MANAGEMENT ACCOUNTING (VOLUME II) - 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 today’s 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:
 27-1
Chapter 27 Managing Accounting in a Changing Environment

Year 1
 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
firm’s TQM.
7. The purposes of conducting a quality audit are to identify strengths and
weaknesses in quality practices and levels of a firm’s 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.
 27-2
Managing Accounting in a Changing Environment Chapter 27

Appraisal costs: Costs of raw materials, work-in-process, and finished

goods inspections.
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.

27-3
Chapter 27 Managing Accounting in a Changing Environment

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
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.

27-4
Managing Accounting in a Changing Environment Chapter 27

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:
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 WCM’s
workers will multiskilled and should therefore command premium
wages.
 (e) Total supervisory salaries should be lower because a WCM’s workers
will not need as much supervision.

27-5
Chapter 27 Managing Accounting in a Changing Environment

(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
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 up—often 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)

P Internal Exter
 A Failure nal
Failu
re

a. Warranty repairs x

b. Scrap x

c. Allowance granted due to

blemish x27-6

Managing Accounting in a Changing Environment Chapter 27

d. Contribution margins of lost

sales x
e. Tuition for quality courses x

f. Raw materials inspections x

g. Work-in-process inspection x

h. Shipping cost for replacements x

i. Recalls x

j. Attorney’s fee for unsuccessful x

defense of complaints about
quality

k. Inspection of reworks x

l. Overtime caused by reworking x

m. Machine maintenance x

n. Tuning of testing equipment x

Exercise 2 (Cost of Quality Report)

 Requirements 1 & 2
Bali Company
Cost of Quality Report
For 2005 and 2006

Cost of Quality 2006 2005 Category Peso % Peso % Prevention costs:

Quality manual P 40,000 P 50,000
Product design 300,000 P 340,000 5.67 270,000 P320,000 5.33 Appraisal costs:
Testing P 80,000 80,000 1.33 P 60,000 60,000 1.00 Internal failure costs:
Rework P200,000 P250,000
Retesting 50,000 90,000
Disposal of defective units 90,000 340,000 5.67 85,000 425,000 7.08 External failure costs:
Product recalls P360,000 P500,000
Field service 230,000 590,000 9.83 350,000 850,000 14.17 Total cost of quality P1,350,000 22.50
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

27-7
Chapter 27 Managing Accounting in a Changing Environment

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.

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
Prevention Appraisal
Internal Failure
Costs of Quality External Failure
Rework P 6,000 Recalls P15,000 Reengineering efforts P 9,000
Repair 12,000 Replacements 12,000 Retesting 5,000 Supervision P18,000
Scrap 9,000 Training 15,000
Testing of incoming
materials 7,000
Inspection of work in
process 18,000

27-8
Managing Accounting in a Changing Environment Chapter 27

Downtime 10,000 Product liability

insurance 9,000 Quality audits 5,000
Continuous
improvement 1,000
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

2006 2005
Revenues P12,500,000 P10,000,000
 Prevention costs Percentage of Revenues (4) =
Revenues (2) = (3) 
(1)  Cost (3) P10,000,000
Costs of Quality Cost (1) P12,500,000 Percentage of

Design engineering P240,000 P100,000 Preventive maintenance

90,000 35,000 Training 120,000 45,000 Supplier evaluation 50,000
20,000 Total prevention
costs 500,000 4.0% 200,000 2.0%27-9

Chapter 27 Managing Accounting in a Changing Environment

Appraisal costs
Line inspection 85,000 110,000
Product-testing
equipment 50,000 50,000
Incoming materials
inspection 40,000 20,000
Product-testing labor 75,000 220,000
Total appraisal costs 250,000 2.0% 400,000 4.0%
Internal failure costs
Scrap 200,000 250,000
Rework 135,000 160,000
Breakdown
maintenance 40,000 90,000
Total internal failure
costs 375,000 3.0% 500,000 5.0%
External failure costs
Returned goods 145,000 60,000
Customer support 30,000 40,000
Product liability claims 100,000 200,000
Warranty repair 200,000 300,000 475,000 3.8% 600,000 6.0%
Total costs of quality P1,600,000 12.8% P1,700,000 17.0%

Between 2005 and 2006, Gabriel’s 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. Gabriel’s 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.

27-10
Managing Accounting in a Changing Environment Chapter 27

b. Ratio of good output to total output at each production process.

c. Employee turnover.

Exercise 5 (Costs of Quality Analysis, Nonfinancial Quality Measures)

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

Percentage of
Revenues
Design engineering (2) = (1) 
Costs of Quality (P75 x P20,000,000
Prevention costs Costs (1)

6,000 hours) P 450,000 2.25% Appraisal costs

Testing and inspection (P40 x
1 hour x 10,000 units) 400,000 2.00% Internal failure costs
Rework (P500 x 5% x 10,000
units) 250,000 1.25% External failure costs
Repair (P600 x 4% x 10,000
units) 240,000 1.20% Total costs of quality P1,340,000
 6.70%

27-11
Chapter 27 Managing Accounting in a Changing Environment

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

Percentage of
Revenues
Prevention costs Costs (1)
Costs of Quality Design engineering (2) = (1)  P7,500,000
(P75 x

1,000 hours) P 75,000 1.00% Appraisal costs

Testing and inspection (P40 x
0.5 x 5,000 units) 100,000 1.33% Internal failure costs
Rework (P400 x 10% x 5,000
units) 200,000 2.67% External failure costs
Repair (P450 x 8% x 5,000
units) 180,000 2.40% Estimated forgone
contribution margin on
lost sales [(P1,500 –
P800) x 300] 210,000 2.80% Total external failure
costs 390,000 5.20%
Total costs of quality 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.

27-12
Managing Accounting in a Changing Environment Chapter 27

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

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 P12,000,000 Training

3,000,000 Total additional cost of the new process P15,000,000

Requirement 2

Quality cost if no change is made:

Rework 3,000 x 40% x P2,000 = P 2,400,000 Repair 3,000 x 15% x P2,500 =

1,125,000 Appraisal 600,000 Inspection 3,000 x P50 = 150,000 Lost contribution:
Contribution margin per unit P12,000 x 85% - P2,500 = P7,700
Lost sales 3,000  0.8 – 3,000 = x 750 5,775,000 Total current cost of quality
P10,050,000 Quality cost with the new process:
Warranty repair 3,000  0.8 x 5% x P1,000 = – 187,500 Savings from the new
process each year P 9,862,500 Years effective x 3 Total P29,587,500 Appraisal and
 inspection cost in Year 1 – 750,000 Total savings over 3 years P28,837,500

27-13
Chapter 27 Managing Accounting in a Changing Environment

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%.

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

Increase
Costs Categories 2005 2006 Prevention costs:
(Decrease)
 Training P 75,000 P 100,000 P 25,000 Product design 150,000 175,000
25,000 Total prevention 225,000 275,000 50,000

27-14
Managing Accounting in a Changing Environment Chapter 27

Appraisal costs:

Testing 50,000 150,000 100,000 Calibration 75,000 100,000 25,000 Total

appraisal 125,000 250,000 125,000

Internal failure costs:

Rework 325,000 100,000 (225,000) Retesting 250,000 200,000 (50,000) Total
internal failure 575,000 300,000 (275,000)

External failure costs:

Warranty repairs 150,000 75,000 (75,000) Product recalls 400,000 200,000
(200,000) Product liability 125,000 75,000 (50,000) Total external failure
675,000 350,000 (325,000)
Total costs of quality P1,600,000 P1,175,000 P (425,000) Problem 3 (JIT

Production, Relevant Benefits, Relevant Costs) Requirement 1

Incremental
Costs under Current under JIT Production
Production System System
Incremental Costs
Relevant Items
Annual tooling costs – P150,000 Required return on investment
12% per year x P900,000 of average
inventory per year P108,000
12% per year x P200,000 of average
inventory per year 24,000 Insurance, space, materials
handling, and setup costs 200,000 140,000a Rework costs 350,000
280,000b Incremental revenues from higher
selling prices – (90,000)c Total net incremental costs P658,000
P504,000 Annual difference in favor of JIT
production P154,00027-15

Chapter 27 Managing Accounting in a Changing Environment

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

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
Incremental 20% per year x P600,000 of
Costs under JIT Costs under Current
Purchasing Purchasing System
Policy
Required return on investment

average inventory per year P120,000

20% per year x P0 of inventory
per year P 0 Annual insurance costs 14,000 0 Warehouse rent 60,000
(13,500)a
 27-16
Managing Accounting in a Changing Environment Chapter 27

Overtime costs

No overtime 0
Overtime premium 40,000 Stockout costs
No stockouts 0
P6.50bcontribution margin per
unit x 20,000 units 130,000 Total incremental costs P194,000
P156,500 Difference in favor of JIT
purchasing P37,500
a
P(13,500) = Warehouse rental revenues, [(75% x 12,000) x P1.50].
b
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 P40,000

 Incremental costs of the jigs and tools 30,000 Net benefit of
investing in jigs and tools P10,000

27-17
Chapter 27 Managing Accounting in a Changing Environment

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 increase
the Machining Department’s 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 P480,000

Incremental contracting costs P10 x 12,000 120,000 Net benefit of
contracting 12,000 units of finishing 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 Zashi’s 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
Rainee’s offer. The fact that Rainee’s costs of machining per unit are half of
what it costs Zashi in-house is irrelevant.

27-18
Managing Accounting in a Changing Environment Chapter 27

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
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 P 64,000 Forgone throughput

contribution (P72 – P32) x 2,000 80,000 Total cost of 2,000
defective units 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.
 27-19
Chapter 27 Managing Accounting in a Changing Environment

Problem 8

Requirement (a)

The following table reclassified the cost-of-quality expenses:

Anthony Foods
Quality Costs
2005-2006
(Millions)

2005 2006
Q1 Q2 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.
The following graph plots three series: prevention and appraisal costs, failure
costs, and total quality costs.
 27-20
Managing Accounting in a Changing Environment Chapter 27

140

120

100

80

60

40

20
0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2005 2006Quarters

Appraisal and prevention costs

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 team’s 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 didn’t 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.

27-21
Chapter 27 Managing Accounting in a Changing Environment

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. C 11. C
2. B 12. A
3. C 13. C
4. D 14. B
5. D 15. C
6. A 16. D
7. C 17. D
8. C 18. D
9. D 19. A
10. D 20. A
27-22