Appraisal Costs

Internal Failure Costs

External Failure Costs

Total Quality Cost

          Year 2        

     Year 1         

Amount

1,000,000

1,500,000

3,000,000

2,000,000
———–
7,500,000
======

Percent

2.00%

3.00%

6.00%

4.00%
———
15.00%
=====

Amount

650,000

1,200,000

2,000,000

5,150,000
———-
9,000,000
======

Percent

1.30%

2.40%

4.00%

10.30%
———
18.00%
=====

Distribution of Quality Costs/Quality Cost Report:

Learning objectives of this article:

• Prepare and interpret a quality cost report.

How to Distribute Quality Costs?

A company’s total quality cost is likely to be very high unless management gives this area special attention. Experts say that these costs should be more in 2% to 4% range. How does a company reduces its total quality cost? The answer lies in how the quality costs are distributed. Total quality cost is a function of quality of conformance. A high quality of conformance means that a product is free of defects and a low quality of conformance means that a product has defects. In this sense an economy car may have a quality of conformance same as a very expensive car if it has no defects. Like wise an  expensive car may have less quality of conformance if it has defects that effect its use. When the quality of conformance is low, total quality cost is high and most of this cost consists of cost of internal and external failure. A low quality of conformance means that a high percentage of units is defective and hence the company must incur high failure costs. However, as a company spends more and more on prevention and appraisal activities, the percentage of defective units drops. This results in lower costs of internal and external failure costs. Ordinarily total quality cost drops rapidly as the quality of conformance increases.

Thus, a company can reduce its total quality cost by focusing its efforts on prevention and appraisal. The cost savings from reduced defects usually swamp the costs of the additional prevention and appraisal efforts.

As a company’s quality program becomes more refined and as its failure costs begin to fall, prevention activities usually become more effective than appraisal activities. Appraisal can only find defects, whereas prevention can eliminate them. The best way to prevent defects from happening is to design processes that reduce the likelihood of defects and to continually monitor processes using statistical process control methods.

Quality Cost Report:

A quality cost report details the prevention costs, appraisal costs, and internal failure cost and external failure cost that arise from company’s current level of defective products or services. Companies often construct a quality cost report that provides an estimate of the financial consequences of the company’s current level of defects. A simple quality cost report is shown in the following example:

Example of Quality Cost Report

Ventura Company
Quality Cost Report
For the Year1 & 2

Prevention cost increased by (1,000,000 – 650,000) = 350,000
Appraisal cost increased by (1,500,000 – 1,200,000) = 300,000
Internal Failure cost (3,000,000 – 2,000,000) = 1,000,000
Total Increase = 1,650,000

External failure cost decreased by = 3,150,000

Net Quality Cost Benefit = 3,150,000 – 1,650,000
= 1,500,000

Several things should be noted from the data in the quality cost report. First, note that the quality costs are poorly distributed in both years, with most of costs being traceable to either internal or external failure. The external failure costs are particularly high in year 1 in comparison to other costs. Second note that the company increased its spending on prevention and appraisal activities in year 2. As a result, internal failure costs went up in that year (from $2 million in first year to $3 million in year 2), but external failure costs dropped sharply (from $5.15 million in year 1 to $3 million in year 2). Because of the increase in appraisal activates in year 2,more defects were caught inside the company before they were shipped to the customers. This resulted in more cost for scrap, rework, and so forth, but saved huge amounts in warranty repairs, warranty replacements, and external failure costs. Third, note that as a result of greater emphasis on prevention and appraisal, total quality cost decreased inyear2.As continued emphasis is placed on prevention and appraisal in future years, total quality cost should continue to decrease. That is , future increases in prevention and appraisal costs should be more than offset by decreases in failure costs. Moreover, appraisal costs should also decrease as more effort is placed into prevention.

Also See

• Uses and limitations of quality cost information
• International Aspects of Quality

You may also be interested in other useful articles from “cost terms, concepts and classifications” chapter:

1. Manufacturing and Non-manufacturing Costs
2. Product Costs Versus Period Costs
3. Cost Classifications on Financial Statement
4. Cost Classifications for Predicting Cost Behavior (Variable and Fixed cost)
5. Mixed or Semi variable Cost
6. Cost classification for Assigning Costs to Cost Objects (Direct and Indirect Cost)
7. Decision making costs – cost classification for decision making
8. Quality Costs
9. Further Classification of Labor Costs