The role of quality in performance measurement p5

Assumed knowledge


Quality was covered briefly in PM.   13 builds on this knowledge and adds to it.


2      Introduction


In today’s competitive global business environment, quality is one of the key ways in which a business can differentiate its product or service, improve performance and gain competitive advantage. Quality can form a key part of a strategy.


Quality can be defined in a number of ways:


  • Is the product/service free from errors and does it adhere to design specifications?


  • Is the product/service fit for use?


  • Does the product/service meet customers’ needs?


Test your understanding 1






Explain the reasons why quality may be important to an organisation?


Other important definitions




Quality management involves planning and controlling activities to ensure the product or service is fit for purpose, meets design specifications and meets the needs of customers. Quality management should lead to improvements in performance.


Quality control involves a number of routine steps which measure and control the quality of the product/service as it is developed.


Quality assurance involves a review of the quality control procedures, usually by an independent third party, such as ISO. It aims to verify that the desired level of quality has been met.



Quality certification




The International Organisation for Standardisation (ISO) is one of the major bodies responsible for producing quality standards that can be applied to a variety of organisations.


The ISO 9000 quality standards have been adopted by many organisations. An ISO 9000 registered company must:


  • submit its quality procedures for external inspection


  • keep adequate records


  • check outputs for differences


  • facilitate continuous improvement.


A certified company will be subject to continuous audit.


There are a number of advantages and disadvantages for a company of becoming ISO certified:




  • Recognised standard – the company’s reputation for quality will be enhanced since ISO is a recognised international standard of quality.


  • Marketing – ISO certification will act as an excellent marketing tool. It will help to differentiate the company, on the grounds of quality, in the customers’ eyes.


  • Improved profitability – fulfilment of the ISO criteria should help the company to improve quality. This, in turn, should reduce costs and improve quality.


  • International competitiveness – ISO certification is becoming increasingly useful in international markets and may help the company to compete on a world stage.




  • Cost – fees are upward of $1,500 depending on the size of the company.


  • Time – documentation can be time consuming to produce.


  • Bureaucracy – the scheme encourages bureaucracy with lots of form filling and filing rather than positive actions.


  • Rigid policies – these might discourage initiative and innovation and may therefore hinder the quality process.


  • Not all embracing – ISO certification will form a small part of a quality practice such as TQM.


3      Quality-related costs


  • Monitoring the costs of quality is central to the operation of any quality improvement programme.


  • KPIs should be developed based on the costs of quality and these can be used as a basis for staff rewards.

  • The organisation’s costing system should be capable of identifying and collecting these costs. This will lead to a greater management focus on quality since ‘what gets measured gets done’.


Test your understanding 2






Provide an example for each of the four sub-categories of quality cost.




Test your understanding 3




The following information has been supplied for Company X.
Revenue 320,000
Design engineering 5,000
Warranty 8,950
Estimated lost contribution from public knowledge of poor 9,561
Training 560
Process engineering 3,450
Rework 7,545
Customer support per repaired unit 645
Product testing 65
Transportation costs per repaired unit 546
Inspection 13,800




Prepare a cost analysis that shows the prevention, appraisal, internal failure and external failure costs for Company X. Your statement should show each cost heading as a % of turnover and clearly show the total cost of quality (including any opportunity costs).


4         Quality management systems


4.1 What is a quality management system?


A quality management system (QMS) is a set of co-ordinated activities to direct and control an organisation in order to continually improve its performance.


The total cost of conformance is the cost of operating a QMS. The more rigorous the QMS, the lower the costs of non-conformance will be.


4.2 Implementing a QMS


Delivering products which meet the desired level of quality will only occur if all the factors that have an impact on quality are managed effectively.


A QMS should pervade the whole organisation recognising the quality impact of all areas of the organisation. There are a number of ways of implementing a QMS. For example, ISO 9001:2005 recommends that the design should be based on 8 principles:

Test your understanding 4






Explain how the 8 principles of ISO 9001:2005 should result in quality improvements.


4.3 Impact of a QMS on performance management


The adoption of a QMS should complement an organisation’s strategy and help it in achieving its quality objectives. An effective QMS should:


  • minimise the overall costs of quality


  • improve customer satisfaction due to higher levels of quality


  • improve staff morale and productivity due to the involvement and pride taken in the work done.

1 Kaizen Costing


What is Kaizen?


Kaizen is a Japanese term for the philosophy of continuous improvement in performance via small, incremental steps.




  • Kaizen involves setting standards and then continually improving these standards to achieve long-term sustainable improvements.


  • The focus is on eliminating waste, improving processes and systems and improving productivity.


  • Involves all areas of the business.


  • Employees often work in teams and are empowered to make changes. Rather than viewing employees as the source of high costs, Kaizen views the employees as a source of ideas on how to reduce costs. A change of culture will be required, encouraging employees to suggest ideas (perhaps using quality circles) to reduce costs.


  • Allows the organisation to respond quickly to changes in the competitive environment.


Illustration 1 – Kaizen




Many Japanese companies have introduced a Kaizen approach:


  • In companies such as Toyota and Canon, a total of 60–70 suggestions per employee are written down and shared every year.


  • It is not unusual for over 90% of those suggestions to be implemented.



Illustration 2 – British cycling




British cycling’s revolution through small, incremental improvements


When Sir David Brailsford became performance director of British cycling, he believed that if it were possible to make a 1 % improvement in a whole host of areas, the cumulative gains would end up being hugely significant. He was on the look-out for all the weaknesses in the team’s assumptions and saw these as opportunities to adapt and make marginal gains. For example:


  • By experimenting in a wind tunnel he noted that the bike was not sufficiently aerodynamic. Then by analysing the mechanics area in the team truck, he discovered that dust was accumulating on the floor, undermining bike maintenance. So he had the floor painted pristine white, in order to spot any impurities.


  • The team started using antibacterial hand gel to cut down on any infections.


  • The team bus was redesigned to improve comfort and recuperation.


Many critiqued the approach and saw David Brailsford as laughing stock. However, the last two Olympics have seen the team win an unprecedented host of gold medals and, never having previously secured a win in over 100 years, British riders have won the Tour de France a number of times since 2012.



Continuous improvement explained




Continuous improvement is the continual examination and improvement of existing processes and is very different from approaches such as business process re-engineering (BPR), which seeks to make radical one-off changes to improve an organisation’s operations and processes. The concepts underlying continuous improvement are:


  • The organisation should always seek perfection. Since perfection is never achieved, there must always be scope for improving on the current methods.


  • The search for perfection should be ingrained into the culture and mind-set of all employees. Improvements should be sought all the time.


  • Individual improvements identified by the work force will be small rather than far-reaching.


What is Kaizen costing?


Kaizen costing focuses on producing small, incremental cost reductions throughout the production process through the product’s life.


The steps in Kaizen costing are as follows:

One of the main ways to reduce costs is through the elimination of waste.


Impact of Kaizen on traditional management accounting techniques


There is a marked distinction between a traditional standard costing system and a modern Kaizen costing approach.


  • A traditional standard costing system would not be suitable in a Kaizen environment. Workers who are used to a command and control structure will have to change their behaviour and speak out about possible improvements.


  • Standard costs will have much less value as they are fixed over a relevant period where as Kaizen costing can respond more easily in a dynamic environment.


  • Standard costing is used to control costs whereas Kaizen costing has the advantage of focusing on cost reductions.


  • In a standard costing system, employees are often seen as the source of problems where as in a Kaizen system, employees often work in teams and are empowered to make changes.



Target costing


Target costing involves setting a target cost by subtracting a desired profit from a competitive market price.


It is the opposite of conventional cost-plus pricing which arrives at a selling price by adding the standard cost to the desired profit.



Test your understanding 5






What are the disadvantages of cost-plus pricing for an organisation?


The steps in target costing are as follows:


  • A competitive market price is set based on what customers are willing to pay and how much competitors are charging for similar products.


  • The desired profit margin is deducted from this price to arrive at a target cost.


  • The difference between the estimated cost for the product and the target cost is the cost gap.


  • Techniques are used to close the gap, for example:


  • Can any materials be eliminated or can a cheaper material be substituted without affecting quality?


  • Can productivity be improved, for example by providing additional training?


  • Can a cheaper source of labour be used, for example lower skilled labour, without compromising quality?


  • Can the layout of the factory be redesigned, for example by reorganising production into teams and ensuring all production is done at a single site?


  • Can a move to a just-in-time production system be considered?


  • Can the incidence of cost drivers be reduced?


  • Can production volumes be increased to improve economies of scale?


Many of these techniques will be employed at the design stage.


Attention should be focused on reducing the cost of features perceived by the customer not to add value; this is called value analysis.


Note: Target costing can also be applied to the service sector.



Key features of target costing




  • Target costing forces a focus on the customer: Product decisions and cost analysis have to take account of customer requirements such as quality, features and price. This is not always the case with other cost management methods.


  • Successful target costing considers all costs related to production and distribution of the products and involves the whole supply chain. This may even include joint working between suppliers and manufacturers to share information and enable cost reductions, particularly for products for which raw materials contribute a high proportion of the manufactured cost.


  • Target costing considers the entire life-cycle of the product, so that total costs to the manufacturer are minimised.


  • Target costing begins very early in the development phase of new products, so that changes are made before production begins. Decisions made at this stage generally determine a high proportion of the costs of any product.


  • Target costing is a multi-disciplinary approach which involves staff from all functions in the analysis and decision making.


  • Target costing is an iterative process in which teams are making judgements and trade-offs between product features, price, sales volumes, costs and investment requirements.


  • Target costing provides cost targets for individual inputs and processes which can be used for performance monitoring.



Target costing question






Edward Electronics assembles and sells many types of radio. It is considering extending its product range to include digital radios. These radios produce a better sound quality than traditional radios and have a large number of potential additional features not possible with the previous technologies (station scanning, more choice, one touch tuning, station identification text and song identification text etc).


A radio is produced by assembly workers assembling a variety of components. Production overheads are currently absorbed into product costs on an assembly labour hour basis.


Edward Electronics is considering a target costing approach for its new digital radio product.




  • Briefly describe the target costing process that Edward Electronics should undertake.


(3 marks)


  • Explain the benefits to Edward Electronics of adopting a target costing approach at such an early stage in the product development process.


(4 marks)


A selling price of $44 has been set in order to compete with a similar radio on the market that has comparable features to Edward Electronics’ intended product. The board have agreed that the acceptable margin (after allowing for all production costs) should be 20%.


Cost information for the new radio is as follows:


Component 1 (Circuit board) – these are bought in and cost $4.10 each. They are bought in batches of 4,000 and additional delivery costs are $2,400 per batch.


Component 2 (Wiring) – in an ideal situation 25 cm of wiring is needed for each completed radio. However, there is some waste involved in the process as wire is occasionally cut to the wrong length or is damaged in the assembly process. Edward Electronics estimates that 2% of the purchased wire is lost in the assembly process. Wire costs $0.50 per metre to buy.


Other material – other materials cost $8.10 per radio.


Assembly labour – these are skilled people who are difficult to recruit and retain. Edward Electronics has more staff of this type than needed but is prepared to carry this extra cost in return for the security it gives the business. It takes 30 minutes to assemble a radio and the assembly workers are paid $12.60 per hour. It is estimated that 10% of hours paid to the assembly workers is for idle time.


Production Overheads – recent historic cost analysis has revealed the following production overhead data:


Total production Total assembly labour
overhead ($) hours
Month 1 620,000 19,000
Month 2 700,000 23,000


Fixed production overheads are absorbed on an assembly hour basis based on normal annual activity levels. In a typical year 240,000 assembly hours will be worked by Edward Electronics.




  • Calculate the expected cost per unit for the radio and identify any cost gap that might exist.


(13 marks)


(Total: 20 marks)





  • The target costing process should be undertaken as follows: Step 1: Establish the selling price by considering how much customers will be willing to pay and how much competitors charge for similar products.


Step 2: Deduct the required profit from the selling price.


Step 3: Calculate the target cost, i.e. selling price minus profit.


Step 4: Find ways to reduce the cost gap, e.g. cheaper materials, cheaper labour, increased productivity or reduced waste.


  • The benefits are as follows:


– Target costing has an external focus, i.e. it considers how much customers will pay/ competitors will charge.


– Cost control can occur earlier in the design process and the required steps can be taken to reduce the cost gap.


– The performance of the business should be enhanced due to better management of costs.


– The focus will be on getting things right first time which should reduce the development time.


  • (W1) Production overhead (using high low method)


Production Labour hours
High 700,000 23,000
Low 620,000 19,000
Difference 80,000 4,000


  • Variable overhead = $80,000 ÷ 4,000 = $20 per hour


  • Total cost $700,000 = fixed cost + variable cost ($20/hour ×

23,000). This gives a monthly fixed cost of $240,000. (Note: the total cost at the low level of production could also be used to find the fixed cost).


  • Annual fixed cost = $240,000 × 12 = $2,880,000


  • Overhead absorption rate (OAR) = $2,880,000 ÷ 240,000 hours = $12 per hour




Cost card and cost gap calculation
$ per radio
Component 1 4.10
Component 1 delivery = $2,400 ÷ 4,000 0.60
Component 2 wiring = $0.50 × 0.25 metres × 100/98 0.128
Other material 8.10
Assembly labour = $12.60 × 0.5 hours × 100/90 7.00
Variable production overhead = $20/hour (W1) × 0.5
hours 10.00
Fixed production overhead = $12/hour (W1) × 0.5
hours 6.00


Total cost 35.928
Desired cost 35.20
Cost gap 0.728


Target costing and Kaizen costing


  • Target costing usually occurs at the beginning of a product’s life.


  • Kaizen costing uses the principles of target costing but it is the process of long-term continuous improvements by small, incremental cost reductions throughout the product’s life.


  • With Kaizen costing, any target cost that is established will be revised on a regular basis.


5.2 Total Quality Management


What is total quality management?


Total Quality Management (TQM) is a philosophy of quality management that originated in Japan in the 1950s.


Fundamental features of TQM:


  • Prevention of errors before they occur: The aim of TQM is to get thing’s right first time. This contrasts with the traditional approach that less than 100% quality is acceptable. TQM will result in an increase in prevention costs, e.g. quality design of systems and products, but internal and external failure costs will fall to a greater extent.


  • Continual improvement: Quality management is not a one-off process, but is the continuous examination and improvement of processes.


  • Real participation by all: The ‘total’ in TQM means that everyone in the value chain is involved in the process, including:


– Employees – they are expected to seek out, identify and correct quality problems. Teamwork will be vital.


–    Suppliers – quality and reliability of suppliers will play a vital role.


–    Customers – the goal is to identify and meet the needs of customers.


  • Management commitment: Managers must be committed and encourage everyone else to be quality conscious.


Illustration 3 – TQM success/failure




A TQM success story


Corning in one of the world’s leading innovators in materials science. This is partly due to the implementation of a TQM approach, the leadership stamp of the, then, CEO James Houghton. Houghton announced a $1.6 billion investment in TQM. After several years of intensive training and a decade of applying the TQM approach, all of Corning’s employees had bought into the quality concept. They knew the lingo – continuous improvement, empowerment, customer focus, management by prevention and they witnessed the impact of the firm’s techniques as profits soared.

An example of TQM failure


The communication and services company BT launched a total quality program in the late 1980s. This resulted in the company getting bogged down by quality processes and bureaucracy. The company failed to focus on its customers and later decided to dismantle its TQM programme. This was at great cost to the company and they have failed to make a full recovery.


Performance measures in a TQM environment


Measuring performance is a key part of a TQM programme. The cost of implementing TQM and measuring performance can often be offset by the costs saved through increased efficiency, improved product quality and higher levels of customer service.


Performance measures must be linked to the TQM programme’s CSFs, be widely understood, be based on correct data and data should be easy to collect.


Each organisation will develop its own way of measuring TQM performance but key areas to investigate may be:


  • Effectiveness, i.e. the extent to which goals are achieved. Examples include comparing actual and expected figures for:


– quality of product or service (may be gauged through customer feedback)


–    quantity of units sold


–    number of on time deliveries


–    speed of response, and


–    unit cost.


  • Efficiency will compare actual with planned use of resources such as labour, staff, equipment and materials.


  • Economy will compare the actual costs of TQM with the planned cost, e. cost of prevention, detection, internal failure and external failure.


5.3 Just-in-time


What is just-in-time?


Just-in-time (JIT) is a demand -pull system of ordering from suppliers which aims to reduce inventory levels to zero.


JIT applies to both production within an organisation and to purchasing from external suppliers.


JIT purchasing is a method of purchasing that involves ordering materials only when customers place an order. When the goods are received they go straight into production.


JIT production is a production system that is driven by demand for the finished products (a ‘pull’ system), whereby each component on a production line is produced only when needed for the next stage.


JIT is often used in conjunction with other continuous improvement methods.



Illustration 4 – Toyota




Toyota pioneered the JIT manufacturing system, in which suppliers send parts daily – or several times a day – and are notified electronically when the production line is running out.


More than 400 trucks a day come in and out of Toyota’s Georgetown plant in the USA, with a separate logistics company organising shipment from Toyota’s 300 suppliers – most located in neighbouring state within half a day’s drive of the plant.


Toyota aims to build long-term relationships with suppliers, many of whom it has a stake in, and says it now produces 80% of its parts within North America.


Requirements for successful operation of a JIT system


Requirements include:


  • High quality and reliability – disruptions cause hold ups in the entire system and must be avoided. The emphasis is on getting the work right first time:


– Highly skilled and well trained staff should be used. – Machinery must be fully maintained.


– Long-term links should be established with suppliers in order to ensure a reliable and high quality service and to minimise any stoppages in production.


  • Elimination of non-value added activities – for example, value is not added whilst storing the products and therefore inventory levels should be minimised.


  • Speed of throughput – the speed of production should match the rate at which customers demand the product. Production runs should be shorter with smaller stocks of finished goods.


  • Flexibility – a flexible production system and workforce is needed in order to be able to respond immediately to customers’ orders.


  • Lower costs – another objective of JIT is to reduce costs by: – Raising quality and eliminating waste.


–    Achieving faster throughput.


–    Minimising inventory levels.



Test your understanding 6






Explain the advantages and disadvantages to an organisation of operating a JIT system.



JIT and supplier relationships




A company is a long way towards JIT if its suppliers will guarantee the quality of the material they deliver and will give it shorter lead-times, deliver smaller quantities more often, guarantee a low reject rate and perform quality-assurance inspection at source. Frequent deliveries of small quantities of material to the company can ensure that each delivery is just enough to meet its immediate production schedule. This will keep its inventory as low as possible. Materials handling time will be saved because as there is no need to move the stock into a store, the goods can be delivered directly to a workstation on the shop floor. Inspection time and costs can be eliminated and the labour required for reworking defective material or returning goods to the supplier can be saved.


The successful JIT manufacturer deliberately sets out to cultivate good relationships with a small number of suppliers and these suppliers will often be situated close to the manufacturing plant. It is usual for a large manufacturer that does not use the JIT approach to have multiple suppliers. When a new part is to be produced, various suppliers will bid for the contract and the business will be given to the two or three most attractive bids.


A JIT manufacturer is looking for a single supplier that can provide high quality and reliable deliveries, rather than the lowest price. This supplier will often be located in close proximity to the manufacturing plant.


There is much to be gained by both the company and its suppliers from this mutual dependence. The supplier is guaranteed a demand for the products as the sole supplier and is able to plan to meet the customer’s production schedules. If an organisation has confidence that suppliers will deliver material of 100% quality, on time, so that there will be no rejects, returns and hence no consequent production delays, usage of materials can be matched with delivery of materials and stocks can be kept at near zero levels.


Jaguar, when it analysed the causes of customer complaints, compiled a list of 150 areas of faults. Some 60% of them turned out to be faulty components from suppliers. One month the company returned 22,000 components to different suppliers. Suppliers were brought on to the multi-disciplinary task forces the company established to tackle each of the common faults. The task force had the simple objective of finding the fault, establishing and testing a cure, and implementing it as fast as possible. Jaguar directors chaired the task forces of the 12 most serious faults, but in one case the task force was chaired by the supplier’s representative.


JIT and service operations


Although it originated with manufacturing systems, the JIT philosophy can also be applied to some service operations.


  • Whereas JIT in manufacturing seeks to eliminate inventories, JIT in service operations will seek to eliminate internal or external queues of customers.


  • Other concepts of JIT, such as eliminating wasteful motion and seeking ways of achieving continuous improvement are also applicable to services as much as to manufacturing activities.


The impact on management accounting


The introduction of a JIT system will have a number of effects on the costing system and performance management.


  • Allowances for waste, scrap and rework are moved to the ideal standard, rather than an achievable standard.


  • Costs are only allowed to accumulate when the product is finished.


  • The inevitable reduction in inventory levels will reduce the time taken to count inventory and the clerical cost.


  • Minimal inventory makes it easier for a firm to switch to backflush accounting (a simplified method of cost bookkeeping).


  • Traditional performance measures such as inventory turnover and individual incentives are replaced by more appropriate performance measures, such as:


–    total head count productivity


–    inventory days


–    ideas generated and implemented


–    customer complaints


–    bottlenecks in production


–    the amount and effectiveness of staff training.



Illustration 5 – JIT and management accounting control systems




Management accounting systems within a JIT environment must be capable of producing performance and control information consistent with a JIT philosophy. Information must therefore be produced that directs management attention to the following issues:


  • elimination of waste


  • reduction in set-up time


  • continuous improvement.


5.4 Six Sigma


  • Six Sigma is a quality management programme that was pioneered by Motorola in the 1980s.


  • The aim of the approach is to achieve a reduction in the number of faults that go beyond an accepted tolerance level. It tends to be used for individual processes.


  • The sigma stands for the standard deviation. For reasons that need not be explained here, it can be demonstrated that, if the error rate lies beyond the sixth sigma of probability there will be fewer than 3.4 defects in every one million units produced.


  • This is the tolerance level set. It is almost perfection since customers will have room to complain fewer than four times in a million.


Illustration 6 – The Six Sigma approach




A hospital is using the Six Sigma process to improve patient waiting times. An investigation of the views of patients has revealed that:


  • patients do not want to be called before their appointment time as they do not want to feel that they have to be at the hospital early to avoid missing an appointment


  • the maximum length of time they are prepared to wait after the appointment time is 30 minutes.

The aim of the Six Sigma programme will be to ensure that no more than 3. 4 waits in every million occurrences exceed 30 minutes or are less than 0 minutes.



Key requirements and criticisms




There are a number of key requirements for the implementation of Six




  • Six Sigma should be focused on the customer and based on the level of performance acceptable to the customer.


  • Six Sigma targets for a process should be related to the main drivers of performance.


  • To maximise savings Six Sigma needs to be part of a wider performance management programme which is linked to the strategy of the organisation. It should not be just about doing things better but about doing things differently.


  • Senior managers within the organisation have a key role in driving the process.


  • Training and education about the process throughout the organisation are essential for success.


  • Six Sigma sets a tight target, but accepts some failure – the target is not zero defects.


Literature on Six Sigma contains some criticisms of the process and identifies a number of limitations as follows.


  • Six Sigma has been criticised for its focus on current processes and reliance on data. It is suggested that this could become too rigid and limit process innovation.


  • Six Sigma is based on the use of models which are by their nature simplifications of real life. Judgement needs to be used in applying the models in the context of business objectives.


  • The approach can be very time consuming and expensive. Organisations need to be prepared to put time and effort into its implementation.


  • The culture of the organisation must be supportive – not all organisations are ready for such a scientific process.


  • The process is heavily data-driven. This can be a strength, but can become over-bureaucratic.


  • Six Sigma can give all parts of the organisation a common language for process improvement, but it is important to ensure that this does not become jargon but is expressed in terms specific to the organisation and its business.


  • There is an underlying assumption in Six Sigma that the existing business processes meet customers’ expectations. It does not ask whether it is the right process.




The five steps of the Six Sigma process (DMAIC)

How does Six Sigma improve the quality of performance?


Six Sigma improves quality in a number of ways:


  • An increased focus on the customer.


  • The identification of business process improvements as key to success.


  • Management decision making is driven by data and facts, for example the number of customer complaints as a key performance measure.


  • The proactive involvement of management and effective leadership to co-ordinate the different Six Sigma projects.


  • It involves collaboration across functional and divisional boundaries focusing the whole organisation on quality issues.


  • The increased profile of quality issues and the increased knowledge of quality management that comes from the use of different layers of trained experts.


Test your understanding 7






How can management accountants contribute to the Six Sigma process?




Additional question on quality






Explain how management accounting/management techniques such as total quality management, just in time, value analysis, activity based costing and the balanced scorecard could contribute towards the analysis of the relationship between costs and quality.




Total Quality Management (TQM)


TQM is an approach that seeks to ensure that all aspects of providing goods and services are delivered at the highest possible standard, and that standards keep improving. The underlying principle is that the cost of preventing deficient quality is less than the costs of correcting poor quality. This denies the idea that improved quality can only be secured with greater expenditure, but adopts the approach that improved quality will reduce costs.


Quality related costs are concerned with both achieving quality and failure to achieve quality.


Quality costs can categorised as:


  • Prevention costs – communicating the concept, training, establishing systems to deliver quality services


  • Appraisal costs – e.g. inspection and testing


  • Internal failure costs – wasted materials used in rejects, down time resulting from internal service quality failures, resources devoted to dealing with complaints


  • External failure costs – loss of goodwill and future business, compensation paid to customers and rectification costs.



The TQM view is that by getting it right first time and every time, the prevention and appraisal costs will be outweighed by the savings in failure costs, hence lower costs and improved quality are congruent goals. TQM requires everyone in the organisation to have identified customers, whether external or internal, so that a continuous service quality chain is maintained all the way through the organisation to the final customer.


Just In Time (JIT)


JIT is a manufacturing and supply chain process that is intended to reduce inventory levels and improve customer service by ensuring that customers receive their orders at the right time and in the right quantity. The system should facilitate a smooth workflow throughout the business and reduce waste. Goods are produced to meet customer needs directly, not for inventory.


Cost reductions should arise from:


  • Lower raw material and finished goods inventory levels, therefore reduced holding costs.


  • Reduced material handling.


  • Often a reduction in the number of suppliers and lower administration and communication costs.


  • Guaranteed quality of supplies reduces inspection and rectification costs.


Quality improvements should arise from:


  • Fewer or even single sourcing of supplies strengthens the buyer– supplier relationship and is likely to improve the quality.


  • The absence of customer stockholding compels the supplier (if they want continued business) to guarantee the quality of the material that they deliver.


  • The necessity to work regularly and closer with hauliers strengthens the relationship with them. The deliveries become high priority and more reliable.


  • Customers are not faced with the traditional problems of having to wait until their supplier’s inventories are replenished. The system is designed to respond to customers’ needs rapidly.


  • Direct focus on meeting an identified customer’s need, production is merely to add to an anonymous pile of inventory.


Value analysis


Value analysis is concerned with concentrating on activities that add value to the product/service as perceived by the customer. It examines business activities and questions why they are being undertaken and what contribution do they make to customer satisfaction. Value added activities include designing products, producing output and developing customer relationships. Non-value added activities include returning goods, inventory holding, and checking on the quality of supplies received. Wherever possible eliminate the non-value added activities.


Value analysis commences with a focus on customers. What do they want? What do they regard as significant in the buying decision: function, appearance, longevity or disposal value? This is concerned with identifying what customers regard as quality and then providing it: do not expend effort on what they regard as unimportant. It is about clarifying what the constituents of quality are on the Costs and Quality diagram. Having decided this there is a need to develop alternative designs, estimate costs and evaluate alternatives.


Activity Based Costing (ABC)


ABC is concerned with attributing/assigning costs to cost units on the basis of the service received from indirect activities e.g. public relations, recruitment, quality assurance general meetings. The organisation needs to identify cost drivers – the specific activities that cause costs to arise e.g. number of orders taken, telephone calls made, number of breakdowns or the number of visitors to an attraction.


ABC intends to avoid the arbitrary allocation of overheads to products/services by identifying a causal link between costs, activities and outputs. Because of higher degrees of automation, the increasing significance of overheads in the cost make up of output intensifies the need to improve the apportionment of them. Accountants can contribute towards providing better cost information to the value analysis referred to above. Product managers need to know what they are getting for their money – what is the real cost of quality? What are the cost driving activities that do not impact on quality? What activities that generate minimal costs have a significantly favourable impact on quality?


The Balanced Scorecard (Kaplan and Norton)


The Balanced Scorecard provides a framework for a business to achieve its strategic objectives include both financial and non-financial objectives. The approach claims that performance has four dimensions: financial, customer, internal business, and innovation and learning. The customer perspective asks: How does the business appear to the customers? The internal business perspective asks: What do we need to do to satisfy shareholders and customers, including the monitoring of unit costs? The innovation and learning perspective looks at how products and processes should be changed and improved.


The scorecard is concerned with monitoring and measuring the critical variables that comprise the customer and internal perspective. The choice of variables for inclusion in the scorecard is significant because the scorecard report is a design for action. Inappropriate indicators will trigger damaging responses. For example, the organisation needs to monitor what factors customers regard as contributing to improved quality, not what the business thinks it should provide. Therefore the scorecards would be suitable for inclusion as quantifiable indicators on the axis on the Costs and Quality diagram. The Balanced Scorecard attempts to improve the range and relationship between alternative performance measures, in the case under discussion, costs and quality.


6      Lean production


6.1 What is lean production?


Lean production is a philosophy of management based on cutting out waste and unnecessary activities including:


  • Over-production – produce more than customers have ordered.


  • Inventory – holding or purchasing unnecessary inventory.


  • Waiting – production delays/idle time when value is not added to the


  • Defective units – production of a part that is scrapped or requires rework.


  • Motion – actions of people/equipment that do not add value.


  • Transportation – poor planning or factory layout results in unnecessary transportation of materials/work-in-progress.


  • Over-processing – unnecessary steps that do not add value.


Lean production is closely related to quality practices such as Kaizen, JIT and TQM.


Comparison of Toyota (a lean pioneer) to a non-lean car manufacturer


Non-Lean manufacturer Lean pioneer – Toyota
Production Mass production requiring: Production smaller batches
• time to set up machinery leading to:
and • quick set up
• skilled engineers. • flexibility
• production line staff
trained to do set ups
• job for life
• defined career path
• empowered staff.




Human Cyclical nature of industry • Job for life
resources resulting in: • Defined career path
• staff layoffs
• Empowered staff
• unmotivated staff.
Employee • Assembly worker Eliminates non-value adding
roles • Foreman activities so all workers trained
on all aspects hence no indirect
• Housekeeper wages.
• Engineer
Production • Couldn’t stop the • Stops the production line
problems production line and then the team works
• 20–25% defects to solve issues quickly
• Zero defects
Suppliers Chosen on cost • Use supplier expertise
• Fair price
Sales • Sell through dealers • Sell direct to customers
• Narrow product range • Customer feedback
• Flexibility resulting in wide
product range



Test your understanding 8




Although the lean approach was developed in the manufacturing industry it can also be applied in the service sector.




Identify some possible sources of waste in a restaurant business and categorise them according to the seven main types of waste described above.


6.2 Application of lean to management information systems


A lean approach would aim to identify and eliminate waste in the MIS and improve the efficiency of the flow of information to users. The system should be simplified but also improved as a result.


A lean system aims to get the right thing to the right place at the right time, first time.


The MIS should:


  • only produce a report if it adds value


  • only produce a report for the people who need them


  • should produce information that is accurate, presented clearly and can be retrieved easily


  • be capable of real time information processing


  • eliminate waste, such as data duplication


  • be flexible enough to adapt to the changing needs of the organisation or to ad hoc requirements


  • be continually improved, for example regular user meetings should be held to discuss requirements.


The 5 S’s concept


The 5 S’s concept is often associated with lean principles and has the aim of creating a workplace which is in order. The 5 S’s are:


  • Structurise – introduce order where possible, for example by ensuring that items are arranged so that they are easy to find.


  • Systemise – arrange and identify items for ease of use and approach tasks systematically. For example, by arranging items so that they can be accurately picked in the shortest time.


  • Sanitise – be tidy, avoid clutter. This makes things easier to find, makes access more efficient and may improve safety.


  • Standardise – this involves finding the best way of undertaking a process or task and applying it consistently.


  • Self-discipline – this relates to sustaining the other S’s by motivating employees to do the above daily.


Student accountant article: visit the ACCA website,, to review the article on ‘Lean enterprises and lean information systems’.


7         Quality in management information systems


7.1 Features of a quality system

Test your understanding 9






Explain the consequences of failing to include these four features in a management information system.


7.2 Designing a quality system


Designing a quality system




In order to ensure that the system fulfils the quality criteria of functionality, reliability, usability and build quality a structured approach to development should be used. One such approach is the systems development life cycle (SDLC):

8 Exam focus
Exam sitting Area examined Question Number
number of marks
Sept/Dec 2017 Target costing, TQM, quality costs 1(iii)(iv) 25
Mar/Jun 2017 Target costing, Kaizen costing 2 25
Mar/Jun 2017 Lean including lean MIS and 5 S’s 3
Sept/Dec 2016 Quality costs, TQM, lean systems 1(iv)(v) 15
Sept/Dec 2015 Lean, JIT, Kaizen, quality costs 1(iii)(iv) 25
Sept/Dec 2015 Six Sigma – DMAIC 3(a) 15
December 2014 JIT 1(iv) 7
December 2013 Lean management and accountability 3(b)(c) 13
June 2012 Six Sigma 3 17
December 2011 Quality costs, Kaizen and JIT 5 20

Test your understanding 1




Higher quality can help to increase revenue and reduce costs:


  • Higher quality improves the perceived image of a product or service. As a result, more customers will be willing to purchase the product/service and may also be willing to pay a higher price.


  • A higher volume of sales may result in lower unit costs due to economies of scale.


  • Higher quality in manufacturing should result in lower waste and defective rates, which will reduce production costs.


  • The need for inspection and testing should be reduced, also reducing costs.


  • The level of customer complaints should fall and warranty claims should be lower. This will reduce costs.


  • Better quality in production should lead to shorter processing times. This will reduce costs.



Test your understanding 2




Prevention costs


  • Cost of designing products and services with built in quality.


  • Cost of training employees in the best way to do their job.


  • Cost of equipment testing to ensure it conforms to quality standards required.


Appraisal costs


  • Inspection and testing, for example of a purchased material or service.


Internal failure costs


  • Cost of scrapped material due to poor quality.


  • Cost of re-working parts.


  • Re-inspection costs.


  • Lower selling prices for sub-quality products.


External failure costs


  • Cost of recalling and correcting products.


  • Cost of lost goodwill.



Test your understanding 3
Prevention costs: $000 % of revenue
Design engineering 5,000 1.56
Process engineering 3,450 1.08
Training 560 0.18
Total 9,010 2.82
Appraisal costs:
Inspection 13,800 4.31
Product testing 65 0.02
Total 13,865 4.33
Internal failure costs 7,545 2.36
Total 7,545 2.36
External failure costs:
Warranty 8,950 2.80
Customer support 645 0.20
Transportation 546 0.17
Total 10,141 3.17
Sub-total 40,561 12.68
Opportunity costs 9,561 2.99
Total quality costs 50,112 15.66



Test your understanding 4




The 8 principles of ISO 9001:2005 should result in quality improvements as follows:


•        Customer focus – quality may be defined as ‘the product/service meeting the customer’s needs’ and therefore a customer focus should improve quality.


•        Leadership – leaders should communicate the importance of quality and drive a culture of quality.


•        Involvement of people – everyone in the organisation should have a quality focus.


•        Process approach – related activities and resources should be managed in an integrated quality process.


•        Systems approach to management – groups of related processes should be managed in an integrated quality system.


  • Continual improvement – quality management is not a one off process, but is the continuous examination and improvement of processes.


  • Factual approach to decision making – quality procedures should be documented and applied consistently.


  • Mutually beneficial supplier relationships – long-term links should be established with suppliers in order to ensure a reliable and high quality service.



Test your understanding 5




Cost-plus pricing ignores:


  • The price that customers will be willing to pay.


  • The price charged by competitors for similar products.


  • Cost control – this is not incentivised due to the use of a standard cost.



Test your understanding 6




Advantages of JIT


  • Lower stock holding costs means a reduction in storage space which saves rent and insurance costs.


  • As stock is only obtained when needed, less working capital is tied up in stock.


  • There is less likelihood of stock perishing, becoming obsolete or out of date.


  • Avoids the build-up of unsold finished products that occur with sudden changes in demand.


  • Less time is spent checking and re-working the products as the emphasis is on getting the work right first time.


  • Increased flexibility in meeting the customer’s individual needs.


The result is that costs should fall and quality should increase. This should improve the company’s competitive advantage.


Disadvantages of JIT


  • There is little room for mistakes as little stock is kept for re-working a faulty product.


  • Production is very reliant on suppliers and if stock is not delivered on time or is not of a high enough quality, the whole production schedule can be delayed.


  • There is no spare finished product available to meet unexpected orders, because all products are made to meet actual orders.


  • It may be difficult for managers to empower employees to embrace the concept and culture.


  • It won’t be suitable for all companies. For example, supermarkets must have a supply of inventory.


  • It can be difficult to apply to the service industry. However, in the service industry a JIT approach may focus on eliminating queues, which are wasteful of customers’ time.



Test your understanding 7




  • The provision of data at all stages in the process.


  • Providing expertise in the identification of appropriate output, input and process measures (financial and non-financial) and ways to collect the data.


  • Analysis of data.


  • Evaluation of possible solutions.


  • Identification of performance measures for the control process and monitoring after changes have been implemented.


  • Taking part in multi-disciplinary Six Sigma teams.



Test your understanding 8




Suggestions could include:


  • Pre-preparing plated servings of perishable desserts which are not ordered and need to be thrown away – over-production.


  • Poor kitchen layout which could lead to unnecessary movement of staff and result in waste from motion and from transportation of material or lead to accidents and spillages and waste in processes and methods.


  • Poorly trained cooking staff who produce sub-standard meals which cannot be served – product defects.


  • Producing too many pre-prepared components such as sauces to be incorporated in dishes which are then not needed – waste from inventory.


  • Poor scheduling in the kitchen leading to serving staff waiting for meals to be ready – waste from waiting time.



Test your understanding 9


  • Poor functionality and reliability may result in:


– user dissatisfaction, e.g. because the system does not perform the desired task


–    additional costs, e.g. to correct inaccurate reports.


  • Poor usability may result in:


–    staff dissatisfaction


–    excessive staff training


–    excessive time spent by staff trying to operate the system.


  • Poor build quality will result in difficulties maintaining and upgrading the system which will impact long-term profit.


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