The document discusses concepts related to quality management and the value chain. It defines the four components of the cost of quality as prevention costs, appraisal costs, internal failure costs, and external failure costs. The goal of quality management is to minimize all four cost categories and achieve zero defects. Total quality management aims to shift costs from internal and external failure categories to prevention and appraisal over time through continuous improvement. An example shows how measuring and reporting quality costs as a percentage of sales can help identify opportunities to reduce costs and improve quality.

1. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Costing and the
Value Chain
Chapter
18

2. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
R & D
and
Design
Suppliers
and
Production
Distribution
and
Marketing
Customer
Service
The value chain is the set of activities and
resources necessary to create and deliver
products and services valued by customers.
The value chain is the set of activities and
resources necessary to create and deliver
products and services valued by customers.
The Value Chain—Focus
on Core Operations
The Value Chain—Focus
on Core Operations

3. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Non-value-added activities add cost without
additional desirability, and can be eliminated
without reducing quality or performance.
Value-added activities add to product or service
desirability in customers’ eyes.
Identify Eliminate
Non-value-
added
activities
Value and Non-value-Added
Activities
Value and Non-value-Added
Activities

4. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Analysis and
Classification
Activities
Value and Non-value-Added
Activities
Value and Non-value-Added
Activities
Non-value-
Added
Activities
Reduce or
Eliminate
Value-
Added
Activities
Continually Evaluate
and Improve

5. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Examples of non-value-
added activities are:
Storage of materials,
work-in-process, or
finished goods.
Moving parts and
materials in the
factory.
Waiting for work.
Inspection.
Get rid
of them!
Non-value-Added ActivitiesNon-value-Added Activities

6. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
What’s the difference between
activity-based costing and
activity-based management?
Activity-Based Management —
Drive Out Costs
Activity-Based Management —
Drive Out Costs

7. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Activity-based management
focuses on managing
activities to reduce costs.
Activity-based costing
establishes relationships
between overhead
costs and activities.
Activity-Based Management —
Drive Out Costs
Activity-Based Management —
Drive Out Costs

8. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Analyze
activities
Collect
benchmark
information
Determine
cost per unit
of activity
Identify
activity
measures
Create
cost
pools
Identify
activities
Activity-based costing
Activity-based management
ABC: a Subset of
Activity-Based Management
ABC: a Subset of
Activity-Based Management

9. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Chart activities needed
to meet customer
expectations.
Use ABC to determine
cost of activities.
Classify all activities
as value-added
or non-value-added.
Improve value-added
activities and eliminate
non-value-added activities.
Activity-Based Management
and the Value Chain
Activity-Based Management
and the Value Chain

10. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Let’s move
along to a
new topic.
The Target Costing Process —
Creating Customer Satisfaction
The Target Costing Process —
Creating Customer Satisfaction

11. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Focused
on design.
Consideration
given to the
entire
value chain.
Focused
simultaneously
on profit and
cost planning.
Driven by the
customer.
Target costing is aimed at the earliest stages
of new product and service development.
The Target Costing Process —
Creating Customer Satisfaction
The Target Costing Process —
Creating Customer Satisfaction

12. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Concept
development
Planning
and market
analysis
Production
design and
value
engineering
Production
and
continuous
improvement
Target
price
Profit
margin
Target
cost
Establishing the
Target Price
Attaining the
Target Cost
The Target Costing ProcessThe Target Costing Process

13. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Price
Major Influences on Target PricingMajor Influences on Target Pricing

14. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Develop products
that satisfy
customer needs.
Set target price using
competitors’ prices and
customers’ perceived
value for product.
 Target price
– Profit margin
= Target cost
Use value engineering
to find least costly
combination of resources
to meet customer needs.
Developing target prices and target
costs requires four steps:
Developing target prices and target
costs requires four steps:
Components of the
Target Costing Process
Components of the
Target Costing Process

15. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Life-
cycle
costing
Research,
design, and
development
ProductionMarketing
Product
discontinued
and customer
support ends
Life-Cycle Product
Costing and Pricing
Life-Cycle Product
Costing and Pricing

16. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Pricing must
generate revenue
to cover costs
of all phases
of product
life cycle.
Research,
design, and
development
ProductionMarketing
Product
discontinued
and customer
support ends
Life-Cycle Product
Costing and Pricing
Life-Cycle Product
Costing and Pricing

17. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Involve entire value
chain in reducing
costs while satisfying
customer needs.
An understanding of
relationships between
process components
and costs is critical.
A product’s functional characteristics to the
customer are emphasized.
A primary
objective is reducing
development time.
ABC is used to
determine changes
that will reduce costs.
Characteristics of
Target Costing Processes
Characteristics of
Target Costing Processes

18. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Let’s move
along to
another
topic.
Just-in-time (JIT)
Inventory Procedures
Just-in-time (JIT)
Inventory Procedures

19. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Complete products
just in time to
ship to customers.
Complete parts
just in time for
assembly into products.
Schedule
production.
Receive
customer
orders.
Receive materials
just in time for
production.
Just-In-Time (JIT) InventoryJust-In-Time (JIT) Inventory

20. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Less warehouse
space needed
Reduced
inventory
carrying costs
Reduced risk
of obsolete
inventory
With reduced inventories, quality must
be emphasized to avoid production
delays and late deliveries.
Relationship Between JIT and
Total Quality Management (TQM)
Relationship Between JIT and
Total Quality Management (TQM)

21. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
More rapid
response to
customer orders
Greater
customer
satisfaction
Higher quality
products
Less warehouse
space needed
Reduced
inventory
carrying costs
Reduced risk
of obsolete
inventory
Relationship Between JIT and
Total Quality Management (TQM)
Relationship Between JIT and
Total Quality Management (TQM)

22. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
 A limited number of suppliers who will
make on-time deliveries of quality
materials.
 Quality that is “designed-in” and
“manufactured-in” rather than
“inspected-out”.
 A well-trained flexible work force.
 An efficient plant layout.
Successful implementation of a JIT system requires:
JIT, Supplier Relationships,
and Product Quality
JIT, Supplier Relationships,
and Product Quality

23. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Manufacturing Cycle Time
Process Time + Inspection Time +
Storage and Waiting Time + Move Time
ProductionS
tarted
Goods
Shipped
Only the process time is value-added time.
Measures of Efficiency
in a JIT System
Measures of Efficiency
in a JIT System

24. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Manufacturing Cycle Time
Process Time + Inspection Time +
Storage and Waiting Time + Move Time
ProductionS
tarted
Goods
Shipped
Manufacturing
Efficiency
Ratio
Value-added time
Manufacturing cycle time
=
Measures of Efficiency
in a JIT System
Measures of Efficiency
in a JIT System

25. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
If cycle
time
goes up,
costs may
go up, and
service and
quality may
go down.
Measures of Efficiency
in a JIT System
Measures of Efficiency
in a JIT System

26. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Let’s move
to the last
topic in
the chapter.
Total Quality Management
and the Value Chain
Total Quality Management
and the Value Chain

27. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Greater
customer
satisfaction
Quality
products
and
services
Increased
business
volume
Why is Quality Important?Why is Quality Important?

28. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
 Prevention costs
 Inspection of materials upon delivery
 Inspection of production process
 Equipment inspection
 Employee training
 Appraisal costs
 Finished goods inspection
 Field testing of products
 Prevention costs
 Inspection of materials upon delivery
 Inspection of production process
 Equipment inspection
 Employee training
 Appraisal costs
 Finished goods inspection
 Field testing of products
Components of the Cost of QualityComponents of the Cost of Quality

29. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
 Internal failure costs – defects discovered
before delivery to customers
 Scrap materials
 Rework
 Reinspection of rework
 Lost sales resulting
from late deliveries
 Internal failure costs – defects discovered
before delivery to customers
 Scrap materials
 Rework
 Reinspection of rework
 Lost sales resulting
from late deliveries
Cost
Report
Components of the Cost of QualityComponents of the Cost of Quality

30. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
 External failure costs – defects discovered
after delivery to customers
 Warranty repairs
 Product liability
 Marketing costs to
improve product image
 Lost sales due to poor
product quality
 External failure costs – defects discovered
after delivery to customers
 Warranty repairs
 Product liability
 Marketing costs to
improve product image
 Lost sales due to poor
product quality
Components of the Cost of QualityComponents of the Cost of Quality

31. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Cost of
prevention
and appraisal
Internal
and external
failure costs
Components of the Cost of QualityComponents of the Cost of Quality

32. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Cost of
prevention
and appraisal
Internal
and external
failure costs
Ultimate Objective:
Zero defects
while minimizing
all four quality
cost categories.
Components of the Cost of QualityComponents of the Cost of Quality

33. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Prevention
and Appraisal
External and
Internal Failure Total Cost
of Quality
Low Quality High Quality
CostofQuality
Direction of
recent trend
in industry.
Components of the Cost of QualityComponents of the Cost of Quality

34. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Measuring and Reporting the Cost of Quality
Amount Total % of Sales
Prevention Costs:
Training 12,000$
Maintenance 10,000
Quality planning 8,000 30,000$ 3.2%
Appraisal Costs:
Material inspections 6,000
Equipment inspections 2,000
Supplier relations 4,000
Testing 5,000 17,000 1.8%
Internal Failure Costs:
Rework 5,000
Downtime 7,000
Scrap 8,000 20,000 2.1%
External Failure Costs
Warranty 4,500
Lost sales 20,000
Repairs 6,500 31,000 3.3%
Total 98,000$ 10.4%

35. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
 Traditional managerial
accounting systems may
emphasize production
quotas and cost
minimization.
 Managers often find that
emphasis on quality also
increases productivity.
Productivity and QualityProductivity and Quality

36. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
I’m managing some
quality time in a
value-added activity.
End of Chapter 18End of Chapter 18