Final exam (covers mid sem test de topic also)

Contemporary issue (G7 presentation: Dr say Quite important, maybe got

final?? Recording can listen QNA part)

**Need to know what are the cost under each categories of costs
1. The Jati Company is a wooden door manufacturer. Recently, the company has
faced a bottleneck issue in its plant which is due to constraints in setup time. A
production manager has proposed a plan to reduce setup time at a cost of
RM80,000, resulting in 800 additional doors. The selling price per door is
RM200, direct labour costs are RM30 per door, and direct materials cost RM70
per door. Assume all units produced can be sold.
Calculate the increase in the throughput contribution as the result of the change.
Will the change be made?
Setup time is related to bottleneck issue
In throughput contribution, the assumption is that only direct material is variable cost.
Other costs are fixed cost. Throughput contribution is equal to selling price minus
variable cost only. Is a short term assumption
Assume all units can be sold. (Important assumption for throughput contribution)
(without this assumption cannot calculate throughput contribution)

Throughput per unit = Sales price – DM – DL

= 200 – 70
= RM130
Increase in throughput contribution = RM130 x 800 unit
= RM104,000
The extra cost is RM80,000 as compared with throughput cost of RM104,000,
throughput cost is higher. Yes, the change will be made because throughput
contribution is higher than setup cost by RM24,000.

Since the proposed plan to reduce setup time at a cost of RM80,000 will result in an
increase in throughput contribution of RM104,000, it would be financially beneficial
to make the change. The additional revenue generated from the additional doors will
cover the cost of the setup time reduction and result in a net positive contribution to
the company's profits.
2. Classify each of the following as internal failure costs, external failure costs,
prevention costs or appraisal costs. Why is it useful to classify quality costs in
this way?
Prevention cost: Training cost 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
Appraisal costs: Cost of raw material, work in progress, finished goods inspections
Internal failure cost: Scrap, rework, loss due to downgrades, reinspection costs, loss
due to work interruptions (non conforming products are detected prior to shipment)
External failure costs: Sales returns and allowance due to quality deficiency, warranty
cost, cancelled sales orders due to quality deficiency (non conforming product are
delivered to customers)
i. Sales commission on faulty products (External failure cost)
ii. Defective units that are scrapped (Internal failure cost)
iii. Contribution margin forgone on units scrapped (Internal failure cost)
iv. Supplier evaluation program (Prevention cost)
v. Rework on defective units (Internal failure cost)
vi. Quality inspection in the goods receiving area (Appraisal cost)
vii. Legal fees for product liability cases (External failure cost)
viii. Quality inspection during processing (Appraisal cost)
ix. Product recall (External failure cost)
x. Finished goods product testing (Appraisal cost)
xi. Quality training programs (Prevention cost) (hidden cost)
xii. Contribution margin forgone on lost future sales (External failure cost)
(known as hidden cost/opportunity cost: because it is not obvious and
unsure whether it will incur or not. This cost cannot be found in
accounting record. When have poor quality product, company assume
future sales tend to drop and incur the contribution margin.)
There are several approaches to estimate hidden cost
xiii. Engineering costs to solve problems detected during process inspection
(Internal failure cost)
Engineering cost in general (Prevention cost)
xiv. Lost time to correct production line quality problem (Internal failure
cost)
xv. Design engineering to ensure quality (Prevention cost)
xvi. Laboratory testing of products (Appraisal cost)
Classifying quality costs in this way is useful because it helps organizations
understand the relationship between 4 different categories of costs associated with
quality and identify areas where they can invest resources to prevent quality issues,
reduce failures, and improve overall quality performance. (Identify the opportunity for
cost reduction. To analyze and compare the trend of the cost over years. If
prevention cost and appraisal cost is less than internal and external failure cost, this
shows that there is a problem in the operation. This is because company wants to have
lower failure cost)
It provides a framework for analyzing the costs related to quality and making
informed decisions to optimize quality control processes.
Additionally, it helps in evaluating the effectiveness of quality improvement
initiatives by comparing the costs incurred in each category over time. (Company will
to prepare a quality cost report. Company wants to see at the end, in terms of total
cost whether it has increased or decreased. Company will then look in details to see
the category of cost. The total cost increased, where prevention and appraisal cost
increased but it doesn’t decrease the failure cost. The total cost decreased, where
prevention and appraisal decreased and as a result failure cost reduced.
The bottom line is that when increase in control cost is higher than decrease in failure
cost, it will cause total cost to increase. This means that the quality improvement
programs are not effective.
The company quality improvement program is effective if the increase in control cost
is lower than decrease in failure costs // the reduction in failure cost is higher than the
increase in control cost. There is an inverse relationship between control costs
(prevention & appraisal) and failure cost (internal & external)

3. Table below belongs to Larry Company. It shows information relating to quality

costs as they relate to sales for the past five years:
Year Prevention Appraisal Internal External
Failure Failure
2000 2% 3% 9% 10%

2001 3% 4% 8% 10%

2003 3% 4% 8% 9%

2004 3% 3% 7% 9%

2005 4% 3% 6% 8%

Larry has plotted the data on a multiple-period trend graph as follows:

Required:
1) In which quality cost areas does the company appear to be doing better?
Prevention cost: because the percentage of the prevention cost has increased over the
years, this shows that the company is spending more resources to prevent the quality
problem
Internal failure cost: because the percentage has decreased over the years, this shows
that the company has successful in reducing the cost regarding the internal failure
2) List a possible explanation for the improvements suggested in 1) above.
Prevention cost: because the company has included some training so that the
employees can do properly for the products. Because the company has conduct survey
to collect customers’ feedback as well as market survey to understand customers’
needs. Company can act accordingly to address potential quality issues.
Internal failure cost: company has improved their process such as changes in
operation process, technology advancement
3) What is the potential significance of a decrease in external failure costs?
External failure costs refer to costs incurred due to quality problems that occur after
the product or service has been delivered to the customer. A decrease in external
failure costs suggests that the company has been successful in reducing customer
complaints, returns, warranty claims, or other issues that result in additional expenses
or damage to the company's reputation. This improvement can lead to increased
customer satisfaction, repeat business, which can ultimately contribute to higher sales
and profitability. It also indicates that the company has been able to address and
resolve quality issues before they reach the customer, potentially saving costs
associated with product recalls, legal actions, or customer dissatisfaction.
Decrease in external failure cost because the company may have a good relationship
with suppliers. The suppliers might be supplying good quality materials needed to
produce the products. As a result, the customers satisfaction has improved and the
warranty and product liability costs is reduced.
Improve the customer satisfaction
Warranty cost is reduced
Quality had been improved
Gain competitive advantage

4. The management of Saudagar Company believes that its total costs of quality can
be reduced if the firm increases expenditures in certain key costs of quality categories.
Management has identified the following costs of quality
Cost of Quality Costs (RM)

Rework 8,000

Recalls 17,000

Reengineering efforts 11,000

Repair 14,000

Replacements 14,000

Retesting 7,000

Supervision 20,000

Scrap 11,000

Training 17,000

Testing of incoming materials 9,000

Inspection of work in process 20,000

Downtime 12,000

Product liability insurance 11,000

Quality audits 7,000

Continuous improvement 3,000

Warranty repairs 17,000

Required:

a. Classify these costs into cost of quality categories and determine the
total dollars being spent on each category.
 RM
Prevention cost
Reengineering efforts (usually is prevention cost) 11,000
Training 17,000
Continuous improvement 3,000
31,000
Appraisal cost
Supervision 20,000
Testing of incoming materials 9,000
Inspection of work in process 20,000
Quality audits 7,000
56,000
Internal failure cost
Rework 8,000
Repair 14,000
Retesting (usually after do rework then retest) 7,000
Scrap 11,000
Downtime 12,000
52,000
External failure cost
Recalls 17,000
Replacement 14,000
Product liability insurance 11,000
Warranty repairs 17,000
59,000

b. Based on the company’s expenditures by cost of quality categories, on

which cost category should the company concentrate its efforts to
decrease its overall costs of quality? Explain.

Company should concentrate on control cost (prevention and appraisal) so that it can
see the reduction in external and internal failure costs.

By focusing on reducing these failure costs, the company can make substantial
improvements in its overall costs of quality. Implementing measures to prevent
defects and failures, improving quality control processes, enhancing product design
and manufacturing practices, and addressing the root causes of quality issues can help
in minimizing internal and external failure costs.
5. Analysis shows that Kenari Bhd incurred the following five-year gross margin and
cost histories to serve customer number 123. (Related to managing customer – is part
of Customer Profitability Analysis)
Year 1 (RM) Year 2 Year 2 Year 4 Year 5
(RM) (RM) (RM) (RM)
Gross 602,000 638,000 636,000 652,000 670,000
margin
Cost of 6,600 12,120 7,000 7,200 80,250
engineering
changes
Special 66,200 73,360 82,600 78,100 80,400
packaging

Required:
a. Prepare a trend analysis (in terms of percentages of gross margin) for
these two customer-related costs.
Year Trend % (Cost/Gross Margin x 100%)
Cost of engineering changes Special packaging
1 1.096 10.997
2 1.810 11.498
3 1.101 12.987
4 1.104 11.979
5 11.978 12.00

b. What different conclusions might management draw about the behavior

of these two costs (recording)
From the trend analysis, management might draw the following conclusions about the
behavior of these two costs:
Cost of Engineering Changes: The cost of engineering changes shows a fluctuating
pattern over the five years. The percentage of the cost of engineering changes relative
to the gross margin has increased significantly in Year 5, reaching 11.97%. This
indicates a notable deviation from the previous years' percentages, which ranged from
1.096% to 1.810%. In year 5, there was sudden spike in engineering changes. This is a
worrying situation for the company. Further investigations for engineering cost must
be made by the company in year 5 to know what went wrong for this cost.
Understanding the reasons behind this increase, evaluating the effectiveness of the
engineering change processes, and identifying opportunities for cost reduction or
process improvement can help mitigate the impact on the company's gross margin.

Special Packaging: The cost of special packaging demonstrates a more stable

behavior. The percentage of special packaging costs relative to the gross margin has
shown some variability over the five years, ranging from 10.997% to 12%. This
indicates that the proportion of special packaging costs to the gross margin has
experienced fluctuations but has not shown a significant increase or decrease over the
years. The cost incurred for 5 years is quite consistent and stable. However, the
special packaging cost is higher than engineering changes cost. Company may need to
investigate in special packaging cost to know the reason of the high special packaging
cost is incurred. Company should continue monitoring and analyzing the special
packaging costs to identify any underlying trends or patterns that whether the cost can
be cut down. They need to analyze the type of packaging giving to customer and the
worthiness to spend this kind of expenses. This is because the cost is huge (12%) and
it may affect the profit.

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