Management And Accounting Web

Carr, L. P. and L. A. Ponemon. 1994. The behavior of quality costs: Clarifying the confusion. Journal of Cost Management (Summer): 26-34.

Summary by Nicholas Sisto
Master of Accountancy Program
University of South Florida, Summer 2003

Cost Management Main Page | Quality Related Main Page

The purpose of this article is to examine the cost-of-quality (COQ) model and to determine if any statistical evidence supports the trade-offs required to obtain the optimal cost level.

Today’s managers are feeling an ever-increasing pressure from stockholders to obtain stronger financial results while their competitors are increasing the quality of their products and processes. The article mentions the huge financial investments that companies have made for quality in an effort to remain competitive in today’s global environment. For example, the Commercial Nuclear Fuel Division of Westinghouse has estimated that 75 percent of its capital allocations relate to quality. Motorola spent $170 million on employee quality education and Texas Instruments spends $8 million a year on quality training. These huge financial outlays have placed great demand on management to measure the benefits of these programs as well as determine how scarce resources should be allocated for these quality programs.

A study was undertaken to analyze the behavior of quality costs at forty-seven pulp and paper mills over a four-year period. The study was designed to prove that cost-of-quality information could assist management in making better decisions regarding the use of scarce resources for quality programs.

The study focused on the two major components of the traditional cost-of-quality model.

1. The cost of control, or conformance costs, which consist of prevention and appraisal expenditures used to mitigate defects; and

2. The costs of the failure to control, or nonconformance costs, which include both internal and external failure costs.

The classic COQ model states that a company that produces poor quality products can greatly reduce failure by instituting a relatively low cost prevention and appraisal measure. However, the model suggests that at some point increased conformance expenditures do not equal the benefit from nonconformance cost reductions. The debate over the value of the COQ model consists of the advocates who believe that managing conformance and nonconformance cost trade-offs leads to the lowest COQ or the optimal level of quality cost. However, the zero-defect advocates believe that there is little value in the COQ model and they endorse the continuous improvement philosophy and ignore the cost trade-offs analysis.

Resolving the debate was not the goal of the study. The study sought to answer the following four questions:

1. Do increased prevention or appraisal expenditures lead to improved levels of quality?

2. Do diminishing quality levels result in increased internal or external failure costs?

3. Does the hypothesized trade-off between conformance costs and nonconformance truly exist?

4. How long will it take for conformance expenditures made today to reduce internal or external failure costs in the future?

The results of the study provided some interesting information and only partially confirmed the classic cost-of-quality model. The study showed that prevention and appraisal costs significantly influenced external failure cost. However, neither prevention nor appraisal costs have a statistically significant association with internal failure costs. The finding suggests that companies in this industry use conformance cost to reduce the external failure without necessarily improving internal failure rates. In addition, the studies showed that prevention and appraisal costs had a strong influence on external costs when the quality of the company was poor, in cases were the quality of the company was high there was less effect on external costs.

The study also showed that a quality cost trade-off exists over time between conformance expenditures and external failure only.

The studied also confirmed the five phases of quality improvement theory. The theory states that companies that are in the early stages of a quality improvement process focus initially on reducing external failure. This knowledge should encourage managers at the pulp and paper mills to continue to invest in quality programs. They should focus their resources on reducing internal failure as they still have a way to go before they reach the optimal quality level.

It appears that this study has provided managers with the empirical evidence needed to commit the resources required for a quality program. It provides statistical evidence that a company with poor quality could greatly reduce external failure with a relatively low investment in conformance costs. It also demonstrates that there is a trade-off between prevention or appraisal costs and external failure, but this trade-off may be at the expense of internal failure costs. While this study does not validate all the assumptions of the cost-of-quality model, I do believe it demonstrates the possibility of balancing conformance and nonconformance costs.

________________________________________________

Related summaries:

Albright, T. L. and H. Roth. 1992. The measurement of quality costs: An alternative paradigm. Accounting Horizons (June): 15-27. (Summary).

Albright, T. L. and H. Roth. 1993. Controlling quality on a multidimensional level. Journal of Cost Management (Spring): 29-37. (Summary).

Albright, T. L. and H. P. Roth. 1994. Managing quality through the quality loss function. Journal of Cost Management (Winter): 20-37. (Summary).

Anderson, S. W. and K. Sedatole. 1998. Designing quality into products: The use of accounting data in new product development. Accounting Horizons (September): 213-233. (Summary).

Carr, L. P. 1995. How Xerox sustains the cost of quality. Management Accounting (August): 26-32. (Summary).

Deming, W. E. 1993. The New Economics for Industry For Industry, Government & Education. Cambridge: Massachusetts Institute of Technology Center for Advanced Engineering Study. Chapter 10. (Summary).

Fargher, N. and D. Morse 1998. Quality costs: Planning the trade-off between prevention and appraisal activities. Journal of Cost Management (January/February): 14-22. (Summary).

Gabel, N. 1991. Is 99.9% good enough? Training Magazine (March). (Summary).

Hughes, S. B. and D. M. Willis. 1995. How quality control concepts can reduce environmental expenditures. Journal of Cost Management (Summer): 15-19. (Summary).

Kettering, R. C. 2001. Accounting for quality with nonfinancial measures: A simple no-cost program for the small company. Management Accounting Quarterly (Spring): 14-19. (Summary).

Kim, M. W. and W. M. Liao. 1994. Estimating hidden quality costs with quality loss functions. Accounting Horizons (March): 8-18. (Summary).

Lucier, G. T. and S. Seshadri. 2001. GE takes six sigma beyond the bottom line. Strategic Finance (May): 40-46. (Summary).

Morse, W. J. 1983. Measuring quality costs. Cost and Management (July-August): 16-20. (Summary).

Pasewark, W.R. 1991. The evolution of quality control costs in U.S. manufacturing. Journal of Cost Management (Spring): 46-52. (Summary).

Roehm, H. A., D. Klein and J. F. Castellano. 1995. Blending quality theories for continuous improvement. Management Accounting (February): 26-32. (Summary).

Roth, H. P. and T. L. Albright. 1994. What are the costs of variability? Management Accounting (June): 51- 55. (Summary).

Rust, K. G. 1995. Measuring the costs of quality. Management Accounting (August): 33-37. (Summary).

Sedatole, K. L. 2003. The effect of measurement alternatives on a nonfinancial quality measure's forward-looking properties. The Accounting Review (April): 555-580. (Summary) and (JSTOR link).

Shank, J. K. and V. Govindarajan. 1994. Measuring the "cost of quality": A strategic cost management perspective. Journal of Cost Management (Summer): 5-17. (Summary).

Sjoblom, L. M. 1998. Financial information and quality management - Is there a role for accountants? Accounting Horizons (December): 363-373. (Summary).

Taguchi, G. and D. Clausing. 1990. Robust quality. Harvard Business Review (January-February): 67-75. (Summary).