In simple terms, the cost of quality defines the expenses that a company has to incur to ensure that the products produced or the services provided adhere to the quality standards.
Cost of quality provides the necessary information required by the management to evaluate their internal operations and the effectiveness of their quality assurance systems. In financial reporting, cost of quality falls under the ambit of cost of quality, and the companies can often hire a Certified Management Accountant (CMA) to assess these expenses to augment strategic policies of pricing, outsourcing and improvement of processes.
Need for Implementing Cost of Quality
The primary reason for applying the techniques of cost of quality is the aim to achieve two goals at the same time. Those are one, maximising the quality of the product, and two, reducing the expenses or the cost to a minimum. Once a company can effectively use ‘cost of quality’ methods, it can keep track of the resources needed to evaluate the ‘Cost of Good Quality’ and the ‘Cost of Bad Quality’. Once it possesses this vital information, the company can now accurately determine where to invest its resources to upgrade product quality.
Steps to Measure Cost of Quality
The procedure for measuring the cost of quality is unique for every company. In most cases, the companies calculate the total warranty expenses as a percentage of the transactions. However, this is an external method of assessing the cost of quality and it is imperative to assess all kinds of quality costs more holistically so that one can outline all the necessary expenses in financial reporting.
One can divide the cost of quality into four categories: Prevention Costs, Appraisal Costs, Internal Failure Costs, and External Failure Costs. The specific cost then needs to be applied to the equation of cost of quality, that is, the added result of the ‘Cost of Good Quality’ and the ‘Cost of Bad Quality’. Then, the expanded equation turns out to be as follows:
- Cost of Good Quality = Cost of Appraisal + Cost of Prevention
- Cost of Poor Quality = Cost of Internal Failure Cost of External Failure
Then, Cost of Quality = (Cost of Appraisal + Cost of Prevention)+ Cost of Internal Failure Cost of External Failure
Cost of Good Quality and Cost of Bad Quality: what are the differences?
The ‘Cost of Good Quality’ comprises the entire expense related to quality compliance, which includes expenses on both appraisal and prevention. On the other hand, the cost of ‘Poor Quality’ involves costs not involving quality adherence, which are internal as well as external to the operations of the organisation.
Types of Cost of Quality
Such kinds of costs of quality are incurred when the company carries out inspections, performs checks, and monitors measurements so that the requirements of the quality standards are fulfilled. These expenses are related to the assessment that the product suppliers and the consumers make of the purchased resources, procedures, end products, and services.
Some instances where appraisal costs are incurred are:
- Verification: Quality inspection of incoming raw material as well as finished goods, the equipment needed for processing as well as the final material against the notifications that have been agreed upon.
- Quality audit: This is done to ensure the smooth operations of the quality system.
- Ratings and assessments provided by the supplier: The supplier assesses and then approves the products and services to be provided.
- Documentation of the procedures of inspection, tests and the salaries of the employees.
As the name indicates, prevention costs are incurred by the company to avoid the risk of defects or any other problems in quality. A typical risk management move, prevention cost typically involves designing, executing and regularly maintaining the quality management system. The following expenses fall under the ambit of prevention costs:
- Requirements of the products or the services provided: laying down specific rules and regulations for the incoming supply of raw materials, finished goods and services
- Quality planning: Establishment of a system for quality management, planning and reliability, operations, and assessment.
- Analysing the quality of the audit and the structure of the programme devised for quality control and improvement
- Training the employees for awareness about quality, preparing and maintaining programmes
Internal Failure Costs
If a product or service does not align with the quality standards, that is, if defects are found, then the company has to rectify the defects before sending the commodity to the customer. The following kinds of expenses are labelled as internal failure costs:
- Waste: extra, irrelevant labour or holding stocks as a result of some error, organisational miscommunication or poor management.
- Scrap: Defective material which cannot be put to any use.
- Expenses incurred while processing and performing the tests again
- Malfunctioning of machines due to lack of proper maintenance and faulty designing processes.
External Failure Costs
If internal failure costs of quality are related to defects discovered before supplying the product/service to the customer, then external failure costs are the ones detected after delivery. Usually, these defects are noticed by the customer and then notified to the supplier or the producer.
External failure costs typically include:
- Repairing and servicing charges: These charges are applicable for products which have been returned as well as the goods actively in use.
- Claims of warranty: Replacement of damaged goods or re-tendering of services
- Complaints by customers and returning of products, and the work and expenses associated with handling the customer’s requests.
- Handling and inspecting rejected or returned products, and the associated transportation charges.
- Rectifying inaccurate sales orders and faulty bills of materials (BOMS)
In today’s world, the cost of quality forms a major part of the accounting and financial strategies of an organisation, as well as risk management, hence they are always on the lookout for personnel who can efficiently perform this responsibility. If you are interested in this sector, then the profile of a Certified Management Accountant is the right fit for you. Sign up for the US CMA Course offered by Imarticus and learn all the top trade secrets of management accounting, not to mention, comprehensive coaching for the US CMA exam.
Companies are increasingly realising the need for a proactive approach to managing the cost of quality to maintain brand reputation. Help your company create a loyal consumer base by mastering the techniques of Certified Management Accounting and cracking the US CMA exam with a foundational US CMA Course.