incoming materials inspection 40 20

 Breakdown maintenance 40 90

Product-testing labor 75 220

Training 120 45

Warranty repair 200 300

Supplier evaluation 50 20

Required:
1. Classify the cost item into the four costs of quality categories.
2. Calculate the ratio of each category to revenues in 2021 and 2022.

Requirements 1 and 2

2022 2021
Revenues P12,500 P10,000
Percentage Percentage
of Revenues of Revenues
Cost (2) = (1)  Cost (4) = (3) 
Costs of Quality (1) P12,500 (3) P10,000
Prevention costs
Design engineering P240 P100
Preventive maintenance 90 35
Training 120 45
Supplier evaluation 50 20
Total prevention
costs 500 4.0% 200 2.0%

Appraisal costs
Line inspection 85 110
Product-testing
equipment 50 50
Incoming materials
inspection 40 20
Product-testing labor 75 220
Total appraisal costs 250 2.0% 400 4.0%
Internal failure costs
Scrap 200 250
Rework 135 160
 Breakdown
maintenance 40 90
Total internal failure
costs 375 3.0% 500 5.0%
External failure costs
Returned goods 145 60
Customer support 30 40
Product liability claims 100 200
Warranty repair 200 300
475 3.8% 600 6.0%
Total costs of quality P1,600 12.8% P1,700 17.0%

Between 2021 and 2022, 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 2022 relative to 2021. 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.