7/28/2019 Quality Costs.doc

1/3

Quality CostsQuality is the total features and characteristics of a product/servicemade/performed according to specifications to satisfy customers at thetime of purchase and during use.

Costs of quality are costs incurred to prevent or the cost arising as aresult of, producing a low quality product. Such costs are categorisedinto prevention costs, quality appraisal (detection) costs, internalfailure costs and external failure costs.

Prevention CostsPrevention costs are incurred to prevent defects and other qualityproblems/to preclude the production of goods that do into conform tospecifications.

Quality Appraisal (Detection) Costs

Quality appraisal costs are incurred to detect which individual unit of aproduct does not conform to specifications.

Internal Failure CostsThese costs are incurred as a result of the appraisal activities. Theseare incurred on a defective product before it is despatched tocustomers.

External Failure CostsExternal failure costs are costs of making things right when a qualityproblem has occurred after the product has been delivered to the

customer.

Quality Costs IllustratedStep 1: Identify the Chosen Product.Step 2: Select Cost-Allocation Base for Allocating Indirect Costs ofQuality.Step 3: Identify Indirect Costs Associated With Each Cost-AllocationBase.Step 4: Compute the Rate Per Unit of Each Cost Allocation Base Usedto Allocate Indirect Costs of Quality to Product.Step 5: Compute the Indirect Costs of Quality Allocated to the Product.

Step 6: Compute the Total Costs of Quality by Adding All Costs ofQuality Assigned to the Product. This is shown in Column 5 of Exhibit 1.

Non-Financial Measures of Quality and Customer SatisfactionFinancial measures of quality focus on the short-run. Non-financialmeasures indicate the future needs and preferences of customers aswell as the specific areasthat need improvement.

7/28/2019 Quality Costs.doc

2/3

The non-financial measures of customer satisfaction, inter-alia, includethe following:

Market research information on customerpreferences/satisfaction with specific product features.

Number of defective units delivered to customers as percentageof total units delivered.

Number of customer complaints.

Percentage of products that fail soon/often.

Delivery delays in terms of differences between the scheduleddelivery date and the date requested by the customers.

On-time delivery rate (i.e. percentage of delivery made on/beforethe scheduled delivery date).

Surveys to measure customer satisfaction.

Target CostingTarget costing is an integrated approach to determine product

features, product price, product cost and product design that helpsensure a companywill earn reasonable profit on new products.

Target cost is the cost of resources that should be consumed to createa product that can be sold at a target price.

Target Costing ProcessA target price is the estimated price for a product/service that potentialcustomers will pay.Target Cost = Target price Profit margin.

Target PriceTarget price is the estimated price for a product/service that potentialcustomers will pay.

Target Operating Income Per UnitTarget operating income per unit is the operating income that acompany aims to earn per unit of a product/service sold.

Target Cost Per UnitTarget cost per unit is the estimated long-run cost per unit of aproduct/service that enables the company to achieves its targetoperating income per unit when selling at the target price.

Four components of target costing process(1) Planning and market analysis

7/28/2019 Quality Costs.doc

3/3

(2) Development(3) Production design(4) Production and continuous improvement.