MANAGEMENT ACCOUNTING - Solutions Manual

CHAPTER 27
MANAGING ACCOUNTING IN
A CHANGING ENVIRONMENT
I.

Questions
1. The American Heritage Dictionary defines quality as 1. a characteristic
or attribute of something; property; a feature. 2. the natural or essential
character of something. 3. excellence; superiority.
Quality for a product or service can be defined as a product or service
that conforms with a design which meets or exceeds the expectations of
customers at a price they are willing to pay.
2. Procter & Gamble defines TQM as the unyielding and continually
improving effort by everyone in an organization to understand, meet, and
exceed the expectations of customers. Typical characteristics of TQM
include focusing on satisfying customers, striving for continuous
improvement, and involving the entire workforce.
TQM is a continual effort and never completes. Global competition, new
technology, and ever-changing customer expectations make TQM a
continual effort for a successful firm.
3. The core principles of TQM include (1) focusing on satisfying the
customer, (2) striving for continuous improvement, and (3) involving the
entire work force.
4. Continuous improvement (Kaizen) in total quality management is the
belief that quality is not a destination; rather, it is a way of life and firms
need to continuously strive for better products with lower costs.
In todays global competition, where firms are forever trying to
outperform the competition and customers present ever-changing
expectations, a firm can never reach the ideal quality standard and needs
to continuously improve quality and reduce costs to remain competitive.
5. The Institute of Management Accountants (IMA) believes an effective
implementation of total quality management will take between three and
five years and involves the following tasks:
Year 1
27-1

Managing Accounting in a Changing Environment Chapter 27

Create a quality council and staff

Conduct executive quality training programs
Conduct quality audits
Prepare gap analysis
Develop strategic quality improvement plans

Year 2

Conduct employee communication and training programs

Establish quality teams
Create measurement systems and set goals

Year 3

Revise compensation / appraisal / recognition systems

Launch external initiatives with suppliers
Review and revise

6. Reward and recognition are the best means of reinforcing the emphasis
on TQM. Moreover, proper reward and recognition structures can be
very powerful stimuli to promote TQM. Efforts and progress will most
likely be short-lived if no change is made to the compensation / appraisal
/ recognition systems to make them in line with the objectives of the
firms TQM.
7. The purposes of conducting a quality audit are to identify strengths and
weaknesses in quality practices and levels of a firms quality and to help
the firm identify the target areas for quality improvements.
8. A gap analysis is a type of benchmarking that includes analyzing the
differences in practices between the firm and the best-in-class. The
objective of gap analyses is to identify strengths, weaknesses, and target
areas for quality improvement.
9. Some examples of costs associated with cost of quality categories are:
Prevention costs: Training costs such as instructors fees, purchase of
training equipment, tuition for external training, training wages and
salaries; salaries for quality planning and executions, cost of preventive
equipment, printing and promotion costs for quality programs, awards
for quality.
Appraisal costs: Costs of raw materials, work-in-process, and finished
goods inspections.

27-2

Managing Accounting in a Changing Environment Chapter 27

Internal failure costs:

Scrap, rework, loss due to downgrades,
reinspection costs, and loss due to work interruptions.
External failure costs: Sales returns and allowance due to quality
deficiency, warranty cost, and canceled sales orders due to quality
deficiency.
10. Prevention costs rise during the early years of implementing TQM as the
firm engages in education to prepare its employees and in the planning
and promotion of the quality program. Appraisal costs will also likely
rise during the early years of TQM, because the firm needs to ensure that
quality is actually being achieved. The increase in appraisal cost,
however, is most likely to occur at a slower pace than those of the
prevention costs because at the beginning of a TQM program there will
be substantial increases in quality training and in promotion to raise
awareness on the importance of quality.
The firm may see some decreases in internal and external failure costs in
the early years of implementing a TQM. However, these two costs most
likely will remain at about the same level as before during the first
several years of TQM. Many firms may actually see internal failure cost
rise, because of the higher standard demanded by the TQM or the higher
level of employees awareness on the critical importance of perfection in
every step of the process. As the firm makes progress in TQM, both
internal failure and external failure costs should decrease.
11. Costs of conformance are costs incurred to ensure that products or
services meet quality standards and include prevention costs and
appraisal costs.
Internal and external failure costs are costs of non-conformance. They
are costs incurred or opportunity costs because of rejection of products or
services.
12. Better prevention of poor quality often reduces all other costs of quality.
With fewer problems in quality, appraisal is needed because the products
are made right the first time. Fewer defective units also reduce internal
and external failure costs as the occasion for repairs, rework, and recalls
decrease.
It is easier to design and build quality in than try to inspect or repair
quality in. Theoretically, if prevention efforts are completely successful,
there will be no need to incur appraisal costs and there will be no internal
failure or external failure costs. In practice, appraisal costs usually do
not decrease, partly because management needs to ensure that quality is
27-3

Chapter 27 Managing Accounting in a Changing Environment

there as expected. Nonconformance costs, however, decrease at a much

faster pace than prevention costs increase.
13. The role of management accountants in total quality management
includes gathering all relevant quality information, participating actively
in all phases of the quality program, and reviewing and disseminating
quality cost reports.
14. To meet the challenges of total quality management, management
accountants need to have a clear understanding of TQM methodology.
They must be able to design, create, or modify information systems that
measure and monitor quality and evaluate progress toward total quality
as expected of each organizational unit and the total enterprise.
15. Just-in-time (JIT) purchasing is the purchase of goods or materials such
that a delivery immediately precedes demand or use. Benefits include
lower inventory holdings (reduced warehouse space required and less
money tied up in inventory) and less risk of inventory obsolescence and
spoilage.
16. The sequence of activities involved in placing a purchase order can be
facilitated by use of the Internet. A company can streamline the
procurement process for its customers e.g., having online a complete
price list, information about expected shipment dates, and a service order
capability that is available 24 hours a day with email or fax confirmation.
17. Just-in-time (JIT) production is a demand-pull manufacturing system
that has the following features:

Organize production in manufacturing cells,

Hire and retain workers who are multiskilled,
Aggressively pursue total quality management (TQM) to
eliminate defects,
Place emphasis on reducing both setup time and manufacturing
lead time, and
Carefully select suppliers who are capable of delivering quality
materials in a timely manner.

18. Reengineering is the fundamental rethinking and redesign of business

processes to achieve improvements in critical measures of performance
such as cost, quality, service, speed, and customer satisfaction.
19. The three main measures used in the theory of constraints are:

27-4

Managing Accounting in a Changing Environment Chapter 27

a. Throughput contribution equal to sales revenue minus direct

materials costs.
b. Investments (inventory) equal to the sum of materials costs of direct
materials inventory, work-in-process inventory and finished goods
inventory, research and development costs, and costs of equipment
and buildings.
c. Other operating costs equal to all operating costs (other than direct
materials) incurred to earn throughput contribution.
20. The four key steps in managing bottleneck resources are:
Step 1: Recognize that the bottleneck operation determines throughput
contribution.
Step 2: Search for, and find the bottleneck.
Step 3: Keep the bottleneck busy, and subordinate all nonbottleneck
operations to the bottleneck operation.
Step 4: Increase bottleneck efficiency and capacity.
21. (a) Product warranty costs should be lower because a world-class
manufacturer (WCM) will make fewer defectives.
(b) Salaries of quality control inspectors should be lower because a
WCM will have its workers inspect as they go, rather than having
separate inspections. Nor will a WCM inspect incoming materials
and components because it will deal only with vendors whose quality
has been demonstrated.
(c) Amounts paid to vendors for parts and components should be higher
because a WCM will not search out the lowest prices, but will seek
high-quality components delivered when needed.
(d) Wages rates for direct laborers should be higher because a WCMs
workers will multiskilled and should therefore command premium
wages.
(e) Total supervisory salaries should be lower because a WCMs
workers will not need as much supervision.
(f) Warehousing costs should be lower because a WCM will produce as
needed and so will not require storage space for materials or finished
product.
22. At the final assembly stage in a JIT system, a signal is sent to the
preceding workstation as to the exact parts and materials that will be
needed over the next few hours for the final assembly of products. Only
those parts and materials are provided. The same signal is sent back
through each preceding workstation so that a smooth flow of parts and
27-5

Chapter 27 Managing Accounting in a Changing Environment

materials is maintained with no buildup of inventories at any point. Thus,

all workstations respond to the pull exerted by the final assembly
stage.
The pull approach just described can be contrasted to the push
approach used in conventional systems. In a conventional system,
inventories of parts and materials are built upoften simply to keep
everyone busy. These semi-completed parts and materials are pushed
forward to the next workstation whether or not there is actually any
customer demand for the products they will become part of. The result is
large stockpiles of work in process inventories.
23. A number of benefits accrue from reduced setup time. First, reduced
setup time allows a company to produce in smaller batches, which in turn
reduces the level of inventories. Second, reduced setup time allows a
company to spend more time producing goods and less time getting
ready to produce. Third, the ability to rapidly change from making one
product to making another allows the company to respond more quickly
to customers. Finally, smaller batches make it easier to spot
manufacturing problems before they result in a large number of defective
units.
II. Exercises
Exercise 1 (Quality Cost Classification)
Preventio
n
Appraisal
a.
b.
c.
d.
e.
f.
g.
h.

Warranty repairs
Scrap
Allowance granted due
to blemish

Internal
Failure

Externa
l
Failure
x

x
x

Contribution margins of
lost sales
Tuition for quality
courses
Raw materials
inspections
Work-in-process
inspection
Shipping cost for
replacements
27-6

x
x
x
x
x

Managing Accounting in a Changing Environment Chapter 27

i.
j.

Recalls
Attorneys fee for
unsuccessful defense of
complaints about quality
k.
Inspection of reworks
l.
Overtime caused by
reworking
m.
Machine maintenance
n.
Tuning of testing
equipment

x
x
x
x
x
x

Exercise 2 (Cost of Quality Report)

Requirements 1 & 2
Bali Company
Cost of Quality Report
For 2005 and 2006
Cost of Quality
Category
Prevention costs:
Quality manual
Product design
Appraisal costs:
Testing
Internal failure costs:
Rework
Retesting
Disposal of defective
units
External failure costs:
Product recalls
Field service
Total cost of quality

2006
Peso

2005
Peso

P 40,000
300,000 P 340,000

5.67

P 50,000
270,000

P320,000

5.33

P 80,000

1.33

P 60,000

60,000

1.00

425,000

7.08

80,000

P200,000
50,000
90,000
P360,000
230,000

P250,000
90,000
340,000

5.67

590,000
P1,350,000

9.83
22.50

85,000
P500,000
350,000

850,000 14.17
P1,655,000 27.58

a. There were slight increases in both prevention and appraisal costs from
2005 to 2006. Each of these two cost of quality increased by
approximately 0.33 percent of the total sales. These two costs increased
by P40,000 over the two years.
b. Both internal failure costs and external failure costs decreased
substantially in 2006 as compared to those in 2005. The firm
experienced a 1.41 percent decrease in internal failure and a 4.34 percent
decrease in external failure costs with the total savings of P345,000. The
savings was 863 percent of the increases in prevention and appraisal
costs.
27-7

Chapter 27 Managing Accounting in a Changing Environment

Requirement 3
Among nonfinancial measures the firm may want to monitor are:

The number of defects or the processes yield (ratio of good output to

total output)
The percentage of defective units shipped to customers to total units
of products shipped
The number of customer complaints
Difference between delivery date requested by the customer
On-time delivery percentage (total units shipped on or before the
scheduled date to the total units shipped)
Surveys of customer satisfaction

It should be noted that nonfinancial measures by themselves often have

limited meaning. Nonfinancial measures are more informative when trends
of the same measure over time are examined.
Exercise 3 (Cost of Quality Category)
Requirement 1
Costs of Quality
Rework
Recalls
Reengineering efforts
Repair
Replacements
Retesting
Supervision
Scrap
Training
Testing of incoming
materials
Inspection of work in
process
Downtime
Product liability
insurance
Quality audits
Continuous

Prevention

Appraisal

Internal
Failure
P 6,000

External
Failure
P15,000

P 9,000
12,000
12,000
5,000
P18,000
9,000
15,000
7,000
18,000
10,000
9,000
5,000
1,000
27-8

Managing Accounting in a Changing Environment Chapter 27

improvement
Warranty repairs

15,000

Requirement 2
Total spent by
category

P25,000

P48,000

P42,000

P51,000

Requirement 3
The company is currently spending the least on preventive costs. They
should concentrate their efforts on preventive costs because they prevent
poor quality products from being manufactured.
By increasing amount spent on prevention, they could reduce spending on
the other cost of quality categories.
Exercise 4 (Cost of Quality Analysis, Nonfinancial Quality Measures)
Requirements 1 and 2
Revenues

Costs of Quality
Prevention costs
Design engineering
Preventive maintenance
Training
Supplier evaluation
Total prevention
costs

Appraisal costs
Line inspection
Product-testing
equipment
Incoming materials

2006
P12,500,000
Percentage
of Revenues
(2) = (1)
Cost
(1)
P12,500,000
P240,000
90,000
120,000
50,000
500,000

2005
P10,000,000
Percentage
of Revenues
(4) = (3)
Cost
(3)
P10,000,000
P100,000
35,000
45,000
20,000

4.0%

200,000

85,000

110,000

50,000
40,000

50,000
20,000

27-9

2.0%

Chapter 27 Managing Accounting in a Changing Environment

inspection
Product-testing labor
Total appraisal costs
Internal failure costs
Scrap
Rework
Breakdown
maintenance
Total internal failure
costs
External failure costs
Returned goods
Customer support
Product liability claims
Warranty repair
Total costs of quality

75,000
250,000

2.0%

220,000
400,000

200,000
135,000

250,000
160,000

40,000

90,000

375,000
145,000
30,000
100,000
200,000
475,000
P1,600,000

4.0%

3.0%

500,000

5.0%

3.8%
12.8%

60,000
40,000
200,000
300,000
600,000
P1,700,000

6.0%
17.0%

Between 2005 and 2006, Gabriels costs of quality have declined from 17%
of sales to 12.8% of sales. The analysis of individual costs of quality
categories indicates that Gabriel began allocating more resources to
prevention activities design engineering, preventive maintenance, training
and supplier evaluations in 2006 relative to 2005. As a result, appraisal costs
declined from 4% of sales to 2%, costs of internal failure fell from 5% of
sales to 3%, and external failure costs decreased from 6% of sales to 3.8%.
The one concern here is that, although external failure costs have decreased,
the cost of returned goods has increased. Gabriels management should
investigate the reasons for this and initiate corrective action.
Requirement 3
Examples of nonfinancial quality measures that Gabriel Corporation could
monitor are:
a. Number of defective grinders shipped to customers as a percentage of
total units of grinders shipped.
b. Ratio of good output to total output at each production process.
c. Employee turnover.
Exercise 5 (Costs of Quality Analysis, Nonfinancial Quality Measures)

27-10

Managing Accounting in a Changing Environment Chapter 27

Requirements 1 and 2
Revenues, Costs of Quality and Costs of Quality as a
Percentage of Revenues for Victoria
Revenues = P2,000 x 10,000 units = P20,000,000

Costs of Quality
Prevention costs
Design engineering (P75 x
6,000 hours)
Appraisal costs
Testing and inspection (P40 x
1 hour x 10,000 units)
Internal failure costs
Rework (P500 x 5% x 10,000
units)
External failure costs
Repair (P600 x 4% x 10,000
units)
Total costs of quality

Costs
(1)

Percentage of
Revenues
(2) = (1)
P20,000,000

P 450,000

2.25%

400,000

2.00%

250,000

1.25%

240,000

1.20%

P1,340,000

6.70%

Revenues, Costs of Quality and Costs of Quality as a

Percentage of Revenues for Vancouver
Revenues = P1,500 x 5,000 units = P7,500,000
Costs of Quality

Costs
27-11

Percentage of

Chapter 27 Managing Accounting in a Changing Environment

(1)
Prevention costs
Design engineering (P75 x
1,000 hours)
Appraisal costs
Testing and inspection (P40 x
0.5 x 5,000 units)
Internal failure costs
Rework (P400 x 10% x 5,000
units)
External failure costs
Repair (P450 x 8% x 5,000
units)
Estimated forgone
contribution margin on
lost sales [(P1,500
P800) x 300]
Total external failure
costs
Total costs of quality

Revenues
(2) = (1)
P7,500,000

P 75,000

1.00%

100,000

1.33%

200,000

2.67%

180,000

2.40%

210,000

2.80%

390,000

5.20%

P765,000

10.20%

Costs of quality as a percentage of sales are significantly different for

Vancouver (10.20%) compared with Victoria (6.70%). Canada spends very
little on prevention and appraisal activities for Vancouver, and incurs high
costs of internal and external failures. Canada follows a different strategy
with respect to Victoria, spending a greater percentage of sales on prevention
and appraisal activities. The result: fewer internal and external failure costs
and lower overall costs of quality as a percentage of sales compared with
Vancouver.

Requirement 3
Examples of nonfinancial quality measures that Canada Industries could
monitor as part of a total quality-control effort are:
a. Outgoing quality yield for each product
27-12

Managing Accounting in a Changing Environment Chapter 27

b. Returned refrigerator percentage for each product

c. On-time delivery
d. Employee turnover
III. Problems
Problem 1 (Quality Improvement, Relevant Cost Analysis)
Requirement 1
Cost of new equipment and installation
Training
Total additional cost of the new process

P12,000,000
3,000,000
P15,000,000

Requirement 2
Quality cost if no change is made:
Rework
3,000 x 40% x P2,000 =
Repair
3,000 x 15% x P2,500 =
Appraisal
Inspection
3,000 x P50 =
Lost contribution:
Contribution margin per unit P12,000 x 85% - P2,500 = P7,700
Lost sales
3,000 0.8 3,000 = x 750
Total current cost of quality

P 2,400,000
1,125,000
600,000
150,000
5,775,000
P10,050,000

Quality cost with the new process:

Warranty repair
3,000 0.8 x 5% x P1,000 =
Savings from the new process each year
Years effective
Total

187,500
P 9,862,500
x
3
P29,587,500

Appraisal and inspection cost in Year 1

Total savings over 3 years

750,000
P28,837,500

Requirement 3
Yes. The cost of the new process is P15,000,000 and the expected benefits is
P28,837,500 over three years. The firm can expect to earn a return of over
90%.
27-13

Chapter 27 Managing Accounting in a Changing Environment

Requirement 4
The following factors should be considered before making the final decision:
a. Accuracy of cost estimates including
Contribution margin per unit
Costs of current repair and rework
Cost of repair with the new process
Cost of the new process
b. Reliability of estimations of
Rates of rework and repair
Lost sales
Amount of time before the current product become obsolete
c. Reaction of competitors
Requirement 5
The member of the board would be right if we ignore the financial payoff of
the new process and if the firm is going to be in business for only three years.
Having high quality products, especially for a high-end product such as the
one the firm is selling, is crucial for a long term success.
Problem 2 (Preparing a Cost of Quality Report)
The Adoracion Company
Comparative Costs of Quality Report
Costs Categories
Prevention costs:
Training
Product design
Total prevention
Appraisal costs:
Testing
Calibration
Total appraisal

2006

Increase
(Decrease)

75,000
150,000
225,000

P 100,000
175,000
275,000

P 25,000
25,000
50,000

50,000
75,000
125,000

150,000
100,000
250,000

100,000
25,000
125,000

2005
P

27-14

Managing Accounting in a Changing Environment Chapter 27

Internal failure costs:
Rework
Retesting
Total internal failure

325,000
250,000
575,000

100,000
200,000
300,000

(225,000)
(50,000)
(275,000)

External failure costs:

Warranty repairs
Product recalls
Product liability
Total external failure

150,000
400,000
125,000
675,000

75,000
200,000
75,000
350,000

(75,000)
(200,000)
(50,000)
(325,000)

P1,600,000

P1,175,000

P (425,000)

Total costs of quality

Problem 3 (JIT Production, Relevant Benefits, Relevant Costs)

Requirement 1

Relevant Items
Annual tooling costs
Required return on investment
12% per year x P900,000 of average
inventory per year
12% per year x P200,000 of average
inventory per year
Insurance, space, materials handling,
and setup costs
Rework costs
Incremental revenues from higher
selling prices
Total net incremental costs
Annual difference in favor of JIT
production
a
P200,000 (1 0.30) = P140,000
b
P350,000 (1 0.20) = P280,000
c
P3 x 30,000 units = P90,000
Requirement 2

27-15

Incremental
Costs under
Current
Production
System

Incremental
Costs under JIT
Production
System
P150,000

P108,000
24,000
200,000
350,000

140,000a
280,000b

P658,000

(90,000)c
P504,000

P154,000

Chapter 27 Managing Accounting in a Changing Environment

Other nonfinancial and qualitative factors that Francisco should consider in

deciding whether it should implement a JIT system include:
a. The possibility of developing and implementing a detailed system for
integrating the sequential operations of the manufacturing process.
Direct materials must arrive when needed for each subassembly so
that the production process functions smoothly.
b. The ability to design products that use standardized parts and reduce
manufacturing time.
c. The ease of obtaining reliable vendors who can deliver quality direct
materials on time with minimum lead time.
d. Willingness of suppliers to deliver smaller and more frequent orders.
e. The confidence of being able to deliver quality products on time.
Failure to do so would result in customer dissatisfaction.
f. The skill levels of workers to perform multiple tasks such as minor
repairs, maintenance, quality testing and inspection.
Problem 4 (JIT Purchasing, Relevant Benefits, Relevant Costs)
Requirement 1
Incremental
Costs under
Current
Purchasing
System
Required return on investment
20% per year x P600,000 of
average inventory per year
20% per year x P0 of inventory
per year
Annual insurance costs
Warehouse rent
Overtime costs
No overtime
Overtime premium
Stockout costs
No stockouts
P6.50b contribution margin per
unit x 20,000 units
27-16

Incremental
Costs under JIT
Purchasing
Policy

P120,000
P
14,000
60,000

0
0
(13,500)a

0
40,000
0
130,000

Managing Accounting in a Changing Environment Chapter 27

Total incremental costs

Difference in favor of JIT
purchasing
a
b

P194,000

P156,500
P37,500

P(13,500) = Warehouse rental revenues, [(75% x 12,000) x P1.50].

Calculation of unit contribution margin
Selling price (P10,800,000 900,000 units)
P12.00
Variable costs per unit:
Variable manufacturing costs per unit
(P4,050,000 900,000 units)
P4.50
Variable marketing and distribution
costs per unit
(P900,000 900,000 units)
1.00
Total variable costs per unit
5.50
Contribution margin per unit
P6.50

Note that the incremental costs of P40,000 for overtime premiums to make
the additional 15,000 units are less than the contribution margin from losing
these sales equal to P97,500 (P6.50 x 15,000). Josefina would rather incur
overtime than lose 15,000 units of sales.
Problem 5 (Theory of Constraints, Throughput Contribution, Relevant
Costs)
Requirement 1
Finishing is a bottleneck operation. Hence, producing 1,000 more units will
generate additional throughput contribution and operating income.
Increase in throughput contribution (P72 P32) x 1,000
Incremental costs of the jigs and tools
Net benefit of investing in jigs and tools

P40,000
30,000
P10,000

Zashi should invest in the modern jigs and tools because the benefit of higher
throughput contribution of P40,000 exceeds the cost of P30,000.
Requirement 2
The Machining Department has excess capacity and is not a bottleneck
operation. Increasing its capacity further will not increase throughput
contribution. There is, therefore, no benefit from spending P5,000 to
27-17

Chapter 27 Managing Accounting in a Changing Environment

increase the Machining Departments capacity by 10,000 units. Zashi should

not implement the change to do setups faster.
Problem 6 (Theory of Constraints, Throughput Contribution, Relevant
Costs)
Requirement 1
Finishing is a bottleneck operation. Hence, getting an outside contractor to
produce 12,000 units will increase throughput contribution.
Increase in throughput contribution (P72 P32) x 12,000
Incremental contracting costs P10 x 12,000
Net benefit of contracting 12,000 units of finishing

P480,000
120,000
P360,000

Zashi should contract with an outside contractor to do 12,000 units of

finishing at P10 per unit because the benefit of higher throughput
contribution of P480,000 exceeds the cost of P120,000. The fact that the
costs of P10 are double Zashis finishing cost of P5 per unit are irrelevant.
Requirement 2
Operating costs in the Machining Department of P640,00, or P8 per unit, are
fixed costs. Zashi will not save any of these costs by subcontracting
machining of 4,000 units to Rainee Corporation. Total costs will be greater
by P16,000 (P4 per unit x 4,000 units) under the subcontracting alternative.
Machining more filing cabinets will not increase throughput contribution,
which is constrained by the finishing capacity. Zashi should not accept
Rainees offer. The fact that Rainees costs of machining per unit are half of
what it costs Zashi in-house is irrelevant.
Problem 7 (Theory of Constraints, Throughput Contribution, Quality)
Requirement 1
Cost of defective unit at machining operation which is not a bottleneck
operation is the loss in direct materials (variable costs) of P32 per unit.
Producing 2,000 units of defectives does not result in loss of throughput
contribution. Despite the defective production, machining can produce and

27-18

Managing Accounting in a Changing Environment Chapter 27

transfer 80,000 units to finishing. Therefore, cost of 2,000 defective units at

the machining operation is P32 x 2,000 = P64,000.
Requirement 2
A defective unit produced at the bottleneck finishing operation costs Zashi
materials costs plus the opportunity cost of lost throughput contribution.
Bottleneck capacity not wasted in producing defective units could be used to
generate additional sales and throughput contribution. Cost of 2,000
defective units at the finishing operation is:
Lost of direct materials P32 x 2,000
Forgone throughput contribution (P72 P32) x 2,000
Total cost of 2,000 defective units

P 64,000
80,000
P144,000

Alternatively, the cost of 2,000 defective units at the finishing operation can
be calculated as the lost revenue of P72 x 2,000 = P144,000. This line of
reasoning takes the position that direct materials costs of P32 x 2,000 =
P64,000 and all fixed operating costs in the machining and finishing
operations would be incurred anyway whether a defective or good unit is
produced. The cost of producing a defective unit is the revenue lost of
P144,000.

Problem 8
Requirement (a)
The following table reclassified the cost-of-quality expenses:
Anthony Foods
Quality Costs
2005-2006
(Millions)
27-19

140
2005

Quarters

2006

Chapter 27 Managing Accounting in a Changing Environment

120

2005
Q1

100

80

Q2

2006
Q3

Q4

Q1

Q2

Q3
Q4
Quality assurance
administration
P 6.20 P 6.52 P 6.86 P 7.19 P 7.93 P 8.74 P 9.61 P10.53
Training
13.10
14.39
15.90
17.46
21.12
25.50
30.37
36.35
Process
engineering
2.20
2.46
2.76
3.11
3.87
4.86
6.13
7.58
Prevention
21.50
23.37
25.52
27.76
32.92
39.10
46.11
54.46
Inspection
1.40
1.56
1.75
1.95
2.39
2.96
3.63
4.46
Testing
1.60
1.72
1.85
1.99
2.29
2.62
3.01
3.45
Appraisal
3.00
3.28
3.60
3.94
4.68
5.58
6.64
7.91
Rework
15.80
12.65
10.03
8.49
7.25
6.16
5.56
5.00
Scrap
17.60
14.48
11.92
10.32
8.92
7.72
7.00
6.34
Internal failure
33.40
27.13
21.95
18.81
16.17
13.88
12.56
11.34
Returns
26.90
21.09
16.35
13.53
11.32
9.50
8.43
7.52
Customer complaint
dept.
3.90
3.45
3.03
2.76
2.50
2.27
2.14
2.01
Lost sales
49.20
40.31
33.11
28.42
24.45
21.08
19.20
17.44
External failure
80.00
64.85
52.49
44.71
38.27
32.85
29.77
26.97
Total costs
P137.90 P118.63 P103.56 P95.22 P92.04 P91.41 P95.08 P100.68

Requirement (b)
From the preceding data we see that prevention and appraisal costs are
increasing while internal and external failure costs have been decreasing.
60 The following graph plots three series: prevention and appraisal costs,
failure costs, and total quality costs.

40

20
0

Appraisal and prevention costs

27-20
Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Managing Accounting in a Changing Environment Chapter 27

Failure costs
Total quality costs

A preliminary conclusion from the graph is that Anthony Foods is probably

now spending too much on trying to improve quality. Assuming that the
underlying production processes have not changed over time, quality costs
were minimized in the second quarter of 2006. Since then, the additional
money spent on appraisal and prevention has yielded smaller internal- and
external-failure costs savings.
Problem 9 (Applying TQM in Manufacturing versus Administration)
The ability of TQM to deliver cost savings and performance enhancements
depends directly on how easy it is to measure and observe the output of the
process. If a TQM teams output is easy to measure, it is easier to hold the
team members responsible for improving quality. If quality improvements
are difficult to observe, then holding team members responsible imposes
more risk on them. It is easier for them to argue that they didnt achieve their
goals because they were hard to observe. If the benefits from TQM are lower
because it is more difficult to observe the TQM output, less will be invested
in such activities.

Measuring quality improvements in a manufactured process tends to be

easier than a service. Engineering standards can be set for a manufactured
good and conformance to the standards can be relatively easy to measure.
But the output of many administrative departments is multidimensional and
often hard to observe. Manufacturing involves repetitive processes with few
exceptions. Administrative functions often involve handling numerous
exceptions. It is likely to be easier to observe quality improvements in a
television set than it is in a human resources department or a legal
department.
IV. Multiple Choice Questions
1.
2.
3.
4.
5.

C
B
C
D
D

11.
12.
13.
14.
15.

C
A
C
B
C
27-21

Chapter 27 Managing Accounting in a Changing Environment

6.
7.
8.
9.
10.

A
C
C
D
D

16.
17.
18.
19.
20.

D
D
D
A
A

27-22