UNIVERSITY OF SAINT LOUIS

Tuguegarao City

SCHOOL OF ACCOUNTANCY, BUSINESS and HOSPITALITY

Second Semester
A.Y. 2023-2024

COURSE LEARNING MODULE

OMGT 1013 – Operations Management and Total Quality Management

Prepared by:

GLADYS T. TUMBALI, DBM

Reviewed by:

MARY ANN C. BARTOLOME, DBM

Business Administration Department Head

Recommended by:

ALICIA S. TULIAO, DBM

Academic Dean

Approved by:

EMMANUEL JAMES PATTAGUAN, Ph.D.

Vice President for Academics

WARNING: No part of this E-module/LMS Content can be reproduced, or transported or shared to others without
permission from the University. Unauthorized use of the materials, other than personal learning use, will be penalized.
Please be guided accordingly.

OMGT 1013-Operations Management and TQM | 1

 School of Accountancy, Business and Hospitality
Business Administration Department
Curriculum 2018-2019

COURSE LEARNING MODULE

OMGT 1013 (Operations Management and Total Quality Management)
AY 2023-2024

Lesson 18: Quality Costs

Topic: Quality Costs

Learning Outcomes: After reading this module, you are expected to:

 Identify the different classifications of cost of quality;

 Determine possible ways of reducing costs in the production of products.

LEARNING CONTENT

Introduction:

The top management looks at every activity in the organization in terms of return on direct and indirect
investment. However, this does not mean that they are looking for short-term gains only. They don’t mind
waiting for years, if ultimately the efforts are going to pay out. Top management will adopt ISO 9000 or TQM if
it is going to help the organization. In fact, many companies have adopted ISO 9000, TQM Six Sigma, etc. for
growth coupled with profits.

TQM was evolved to satisfy customers in the most economical way Quality means cost effectiveness. It means
reducing expenditure by eliminating wastes through systematic quality management approach. Therefore it is
important to compute expenditure incurred on account of poor quality, and prevent it. TQM should result in the
progressive reduction of inferior quality goods. Quality cost is a tool to demonstrate cost of poor quality to the
top management as well as the entire organization. It will also highlight the importance of TQM activities to the
top management clearly. Above all it will help the organization to know the effectiveness of the organization
and the areas where the efforts are wasted.

TQM aims at gradual reduction of wasteful expenditure and eventually their total elimination. Quality costs
should be accounted separately so as to know how much the organization is losing on account of poor quality.
Decreasing cost of production should indicate quality improvement. Accounting and analyzing quality costs has
given innumerable benefits to the organizations. Thus quality costs is an important tool for TQM.

Lesson Proper:

COST OF QU ALITY
Cost of Quality (COQ) is the sum of costs incurred by an organization in preventing poor quality. There
are essentially three types of Quality Costs as given below:

1. Prevention Costs

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 2. Appraisal Costs

3. Failure Costs

Thus, the COQ can be classified into 3 categories as given in Figure 2.1.

This is called PAF model, name abbreviated from the first letters of the three categories: Any quality cost which
arises in an industry can be classified into one of the above three categories.

The prevention costs are the planned costs incurred by an organization to ensure that no defects occur in any
of the stages such as design, development, production and delivery of a product or service. They are incurred
to reduce the inspection as well as the failure costs. The expenditure on account of TQM implementation is a
prevention cost. Prevention costs include education and training of employees, process improvement efforts,
process control, market research, product qualification, field testing, preventive maintenance, calibration of
instruments, audits, quality assurance staff, etc.

The appraisal costs are incurred in verifying, checking or evaluating a product or service at various stages
during manufacturing or delivering. They are incurred due to lack of confidence in the quality of the product or
service either due to the incoming material or due to the process. For instance, the incoming materials are
inspected, because, the receiver is not sure about the 'quality of the incoming goods. During the process, a
number of inspections take place, since the quality of the process is in doubt. Therefore, if quality improves in
the organization as well as among the vendors, inspection cost can be reduced. Appraisal costs include
incoming inspection, internal product audit, supplier evaluation and audit, inspection during process and final
inspection, etc.

The failure costs are incurred by an organization because the product or service did not meet the expected
requirements and the product had to be fixed or replaced or the service had to be repeated. The failure costs
are due to the incurred failure of the organization to control defects in the product.

Defective products in the market can lead to the loss of reputation and customer loyalty. One dissatisfied
customer will tell 100 others, which means the loss of both present and future customers. It will also affect the
brand image, leading to loss of good will and customer loyalty. If the trend is not corrected, and the quality is
not restored, the company will have to close down.

Thus the organization should start accounting separately the costs of quality, preferably under these three
heads.

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CLASSIFICATION OF F AILURE COST

The failure costs can be classified into:

Internal Failure Costs Includes costs of every failure that takes place before the product is delivered to the
customers. It accrues due to defective processes. The following accounts for internal failures:

Rejected material, supplied by vendor

Rejected pieces of sub-assemblies
Rejected products at final inspection
Scrap on account of poor workmanship
Overtime due to non-conforming products

External Failure Costs These are on cost of failure of the product after its delivery to the customers.

Examples of external failure are:

Warranty costs
Free replacements given due to failure of items supplied
Cost incurred to travel to customer’s site for repair
Cost of products returned.
Cost of customer complaint administration
Cost of customer follow up and field service department.

The aim of strategic planning and quality planning is the total elimination of wastes. This elimination leads to
meeting customer requirements, at the lowest possible cost. Any defective component only adds to the cost of
product. A sub-assembly that contains defective components is a waste as is the case with any product that
does not work for the first time after assembly. Any defective part supplied by the vendor is a waste. Also
problems encountered 1n the field, in the product causes a lot of unnecessary expenditure. Such causes of
waste are too many. Therefore, Juran introduced the concept of Cost of Quality (COQ) in the year 1951 in his
Quality Control Handbook. The other Gurus such as Philip Crosby, Harrington also advocated due emphasis
on COQ.

REDUCING COSTS

Reduction of Prevention Cost

Prevention cost has to be incurred. Every preventive activity should have been pre-planned to avoid
wastes during the process. Periodically, the senior management should devote time to prevent problems from
occurring. The establishment of a Quality System in every organization calls for the preparation of a quality
manual and a set of procedures. Even the documented quality system should have been planned with a vision.
If a documented set of policies and procedures already exist for an organization, the employees should strictly
adhere to the same. Prevention cost means expenditure. While the organization should not hesitate to improve
the processes and reduce the waste through prevention, the prevention activity itself should be carried out
without wastes.

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Progressive Reduction of Appraisal Costs

Inspection is essential before assessing a new vendor, a new process or a new product line. Inspection
generates a lot of information. This information should be utilized skilfully by the organization to reduce future
costs. For instance, for a new vendor who is already qualified, the organization may start with 100 per cent
inspection; with experience this could be reduced to a sampling inspection. With the increase in confidence
level, the responsibility of the inspection could be totally left to the vendor. Soon, the organization should be
looking forward to reducing the cost of inspection, at the same time encouraging the vendor to maintain and
improve the quality of his processes. The organization should try to make best use of the data available within
the organization in the form of inspection records to improve quality and reduce the need for inspection. The
inspection costs should also be reduced with the maturity of the processes.

Reduction of Failure Costs

Manufacturing or delivery of a product or a service with defects is a total waste. Everything should be
done right the first time and every time. There should be no occasion to reject a product or a service either at
the initial stage, the intermediate stages or, at the final stages. Right the first time will happen only if the
processes are streamlined and made effective and efficient. Every cause, which may lead to the immediate or
gradual failure of the product, should be identified and eliminated. If a system is established to measure the
process parameters and study their variations, the confidence level should go up to an extent that inspection
may be forgone. Therefore, a lot of emphasis should be given to establishing a proper system to control the
processes. Efforts should be made to control the process, which would lead to automatic control of the quality
of the output. Scraps and reworks are the biggest wastes in any organization. Any rework reduces the value of
the output. It only increases hassles and scraps, accounting and storage of which is a problem. Therefore,
systematic action should be taken to reduce the rework and the scrap by following TQM principles.

Hidden Costs

There are many costs, which cannot be identified easily. They may be defined as hidden costs. These
include customer-incurred costs, lost reputation costs and customer dissatisfaction costs. These costs can vary
and sometimes affect business. Hidden costs can be eliminated only by eliminating external failures.

JURAN’S MODEL OF OPTIMUM QUALITY COSTS

Juran’s model for quality costs is illustrated in Fig. 2.2, the quality level increases, when the number of
defects in the product or service reduces. The cost of non-conformance (failure cost) decreases as quality level
improves. The quality level increases when the cost of conformance (sum of prevention and appraisal)

OMGT 1013-Operations Management and TQM | 5

Additional Information:

The concept of quality costs is a means to quantify the total cost of quality-related defects and
deficiencies. It was first described by Armand V. Feigenbaum in a 1956 Harvard Business Article.

Feigenbaum defined the following quality cost areas:

Cost of Area Description Examples

Costs of Control Prevention Arise from efforts to keep - Quality planning
( Cost of Costs defects from occurring at all - Statistical
Conformance ) process control
- Investment in
quality-related
information
systems
- Quality training
and workforce
development
- Product design
verification
- Systems
development and
management
Appraisal Costs Arise from detecting defects - Test and
via inspection, test, audit inspection of
purchased
materials
- Acceptance
testing
- Inspection
- Testing
- Checking labor
- Set-up for test or
inspection
- Quality audits

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 - Field testing
Costs of Failure of Internal Failure Arise from defects caught - Scrap
Control ( Cost of Costs internally and dealt with by - Rework
Non-Conformance) discarding or repairing the - Material
defective items procurement
cost
External Failure Arise from defects that - Complaints in
Costs actually reach customer warranty
- Complaints out
of warranty
- Product service
- Product liability
- Product recall
- Loss of
reputation

Variants of the concept of quality costs include cost of poor quality and categorization based on account type.
Joseph M. Juran described quality costs as follows:

Cost Area Examples

Tangible Costs-Factory - Materials scrapped or junked
Accounts - Labor and burden on product scrapped or junked
- Labor, materials, and burden necessary to effect
repairs on salvageable product
- Extra operations added because of presence of
defectives
- Burden arising from excess production capacity
necessitated by defectives
- Excess inspection costs
- Investigation of causes of defects
Tangible Costs-Sales Accounts - Discount
- Customer complaints
- Charges to quality guarantee account
Intangible Costs - Delays and stoppages caused by defectives
- Customer goodwill
- Loss in morale due to friction between departments

*** END of LESSON***

REFERENCES

Textbooks

Ramasamy, Subburaj. Total Quality Management. Tata McGraw-Hill Publishing Company Limited. New Delhi

Collier, David Alan, et.al.(2020). Operations Management and Total Quality Management. Cengage Learning
Asia Pte. Ltd.

Stevenson, William J. (2018). Operations management thirteenth edition. McGraw Hill Education, 2 Penn
Plaza, New York, NY 10121.

OMGT 1013-Operations Management and TQM | 7

WARNING: No part of this E-module/LMS Content can be reproduced, or transported or shared to others without
permission from the University. Unauthorized use of the materials, other than personal learning use, will be penalized.
Please be guided accordingly.

OMGT 1013-Operations Management and TQM | 8