Quality Cost Summary

Danna Wise, president of Tidwell Company, recently returned from a conference on quality and productivity. At the conference, she was told that many American firms have quality costs totaling 20 to 30% of sales. The quality experts at the conference convinced her that a company could increase its profitability by improving quality. However, she was of the opinion that the quality of Tidwell Company was much less than 20%probably more in the 4 to 6% range. However, because the potential for increasing profits was so great if she was wrong, she decided to request a preliminary estimate of the total quality costs currently being incurred. She asked her controller for a summary of quality costs, with the costs classified into four categories: prevention, appraisal, internal failure, or external failure. She also wanted the costs expressed as a percentage of both sales and profits. The controller had his staff assemble the following information from the past year, 20X1:

1. Sales revenue, $37,240,000; net income, $4,000,000.
2. During the year, customers returned 40,000 units needing repair. Repair cost averages $9 per unit.
3. Twelve inspectors are employed, each earning an annual salary of $80,000. The inspectors are involved only with final inspection (product acceptance).
4. Total scrap is 200,000 units. Of this total, ninety percent is quality related. The cost of scrap is about $10 per unit.
5. Each year, approximately 800,000 units are rejected in final inspection. Of these units, seventy-five percent can be recovered through rework. The cost of rework is $1.80 per unit.
6. A customer cancelled an order that would have increased profits by $600,000. The customers reason for cancellation was poor product performance.
7. The company employs 10 full-time employees in its complaint department. Each earns $48,600 a year.
8. The company gave sales allowances totaling $180,000 due to substandard products being sent to the customer.
9. The company requires all new employees to take its 4-hour quality training program. The estimated annual cost of the program is $120,000.

Prepare a simple quality cost report classifying costs by category. Round percentage values to two decimal places.

Tidwell Company Quality Cost Report For the Year Ended 20X1

Percentage of Sales Quality Costs Prevention costs: Appraisal costs: Internal failure costs: External failure costs: Total quality costs 2. Compute the quality cost-sales ratio. Also, compare the total quality costs with total profits. Round the answer to two decimal places. Cost-sales ratio Cost-profit ratio % Although the cost-sales ratio is lower than the 20 to 30% Danna should be concerned as the quality cost-sales ratio is 15%, and the quality costs are greater than range that many companies apparently have, there is still ample opportunity for improvement. Should Danna be concerned with the level of quality costs? 3. From the pie chart for the quality costs developed on your own paper. Determine the quality costs among the four categories. Round the answers to one decimal place. Prevention Appraisal Internal failure External failure Are they properly distributed? Explain. 1. Too much is spent on failure cost. It is a non value added cost and should be eliminated. Prevention and appraisal cost should be given much emphasis. 2. Too little is spent on failure cost. It is a value added cost should be given much emphasis. 3. All the costs are non value added cost and should be eventually eliminated. The quality cost needs to be reversed. 4. The company should increase and costs. 5. By how much will profits increase if quality costs are reduced to 3% of sales? Profits would increase by $