MANAGEMENT ACCOUNTING - Solutions Manual

CHAPTER 26

MANAGING ACCOUNTING IN
A CHANGING ENVIRONMENT

I. Questions
1. The American Heritage Dictionary defines quality as “1. a characteristic
or attribute of something; property; a feature. 2. the natural or essential
character of something. 3. excellence; superiority.”
Quality for a product or service can be defined as a “product or service
that conforms with a design which meets or exceeds the expectations of
customers at a price they are willing to pay.”
2. Procter & Gamble defines TQM as “the unyielding and continually
improving effort by everyone in an organization to understand, meet, and
exceed the expectations of customers.” Typical characteristics of TQM
include focusing on satisfying customers, striving for continuous
improvement, and involving the entire workforce.
TQM is a continual effort and never completes. Global competition, new
technology, and ever-changing customer expectations make TQM a
continual effort for a successful firm.
3. The core principles of TQM include (1) focusing on satisfying the
customer, (2) striving for continuous improvement, and (3) involving the
entire work force.
4. Continuous improvement (Kaizen) in total quality management is the
belief that quality is not a destination; rather, it is a way of life and firms
need to continuously strive for better products with lower costs.
In today’s global competition, where firms are forever trying to
outperform the competition and customers present ever-changing
expectations, a firm can never reach the ideal quality standard and needs
to continuously improve quality and reduce costs to remain competitive.
5. The Institute of Management Accountants (IMA) believes an effective
implementation of total quality management will take between three and
five years and involves the following tasks:
Year 1

27-1
Chapter 27 Managing Accounting in a Changing Environment

 Create a quality council and staff

 Conduct executive quality training programs
 Conduct quality audits
 Prepare gap analysis
 Develop strategic quality improvement plans
Year 2
 Conduct employee communication and training programs
 Establish quality teams
 Create measurement systems and set goals
Year 3
 Revise compensation / appraisal / recognition systems
 Launch external initiatives with suppliers
 Review and revise
6. Reward and recognition are the best means of reinforcing the emphasis on
TQM. Moreover, proper reward and recognition structures can be very
powerful stimuli to promote TQM. Efforts and progress will most likely
be short-lived if no change is made to the compensation / appraisal /
recognition systems to make them in line with the objectives of the firm’s
TQM.
7. The purposes of conducting a quality audit are to identify strengths and
weaknesses in quality practices and levels of a firm’s quality and to help
the firm identify the target areas for quality improvements.
8. A gap analysis is a type of benchmarking that includes analyzing the
differences in practices between the firm and the best-in-class. The
objective of gap analyses is to identify strengths, weaknesses, and target
areas for quality improvement.
9. Some examples of costs associated with cost of quality categories are:
Prevention costs: Training costs such as instructors’ fees, purchase of
training equipment, tuition for external training, training wages and
salaries; salaries for quality planning and executions, cost of preventive
equipment, printing and promotion costs for quality programs, awards for
quality.
Appraisal costs: Costs of raw materials, work-in-process, and finished
goods inspections.
Internal failure costs: Scrap, rework, loss due to downgrades,
reinspection costs, and loss due to work interruptions.

27-2
 Managing Accounting in a Changing Environment Chapter 27

External failure costs: Sales returns and allowance due to quality

deficiency, warranty cost, and canceled sales orders due to quality
deficiency.
10. Prevention costs rise during the early years of implementing TQM as the
firm engages in education to prepare its employees and in the planning and
promotion of the quality program. Appraisal costs will also likely rise
during the early years of TQM, because the firm needs to ensure that
quality is actually being achieved. The increase in appraisal cost,
however, is most likely to occur at a slower pace than those of the
prevention costs because at the beginning of a TQM program there will be
substantial increases in quality training and in promotion to raise
awareness on the importance of quality.
The firm may see some decreases in internal and external failure costs in
the early years of implementing a TQM. However, these two costs most
likely will remain at about the same level as before during the first several
years of TQM. Many firms may actually see internal failure cost rise,
because of the higher standard demanded by the TQM or the higher level
of employees’ awareness on the critical importance of perfection in every
step of the process. As the firm makes progress in TQM, both internal
failure and external failure costs should decrease.
11. Costs of conformance are costs incurred to ensure that products or
services meet quality standards and include prevention costs and appraisal
costs.
Internal and external failure costs are costs of non-conformance. They are
costs incurred or opportunity costs because of rejection of products or
services.
12. Better prevention of poor quality often reduces all other costs of quality.
With fewer problems in quality, appraisal is needed because the products
are made right the first time. Fewer defective units also reduce internal
and external failure costs as the occasion for repairs, rework, and recalls
decrease.
It is easier to design and build quality in than try to inspect or repair
quality in. Theoretically, if prevention efforts are completely successful,
there will be no need to incur appraisal costs and there will be no internal
failure or external failure costs. In practice, appraisal costs usually do not
decrease, partly because management needs to ensure that quality is there
as expected. Nonconformance costs, however, decrease at a much faster
pace than prevention costs increase.

27-3
Chapter 27 Managing Accounting in a Changing Environment

13. The role of management accountants in total quality management includes

gathering all relevant quality information, participating actively in all
phases of the quality program, and reviewing and disseminating quality
cost reports.
14. To meet the challenges of total quality management, management
accountants need to have a clear understanding of TQM methodology.
They must be able to design, create, or modify information systems that
measure and monitor quality and evaluate progress toward total quality as
expected of each organizational unit and the total enterprise.
15. Just-in-time (JIT) purchasing is the purchase of goods or materials such
that a delivery immediately precedes demand or use. Benefits include
lower inventory holdings (reduced warehouse space required and less
money tied up in inventory) and less risk of inventory obsolescence and
spoilage.
16. The sequence of activities involved in placing a purchase order can be
facilitated by use of the Internet. A company can streamline the
procurement process for its customers – e.g., having online a complete
price list, information about expected shipment dates, and a service order
capability that is available 24 hours a day with email or fax confirmation.
17. Just-in-time (JIT) production is a “demand-pull” manufacturing system
that has the following features:
 Organize production in manufacturing cells,
 Hire and retain workers who are multiskilled,
 Aggressively pursue total quality management (TQM) to
eliminate defects,
 Place emphasis on reducing both setup time and manufacturing
lead time, and
 Carefully select suppliers who are capable of delivering quality
materials in a timely manner.
18. Reengineering is the fundamental rethinking and redesign of business
processes to achieve improvements in critical measures of performance
such as cost, quality, service, speed, and customer satisfaction.
19. The three main measures used in the theory of constraints are:
a. Throughput contribution equal to sales revenue minus direct materials
costs.
b. Investments (inventory) equal to the sum of materials costs of direct
materials inventory, work-in-process inventory and finished goods

27-4
 Managing Accounting in a Changing Environment Chapter 27

inventory, research and development costs, and costs of equipment

and buildings.
c. Other operating costs equal to all operating costs (other than direct
materials) incurred to earn throughput contribution.
20. The four key steps in managing bottleneck resources are:
Step 1: Recognize that the bottleneck operation determines throughput
contribution.
Step 2: Search for, and find the bottleneck.
Step 3: Keep the bottleneck busy, and subordinate all nonbottleneck
operations to the bottleneck operation.
Step 4: Increase bottleneck efficiency and capacity.
21. (a) Product warranty costs should be lower because a world-class
manufacturer (WCM) will make fewer defectives.
(b) Salaries of quality control inspectors should be lower because a
WCM will have its workers inspect as they go, rather than having
separate inspections. Nor will a WCM inspect incoming materials
and components because it will deal only with vendors whose quality
has been demonstrated.
(c) Amounts paid to vendors for parts and components should be higher
because a WCM will not search out the lowest prices, but will seek
high-quality components delivered when needed.
(d) Wages rates for direct laborers should be higher because a WCM’s
workers will multiskilled and should therefore command premium
wages.
(e) Total supervisory salaries should be lower because a WCM’s workers
will not need as much supervision.
(f) Warehousing costs should be lower because a WCM will produce as
needed and so will not require storage space for materials or finished
product.
22. At the final assembly stage in a JIT system, a signal is sent to the
preceding workstation as to the exact parts and materials that will be
needed over the next few hours for the final assembly of products. Only
those parts and materials are provided. The same signal is sent back
through each preceding workstation so that a smooth flow of parts and
materials is maintained with no buildup of inventories at any point. Thus,
all workstations respond to the “pull” exerted by the final assembly stage.
The “pull” approach just described can be contrasted to the “push”
approach used in conventional systems. In a conventional system,
inventories of parts and materials are built up—often simply to keep

27-5
Chapter 27 Managing Accounting in a Changing Environment

everyone busy. These semi-completed parts and materials are “pushed”

forward to the next workstation whether or not there is actually any
customer demand for the products they will become part of. The result is
large stockpiles of work in process inventories.
23. A number of benefits accrue from reduced setup time. First, reduced setup
time allows a company to produce in smaller batches, which in turn
reduces the level of inventories. Second, reduced setup time allows a
company to spend more time producing goods and less time getting ready
to produce. Third, the ability to rapidly change from making one product
to making another allows the company to respond more quickly to
customers. Finally, smaller batches make it easier to spot manufacturing
problems before they result in a large number of defective units.

II. Exercises

Exercise 1 (Quality Cost Classification)

Preventio Internal External

n Appraisal Failure Failure
a. Warranty repairs x
b. Scrap x
c. Allowance granted due
to blemish x

d. Contribution margins
of lost sales x
e. Tuition for quality
courses x
f. Raw materials
inspections x
g. Work-in-process
inspection x
h. Shipping cost for
replacements x
i. Recalls x
j. Attorney’s fee for
unsuccessful defense of
complaints about quality x
k. Inspection of reworks x
l. Overtime caused by
reworking x
m. Machine maintenance x
n. Tuning of testing
equipment x

27-6
 Managing Accounting in a Changing Environment Chapter 27

Exercise 2 (Cost of Quality Report)

Requirements 1 & 2
Bali Company
Cost of Quality Report
For 2005 and 2006

Cost of Quality 2006 2005

Category Peso % Peso %
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 P 80,000 80,000 1.33 P 60,000 60,000 1.00
Internal failure costs:
Rework P200,000 P250,000
Retesting 50,000 90,000
Disposal of defective units 90,000 340,000 5.67 85,000 425,000 7.08
External failure costs:
Product recalls P360,000 P500,000
Field service 230,000 590,000 9.83 350,000 850,000 14.17
Total cost of quality P1,350,000 22.50 P1,655,000 27.58

a. There were slight increases in both prevention and appraisal costs from
2005 to 2006. Each of these two cost of quality increased by
approximately 0.33 percent of the total sales. These two costs increased
by P40,000 over the two years.
b. Both internal failure costs and external failure costs decreased
substantially in 2006 as compared to those in 2005. The firm experienced
a 1.41 percent decrease in internal failure and a 4.34 percent decrease in
external failure costs with the total savings of P345,000. The savings was
863 percent of the increases in prevention and appraisal costs.

Requirement 3

Among nonfinancial measures the firm may want to monitor are:

 The number of defects or the processes yield (ratio of good output to
total output)
 The percentage of defective units shipped to customers to total units
of products shipped
 The number of customer complaints
 Difference between delivery date requested by the customer
 On-time delivery percentage (total units shipped on or before the
scheduled date to the total units shipped)

27-7
Chapter 27 Managing Accounting in a Changing Environment

 Surveys of customer satisfaction

It should be noted that nonfinancial measures by themselves often have limited

meaning. Nonfinancial measures are more informative when trends of the
same measure over time are examined.

Exercise 3 (Cost of Quality Category)

Requirement 1

Internal External
Costs of Quality Prevention Appraisal Failure Failure
Rework P 6,000
Recalls P15,000
Reengineering efforts P 9,000
Repair 12,000
Replacements 12,000
Retesting 5,000
Supervision P18,000
Scrap 9,000
Training 15,000
Testing of incoming
materials 7,000
Inspection of work in
process 18,000
Downtime 10,000
Product liability
insurance 9,000
Quality audits 5,000
Continuous
improvement 1,000
Warranty repairs 15,000

Requirement 2

Total spent by
category P25,000 P48,000 P42,000 P51,000

Requirement 3

The company is currently spending the least on preventive costs. They should
concentrate their efforts on preventive costs because they prevent poor quality
products from being manufactured.

27-8
 Managing Accounting in a Changing Environment Chapter 27

By increasing amount spent on prevention, they could reduce spending on the

other cost of quality categories.

Exercise 4 (Cost of Quality Analysis, Nonfinancial Quality Measures)

Requirements 1 and 2

2006 2005
Revenues P12,500,000 P10,000,000
Percentage Percentage
of Revenues of Revenues
Cost (2) = (1)  Cost (4) = (3) 
Costs of Quality (1) P12,500,000 (3) P10,000,000
Prevention costs
Design engineering P240,000 P100,000
Preventive
maintenance 90,000 35,000
Training 120,000 45,000
Supplier evaluation 50,000 20,000
Total prevention
costs 500,000 4.0% 200,000 2.0%

Appraisal costs
Line inspection 85,000 110,000
Product-testing
equipment 50,000 50,000
Incoming materials
inspection 40,000 20,000
Product-testing labor 75,000 220,000
Total appraisal costs 250,000 2.0% 400,000 4.0%
Internal failure costs
Scrap 200,000 250,000
Rework 135,000 160,000
Breakdown
maintenance 40,000 90,000
Total internal failure
costs 375,000 3.0% 500,000 5.0%
External failure costs
Returned goods 145,000 60,000
Customer support 30,000 40,000
Product liability claims 100,000 200,000
Warranty repair 200,000 300,000

27-9
Chapter 27 Managing Accounting in a Changing Environment

475,000 3.8% 600,000 6.0%

Total costs of quality P1,600,000 12.8% P1,700,000 17.0%

Between 2005 and 2006, 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 2006 relative to 2005. 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.

Requirement 3

Examples of nonfinancial quality measures that Gabriel Corporation could

monitor are:

a. Number of defective grinders shipped to customers as a percentage of

total units of grinders shipped.
b. Ratio of good output to total output at each production process.
c. Employee turnover.

Exercise 5 (Costs of Quality Analysis, Nonfinancial Quality Measures)

Requirements 1 and 2

Revenues, Costs of Quality and Costs of Quality as a

Percentage of Revenues for Victoria

Revenues = P2,000 x 10,000 units = P20,000,000

Percentage of
Revenues
Costs (2) = (1) 
Costs of Quality (1) P20,000,000
Prevention costs
Design engineering (P75 x
6,000 hours) P 450,000 2.25%
Appraisal costs
Testing and inspection (P40 x 400,000 2.00%

27-10
 Managing Accounting in a Changing Environment Chapter 27

1 hour x 10,000 units)

Internal failure costs
Rework (P500 x 5% x 10,000
units) 250,000 1.25%
External failure costs
Repair (P600 x 4% x 10,000
units) 240,000 1.20%
Total costs of quality P1,340,000 6.70%

Revenues, Costs of Quality and Costs of Quality as a

Percentage of Revenues for Vancouver

Revenues = P1,500 x 5,000 units = P7,500,000

Percentage of
Revenues
Costs (2) = (1) 
Costs of Quality (1) P7,500,000
Prevention costs
Design engineering (P75 x
1,000 hours) P 75,000 1.00%
Appraisal costs
Testing and inspection (P40 x
0.5 x 5,000 units) 100,000 1.33%
Internal failure costs
Rework (P400 x 10% x 5,000
units) 200,000 2.67%
External failure costs
Repair (P450 x 8% x 5,000
units) 180,000 2.40%
Estimated forgone 210,000 2.80%
contribution margin on
lost sales [(P1,500 –

27-11
Chapter 27 Managing Accounting in a Changing Environment

P800) x 300]
Total external failure
costs 390,000 5.20%
Total costs of quality P765,000 10.20%

Costs of quality as a percentage of sales are significantly different for

Vancouver (10.20%) compared with Victoria (6.70%). Canada spends very
little on prevention and appraisal activities for Vancouver, and incurs high
costs of internal and external failures. Canada follows a different strategy
with respect to Victoria, spending a greater percentage of sales on prevention
and appraisal activities. The result: fewer internal and external failure costs
and lower overall costs of quality as a percentage of sales compared with
Vancouver.

Requirement 3

Examples of nonfinancial quality measures that Canada Industries could

monitor as part of a total quality-control effort are:

a. Outgoing quality yield for each product

b. Returned refrigerator percentage for each product
c. On-time delivery
d. Employee turnover

III. Problems

Problem 1 (Quality Improvement, Relevant Cost Analysis)

Requirement 1

Cost of new equipment and installation P12,000,000

Training 3,000,000
Total additional cost of the new process P15,000,000

Requirement 2

Quality cost if no change is made:

Rework 3,000 x 40% x P2,000 = P 2,400,000

27-12
 Managing Accounting in a Changing Environment Chapter 27

Repair 3,000 x 15% x P2,500 = 1,125,000

Appraisal 600,000
Inspection 3,000 x P50 = 150,000
Lost contribution:
Contribution margin per unit P12,000 x 85% - P2,500 = P7,700
Lost sales 3,000  0.8 – 3,000 = x 750 5,775,000
Total current cost of quality P10,050,000

Quality cost with the new process:

Warranty repair 3,000  0.8 x 5% x P1,000 = – 187,500
Savings from the new process each year P 9,862,500
Years effective x 3
Total P29,587,500

Appraisal and inspection cost in Year 1 – 750,000

Total savings over 3 years P28,837,500

Requirement 3

Yes. The cost of the new process is P15,000,000 and the expected benefits is
P28,837,500 over three years. The firm can expect to earn a return of over
90%.

Requirement 4

The following factors should be considered before making the final decision:

a. Accuracy of cost estimates including

 Contribution margin per unit
 Costs of current repair and rework
 Cost of repair with the new process
 Cost of the new process
b. Reliability of estimations of
 Rates of rework and repair
 Lost sales
 Amount of time before the current product become obsolete
c. Reaction of competitors

Requirement 5

The member of the board would be right if we ignore the financial payoff of
the new process and if the firm is going to be in business for only three years.

27-13
Chapter 27 Managing Accounting in a Changing Environment

Having high quality products, especially for a high-end product such as the
one the firm is selling, is crucial for a long term success.

Problem 2 (Preparing a Cost of Quality Report)

The Adoracion Company

Comparative Costs of Quality Report

Increase
Costs Categories 2005 2006 (Decrease)
Prevention costs:
Training P 75,000 P 100,000 P 25,000
Product design 150,000 175,000 25,000
Total prevention 225,000 275,000 50,000

Appraisal costs:
Testing 50,000 150,000 100,000
Calibration 75,000 100,000 25,000
Total appraisal 125,000 250,000 125,000

Internal failure costs:

Rework 325,000 100,000 (225,000)
Retesting 250,000 200,000 (50,000)
Total internal failure 575,000 300,000 (275,000)

External failure costs:

Warranty repairs 150,000 75,000 (75,000)
Product recalls 400,000 200,000 (200,000)
Product liability 125,000 75,000 (50,000)
Total external failure 675,000 350,000 (325,000)
Total costs of quality P1,600,000 P1,175,000 P (425,000)

Problem 3 (JIT Production, Relevant Benefits, Relevant Costs)

Requirement 1

Incremental
Costs under Incremental
Current Costs under JIT
Production Production
Relevant Items System System
Annual tooling costs – P150,000
Required return on investment

27-14
 Managing Accounting in a Changing Environment Chapter 27

12% per year x P900,000 of average

inventory per year P108,000
12% per year x P200,000 of average
inventory per year 24,000
Insurance, space, materials handling,
and setup costs 200,000 140,000a
Rework costs 350,000 280,000b
Incremental revenues from higher
selling prices – (90,000)c
Total net incremental costs P658,000 P504,000
Annual difference in favor of JIT
production P154,000
a
P200,000 (1 – 0.30) = P140,000
b
P350,000 (1 – 0.20) = P280,000
c
P3 x 30,000 units = P90,000

Requirement 2

Other nonfinancial and qualitative factors that Francisco should consider in

deciding whether it should implement a JIT system include:

a. The possibility of developing and implementing a detailed system for

integrating the sequential operations of the manufacturing process.
Direct materials must arrive when needed for each subassembly so
that the production process functions smoothly.
b. The ability to design products that use standardized parts and reduce
manufacturing time.
c. The ease of obtaining reliable vendors who can deliver quality direct
materials on time with minimum lead time.
d. Willingness of suppliers to deliver smaller and more frequent orders.
e. The confidence of being able to deliver quality products on time.
Failure to do so would result in customer dissatisfaction.
f. The skill levels of workers to perform multiple tasks such as minor
repairs, maintenance, quality testing and inspection.

Problem 4 (JIT Purchasing, Relevant Benefits, Relevant Costs)

Requirement 1
Incremental
Costs under Incremental
Current Costs under JIT
Purchasing Purchasing
System Policy

27-15
Chapter 27 Managing Accounting in a Changing Environment

Required return on investment

20% per year x P600,000 of
average inventory per year P120,000
20% per year x P0 of inventory
per year P 0
Annual insurance costs 14,000 0
Warehouse rent 60,000 (13,500)a

Overtime costs
No overtime 0
Overtime premium 40,000
Stockout costs
No stockouts 0
P6.50b contribution margin per
unit x 20,000 units 130,000
Total incremental costs P194,000 P156,500
Difference in favor of JIT purchasing
P37,500
a
P(13,500) = Warehouse rental revenues, [(75% x 12,000) x P1.50].
b
Calculation of unit contribution margin
Selling price (P10,800,000  900,000 units) P12.00
Variable costs per unit:
Variable manufacturing costs per unit
(P4,050,000  900,000 units) P4.50
Variable marketing and distribution
costs per unit
(P900,000  900,000 units) 1.00
Total variable costs per unit 5.50
Contribution margin per unit P6.50

Note that the incremental costs of P40,000 for overtime premiums to make the
additional 15,000 units are less than the contribution margin from losing these
sales equal to P97,500 (P6.50 x 15,000). Josefina would rather incur
overtime than lose 15,000 units of sales.

Problem 5 (Theory of Constraints, Throughput Contribution, Relevant

Costs)

Requirement 1

27-16
 Managing Accounting in a Changing Environment Chapter 27

Finishing is a bottleneck operation. Hence, producing 1,000 more units will

generate additional throughput contribution and operating income.

Increase in throughput contribution (P72 – P32) x 1,000 P40,000

Incremental costs of the jigs and tools 30,000
Net benefit of investing in jigs and tools P10,000

Zashi should invest in the modern jigs and tools because the benefit of higher
throughput contribution of P40,000 exceeds the cost of P30,000.

Requirement 2

The Machining Department has excess capacity and is not a bottleneck

operation. Increasing its capacity further will not increase throughput
contribution. There is, therefore, no benefit from spending P5,000 to increase
the Machining Department’s capacity by 10,000 units. Zashi should not
implement the change to do setups faster.

Problem 6 (Theory of Constraints, Throughput Contribution, Relevant

Costs)

Requirement 1

Finishing is a bottleneck operation. Hence, getting an outside contractor to

produce 12,000 units will increase throughput contribution.

Increase in throughput contribution (P72 – P32) x 12,000 P480,000

Incremental contracting costs P10 x 12,000 120,000
Net benefit of contracting 12,000 units of finishing P360,000

Zashi should contract with an outside contractor to do 12,000 units of

finishing at P10 per unit because the benefit of higher throughput contribution
of P480,000 exceeds the cost of P120,000. The fact that the costs of P10 are
double Zashi’s finishing cost of P5 per unit are irrelevant.

Requirement 2

Operating costs in the Machining Department of P640,00, or P8 per unit, are

fixed costs. Zashi will not save any of these costs by subcontracting
machining of 4,000 units to Rainee Corporation. Total costs will be greater
by P16,000 (P4 per unit x 4,000 units) under the subcontracting alternative.
Machining more filing cabinets will not increase throughput contribution,
which is constrained by the finishing capacity. Zashi should not accept
27-17
Chapter 27 Managing Accounting in a Changing Environment

Rainee’s offer. The fact that Rainee’s costs of machining per unit are half of
what it costs Zashi in-house is irrelevant.

Problem 7 (Theory of Constraints, Throughput Contribution, Quality)

Requirement 1

Cost of defective unit at machining operation which is not a bottleneck

operation is the loss in direct materials (variable costs) of P32 per unit.
Producing 2,000 units of defectives does not result in loss of throughput
contribution. Despite the defective production, machining can produce and
transfer 80,000 units to finishing. Therefore, cost of 2,000 defective units at
the machining operation is P32 x 2,000 = P64,000.

Requirement 2

A defective unit produced at the bottleneck finishing operation costs Zashi

materials costs plus the opportunity cost of lost throughput contribution.
Bottleneck capacity not wasted in producing defective units could be used to
generate additional sales and throughput contribution. Cost of 2,000 defective
units at the finishing operation is:

Lost of direct materials P32 x 2,000 P 64,000

Forgone throughput contribution (P72 – P32) x 2,000 80,000
Total cost of 2,000 defective units P144,000

Alternatively, the cost of 2,000 defective units at the finishing operation can be
calculated as the lost revenue of P72 x 2,000 = P144,000. This line of
reasoning takes the position that direct materials costs of P32 x 2,000 =
P64,000 and all fixed operating costs in the machining and finishing
operations would be incurred anyway whether a defective or good unit is
produced. The cost of producing a defective unit is the revenue lost of
P144,000.

27-18
 Managing Accounting in a Changing Environment Chapter 27

Problem 8

Requirement (a)

The following table reclassified the cost-of-quality expenses:

Anthony Foods
Quality Costs
2005-2006
(Millions)

2005 2006
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Quality assurance
administration P 6.20 P 6.52 P 6.86 P 7.19 P 7.93 P 8.74 P 9.61 P10.53
Training 13.10 14.39 15.90 17.46 21.12 25.50 30.37 36.35
Process
engineering 2.20 2.46 2.76 3.11 3.87 4.86 6.13 7.58
Prevention 21.50 23.37 25.52 27.76 32.92 39.10 46.11 54.46
Inspection 1.40 1.56 1.75 1.95 2.39 2.96 3.63 4.46
Testing 1.60 1.72 1.85 1.99 2.29 2.62 3.01 3.45
Appraisal 3.00 3.28 3.60 3.94 4.68 5.58 6.64 7.91
Rework 15.80 12.65 10.03 8.49 7.25 6.16 5.56 5.00
Scrap 17.60 14.48 11.92 10.32 8.92 7.72 7.00 6.34
Internal failure 33.40 27.13 21.95 18.81 16.17 13.88 12.56 11.34
Returns 26.90 21.09 16.35 13.53 11.32 9.50 8.43 7.52
Customer
complaint dept. 3.90 3.45 3.03 2.76 2.50 2.27 2.14 2.01
Lost sales 49.20 40.31 33.11 28.42 24.45 21.08 19.20 17.44
External failure 80.00 64.85 52.49 44.71 38.27 32.85 29.77 26.97
Total costs P137.90 P118.63 P103.56 P95.22 P92.04 P91.41 P95.08 P100.68

Requirement (b)

From the preceding data we see that prevention and appraisal costs are
increasing while internal and external failure costs have been decreasing. The
following graph plots three series: prevention and appraisal costs, failure
costs, and total quality costs.

27-19
Chapter 27 Managing Accounting in a Changing Environment

140

120

100
80

60

40

20
0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2005 Quarters 2006

Appraisal and prevention costs
Failure costs
Total quality costs

A preliminary conclusion from the graph is that Anthony Foods is probably

now spending too much on trying to improve quality. Assuming that the
underlying production processes have not changed over time, quality costs
were minimized in the second quarter of 2006. Since then, the additional
money spent on appraisal and prevention has yielded smaller internal- and
external-failure costs savings.

Problem 9 (Applying TQM in Manufacturing versus Administration)

The ability of TQM to deliver cost savings and performance enhancements

depends directly on how easy it is to measure and observe the output of the
process. If a TQM team’s output is easy to measure, it is easier to hold the
team members responsible for improving quality. If quality improvements are
difficult to observe, then holding team members responsible imposes more risk
on them. It is easier for them to argue that they didn’t achieve their goals
because they were hard to observe. If the benefits from TQM are lower
because it is more difficult to observe the TQM output, less will be invested in
such activities.

Measuring quality improvements in a manufactured process tends to be easier

than a service. Engineering standards can be set for a manufactured good and

27-20
 Managing Accounting in a Changing Environment Chapter 27

conformance to the standards can be relatively easy to measure. But the

output of many administrative departments is multidimensional and often hard
to observe. Manufacturing involves repetitive processes with few exceptions.
Administrative functions often involve handling numerous exceptions. It is
likely to be easier to observe quality improvements in a television set than it is
in a human resources department or a legal department.

IV. Multiple Choice Questions

1. C 11. C
2. B 12. A
3. C 13. C
4. D 14. B
5. D 15. C
6. A 16. D
7. C 17. D
8. C 18. D
9. D 19. A
10. D 20. A

27-21