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Total quality management (TQM) ... Feb 2020 The idea is that quality is the key strategic variable in achieving strategic advantage. When a customer considers buying a product he or she is influenced in that choice of supplier by factors other than the technical specifi cation of the product – such as speed of delivery, customisation, reliability, ease of placing an order and attractiveness of design. All these are quality related factors. This is particularly relevant in the era of flexible manufacturing when products are highly customised and product life cycles are short. Customer service and product innovation have become major elements in the quality of products that are being offered. TQM is a philosophy and a movement rather than a body of techniques.

Quality Cost External failure cost There are several measurable costs of external failure to deliver a quality product: ● marketing costs associated with failed products and loss of customer go will; ● manufacturing or process engineering costs relating to failed products ● compensation/replacement for units returned by customers; ● repair costs; ● travel costs to visit sites with faulty products; ● liability claims. The cost associated with the requirement to deliver a q y product internally can be categorised under three headings: internal failure c appraisal costs and prevention costs.

Internal failure cost ● Costs of scrap ● Reworking costs ● Manufacturing and process enginee

required to correct the failed process.

Appraisal costs These are connected with m ring conformity with requirements and include. ● cost of incoming inspect (note that if suppliers adopt a total quality approach, the cost of incoming inspections can be eliminated); ● cost of set-up inspections; ● cost of acquiring and operating the process control and measuring equipment.

Prevention costs These are the costs of ensuring that defects do not occur in the fi rst place. ● Routine preventive repairs and maintenance to equipment. ● Quality training for operatives to improve skills and efficiency. ● Building of quality into the design and manufacturing processes.

Accounting for quality One feature of traditional management accounting is that it may not report the cost of quality failure and quality assurance. Poor-quality work results in costs, but those costs may be ‘ buried ’ at several points in the management accounting system and thus not be specifi cally reported. Lost customer goodwill, for example, is an opportunity costs that may have 1

no immediate impact on accounting costs and are not therefore reported through a conventional management accounting system. The adoption of a TQM approach is likely to require the provision of comprehensive cost of quality reports that are supplied on a frequent basis to all levels in the organisation. This involves identifying the costs of quality control, quality failure and quality assurance – and collecting them together for management information and reporting purposes. It is only when the costs of quality are known that the measures needed to achieve and maintain high quality can be justified.

Q1

SHG realises that its present performance reporting system does not highlight quality costs. The reports contain the information below, but the directors require this to be reported in an appropriate format. The following information is available in respect of the year ended 31 May 2011: 1. Production data: Units requiring rework 1,500 Units requiring warranty repair service 1,800 Design engineering hours 66,00 Inspection hours (manufacturing) 216 2. Cost data: Rs Design engineering cost per hour 75 Inspection cost per hour (manufacturing) 40 Rework cost per heating system unit reworked ( facturing) 3,000 Customer support cost per repaired unit (mar g) 200 Transportation costs per repaired unit (dist on) 240 Warranty repair costs per repaired unit 3,200 3. Staff training costs amounted to Rs 1 00 and additional product testing costs were Rs 49,000. 4. The marketing director has esti d that sales of 1,400 units were lost as a result of bad publicity in trade jour The average contribution per heating system unit is estimated at Rs 6,000. Required: Prepare a cost of qual port for SHG that shows its costs of quality (using appropriate headings) for the ye ded 31 May 2011. (10 marks)

Q2

CAL manufactures and sells solar panels for garden lights. Components are bought in and assembled into metal frames that are machine manufactured by CAL. There are a number of alternative suppliers of these solar panels. Some of CAL’s competitors charge a lower price, but supply lower quality panels; whereas others supply higher quality panels than CAL but for a much higher price. CAL is preparing its budgets for the coming year and has estimated that the market demand for its type of solar panels will be 100,000 units and that its share will be 20,000 units (i.e. 20% of the available market). The standard cost details of each solar panel are as follows: $ per unit Selling price 60 Bought - in components (1 set) 15 Assembly & machining cost 25 Delivery cost 5 Contribution 15 2

An analysis of CAL’s recent performance revealed that 2% of the solar panels supplied to customers were returned for free replacement, because the customer found that they were faulty. Investigation of these returned items shows that the components had been damaged when they had been assembled into the metal frame. These returned panels cannot be repaired and have no scrap value. If the supply of faulty solar panels to customers could be eliminated then, due to improved customer perception, CAL’s market share would increase to 25%. Required: (a) Explain, with reference to CAL, quality conformance costs and quality non-conformance costs and the relationship between them. (4 marks) (b) Assuming that CAL continues with its present systems and that the percentage of quality failings is as stated above: (i) Calculate, based on the budgeted figures and sales returns rate, the total relevant costs of quality for the coming year. (4 marks) (ii) Calculate the maximum saving that could be made by implementing an inspection process for the solar panels, immediately before the goods are delivered. (2 marks) Automotive Engineering (Pvt.) Limited (AEPL) is engaged in production of car lights Nov 19 for the auto industry in Pakistan. The company has achie he sales of Rs. 3,780 million with an operating margin of 16% for the year ended Ju 0, 2019. Despite having profitable business, the higher management of the company concerned about the product's non-conformity with the quality benchmark, resu n failing to meet its maximum capacity in the form of profitability and busine he following information is available for the year ended June 30, 2019: Activity Cost Data: Rupees Design engineering (per hour) 106 106 Quality engineering (per hour) 80 80 Manufacturing - Inspection (pe r) 60 60 Marketing - Customer suppo er repaired unit) 340 340 Staff training (cost per ye 80,000 980,000 Quality review(cost pe r) 1,050,000 1,050,000 Q.3

Volume and Activity ata: Production 280,000 Demand 210,000 Rework required 31,000 Warranty repair service 37,000

Units 280,000 210,000 31,000 37,000 Hours 58,000 64,000 388,000

Design engineering 58,000 Quality engineering 64,000 Manufacturing - Inspection 388,000

Additional Information: • During the year 2019, the company witnessed that 15% of the deliveries were rejected due to a fault and required free replacement. The variable cost of the product was Rs. 10,000 per unit and the cost of delivering the replaced product was Rs. 1,500 per unit. • The cost of additional acceptance testing amounted to Rs. 4,820,000. • The cost of rework (manufacturing) amounted Rs. 5,800 per unit, which includes variable costs (direct materials, direct labours and supplies) and allocated fixed costs. 3

• The Marketing Department estimated that loss of sales of 28,000 units, having average contribution of Rs. 8,000 per unit, occurred due to quality issues. During the year, the production line also experienced an unproductive downtime, which cost Rs. 700,000. • The demand and sales of the product remained same during the year. Required: (a) Prepare Cost of Quality Report for AEPL, allocating each cost to its appropriate quality cost headings, for the year ended June 30, 2019. The report should contain each cost heading as a percentage of turnover and the total cost of quality. 15 (b) Based on your answer, worked out in part (a) above, give briefly the observation on the validity of including opportunity cost in the report. 03 (c) How a Cost of Quality Report could facilitate the development and implementation of a Total Quality Management (TQM) culture at AEPL? Elucidate. 07 Q4

A company manufactures a single product whose annual demand is 4,000 units. The selling price and costs/profit per unit are estimated as follows: Rupees per unit Selling price 80,000 Cost of sales Direct materials (components) 25,000 Direct labour 15,000 Variable overheads 10,000 Fixed overheads 5,000 Administrative and selling expenses Administrative expenses – Fixed 3 Selling expenses – Variable Cost of delivery ,000 Commission on sale 2,000 Net profit 19,000 The above costs do not include mpact of defective units. Previous experience of the company shows that: 12% of the items manuf ed are identified as defective prior to delivery to customers. 4% of ems delivered to customers are returned because of defects which are iden within a week of their use. Defective units id fied by the customers are brought to the factory and replaced immediately, free of cost. All the defective units are sold from the factory on as is where is basis at Rs. 4,000 per unit. The company is now considering the following proposal: (i) Improving the production process which would reduce the defective units produced to 8%. The recurring cost associated with such improvement would be Rs. 10 million per annum; and (ii) Setting up a quality control unit with a per month cost of Rs. 600,000, which would reduce the percentage of defective units delivered to customers to 2%. Required: (a) Prepare a statement showing the quality costs that the company is expected to incur before and after taking the above steps, duly categorised using the four recognised quality cost headings. (10) (b) Recommend with reasons, whether or not the company should accept the proposal. (02)

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Q.5

A company manufactures a single product whose annual demand is 4,000 units. The selling price and costs/profit per unit are estimated as follows: Rupees per unit Selling price 80,000 Cost of sales Direct materials (components) 25,000 Direct labour 15,000 Variable overheads 10,000 Fixed overheads 5,000 Administrative and selling expenses Administrative expenses – Fixed 3,000 Selling expenses – Variable Cost of delivery 1,000 Commission on sale 2,000 Net profit 19,000 The above costs do not include the impact of defective units. Previous experience of the company shows that: - 12% of the items manufactured are identified as defective pr o delivery to customers. 4% of the items delivered to customers are ret d because of defects which are identified within a week of their use. - Defective units identified by the customers are broug the factory and replaced immediately, free of cost. - All the defective units are sold from the factory s is where is basis at Rs. 4,000 per unit. The company is now considering the followin posal: (i) Improving the production process which ld reduce the defective units produced to 8%. The recurring cost associated w uch improvement would be Rs. 10 million per annum; and (ii) Setting up a quality control uni a per month cost of Rs. 600,000, which would reduce the percentage of d ve units delivered to customers to 2%. Required: (a) Prepare a statement wing the quality costs that the company is expected to incur before and after ta the above steps, duly categorised using the four recognised quality cost hea s. (10) (b) Recommend w reasons, whether or not the company should accept the proposal. (02)

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Activity Base Management (ABM) Activity Base Managemen ABM is a ‘ system of management which uses activity-based cost information for a variety of purposes including cost reduction, cost modelling and customer profitability analysis ’ . ABM uses the basic information provided by an ABC analysis to help managers to ensure that customer needs are satisfied with the minimum use of organisational resources.

Activity-based management: cost management of activities ABC provides information that can be used to regularly monitor activities and so it aids continuous cost management or cost control.

Activity-based management: customer profitability analysis In many organisations, it is just as important to cost customers as it is to cost products. Different customers or groups of customers differ in their profi tability. This s a relatively new ABM technique that ABC information makes possible because it cre cost pools for activities. Customers use some activities but not all, and different g s of customers have different ‘ activity profiles ’ . Service organisations, such as a bank or a hotel, in particular A bank’s services for a customer will include the following t ● withdrawal of cash; ● unauthorised overdraft; ● request for a statement; ● stopping a cheque; ● returning a cheque because of insufficient s.

d to cost customers. of activities:

Different customers or categories of cu ers will each use different amounts of these activities and so customer profitabil ofiles can be built up, and customers can be charged according to the cost to e them.

Activity-based manage

t: Distribution channel profitability

Regardless of whether a co pany’s channels are direct or indirect they should always consider the ultimate needs of the customer and therefore use the channels to ensure that those needs are satisfied. Customers will look for ease of access to the supplier, reciprocal communication, products and services which satisfy their needs, prompt delivery, after sales support to name but a few. The channel a company selects is therefore a critical driver to business profitability. A company should not only aim to satisfy the needs of the customer but must also ensure that the products and services that they are providing are profitable. The method of channel distribution chosen can account for a significant proportion of total cost and choosing the wrong channel can result in significant losses for that particular product or service. Key aspects that the company needs to consider in relation to their distribution channels include; access to the customer base, brand awareness, competitiveness, achieving sales and market targets, speed of payment, customer retention rates and most importantly of all profitability.

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Q1 Garden Wizard Ltd manufactures a variety of garden tools for many markets including one item, the EC Trimmer, a hedge trimmer, that is only sold through Garden Centres and DIY chain shops. Currently three large DIY chains (X, Y and Z) and several smaller garden centres purchase this item. Garden Wizard sells this hedge trimmer at Rs 40 per unit and the standard product cost is Rs 20 per unit. Assume 40 per cent of the standard product cost represents fixed overheads. Delivery costs vary according to the distance travelled and costs Rs 5 per kilometre. In addition when a customer’s inventory is very low, Garden Wizard makes the occasional emergency delivery which is outside its normal delivery schedule. These cost Rs 500 per delivery. Each customer also negotiates discounts on sales prices. Order taking costs are Rs 200 per order. Publicity costs are specific to each customer as all publicity occurs in the shops and garden centres. Data relating to each of the customers are as follows:

X Sales in units Kilometres traveled Number of emergency deliveries made Number of orders taken Discounts* Sales commission* Publicity costs

Y

10,000 1,000 0 5 20% 10% 27,000

*Discounts and sales commission calculat

Z

Other Garden Centres

5,000 500

0 ,200

6,000 7,500

5% 10% 39,000

2 7 20% 10% 45,000

0 10 6% 10% 57,000

a perentage of the sales value.

Required: Comment on the profitability of ea Garden Wizard Ltd’s existing customers and what action it should take. You ponse should be supported with suitable financial calculations.

Q2 ST is a distribution company which buys a product in bulk from manufacturers, repackages the product into smaller packs and then sells the packs to retail customers. ST’s customers vary in size and consequently the size and frequency of their orders also varies. Some customers order large quantities from ST each time they place an order. Other customers order only a few packs each time. The current accounting system of ST produces very basic management information that reports only the overall company profit. ST is therefore unaware of the costs of servicing individual customers. However, the company has now decided to investigate the use of Direct Customer Profitability Analysis (DCPA). ST would like to see the results from a small sample of customers before it decides whether to fully introduce DCPA. The information for two customers, and for the whole company, for the previous period was as follows: 7

Customer B Factory contribution ($000) 75 Number of: Packs sold (000) 50 Sales visits to customers 24 Orders placed by customers 75 Normal deliveries to customers 45 Urgent deliveries to customers 5 Activity costs: $000s Sales visits to customers 50 Processing orders placed by customers 70 Normal deliveries to customers 120 Urgent deliveries to customers 60 Required Prepare a Direct Customer Profitability Analysis for each of the two customers

D 40.5

Company 450

27 12 20 15 0

300 200 700 240 30

Q 3 ICMAP Feb 18 Simons Engineering (Pvt.) Limited manufactures electrical components ndustrial consumers. Following annual information is available for three main omers of the company: Jamal Kamal Ne Industries Industries stries Gross margin (Rupees) 4,000,000 4,800,00 5,600,000 After sales visits (Nos.) 100 140 Orders placed (Nos.) 500 00 700 Distance from factory (km) 14.00 5.50 17.00 Shipment weight (kg) 5,000 6,000 7,000 Invoices raised (Nos.) 1,00 1,100 1,400 The company uses an activity based costi BC) system and the analysis of customer related costs is as follows: Rupees Activity er Cost per Driver After sales visits Visit 7000 Order processing Order placed 300 Despatch costs km x kg 25 Billing and collections Invoice raised 100 Required: Rank customers using `customer profitability analysis'. 04

Q4 Aug 2013

(a) Differentiate between value analysis and functional analysis. 03 (b) Pak Products Ltd., sells restaurant equipment and supplies throughout the country. The management of company intends to add an ice cream machine to its line of products and is in process of negotiation with an overseas manufacturer who has demanded Rs. 7,000 per ice cream machine. Management of Pak Products Ltd., believes that the ice cream machine could be sold to its customers for Rs. 7,500 each. At that price, annual sales of the ice cream machines would be 40,000 units. If the ice cream machine is added to Pak Products Ltd., product lines, the company will have to invest Rs. 20,000,000 in inventories and special warehouse fixtures. The variable cost of selling the ice cream machine would be Rs. 500 per unit. 8

Required: (i) If Pak Products Ltd., requires a 20% return on investment (ROI), what is the maximum amount the company would be willing to pay to the overseas manufacturer for an Ice cream machine? 04 (ii) After negotiations, management has concluded that the overseas manufacturer would not sell the ice cream machine at a lower price for Pak P...