Chapter 17 – The Management & Control of Quality
intubation treatment.
As for contract physicians, hospitals must compete for their patronage by providing them quality in
services they consider important. Also, the contract physicians usually are the ones who choose which
hospital the patient will receive treatment.
Nowadays, third party payers typically pay standard rates for many of the procedures that would be
performed in Respiratory Therapy. Hence, the rates they pay are not as affected by poor quality.
Other hospital departments that use Respiratory Therapy’s services might be concerned that lack of
quality in Respiratory Therapy may affect the quality in their own department. Even if this poor
quality is not contagious, it may nevertheless adversely affect customer perceptions about other
departments.
2. Categorize the list of quality costs into prevention, appraisal, internal failure, and external
failure. Justify your choices.
Before categorizing, it might be useful to review definitions for the four categories. General
definitions are as follows:
Prevention costs are incurred to prevent the production of products or services that do not meet
specifications. Appraisal costs are incurred to monitor and inspect production or services. These costs
The categorization arrived at by the consultant (actually, it was a team of graduate students who were
employed on a temporary basis by the hospital) was:
Prevention Costs: Quality Planning and Procedures, Training Procedures, Forecast and Budget
Some of these are subject to debate. For instance, Handling Complaints should probably be
considered an external failure cost since the patients and contract physicians are external customers
(only complaints from house physicians would be an internal failure cost). One could also argue that,
although Administrative Actions and Retraining Current Employees resulted from failures, they
should be classified as prevention costs since the purpose of these expenditures is to improve future
quality. Another item, Therapy Write-ups, may be questioned as to why it is considered a quality cost.
Chapter 17 – The Management & Control of Quality
A response to this is that it is analogous to a 100 percent inspection.
3. What additional costs of quality (COQ) might you suggest? How would you categorize each of
them?
Other costs of quality that may be considered:
• Hiring and retention of employees (Prevention Cost)
4. Discuss how you would estimate (i.e., measure) the following costs for the Respiratory Therapy
Department: Quality Planning and Procedures, Therapy Write-ups, and Incorrect Installation.
Measurement of costs for:
a) Quality Planning and Procedures–prorate (to three hours) the monthly salaries of those
5. Which of Highlander’s COQ measures (or similar ones) might you include in a balanced scorecard for
Kelsey’s Respiratory Therapy Department? What other performance measures would you suggest to
include? Classify each of these measures into the four standard balanced scorecard categories (financial,
customer, internal business process, learning & growth).
The following categorized balanced scorecard (BSC) measures might be suggested from the COQ
measures obtained by Highlander:
Number of malpractice lawsuits (customer)
Other categorized balanced scorecard measures that might be suggested are:
Number of unneeded treatments (internal business process)
Research and development expenditures (learning & growth)
17-12
Education.
Chapter 17 – The Management & Control of Quality
References
Barefield, J. T., C. A. Raiborn, and M. R. Kinney. 2003. Cost Accounting: Traditions and Innovations
(Cincinnati, OH: Southwestern).
Carr, L. P. 1995. Cost of Quality—Making It Work. Journal of Cost Management (Spring) 61-65.
Horngren, C. T., S. M. Datar, and G. Foster. 2003. Cost Accounting: A Managerial Emphasis.
(Englewood Cliff, New Jersey: Prentice-Hall).
Institute of Management Accountants (IMA). 1997. Union Pacific Railroad: Using Cost of Quality in
Environmental Management. In L. P. Carr, Cases from Management Accounting Practice (New
Jersey, Institute of Management Accountants) 103-111.
Ittner, C. 1988. Texas Instruments: Cost of Quality (A). (Boston, MA: Harvard Business School).
Kalagnanam, S. S., and E. M. Matsumura. 1995. Cost of Quality in an Order-Entry Department. Journal
of Cost Management (Fall) 68-74.
Keating, S., and J. Shank. 1998. Iron River Paper Mill. In Anthony, R. N., and V. Govindarajan,
Stanford University. 1982. Signetics Corporation: Implementing a Quality Improvement Program (A). In
Kaplan, R. S., and A. A. Atkinson. 1989. Advanced Management Accounting (Englewood Cliff, New
Jersey: Prentice-Hall), pp. 386-396.
17-13
Education.
Chapter 17 – The Management & Control of Quality
Case 17-3: Union Pacific Railroad—Using Cost of Quality (COQ) in
Environmental Management
1. How valid is the cost of future cleanup of the soil contaminated by the locomotive dripping oil
and grease onto the soil? What additional information would you require before including this
cost in a “return on investment” (ROI) analysis for the installation of the collection pans under
the locomotive?
is currently captured by the drip pans should be used in the studies to confirm the amount of soil
contaminated over a given period. How fast does it leach out of the surrounding soil and drop below
EPA standards?
In addition, the company should perform engineering studies to verify the amount of material leaking
from the locomotive. Does the drip pan really collect all of the material dripping off of the
locomotive, or is there still some portion that is not captured and therefore should be excluded from
the cost analysis?
2. Identify your criteria for failure costs and explain how you would classify the total cost of the
waste-water facilities. Is it a failure or a prevention cost? What are the best arguments for and
against using the cost of the waste-water facilities to justify the higher cost of biodegradable
soaps and solvents?
In the classical definition, failure costs are those costs incurred when customers’ requirements are not
met. In this case, the customer is the EPA, which has very technical specifications.
The cost of the waste water treatment plant is a failure cost if your criteria allows for inefficiency
costs. This means any inefficiencies contained within your operation are classified as failure costs. If
fines are the failure cost and the expense of the waste water treatment plant is the prevention cost.
The best argument for treating the waste water treatment plant as a failure cost is that there are
technological alternatives that would stop the pollutants from entering the water in the first place.
These more costly (to the department using the solvents and soaps) alternatives would be justified by
reductions in the operating costs of the waste water treatment plan. The major argument against using
the operating costs of the waste water treatment plant to justify other technologies is that the waste
water plant would have to remain in case these new techniques did not work.
17-14
3. Looking at the trend in waste water standards established by the Environmental Protection
Agency (EPA), would you feel comfortable closing these facilities permanently? Why or why
not?
The current method used to improve the water quality is to trace the pollutant back to its source and
make the “responsible party” bear the cost of improving water quality. This includes the costs of
additional chemicals, expansion of the facility, and/or other operating costs. These are the costs you
Unless they present a safety hazard, they can be left in place at no additional expense.
4. How realistic is it to hold a manager responsible for reducing the company’s operating costs to a
“World Class” standard as indicated by the disposal of contaminated soil example? What
additional information would you like to have before basing your salary increase on meeting
such a target?
It is very realistic to hold an operating unit responsible to a world class, competitive standard. Are
industrial customers different from you and I? Don’t we want better quality, more quantity at or below
existing prices? If our organization cannot meet our competitors’ costing structures how long would
the organization survive? The use of outside standards should be mandated to produce lower costs as
quickly as possible.
The things that you might want to see before agreeing to link your salary increase to meeting a target
are:
5. Put yourself in the place of an external auditor working for a public accounting firm. Looking
at the four situations outlined in the questions above, would you feel obligated to require any
notes, disclosures, or comments before issuing an opinion? Under what circumstances would
you feel obligated to require a disclosure of the situation?
All of these questions deal with some aspect of FASB Statement No. 5 and materiality. The idea of
importance of these costs to the corporation.
a. What about the current liability of all the soil contaminated by past years’ running of
locomotives without drip pans?
Under current law, as long as the contamination does not present a health hazard, is not moving
and is not being increased, the EPA does not require a cleanup plan on petroleum based products.
17-15
Education.
Chapter 17 – The Management & Control of Quality
The rational is that in 10 to 30 years the petroleum product will break down naturally and will no
longer be a hazard. If you did establish a contingent liability for existing petroleum contaminated
b. Assume that during the study of the waste-water treatment plants it was found that none of
the plants could handle a five-year rain. The fine for each occurrence was $100,000 for each
plant. Would you require a disclosure contained within the financial statements? Give
reasons supporting your position.
6. Looking at the case, what failure costs can you identify: (a) at your place of business? (b) at this
college or university? (c) in the teaching of this course? (d) what costs would you assign to each
of the failures you identify?
Part a
Some typical failure costs would be those associated with rework, scrap, customer returns, and those
found in classical Cost of Quality studies. From the case, you obtain cost of quality accounts due to
inefficient operations. Is your accounting staff less than 0.2% of your revenue? Are the costs for an
The cost of failure for the accounting staff would be the current costs less 0.2% of revenue. The cost
of failure for operating ratio would be the actual operating costs less the best operating ratio times
total revenue.
Part b
First, define who the customer is: the student, the employer with whom the student hopes to find a
job, or society as a whole. Then define the requirements of the customer you identified and look at the
operation.
Second, look at the operational efficiencies of the current process. Is the method of lecturing to a
group of students who have different learning rates the most efficient way to teach a particular
subject? Is the concept of having a department head for various departments efficient? Is the
additional administrative cost justified to the ultimate customer? Does every department need a
computer center or its “OWN” classrooms?
Chapter 17 – The Management & Control of Quality
Use caution in developing the failure costs for customer satisfaction in this specific example. The
costs have to be incurred by the college or university. They can not be costs incurred by the student in
In the second area, the failure costs are easier to determine. For any course, is the cost per student
lower for interactive computer based self- training or for having large lecture courses and discussion
sections? Look at the difference in the cost per student and the lower cost becomes your standard cost
Part c
Does this class meet the requirements of the customer? Does the course require the same number of
man-hours to prepare for as other courses at other facilities? Does the course start on time? Does the
course end on time?
The same caution mentioned above applies here. The cost of not meeting customer requirements has
Part d
The costs are identified with each of the answers above.
7. As the Chief Financial Officer (CFO) of the company, when would you begin to feel
uncomfortable assigning costs to these environmental failures? Discuss the ethical questions
that would be involved in limited the generation of failure costs that are based upon
noncompliance or continued contamination of the environment, resulting in possible violation of
future regulations. During your discussion, address how you would minimize the financial
liability of potential litigation associated with the production and distribution of asbestos and
tobacco products.
This is a question concerning the interpretation the person gives to FASB No. 5 and when the liability
becomes significant in the eyes of the CFO. As more and more documentation is provided, the CFO
should become more uncomfortable with not addressing the issue.
Limiting failure costs, simply because you might have to include a note in your annual report, is a
17-17
Education.
Chapter 17 – The Management & Control of Quality
8. Under what conditions could you see a cost of quality (COQ) system working? What are the key
enablers of such a system if attempted in your organization? Discuss the arguments you would
use to start or “kill” a COQ system.
The key factors are:
• Support of top management
The student should identify the enablers present out of those given above.
Key factors for a COQ system are:
• It takes time
9. What are the major differences between a COQ system as presented in the case and an Activity-
Based costing (ABC) system? What are the similarities?
The major difference between a COQ and ABC system is a COQ system will provide a failure cost
for specific incidents. An ABC system will provide a cost for all incidents but not any cost avoidance
costs.
17-18
Education.
1. Identify at least three factors that should be present for an organization to successfully
implement a quality-improvement program.
At least three of several factors that should be present for an organization’s quality program to be
successful include:
dynamic improvement
2. By analyzing the Cost of Quality (COQ) report provided, determine if Bergen, Inc.’s quality-
improvement program has been successful. List specific evidence to support your answer.
From an analysis of the Cost of Quality (COQ) Report it would appear that Bergen Inc.’s program has
been successful, since:
Total quality costs as a percentage of total production costs have declined from 23.4 percent to
13.1 percent
External failure costs, those costs signaling customer dissatisfaction, have declined from 8
percent. The $30,000 increase is more than offset by decreases in other quality costs.
3. Discuss why Tony Reese’s current reaction to the quality-improvement program is more
favorable than his initial reaction.
Tony Reese’s current reaction to the quality-improvement program is more favorable as he is seeing the
benefits of having the quality problems investigated and solved before they reach the production floor.
Because of improved designs, quality training, and additional pre-production inspections, scrap and
4. Jerry Holman believed that the quality-improvement program was essential and that Bergen,
Inc. could no longer afford to ignore the importance of product quality. Discuss how Bergen could
measure the opportunity cost of not implementing the quality-improvement program.
17-19
Chapter 17 – The Management & Control of Quality
To measure the opportunity cost of not implementing the quality program, Bergen, Inc. could assume
that:
17-20
Education.