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The rational is that in 10 to 30 years the petroleum product will break down naturally and will no
There is no contingent liability because the cost of remedial action is an operating expense and
most sites will be cleaned up within a fairly short period of time.
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
document, or the cost of performing the service a second time.
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
additional administrative cost justified to the ultimate customer? Does every department need a
computer center or its “OWN” classrooms?
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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
failure costs could be the difference between the (existing cost of all departments) less ((the cost of
using the entire staff divided by the number of instructors found in the largest department) times (the
cost of the largest department head)). In the administration area, you could take the current number of
personnel less (the number of transactions performed/the number performed per person at the “best”
facility) times the salary and overhead of the average person.
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
man-hour. The cost of not starting on time or finishing on time would be the additional expense of
operating the classroom at full capacity for the additional time.
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
criminal damages? The account could demonstrate that the probabilities used might have been wrong
but the company was at least looking at the problem in a proactive manner.
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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
• Make the accounts measure incidents and not fixed costs
The student should identify the enablers present out of those given above.
Key factors for a COQ system are:
Key factors against a COQ system include:
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
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Case 17-4: Bergen, Inc.—Cost of Quality (COQ) Reporting
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:
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 of total production cost to 2.3 percent. These declines in warranty repairs and customer
returns should translate into increased sales in the future.
• Internal failure costs have been reduced from 4.6 percent to 2.2 percent of production costs and
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
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
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.
To measure the opportunity cost of not implementing the quality program, Bergen, Inc. could assume
that:
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Teaching Notes for Readings
Reading 17-1: “GE Takes Six Sigma Beyond the Bottom Line” by G. T. Lucier and S. Seshadri,
Strategic Finance (May 2001), pp. 40-46.
This article reports the success of GE Medical Systems Inc.’s Six Sigma effort. It describes the training
programs for employees in statistical process control and s Services and information offered by the Web
site of the company to support the quality improvement efforts of more than 300,000 employees
worldwide.
Discussion Questions:
1. What is a Six Sigma approach?
Sigma is the Greek letter used in statistics to denote standard deviation. Six Sigma means that the
2. Describe the processes that GE uses to implement its Six Sigma program.
GE uses acronym DMAIC to describe its Six Sigma approach:
Define – Define problems related to the business or critical factors to customer satisfaction.
Control – Implement ongoing measures to keep the problem from recurring.
3. What are black belts? What roles black belts play in GE’s Six Sigma program?
Black belts are team leaders of small teams implementing/executing the Six Sigma methodology.
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Reading 17-2: R. C. Kettering, “Accounting for Quality with Nonfinancial Measures: A Simple
No-Cost Program for the Small Company,” Management Accounting Quarterly (Spring 2001),
pp. 14-19.
The author of this article argues that, to improve product/service quality, even small companies can
develop and use nonfinancial, low-cost data to improve performance and customer satisfaction.
Discussion Questions:
1. In terms of a Cost of Quality (COQ) framework for managing and controlling quality costs,
distinguish between cost of conformance and cost of non-conformance. Into what subdivisions
can each of these two broad categories of quality-related costs be made? What is the definition of
each of the four categories of quality cost in a typical COQ report?
Cost of conformance = Prevention Costs + Appraisal Costs; Cost of Nonconformace = Failure Costs
(Internal Failure Costs + External Failure Costs). As the authors of this article point out, the former
costs are associated with the achievement of quality, while the latter costs are associated with
nonachievement of quality of the organization’s output (service or product). Alternatively, one can
view conformance costs as those costs incurred to make sure the product or service is right the first
time; nonconformance costs, on the other hand, are incurred to correct a problem or quality defect.
Breakdown of conformance costs:
▪ Prevention costs—quality costs incurred to prevent poor quality (i.e., defects) from being
▪ External failures costs—these are costs of product/service failure detected after delivery of the
product or service to the customer. Examples include field service costs and the costs of
processing product returns.
2. Provide an overview of the three-step approach that the author of this paper recommends as a
“no–cost” approach that can be used by smaller (i.e., more resource-constrained) organizations
to monitor and control quality.
The authors maintain the financial control of quality, via the Cost of Quality (COQ) reporting
framework outline above in (1), may be more appropriate for larger, more resource-rich organizations.
Thus, the author suggests that smaller, more resource–constrained may be able to control quality costs
by focusing on nonfinancial performance indicators.
In this regard, the author proposes a three-step approach:
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3. Provide at least two examples of non-financial quality indicators for each of the four categories of
quality-related costs typically included in a COQ report.
Examples are provided by the author in Table 2 in the article.
Prevention: Design review (number of hours), preventive maintenance (number of hours), employee
External failure: Warranty claims (number of claims), product recalls (number of recalls), etc.
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Reading 17-3: Marc Epstein, “Implementing Corporate Sustainability: Measuring and Managing
Social and Environmental Impacts,” Strategic Finance (January 2008), pp. 25-31.
This article is an excerpt of the award-winning book by the author: Making Sustainability Work: Best
Practices in Managing and Measuring Corporate Social, Environmental and Economic Impacts, Berrett-
Koehler Publishers (2008). It is also one of a series of four articles, based on the book, published in
Strategic Finance.
Discussion Questions:
1. What is the primary business issue and the primary accounting issue addressed by the author of
this article?
The primary business issue is the role of social and environmental responsibility in business—in short,
sustainability. From an accounting standpoint, the question is: how can management accounting and
2. Provide an overview of the “Corporate Sustainability Model” developed by the author of this
article (see Figure 1).
Figure 1 (Corporate Sustainability Model) describes the drivers of corporate sustainability performance,
actions that managers can take to affect that performance, and consequences of those actions—both on
corporate social and financial performance. Ultimately, the use of such a monitoring and control system
model, similar to the balanced scorecard, is therefore a strategic management system.
3. How is the Corporate Sustainability Model similar to and different from Exhibits 17.1 and 17.2?
Text Exhibit 17.1 provides a general framework that can be used to explain the business rationale for
quality-related spending and investment. It includes both financial and nonfinancial factors associated
with such spending. In a sense, Exhibit 17.1 lays out the business case for such spending. Text Exhibit
17.2 provides one possible comprehensive framework for managing and controlling quality. That is, it
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4. What is the importance of the examples provided in Table 1 of the article?
As indicated in the article, Table 1 provides a small sample of measures for the inputs, processes,
outputs, and outcomes in the Corporate Sustainability Model. Companies will select a small number of
measures and customize them to meet their corporate strategies. The chosen measures should be
quantifiable, in either absolute or percentage terms, as well as complete and controllable. Also, all
measures should be clearly linked in a causal relationship. The instructor can draw a parallel here
Internally, surveys, focus groups, and other techniques are increasingly being used to measure and
monitor employee and other stakeholder reactions and provide feedback.
Although measurement may be imprecise, it certainly is relevant. Social and environmental impacts
should be included in ROI calculations for more effective managerial decision-making at all
organizational levels. Well-designed measurement systems aid in evaluating the impacts of
sustainability initiatives on financial performance and the tradeoffs that ultimately must be made when
there are many competing organizational constraints and numerous barriers to implementation.
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Reading 17-4: “Making the Cost of Quality Practical” by Steve Ball, Strategic Finance (July
2006), pp. 34-41.
The author of this article discusses conditions under which a Cost of Quality (COQ) program may be
warranted, as well as how to establish a COQ system in practice. Four specific examples of using a COQ
program to improve managerial decision-making are presented in the article.
Discussion Questions:
1. What, in your opinion, is the overall purpose of (or message in) this article?
This article addresses the following issue: how best to manage and control spending on quality, that is,
resources devoted to quality-related initiatives. Yes, companies want to improve quality. From an
accounting standpoint, internal systems are needed that help companies manage and control spending
2. Provide a succinct summary of the author’s conceptualization of quality and quality costs? (Hint:
Refer to Tables 1 and 2.)
Table one depicts total quality costs as the sum of conformance (“proactive”) costs + nonconformance
(“reactive”) costs. The former category includes both prevention costs as well as appraisal/detection
costs, while the latter category includes failure costs, both internal and external.
sourcing decision.
3. What is the difference between “fully loaded” and “variable” costs? According to the author,
why is this distinction important?
This distinction is raised by the author in conjunction with example #4—Materials Purge. A materials
purge generates costs throughout the value chain. A mature COQ system will provide data regarding the
cost of purges, thereby enabling management to determine an appropriate level of spending on
4. What is the primary value of the information contained in Table 6 of this article?
The example in Table 6 is important because it represents one possible senior-level report that the
accounting system can prepare. Note that behind Table 6 there probably would be various supporting
schedules, data, and tables. However, top management is probably better served with summary results,
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Reading 17-5: Anton Van Der Werwe and Jeffrey Thompson, “The Lowdown on Lean
Accounting: Should Management Accountants Get on the Bandwagon—or Not?” Strategic
Finance (February 2007), pp. 26-33.
The authors of this article called for reasoned debate regarding the role of “lean accounting” in accounting
practice. As such, they raise some interesting questions for both proponents and opponents of “lean
accounting,” all in an attempt to define a more appropriate role for “leaning accounting.”
Discussion Questions:
1. What two critical questions are raised by the authors as regards the role of lean accounting (LA)
in organizations today?
The author’s address the following two questions regarding lean accounting:
2. Which specific assertions of lean accounting are examined by the authors of this article?
When new systems, including suggested refinements to management accounting systems, are
introduced, it is common practice to focus on limitations or problems associated with existing systems.
This is the case, too, with proponents of lean accounting, who have raised a number of objections to
traditional/existing management accounting systems. The authors of this article address the following
assertions of the proponents of lean accounting:
a) accounting (in particular, full-absorption standard costing) is the problem
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3. What conclusions do the authors draw in response to the two questions raised at the outset of this
article?
In the words of the authors:
a) At best, except for highly simplified contexts, lean accounting in full deployment is probably
premature. It is not that the authors reject a potential role of lean accounting. Rather, their argument
b) The authors assert that the answer to the second question, “Does lean accounting support decision–
making and enterprise optimization?” is a clearer “no,” if the focus is beyond the shop floor.
Overall, this article provides students with a good example of how and why management accounting