Chapter 13, Problem 63C

Luna Company is a printing company and a subsidiary of a large publishing company. Luna is in its fourth year of a 5-year, quality improvement program. The program began in 20X1 as a result of a report by a consulting firm that revealed that quality costs were about 20% of sales. Concerned about the level of quality costs, Luna’s top management began a 5-year plan in 20X1 with the objective of lowering quality costs to 10% of sales by the end of 20X5. Sales and quality costs for each year are as follows:

Quality costs by category are expressed as a percentage of sales as follows:

The detail of the 20X5 budget for quality costs is also provided.

Actual quality costs for 20X4 and 20X5 are as follows:

Required:

1. 1. Prepare an interim quality cost performance report for 20X5 that compares actual quality costs with budgeted quality costs. Comment on the firm’s ability to achieve its quality goals for the year.
2. 2. Prepare a single-period quality performance report for 20X5 that compares the actual quality costs of 20X4 with the actual costs of 20X5. How much did profits change because of improved quality?
3. 3. Prepare a graph that shows the trend in total quality costs as a percentage of sales since the inception of the quality improvement program.
4. 4. Prepare a graph that shows the trend for all four quality cost categories for 20X1 through 20X5. How does this graph help management know that the reduction in total quality costs is attributable to quality improvements?
5. 5. Assume that the company is preparing a second 5-year plan to reduce quality costs to 2.5% of sales. Prepare a long-range quality cost performance report that compares the costs for 20X5 with those planned for the end of the second 5-year period. Assume sales of $45 million at the end of 5 years. The final planned relative distribution of quality costs is as follows: proofreading, 50%; other inspection, 13%; quality training, 30%; and quality reporting, 7%. Assume that all prevention costs are fixed and all other costs are variable (with respect to sales).

To determine

Present interim quality cost performance report.

Explanation of Solution

Quality Cost:

Organizations are required to bear costs due to non-conformity of goods or services with the general specifications. These costs are termed as quality costs. Quality costs can be categorized into preventive costs, detective costs, internal failure costs and external failure costs.

Quality cost performance report:

Particulars	Budgeted ($)	Actual ($)	Variance ($)
Prevention
Quality planning	450,000	450,000	0
Quality training	180,000	160,000	20,000
Special project	430,000	390,000	40,000
Quality reporting	260,000	260,000	0
Total prevention costs(A)	1,320,000	1,260,000	60,000
Appraisal
Proofreading	860,000	800,000	60,000
Other inspection	480,000	460,000	20,000
Total appraisal costs (B)	1,340,000	1,260,000	80,000
Internal Failure
Correction of typos	375,000	350,000	25,000
Plate revisions	125,000	100,000	25,000
Press downtime	221,000	200,000	21,000
Waste	125,000	70,000	55,000
Total internal failure costs (C)	846,000	720,000	126,000
External Failure
Returns/allowances	450,000	400,000	50,000
Lost sales	235,000	200,000	35,000
Rework	195,000	120,000	75,000
Total external failure costs (D)	880,000	720,000	160,000
Total quality cost $\left(\text{A}+\text{B}+\text{C}+\text{D}\right)$	4,386,000	3,960,000	426,000

Table (1)

Total sales in the Year 20X5 are $36,000,000 and quality costs are $3,960,000 which is 11% $\left(\frac{\$3,960,000}{\$36,000,000}\times 100\right)$ of sales. Company wanted to achieve quality costs to be 10% of sales. Further, company has achieved a favorable variance of $426,000 which indicates that company’s actual costs were lower than expected costs for the year.

Therefore, the company has been able to achieve quality goals for the year.

To determine

Compare actual costs of the year 20X4 with the costs of 20X5

Explanation of Solution

Quality cost performance report:

Particulars	Actual ($) 20X4	Actual ($) 20X5	Variance ($)
Prevention
Quality planning	440,000	450,000	$\left(10,000\right)$
Quality training	250,000	160,000	90,000
Special project	150,000	390,000	$\left(240,000\right)$
Quality reporting	240,000	260,000	$\left(20,000\right)$
Total prevention costs(A)	1,080,000	1,260,000	$\left(180,000\right)$
Appraisal
Proofreading	860,000	800,000	60,000
Other inspection	580,000	460,000	120,000
Total appraisal costs (B)	1,440,000	1,260,000	180,000
Internal Failure
Correction of typos	200,000	350,000	$\left(150,000\right)$
Plate revisions	380,000	100,000	280,000
Press downtime	260,000	200,000	60,000
Waste	120,000	70,000	50,000
Total internal failure costs (C)	960,000	720,000	240,000
External Failure
Returns/allowances	620,000	400,000	220,000
Lost sales	330,000	200,000	130,000
Rework	310,000	120,000	190,000
Total external failure costs (D)	1,260,000	720,000	540,000
Total quality cost $\left(\text{A}+\text{B}+\text{C}+\text{D}\right)$	4,740,000	3,960,000	780,000

Table (2)

Profit has been increased by $780,000 due to improved quality and reduction of quality.

To determine

Prepare trend graph for total quality costs.

Explanation of Solution

Trend graph for total quality costs.

Fig (1)

To determine

Prepare trend graph for the category wise quality costs.

Explanation of Solution

Prepare trend graph for category wise quality costs.

Fig (2)

Analysis of the graph:

• This graph depicts progress in quality costs.
• Prevention and detections costs have increased; whereas, failure costs have decreased, which shows a positive balance of cost incurred amongst the four categories.
• External failure costs have decreased from 10% to around 2% which is a significant progress. Similarly, internal failure costs have decreased from around 7% to 2%.
• Since, failure costs are reduced, this indicates that customers are satisfied with the product and costs like loss of sales and repairs due to poor quality have been reduced. Therefore, it can be concluded that, quality of the products have been improved.

To determine

Prepare performance report by comparing actual costs of year 20X5 with costs planned in the next five years.

Explanation of Solution

Quality cost performance report:

Particulars	20X5 ($) (A)	Percentage ($) (B)	Budgeted ($)$\left(\text{A}\times \text{B}\right)$ (C)	Variance ($)$\left(\text{A}-\text{C}\right)$
Prevention;
Quality planning	450,000	100%	450,000	0
Quality training	160,000	30%	48,000	112,000
Special project	390,000	100%	390,000	0
Quality reporting	260,000	7%	18,200	241,800
Total prevention costs(A)	1,260,000		906,200	353,800
Appraisal:
Proofreading	800,000	50%	400,000	400,000
Other inspection	460,000	13%	59,800	400,200
Total appraisal costs (B)	1,260,000		459,800	800,200
Internal Failure:
Correction of typos	350,000	125%	437,500	$\left(87,500\right)$
Plate revisions	100,000	125%	125,000	$\left(25,000\right)$
Press downtime	200,000	125%	250,000	$\left(50,000\right)$
Waste	70,000	125%	87,500	$\left(17,500\right)$
Total internal failure costs (C)	720,000		900,000	$\left(180,000\right)$
External Failure:
Returns/allowances	400,000	125%	500,000	$\left(100,000\right)$
Lost sales	200,000	125%	250,000	$\left(50,000\right)$
Rework	120,000	125%	150,000	$\left(30,000\right)$
Total external failure costs (D)	720,000		900,000	$\left(180,000\right)$
Total quality cost $\left(\text{A}+\text{B}+\text{C}+\text{D}\right)$	3,960,000		3,166,000	794,000

Table (3)

Total quality cost of $3,166,000 is 7.03% of expected sales of $45,000,000$\left(\frac{\$3,166,000}{\$45,000,000}\times 100\right)$. Total quality costs have not been reduced to 2.5% of sales however it has been reduced from 11% to 7.03%, which is significant.

Working Notes:

Sales, for the next period is expected to be $45,000,000 which is 125% of the actual sales of 20X5 of $36,000,000.