TUTORIAL 12 (CHAPTER 17), IMPLEMENTING

QUALITY CONCEPTS RAIBORN

Problem 17.45 Cost of Quality
Burtram Ltd. manufactures handheld organizers. The firm produced 30,000
organizers during its first year of operation. At year-end it had no inventory of
finished goods. Burtram sold 28,200 units through regular market channels, but
300 of the units produced were so defective that they had to be sold as scrap.
The remaining units were reworked and sold as seconds. For the year, the firm
spent $160,000 on prevention costs and $80,000 on quality appraisal. There
were no customer returns. An income statement for the year follows:
Sales
Regular channel
Seconds
Scrap
Cost of goods sold
Original production costs
Rework costs
Quality prevention and appraisal
Gross margin
Selling and administrative expenses (all fixed)
Profit before income taxes

$5,640,000
142,500
10,500
$1,917,600
42,000
240,000

$5,793,000

(2,199,600)
$3.593,400
(980,000)
$2,613,400
========

a. Compute the total pre-tax profit lost by the company in its first year of
operations by selling defective units as seconds or as scrap rather than
selling the units through regular channels.
b. Compute the total failure cost for the company in its first year.
c. Compute total quality cost incurred by the company in its first year.
d. What evidence indicates that the firm is dedicated to manufacturing and
selling high-quality products?
Answer to the Problem 17.45 Cost of Quality
45.a. Price for scrapped units = $10,500 300 = $35
Price for good units = $5,640,000 28,200 = $200
Profit lost = 300 units ($200 - $35) = 300 $165 = $49,500
Price for seconds = $142,500 1,500 = $95
Profit lost = 1,500 units ($200 - $95) = 1,500 $105 = $157,500

Total profit lost = $49,500 + $157,500 = $207,000

b. Profit lost
Less avoided rework cost on scrap
[300 units ($42,000 1,500) = 300 $28]
Rework cost incurred
Total failure cost

$207,000

c. Total failure cost

Prevention and appraisal cost
Total quality cost

$240,600
240,000
$480,600

(8,400)
42,000
$240,600

d. Although the companys failure costs were slightly more than its
prevention and appraisal costs, the majority of the failure costs were
internal. Thus, Burtram Ltd. caught most of the problems prior to
defective products being sold to customers. Also, there were no
product returnseven of the reworked seconds. The large expenditure
on prevention is an investment that should yield fewer failure costs in
future periods.
Problem 17.46 Cost of Quality
During 2008 (the first year of operations), Sorkowsky Company produced 19,900
portable navigation systems; of these, 500 were found defective by quality
appraisers. Three hundred of the defective units were reworked and sold through
regular channels at the original price; the rest were sold as seconds without
rework, (The uncorrected defects did not pose a hazard to customers; it was a
voice flaw which made the units sometimes sound as if they were yelling at the
users.) The navigation systems are sold with a two-year warranty; seconds have
a six month warranty.
In 2008, Sorkowsky Company spent $225,000 as prevention measures and
$98,000 on appraisal. Following is the partnerships 2008 income statement,
which appropriately does not reflect any income taxes:
SORKOWSKY COMPANY
Income Statement
For Year Ended December 31, 2008
Regular sales (19,700 units)
$5,122,000
Sales of seconds (200 units)
28,000
Cost of goods sold
Original production costs
$1,600,000
Rework costs (300 units)
10,500
Prevention and appraisal costs
323,000

$5,150,000

(1,933,500)
$3,216,500

Selling and administrative expenses (all fixed)

(1,200,000)
$2,016,500
=========

a. Compute the total profit lost by Sorkowsky Company in its first year of
operation by selling defective units as seconds rather than reworking them
and selling them at the regular price.
b. Compute the companys total failure cost in 2008.
c. Compute the companys total quality cost in 2008.
d. Assume that selling and administrative expenses include $150,000 to
operate a customer complaint center. How should this cost be categorized
relative to quality costs?
e. Are the costs included in the 2008 income statement completely reflective
of Sorkowskis quality costs?
Answer to the Problem 17.45 Cost of Quality
46.a. Price for seconds = $28,000 200 = $140
Price for good units = $5,122,000 19,700 = $260
Production costs = $1,600,000 19,900 = $80.40 (rounded)
Profit lost = 200 units x ($260 - $140) = 200 $120 = $24,000
b. Profit lost
Less avoided rework cost on seconds
[200 units ($10,500 300) = 200 $35
Profit lost
Rework cost incurred
Total failure cost
c.

Total failure cost

Prevention and appraisal cost
Total quality cost

$24,000
(7,000)
$17,000
10,500
$27,500
$ 27,500
323,000
$350,500

d. The $150,000 cost of the customer complaint center should be

considered as part of external failure costs. That cost would increase
total failure costs to $177,500, making them over half of prevention and
appraisal costs.
e. No, the costs are not fully reflective of the companys cost due to the
outstanding warranties on the products. It is unknown at what point in
time the units were sold during the year and, thus, many of the units
could still be returned for warranty work. The estimated cost of
warranty work is considered a contingency and, if estimable, should be
included within the selling expenses of the current year. That estimate
would also be considered a part of external failure cost.

Problem 17.47 Cost of Quality

Golf courses are demanding in their quest for high-quality carts because of the
critical need for lawn maintenance. Richfield Corp. manufactures golf carts and is
recognized leader in the industry for quality products. In recent months, company
managers have become more interested in trying to quantify the companys cost
of quality. As an initial effort, the company identified the following 2008 costs by
categories that are associated with quality:
Prevention Costs
Quality training
Quality technology
Quality circles

$15,000
50,000
32,000

Appraisal Costs
Quality inspections
Test equipment
Procedure verifications

$18,000
14,000
9,000

Internal Failure Costs

Scrap and waste
Waste disposal

$6,500
2,100

External Failure Costs

Warranty handling
Customer reimbursement/returns

$9,500
7,600

Managers were also aware that in 2008, 250 of the 8,000 carts produced had to
be sold as seconds. These 250 carts were sold for $80 less profit per unit than
good carts. Also, the company incurred the rework costs amounting to $6,000
to sell 200 other carts through regular market channels.
a. Using these data, calculate Richfield Corp.s 2008 expense for the following:
1. Lost profit from the 250 units
2. Total failure cost
3. Total quality cost be reflected in quality cost?
b. Assume that the company is considering expanding its existing 5-year
warranty to a seven-year warranty in 2009. How should such a change be
reflected in quality costs?
Answer to the Problem 17.47 Cost of Quality
47.a. 1. Lost profits 250 $80 = $20,000
4

2. Lost profit from selling defective units (250 $80)

Rework costs
Scrap and waste
Waste disposal
Warranty handling
Customer reimbursements/returns
Total failure costs
3. Prevention costs
Quality training
Quality technology
Quality circles
Appraisal costs
Quality inspections
Test equipment
Procedure verifications
Total failure costs
Total quality costs

$20,000
6,000
6,500
2,100
9,500
7,600
$51,700

$15,000
50,000
32,000

$ 97,000

$18,000
14,000
9,000

41,000
51,700
$189,700

b. If no additional costs were incurred in the prevention category, one

would simply expect the external failure costs to rise. In particular, one
would expect warranty expense to rise. However, because the
warranty is a valuable product characteristic to many buyers, sales
may rise enough to justify the increased quality costs.
Problem 17.48 Cost of Quality
Smooth sailing is very aware that its scuba diving tanks must be of high quality to
maintain its reputation of excellence and safety. The company has retained you
as a consultant and you have suggested that quantifying the costs would be
important to the understanding and management of quality. Your experience as a
cost accountant helped you determine year 2008 costs of quality from the
companys accounting records as follows:
Prevention Costs
Fool-proofing machinery
Quality training
Educating suppliers

$10,000
30,000
22,000

Appraisal Costs
Quality inspections
Recording defects
Procedure verifications

$12,000
9,000
6,000

Internal Failure Costs

Waste disposal
Unplanned downtime

$4,500
1,400

External Failure Costs

Warranty handling
Customer reimbursement/returns

$6,400
5,100

You also determined that 1,200 of the 100,000 tanks made in 2008 had to be
sold as scrap for $70 less profit per tank than the nondefective tanks. Smooth
Sailing also incurred $4,000 of rework costs that had been buried in overhead (in
addition to the failure costs listed) in producing the tanks sold at the regular price.
a. Smooth Sailings management has asked you to determine the 2008
costs of the following:
1. Lost profit from scrapping the 1,200 units.
2. Total failure cost.
3. Total quality cost.
b. Assume that the company is considering expanding its existing full 2-year
warranty to a full 3-year warranty in 2009. How should such a change be
reflected in quality costs?
Answer to the Problem 17.48 Cost of Quality
48.

a. 1. 1,200 units scrapped x $70 = $84,000

2. Lost profits from scrapping 1,200 units
Internal failure costs ($4,500 + $1,400 + $4,000)
External failure costs ($6,400 + $5,100)
Total failure costs

$ 84,000
9,900
11,500
$105,400

3. Total failure costs

Prevention costs ($10,000 + $30,000 + $22,000)
Appraisal costs ($12,000 + $9,000 + $6,000)
Total quality costs

$105,400
62,000
27,000
$194,400

b. Management should expect an increase in warranty costs (external

failure) as an immediate result of the policy change. If management
also accompanies the change in the warranty policy with increased
preventive measures, one can expect an increase in prevention costs
but a resulting drop in appraisal costs and in both internal and external
failures. However, management may also step up appraisal efforts to

reduce warranty claims and these appraisal efforts will, per se,
increase appraisal costs.

End of Tutorial 11 (Raiborn-Chapter-17) (Implementing Quality

Concepts)