The second subsidiary your team visited was Lily Cars Company in Ohio, in the United States of America. Lily has been at the forefront of car production in the USA since 1990s with a current market share of 10 percent of the national market. The company's bottom-line displays a disconcerting downturn for the second successive year, the first time this has happened in a 10 year history. This relatively poor performance is largely attributable to a lack of sales revenue stemming from an inexplicable failure to win orders in competitive tenders. Furthermore, overseas competition is very fierce, especially from Korean and Japanese companies, some of which have now set up subsidiaries in the USA. Recent statistics have shown that these competitors have impressed customers with the quality of their products, their customer relationships and their reasonable prices, thus almost outperforming Lily.

Your team carried out several meetings and consultations with staff, customers and

employees and the following report was compiled by the team.

January February March April

$000 $000 $000 $000

Scrap 402 382 440 246

Quality training workshop 984 1,458 1,146 1,380

Product design review 1,248 1,044 918 1,038

Rework 3,840 3,738 3,906 2,526

Product return 1,410 1,482 572 696

Inspecting by quality control 396 432 186 138

Lost sales 940 988 748 464

Customers repair claims 288 372 378 186

Product quality audits 780 786 1,722 2,208

Defects from production 804 764 880 492

Final inspections and testing 960 966 1,146 2,082

Product liability recalls 470 494 524 232

Seminars with suppliers 0 378 0 78

Total sales 54,300 63,840 64,620 67,236

Required

A memo to the managing director after rearranging the above costs into four

categories of prevention, inspection, internal and external failure and comment on the

data they contain including any possible strengths or limitations they may have. In your

analysis discuss the benefits management can get from implementing accounting for

quality and suggests any further improvement that can be made to product quality and

the quality cost reporting system.

2. In addition, your team analysed the Slab division of Lily's subsidiary. The Slab

division converts synthetic slabs into components AX and BX for use in the car

industry. The cost of the quality management programme was $250,000. The following

information relates to the costs incurred by Slab division both before and after the

implementation of the quality management programme:

i. Synthetic slabs

Synthetic slabs cost $40 per hundred. On average 2.5 per cent of synthetic slabs received are returned to the supplier as scrap because of deterioration in stores. The supplier allows a credit of $1 per hundred slabs for such returns. In addition, on receipt in stores, checks to ensure that the slabs received conform to specification costs $14,000 per annum. A move to a just-in-time purchasing system will eliminate the holding of stocks of synthetic slabs. This has been negotiated with the supplier who will deliver slabs of guaranteed design specification for $44 per hundred units, eliminating all stockholding costs.

ii Curing/moulding process

The synthetic slabs are issued to a curing/holding process which has variable conversion costs of $20 per hundred slabs input. This process produces sub-components A and B which have the same cost structure. Losses of 10 per cent of input are incurred to the process because of incorrect temperature control during the process and are sold as scrap at $5 per hundred units. The quality programme will rectify the temperature control problem thus reducing losses to 1 per cent of input to the process.

iii. Finishing process

The finishing process has a bank of machines that perform additional operations on A and B sub-components as required and converts them into final components AX and BX respectively. The variable conversion costs in the finishing process for AX and BX are $15 and $25 per hundred units respectively. At the end of the finishing process, 15 percent of units are found to be defective. Defective units are sold for scrap at $10 per hundred units. The quality programme will convert the finishing process into two dedicated cells, one for each of component types AX and BX. The dedicated cell variable costs per hundred sub-components A and B processed will be $12 and $20 respectively. Defective units of components AX and BX are expected to fall to 2.5 per cent of the inputs to each cell. Defective components will be sold as scrap as at present.

iv. Finished goods

A finished goods stock of components AX and BX of 15 000 and 30 000 units respectively is held throughout the year in order to allow for customer demand fluctuations and free replacement of units returned by customers due to specification faults. Customer returns are currently 2.5 per cent of components delivered to customers. Variable stock holding costs are $15 per thousand component units. The proposed dedicated cell layout of the finishing process will eliminate the need to hold stocks of finished components, other than sufficient to allow for the free replacement of those found to be defective in customer hands. This stock level will be set at one month's free replacement to customers, which is estimated at 500 and 1000 units for types AX and BX respectively. Variable stockholding costs will remain at $15 per thousand component units.

v. quantitative data

Some preliminary work has already been carried out in calculating the number of units of synthetic slabs, sub- components A and B and components AX and BX that will be required both before and after the implementation of the quality management programme, making use of the information in the question. Table 1 summarizes the relevant figures: Required: Evaluate and present a statement showing the net financial benefit or loss per annum of implementing the quality management programme, using the information in the question and the data in Table 1. (All relevant workings must be shown.)