Question 2

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 has his staff assemble the following information from the past year, 20X1:

a. Sales revenue, R37 240 000; net income, R4 000 000.

b. During the year, customers returned 40 000 units needing repair. Repair cost averages R9 per unit.

c. Twelve inspectors are employed, each earning an annual salary of R80 000. The inspectors are involved only with final inspection (product acceptance).

d. Total scrap is 200 000 units. Of this total, ninety percent is quality related. The cost of scrap is about R10 per unit.

e. 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 R1.80 per unit.

f. A customer cancelled an order that would have increased profits by R600 000. The customers reason for cancellation was poor product performance.

g. The company employs 10 full-time employees in its complaints department. Each earns R48 600 per annum.

h. The company gave sales allowances totaling R180 000 due to substandard products being sent to the customer.

i. The company requires all new employees to take its 4-hour quality training program. The estimated annual cost of the program is R120 000.

Required:

2.1 Prepare a simple quality cost report classifying costs by category.

2.2 Calculate the quality cost-sales ratio. Also, compare total quality costs with total profits. Should Dana be concerned with the level of quality costs?