Benefits Of Coq Information To Management Accounting Essay

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Introduction

In this tough economic climate delivering quality to its customers is regarded as a critical success factor to attain a long term competitive advantage for both service and manufacturing industry. According to Schiffauerova & Thompson (2006) to deliver value and increase customer satisfaction, improvement in product quality is regarded as one of the best ways, while reducing your manufacturing cost and increasing productivity.

According to Feigenbaum (2008) development in technology has made the world smaller than ever before. Companies are realising that to survive in this competitive environment, expansion of their business is a crucial factor. As these companies aim to extend the scope of their business globally a challenge is faced by corporate quality leaders to maintain and sustain quality of their product/services over long run.

The challenge according to Schiffauerova & Thompson (2006) refers to the fact that any attempt to maintain or improve quality has a cost attached to it. So the companies not only face a challenge of achieving quality , but achieving it at the minimum of expenditure as well, which according to Feigenbaum (2008) makes it ever so important for companies to identify and measure these costs. A study conducted has revealed that quality costs range between 4% and 25% of revenue (Porter and Rayner, 1992). Another study by Abed and Dale (1987) showed similar result.

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But the process of identifying and measuring these costs is not simple or straight forward. Various definitions and many models have been proposed by quality "gurus" to simplify the process. In fact the literature goes as far as the 1931 when the term was coined by Shewhart (1931), then significantly improved upon by Juran (1951), Feiganbaum (1957) and many others since.

Influence of other Gurus on quality such as W.Edward Deaming, Phil Crosby, and Joseph. M Juran has helped create recognition of the fact that identifying these costs and managing them is a sure short way of achieving a sustainable long term competitive advantage.

Many models have used the parameter of quality cost in different terms. It could also be linked to the activity based cost (ABC). When we talk of quality management, it could vary from a casual inspection' to TQM and then to more complicated process like six sigma.

What is Costs of Quality

Costs of Quality (CoQ) have been described as the cost that is linked with producing defective product/service (Groocock, 1974). Crosby (1979) referred to these costs as expenditures that have to incur upon as a consequence of failure for not producing goods and services right. Crosby (1979) argue that 'Quality is free' whereas other consider it to be investment which is sure to pay off a healthy dividend in long run. This is one investment that is essential for a firm these days to maintain sustainability in the competitive environment like that of today. It is a well understood fact today that investing in quality will lead to its improvement through less re-work which means fewer delays which in turn leads to saving time, raw material and extra labour cost. But the process itself is not as simple as it sounds. Identifying errors and correcting them do cost as well and calculating this cost and managing it is a challenge in itself as there has been no general agreement on the quality costs till date.

Juran (1951) said that if the quality costs are known they can be reduced, which will help reduce many other related costs as well.

The definition was expanded further in the 1990s with the idea by Dale and Plunkett (1991) who said that to design, implement operate and maintain a quality management system would require a cost, which should be regarded as quality costs. Definition encourage to include all the costs that are incurred in non value adding activities that have to be carried out in order to achieve customer satisfaction whether it's a manufacturing or service industry. So the definition suggests that poor quality can also result in loss of customer which is an indirect cost in itself .Though it's not possible to calculate this cost

Additionally other costs to be included were the related costs that were incurred as a result of the continuous process of improvement for achieving a quality product and service like that of system breakdown and maintenance. The idea was to create a more comprehensive definition of CoQ.

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Going into recent times, this concept has changed a little. A more recent definition by the American Society of Quality (ASQ), cited in July/August 2010 issue of Industrial Management has described these costs as the losses that have to be bared for not producing a quality product/service .

Therefore CoQ refers to the sum of both the costs, for producing product/service that meet the optimum standard and the costs that are the result of not producing the optimum standard product.

Feigenbaum (2001) divided these costs into two groups: Cost of control which consists of all expenditures that make sure that specifications are met, whereas Cost of failure refers to the costs that have to be included as a result of product not meeting specifications.

Measuring the Costs of Quality (Models)

According to Harrington (1999), it was Feigenbaum in 1943 that first came up with the idea of cost analysis when he developed a reporting system to analyse quality cost based on monetary terms. On the other hand, it was Juran (1951) who introduced the concept of "economics of quality" and represented it in graphical form. A Study conducted by Porter and Rayner (1992) revealed that principles of CoQ approach as proposed by Juran and Feigenbaum had been put into practice by the American Society for Quality Control (ASQC,1970)

Approaches to Measuring the Cost of Quality

Prevention-Appraisal-Failure (P-A-F)

According to Harrington (1999) it was Feigenbaum that came up with this categorisation of quality costs that has formed the basis of P-A-F model.Developing on this work, Harrington (1999) summarised the categorisation in to the following:

Prevention costs

Appraisal costs

Internal failure costs

External failure costs

According to Tsai (1998) to calculate total cost of quality it is requires identify quality cost elements under these categories identified by Feigenbaum. A detailed listing of these quality cost elements have been devised in ASQC (1974).

According to Dale and Plunkett (1991) techniques like Fishbone diagram and Pareto analysis can also be used with great effect in identifying these cost elements.

Systematic measurement of these costs according to Feigenbaum (2008) leads to a systematic management of quality costs which allows the companies to compete on basis of cost leadership and provide the customer with value that keeps them satisfied. This was also argued to help companies to achieve a true cost management.

According to Harrington (1999), Feigenbaum's work has been expanded to such a level that it has now become a significant management tool. Feigenbaum (2008) himself argued that the importance of his approach is based on economics of quality cost which has been identified prime component of Total Quality Management (TQM). According to Feigenbaum (2008) TQM helps companies to attain competitive advantage by managing and measuring the economies of quality.

According to Dale & Plunkett P-A_F approach has been found to be at the heart of many costs of quality models. Moen (1998) countered by saying that the approach was outdated and had its shortcomings. A study by Porter and Rayner (1992 cited in Tsai 1998) criticising PAF approach as incapable of classifying activities of a well managed company in different categories. Drawbacks such as not including the losses that have been caused due to loss of goodwill have been a major source of criticism. Authors have even described PAF model to be limited in its use to TQM approach as it does not include process cost which is at the centre of TQM.

Various other authors (Fox, 1989; Price, 1984) have been cited by Schiffauerova & Thompson (2006) challenging the model of having no economic level of quality. It has been argued that expenditure incurred during prevention could not always be justified and optimum level does not always equal zero-defect.

Crosby's Model

Crosby (1965) developed a model that was aimed at demonstrating a relation between measurement and prevention as a source of achieving improvement. According to Harrington (1999), Crosby divided quality costs in four different categories at that time:

Rework cost

Scrap cost

Warranty cost

Quality control labour.

Crosby (1974) categorised quality costs into cost of conformance and cost of non-conformance. Crosby (1984) further divided these into tangible and intangible, and controllable and uncontrollable costs.

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Figure 1: CoQ classification of Crosby's model adapted from ISIXSIGMA

Crosby (1995) brought in the concept of (DIRFT) that is do it right the first time. It was emphasized that the quality cost increase when an activity has not been done right the first time. This could lead to redoing it so that failures can be covered up (Parker 1995). This leads to additional cost. Redelivering and re costing thus effect the firms efficiency. This is one failure that the firms do not want today in the recession times.

According to Dale (1999), Crosby's definition of CoQ referred to the sum of these costs, which were addressed as total quality costs. He further believed that Crosby's approach did not comply with optimum level concept as the one that Crosby (1979) promoted, which was the idea that higher quality would lower the costs and increase profits. Though Crosby's model of doing the thing right and doing it wrong provided the world of quality management with an approach that was easy to adopt and was an alternative to PAF approach.

Process Cost Method

This model according to Schiffauerova & Thompson (2006) was first developed by Ross in 1977 and was put in to use for quality costing by Marsh in 1989. It is considered as one of the first system that shifted the focus from product onto the process of how the good or service is produced.

According to British standard (BS6143: Part 1, 1992) process cost had been identified as "the total of cost of conformance (CoC) and the cost of non-conformance (CoNC) for a particular process".

Tsai (1998) states that purpose of developing process cost model was to list all major activities during the process by developing a flowchart of the process, and calculating CoQ by allocating these activities as CoC and CoNC.

According to Oakland (1993) the process cost model helps to identify the main areas where process needs improvement and finally helps to reduce CoNC by helping to redesign the process.

Porter and Rayner (1992) regarded this process to be at the heart of quality costing in TQM. According to them the model provides more in-depth analysis of quality costs as compared to P-A-F approach by acknowledging the significance of process cost.

According to Hwang and Spinwall (1996) Model has been criticised as more time consuming as compared to PAF approach because there is a risk of duplication of inter linked activities within a company.

The New Approach to Cost of Quality

Traditional CoQ models are criticised by many authors as being difficult to apply outside of manufacturing industry. For instance it is not easy to estimate scrap and waste in service industry (Dale and Plunkett, 1999) whereas in manufacturing those are tangible products.

Montgomery (1996) referred to CoQ models as a mere scorekeeping tool rather than a catalyst to the process of continuous improvement. Models have been criticised for ignoring to trace the source of quality costs, which if traced can provide an opportunity for further improvement in quality.

Cooper and Kaplan(1988) provided a breakthrough to override these shortcomings of traditional Cost of quality approach. According to Mourlas et al (2009) failure of traditional cost of quality approach to distribute overhead cost equally over product will not really have its affect conventional manufacturing because the ratio of overhead cost as compared to production cost is quiet small. However due to automation and computerisation this ratio increases which makes it more important to distribute this cost equally over product.

To improve accuracy of this calculation and to improve the overall process Cooper and Kaplan (1988) identified the application of ABC as the right approach to be deployed in such situations.

The process to use ABC for the purpose of improving business is termed as Activity based management (ABM) (Turnkey, 1991). He further suggests ABM as a way to improve profit by providing value to the customer by focusing on management of activities.

Early ABC model have been criticised by Mourlas et al (2009) for falling to provide enough information about the activities and for not considering the costs that were incurred upon outside the manufacturing environment.

Therefore a Integrated COQ-ABC framework was suggested by Tsai (1998) so that it could overcome the deficiencies of both COQ and ABC approach. He further proposed that both approaches should be merged. It was also suggested by the author to merge the accounting system of the company within the integrated framework of ABC-COQ so that the information and the cost can be shared. It was further outlined that sharing the data base would generate information that will be beneficial for management tools like ABM and TQM .The ultimate goal that he the system aimed at achieving is the 'zero defect' so that there is continuous improvement and there is no need to measure quality costs.

Benefits of COQ Information to management:

Advantages of COQ information as identified by Dale and Plunkett (1991) can be summarised as following:

It helps management justify the investment required for quality improvement. The core purpose of a quality improvement process is to reduce the cost of Poor quality.

Processes like ABC will help management to classify those activities that are largely expensive, so that management can improve upon them.

Secondly, it can also help the management to spot the exact areas where there is a room for improvement by tracing the source of quality costs.

Thirdly , it can help management design a implement a programme to improve quality .According to Sharman PAF approach and Process cost approach are suitable for this purpose. Though this process helps to improve quality over long run , it should be noted that it is not of great importance in day to day use (Tsai 1998)

And last but not least to control quality costs. According to Turnkey connecting computerised manufacturing with ABC can help produce the reports that can help spot the areas that have quality problems and have the biggest impact on cost.

This process can also help to identify the products or services that have biggest impact on cost of poor quality.

However according to Morlaus et al (2009) literature does not provide with enough evidence on consensus on benefits of applying COQ approach. According to authors Deaming recognises Cost of quality analysis as waste of time. According to him achieving optimum defect by measuring quality costs is a failure to understand the root cause of problem.

There are many indicators which tell you that the quality is not up to the mark. One could be the consumer's complaint. Cost of quality will be maximum in the "Complaints Departments". As Deming (2000) rightly states the barriers among departments should be broken in the company. All should work towards quality. This is because the cost of quality can be contributed to different department's activities and process. This makes the cost of quality calculation better. Each department has its own benchmark for quality. Thus it can be seen very clearly as to which is the problem area in the company. When one department does not meet the benchmark it increase cost of quality ,then the effort on the Contact (Service) Centres and then re-doing the things correctly along with the task of getting them fixed is huge (Harrington 1987). Thus even the costing needs a proper quality planning

Importance of COQ in TQM

According to Dale and Plunkett (1991) strategic importance of TQM has been widely accepted by organisations in western world. It has been accepted widely that implementing TQM will help companies attain competitive advantage in home and international markets. Authors further believe that for a company to survive, it has to achieve major reduction in the cost of producing or delivering quality product or service. COQ approach has been suggested as the stepping stone to starting the process of TQM by Feigenbaum (2008). According to him TQM provides a systematic foundation for companies to convert management and reduction of quality costs in to a sustainable competitive advantage. According to Hwang (1996) COQ approach helps to bridge communication barrier between top management and front line work force as COQ is expressed in monetary terms which are better understood by both. According to Macmanus and Hutchinson (1996) Importance of quality cost in TQM is similar to opportunity in financial management.

According to Dale and Plunkett (1991) task of quality costing is not as easy as it seems. Just having a necessary mechanism for their collection is not enough. He further suggests that senior management needs to have the will to carry out costing and implement it as permanent feature in their drive for continuous improvement.

Conclusion

To compete and survive an organisation has to maintain and improve quality, which has a cost attached to it. It becomes a necessary that organisations measure these costs and manage then so that quality can be improved at the lowest of cost.

To classify quality costs a number of models have been proposed and various definitions have been suggested, though there is no agreement among the various academics and practitioners of quality over them.COQ has commonly been understood as Cost of Conformance plus the Cost of non conformance.

Cost of quality has been reported to provide its benefits at both operational and management level. At operational level it has been identified as helpful in monitoring project improvement by identifying the activities which require major rework.

At management level it helps managers quantify quality in monetary terms which is understood well across the board, which provides them with the justification of investment made to improve quality.

P-A-F model has been identified as the most commonly used model across the globe. However it has been recognised as more of a cost categorisation method. P-A-F model has been known to be limited when it comes to its usefulness in TQM, as process approach is needed to implement TQM.

Process Cost approach has been considered as substitute to P-A-F approach, as the purpose of this approach is to quantify cost of quality by focusing on processes. The approach has been regarded as a perfect fit with TQM, as the process cost model is itself a initiator of the process of improvement.

ABC costing approach has been identified a activity oriented method for measuring cost of quality, that includes the overhead cost as well. Implications of this approach own its own have been known to be limited. Therefore an integrated COQ-ABC method was proposed by Kaplan and Cooper to over these limitations significantly.

Though literature provides with enough evidence of importance and benefits of cost of quality approach and its uses research studies conducted confirm that COQ approach is not widely used in real world. A lot of work and effort is required by quality academics and practitioners to raise awareness among future managers.