Quality of conformance is the degree to which the actual product or service meets its design specifications.

Anything that does not meet design specifications is a defect and is indicative of low quality of conformance. There are four broad categories of quality costs: prevention costs, appraisal costs, internal failure costs, and external failure costs. Prevention costs are incurred to support activities whose purpose is to reduce the number of defects. Appraisal costs are incurred to identify defective products before the products are shipped to customers. Internal failure costs are incurred as a result of identifying defects before they are shipped to customers. External failure costs are incurred as a result of defective products being delivered to customers. Here are some examples of each type of quality cost. Prevention costs include: quality training, quality circles, and statistical process control activities. Appraisal costs include: testing and inspection of incoming materials, final product testing, and depreciation of testing equipment. Internal failure costs include: scrap, spoilage, and rework. External failure costs include: the cost of field servicing and handling customer complaints, warranty repairs, and lost sales arising from reputation of poor quality.

Graphs are often used to depict the relationship between the four types of quality costs. The graph on this slide illustrates four key concepts. 1. When the quality of conformance is low, total quality cost is high and most of this cost consists of internal and external failure costs. 2. Total quality costs drop rapidly as the quality of conformance increases. 3. Companies reduce their total quality costs by focusing their efforts on prevention and appraisal because the cost savings from reduced defects usually overwhelm the costs of additional prevention and appraisal. 4. Total quality costs are minimized when the quality of conformance is slightly less than 100%. This is a debatable point in the sense that some experts believe that total quality costs are not minimized until the quality of conformance is 100%. A quality cost report details the prevention, appraisal, internal failure, and external failure costs that arise from a companys current quality control efforts. When interpreting a cost of quality report managers should look for two trends. First, increases in prevention and appraisal costs should be more than offset by decreases in internal and external failure costs. Second, the total quality costs as a percent of sales should decrease. Quality cost reports provide an estimate of the financial consequences of the companys current defect rate. Uses of quality cost information include the following: 1. It helps managers see the financial significance of defects. 2. It helps managers identify the relative importance of the quality problems faced by the company. 3. It helps managers see whether their quality costs are poorly distributed. In general, costs should be distributed more toward prevention and to a lesser extent appraisal than toward failures. Limitations of quality cost information include the following: 1. Simply measuring and reporting quality cost problems does not solve quality problems. 2. Results usually lag behind quality improvement programs. Initially, prevention and appraisal cost increases may not be offset by decreases in failure costs. 3. The most important quality cost, lost sales arising from customer ill-will, is often omitted from quality cost reports because it is difficult to estimate. The International Organization for Standardization, based in Geneva, Switzerland, has established quality control guidelines, known as the ISO 9000 standards. For a company to become ISO 9000 certified by a certifying agency, it must demonstrate that: 1. A quality control system is in use, and the system clearly defines an expected level of quality; 2. The system is fully operational and is backed up with detailed documentation of quality control procedures; and 3. The intended level of quality is being achieved on a sustained basis.

All raw materials, WIP, and unsold finished goods at the end of the period are shown as inventoriable costs in the asset section of the balance sheet. 2. As finished goods are sold, their costs are transferred to cost of goods sold in the income statement. 3. Selling and administrative expenses are not involved in making the product; therefore, they are treated as period costs and reported in the income statement for the period the cost is incurred. Although the ISO 9000 standards were developed in Europe, they have become widely accepted elsewhere, throughout the world, including the United States.

1.

Raw Materials
Beginning raw materials inventory + Raw materials purchased = Raw materials available for use in production Ending raw materials inventory = Raw materials used in production

Manufacturing Costs

Work In Process

Work In Process
Beginning work in process inventory Manufacturing costs for the period Total work in process for the period Ending work in process inventory Cost of goods manufactured

Finished Goods
Beginning finished goods inventory + Cost of goods manufactured = Cost of goods available for sale - Ending finished goods inventory Cost of goods sold

Direct materials Beginning work in + Direct labor process inventory + Mfg. overhead + Total manufacturing = Total manufacturing costs costs = Total work in process for the period Ending work in process inventory = Cost of goods manufactured

+ = =

Labor costs are associated with idle time, overtime, and fringe benefits. Machine breakdowns, material shortages, power failures and the like, result in idle time. The labor costs incurred during idle time are ordinarily treated as manufacturing overhead. The overtime premiums for all factory workers are usually considered to be part of manufacturing overhead. This is done to avoid penalizing particular products or customer orders simply because they happen to fall on the tail end of the daily production schedule. Labor fringe benefit costs are employment-related costs paid by an employer, such as insurance programs, retirement plans, and supplemental unemployment programs. They also include the employers share of Social Security and Medicare, workers compensation, federal employment tax, and state unemployment insurance. These costs often add up to 30 to 40 percent of an employees base pay. Some companies include all of these costs in manufacturing overhead. Other companies opt for the conceptually superior method of treating fringe benefit expenses of direct laborers as additional direct labor costs.