Chapter 11: The role of quality in performance management

Chapter learning objectives

Upon completion of this chapter you will be able to:

• discuss and apply Six Sigma as a quality improvement method using tools such as DMAIC for implementation
• discuss and evaluate the application of Japanese business practices and management accounting techniques, including:
  • Kaizen costing
  • Target costing
  • Just-in-time, and
  • Total Quality Management
• discriminate between quality, quality assurance, quality control and quality management
• assess the relationship of quality management to the performance management strategy of an organisation
• advise on the structure and benefits of quality management systems and quality certification
• justify the need and assess the characteristics of quality in management information systems.

1 Exam focus

Student Accountant articles: visit the ACCA website, www.accaglobal.com, to review the following article on the topics in thischapter:

• Just-in-time operations and back flush accounting - May 2004

2 Introduction

In today's competitive global business environment, quality is oneof the key ways in which a business can differentiate its product orservice and gain competitive advantage.

Quality can be defined in a number of ways:

• Is the product/service free from errors and does it adhere to design specifications?
• Is the product/service fit for use?
• Does the product/service meet customers' needs?

Test your understanding 1

Explain the reasons why quality may be important to an organisation?

Some other important definitions include:

Quality managementinvolves planning and controlling activities to ensure the product orservice is fit for purpose, meets design specifications and meets theneeds of customers.

Quality management should lead to improvements in performance.

Quality control involves a number of routine steps which measure and control the quality of the product/service as it is developed.

Quality assurance involves a review of the quality controlprocedures, usually by an independent third party, such as ISO (seesection 3). It aims to verify that the desired level of quality has beenmet.

3 Quality certification

The International Organisation for Standardisation (ISO) is one of the major bodies responsible for producing quality standards that can be applied to a variety of organisations.

The ISO 9000 quality standards have been adopted by a many organisations. An ISO 9000 registered company must:

• submit its quality procedures for external inspection
• keep adequate records
• check outputs for differences
• facilitate continuous improvement.

A certified company will be subject to continuous audit.

Test your understanding 2

Explain the advantages and disadvantages to a fast growing UK based mobile phone company of becoming ISO certified.

4 Quality management systems

A quality management system(QMS) is a set of co-ordinated activities to direct and control anorganisation in order to continually improve its performance.

A QMS should pervade the whole organisation. There are a number of ways of implementing a QMS.

For example, ISO 9001:2005 recommends that the design should be based on 8 principles:

Test your understanding 3

Explain how the 8 principles of ISO 9001:2005 should result in quality improvements.

The adoption of a QMS should complement an organisation's strategy.

5 Quality-related costs

• Monitoring the costs of quality is central to the operation of any quality improvement programme.
• KPIs should be developed based on the costs of quality and these can be used as a basis for staff rewards.

Test your understanding 4

Provide and example for each of the four sub-categories of quality cost.

A quality management programme is a relatively modern approach toquality. It will require a significant investment in prevention costs but shouldminimise or eliminate appraisal, internal failure and external failure costs.

Test your understanding 5

Prepare a cost analysis that shows actual prevention, appraisal, internal failure and external failure costs.

Your statement should show each cost heading as a % of turnover andclearly show the total cost of quality (including any opportunitycosts).

6 Quality practices

6.1 Kaizen Costing

Kaizen is a Japanese term for the philosophy of continuous improvement in performance via small, incremental steps.

Characteristics:

• Kaizen involves setting standards and then continually improving these standards to achieve long-term sustainable improvements.
• The focus is on eliminating waste, improving processes and systems and improving productivity.
• Involves all employees and all areas of the business.

Illustration 1 - Kaizen

Many Japanese companies have introduced a Kaizen approach:

• In companies such as Toyota and Canon, a total of 60-70 suggestions per employee are written down and shared every year.
• It is not unusual for over 90% of those suggestions to be implemented.
• In 1999, in one US plant, 7,000 Toyota employees submitted over 75,000 suggestions, of which 99% were implemented.

Continuous improvement explained

What is continuous improvement?

Continuous improvement is the continual examination and improvementof existing processes and is very different from approaches such asbusiness process re-engineering (BPR), which seeks to make radicalone-off changes to improve an organisation's operations and processes.The concepts underlying continuous improvement are:

• The organisation should always seek perfection. Since perfection is never achieved, there must always be scope for improving on the current methods.
• The search for perfection should be ingrained into the culture and mindset of all employees. Improvements should be sought all the time.
• Individual improvements identified by the work force will be small rather than far-reaching.

Kaizen costinghas been developed to support the continued cost reduction of existingcomponents and products. Cost reduction targets are set on a regular,e.g. monthly basis and variance analysis is carried out at the end ofeach period to compare the target cost reduction with the actual cost.

One of the main ways to reduce costs is through the elimination of the seven main types of waste:

• Over-production - produce more than customers have ordered.
• Inventory - holding or purchasing unnecessary inventory.
• Waiting - production delays/idle time when value is not added to the product.
• Defective units - production of a part that is scrapped or requires rework.
• Motion - actions of people/equipment that do not add value.
• Transportation - poor planning or factory layout results in unnecessary transportation of materials/work-in-progress.
• Over-processing - unnecessary steps that do not add value.

Test your understanding 6

Although this approach was developed in the manufacturing industry it could also be applied in the service sector.

Identify some possible sources of waste in arestaurant business and categorise them according to the seven maintypes of waste described above.

6.2 Total Quality Management

Total Quality Management (TQM) is a philosophy of quality management that originated in Japan in the 1950s.

Fundamental features of TQM:

• Prevention of errors before they occur: The aim of TQM is to get things right first time. This contrasts with the traditional approach that less than 100% quality is acceptable. TQM will result in an increase in prevention costs, e.g. quality design of systems and products, but internal and external failure costs will fall to a greater extent.
• Continual improvement: Quality management is not a one-off process, but is the continuous examination and improvement of processes.
• Real participation by all: The 'total' in TQM means that everyone in the value chain is involved in the process, including:
  • Employees - they are expected to seek out, identify and correct quality problems. Teamwork will be vital.
  • Suppliers - quality and reliability of suppliers will play a vital role.
  • Customers - the goal is to identify and meet the needs of customers.
• Management commitment: Managers must be committed and encourage everyone else to be quality conscious.

Illustration 2

A TQM success story

Corning Inc is the world leader in speciality glass and ceramics.This is partly due to the implementation of a TQM approach. In 1983 theCEO announced a $1.6 billion investment in TQM. After several years onintensive training and a decade of applying the TQM approach, all ofCorning's employees had bought into the quality concept. They knew thelingo - continuous improvement, empowerment, customer focus, managementby prevention and they witnessed the impact of the firm's techniques asprofits soared.

An example of TQM failure

British Telecom launched a total quality program in the late 1980s.This resulted in the company getting bogged down by quality processesand bureaucracy. The company failed to focus on its customers and laterdecided to dismantle its TQM programme. This was at great cost to thecompany and they have failed to make a full recovery.

Examples of performance measures in a TQM environment include:

• monetary measure - cost of rectification
• non-monetary measures - percentage of wastage
• variance analysis - care must be taken with regard to traditional performance reports such as favourable price variances, these can arise because of using poorer quality resources
• targets or benchmarks must be set against which the performance of suppliers can be measured
• outputs too must be measured for quality against pre-determined targets.

6.3 Just-in-time

Just-in-time (JIT)is a system whose objective is to produce or procure products orcomponents as they are required rather than for inventory. This meansthat inventory levels of raw materials, work-in-progress and finishedgoods can be kept to a minimum.

JIT applies to both production within an organisation and to purchasing from external suppliers.

JIT purchasing is a method of purchasing that involvesordering materials only when customers place an order. When the goodsare received they go straight into production.

JIT production is a production system that is driven bydemand for the finished products (a 'pull' system), whereby eachcomponent on a production line is produced only when needed for the nextstage.

Illustration 3

Toyota pioneered the JIT manufacturing system, in which supplierssend parts daily - or several times a day - and are notifiedelectronically when the production line is running out.

More than 400 trucks a day come in and out of Toyota's Georgetownplant in the USA, with a separate logistics company organising shipmentfrom Toyota's 300 suppliers - most located in neighbouring state withinhalf a day's drive of the plant.

Toyota aims to build long-term relationships with suppliers, manyof whom it has a stake in, and says it now produces 80% of its partswithin North America.

Requirements for successful operation of a JIT system:

• High quality and reliability - disruptions cause hold ups in the entire system and must be avoided. The emphasis is on getting the work right first time:
  • Highly skilled and well trained staff should be used.
  • Machinery must be fully maintained.
  • Long-term links should be established with suppliers in order to ensure a reliable and high quality service.
• Elimination of non-value added activities - for example, value is not added whilst storing the products and therefore inventory levels should be minimised.
• Speed of throughput - the speed of production should match the rate at which customers demand the product. Production runs should be shorter with smaller stocks of finished goods.
• Flexibility - a flexible production system and workforce is needed in order to be able to respond immediately to customers' orders.
• Lower costs - another objective of JIT is to reduce costs by:
  • Raising quality and eliminating waste.
  • Achieving faster throughput.
  • Minimising inventory levels.

Test your understanding 7

Explain the advantages and disadvantages to an organisation of operating a JIT system.

JIT and service operations

Although it originated with manufacturing systems, the JIT philosophy can also be applied to some service operations.

• Whereas JIT in manufacturing seeks to eliminate inventories, JIT in service operations will seek to eliminate internal or external queues of customers.
• Other concepts of JIT, such as eliminating wasteful motion and seeking ways of achieving continuous improvement are also applicable to services as much as to manufacturing activities.

The impact on management accounting

The introduction of a JIT system will have a number of effects on the costing system and performance management.

• Allowances for waste, scrap and rework are moved to the ideal standard, rather than an achievable standard.
• Costs are only allowed to accumulate when the product is finished.
• The inevitable reduction in inventory levels will reduce the time taken to count inventory and the clerical cost.
• Minimal inventory makes it easier for a firm to switch to backflush accounting (a simplified method of cost bookeeping covered in paper F5).
• Traditional performance measures such as inventory turnover and individual incentives are replaced by more appropriate performance measures, such as:
  • total head count productivity
  • inventory days
  • ideas generated and implemented
  • customer complaints.

JIT and supplier relationships

JIT purchasing and developing a close relationship with suppliers

A company is a long way towards JIT if its suppliers will guaranteethe quality of the material they deliver and will give it shorterlead-times, deliver smaller quantities more often, guarantee a lowreject rate and perform quality-assurance inspection at source. Frequentdeliveries of small quantities of material to the company can ensurethat each delivery is just enough to meet its immediate productionschedule. This will keep its inventory as low as possible. Materialshandling time will be saved because as there is no need to move thestock into a store, the goods can be delivered directly to a workstationon the shop floor. Inspection time and costs can be eliminated and thelabour required for reworking defective material or returning goods tothe supplier can be saved.

The successful JIT manufacturer deliberately sets out to cultivategood relationships with a small number of suppliers and these supplierswill often be situated close to the manufacturing plant. It is usual fora large manufacturer that does not use the JIT approach to havemultiple suppliers. When a new part is to be produced, various supplierswill bid for the contract and the business will be given to the two orthree most attractive bids.

A JIT manufacturer is looking for a single supplier that canprovide high quality and reliable deliveries, rather than the lowestprice. This supplier will often be located in close proximity to themanufacturing plant.

There is much to be gained by both the company and its suppliersfrom this mutual dependence. The supplier is guaranteed a demand for theproducts as the sole supplier and is able to plan to meet thecustomer's production schedules. If an organisation has confidence thatsuppliers will deliver material of 100% quality, on time, so that therewill be no rejects, returns and hence no consequent production delays,usage of materials can be matched with delivery of materials and stockscan be kept at near zero levels.

Jaguar, when it analysed the causes of customer complaints,compiled a list of 150 areas of faults. Some 60% of them turned out tobe faulty components from suppliers. One month the company returned22,000 components to different suppliers. Suppliers were brought on tothe multi-disciplinary task forces the company established to tackleeach of the common faults. The task force had the simple objective offinding the fault, establishing and testing a cure, and implementing itas fast as possible. Jaguar directors chaired the task forces of the 12most serious faults, but in one case the task force was chaired by thesupplier's representative.

6.4 Six Sigma

• Six Sigma is a quality management programme that was pioneered by Motorola in the 1980s.
• The aim of the approach is to achieve a reduction in the number of faults that go beyond an accepted tolerance level. It tends to be used for individual processes.
• The sigma stands for the standard deviation. For reasons that need not be explained here, it can be demonstrated that, if the error rate lies beyond the sixth sigma of probability there will be fewer than 3.4 defects in every one million units produced.
• This is the tolerance level set. It is almost perfection since customers will have room to complain fewer than four times in a million.

Illustration 4 – The Six Sigma approach

A hospital is using the Six Sigma process to improve patientwaiting times. An investigation of the views of patients has revealedthat:

• patients do not want to be called before their appointment time as they do not want to feel that they have to be at the hospital early to avoid missing an appointment
• the maximum length of time they are prepared to wait after the appointment time is 30 minutes.

The aim of the Six Sigma programme will be to ensure that no morethan 3.4 waits in every million occurrences exceed 30 minutes or areless than 0 minutes.

Key requirements and criticisms

Key requirements for successful Six Sigma implementation

There are a number of key requirements for the implementation of Six Sigma.

• Six Sigma should be focused on the customer and based on the level of performance acceptable to the customer.
• Six Sigma targets for a process should be related to the main drivers of performance.
• To maximise savings Six Sigma needs to be part of a wider performance management programme which is linked to the strategy of the organisation. It should not be just about doing things better but about doing things differently.
• Senior managers within the organisation have a key role in driving the process.
• Training and education about the process throughout the organisation are essential for success.
• Six Sigma sets a tight target, but accepts some failure – the target is not zero defects.

Some criticisms and limitations of Six Sigma

Literature on Six Sigma contains some criticisms of the process and identifies a number of limitations as follows.

• Six Sigma has been criticised for its focus on current processes and reliance on data. It is suggested that this could become too rigid and limit process innovation.
• Six Sigma is based on the use of models which are by their nature simplifications of real life. Judgement needs to be used in applying the models in the context of business objectives.
• The approach can be very time consuming and expensive. Organisations need to be prepared to put time and effort into its implementation.
• The culture of the organisation must be supportive – not all organisations are ready for such a scientific process.
• The process is heavily data-driven. This can be a strength, but can become over-bureaucratic.
• Six Sigma can give all parts of the organisation a common language for process improvement, but it is important to ensure that this does not become jargon but is expressed in terms specific to the organisation and its business.
• There is an underlying assumption in Six Sigma that the existing business processes meet customers' expectations. It does not ask whether it is the right process.

The five steps of the Six Sigma process (DMAIC)

Test your understanding 8

How can management accountants contribute to the Six Sigma process?

Question focus: now attempt question 20 from chapter 13.

6.5 Target costing

Steps:

(1) Estimate a selling price for the product - consider how muchcustomers will pay and how much competitors charge for similar products.

(2) Deduct the required profit.

(3) Produce a target cost figure.

(4) Reduce cost gap, i.e the difference between the current cost and the target cost.

Techniques to reduce the cost gap include:

• JIT
• TQM
• Kaizen
• ABC
• Value analysis: a systematic examination of the product which asks questions such as:
  • can another dependable supplier be found for less cost?
  • does it need all of its features?

Many of the techniques above have a 'quality' focus

Key features of target costing

• Target costing forces a focus on the customer: Product decisions and cost analysis have to take account of customer requirements such as quality, features and price. This is not always the case with other cost management methods.
• Successful target costing considers all costs related to production: and distribution of the products and involves the whole supply chain. This may even include joint working between suppliers and manufacturers to share information and enable cost reductions, particularly for products for which raw materials contribute a high proportion of the manufactured cost.
• Target costing considers the entire life-cycle: of the product, so that total costs to the manufacturer are minimised.
• Target costing begins very early in the development: phase of new products, so that changes are made before production begins. Decisions made at this stage generally determine a high proportion of the costs of any product.
• Target costing is a multi-disciplinary approach: which involves staff from all functions in the analysis and decision making.
• Target costing is an iterative process: in which teams are making judgements and trade-offs between product features, price, sales volumes, costs and investment requirements.
• Target costing provides cost targets: for individual inputs and processes which can be used for performance monitoring.

Test your understanding 9

Edward Limited assembles and sells many types of radio. It isconsidering extending its product range to include digital radios. Theseradios produce a better sound quality than traditional radios and have alarge number of potential additional features not possible with theprevious technologies (station scanning, more choice, one touch tuning,station identification text and song identification text etc).

A radio is produced by assembly workers assembling a variety ofcomponents. Production overheads are currently absorbed into productcosts on an assembly labour hour basis.

Edward Limited is considering a target costing approach for its new digital radio product.

Required:

(a)Briefly describe the target costing process that Edward Limited should undertake.

(b)Explain the benefits to EdwardLimited of adopting a target costing approach at such an early stage inthe product development process.

A selling price of $44 has been set in order to compete with asimilar radio on the market that has comparable features to EdwardLimited's intended product. The board have agreed that the acceptablemargin (after allowing for all production costs) should be 20%.

Cost information for the new radio is as follows:

Component 1 (Circuit board) – these are bought in and cost$4.10 each. They are bought in batches of 4,000 and additional deliverycosts are $2,400 per batch.

Component 2 (Wiring) – in an ideal situation 25 cm ofwiring is needed for each completed radio. However, there is some wasteinvolved in the process as wire is occasionally cut to the wrong lengthor is damaged in the assembly process. Edward Limited estimates that 2%of the purchased wire is lost in the assembly process. Wire costs $0.50per metre to buy.

Other material – other materials cost $8.10 per radio.

Assembly labour – these are skilled people who aredifficult to recruit and retain. Edward Limited has more staff of thistype than needed but is prepared to carry this extra cost in return forthe security it gives the business. It takes 30 minutes to assemble aradio and the assembly workers are paid $12.60 per hour. It is estimatedthat 10% of hours paid to the assembly workers is for idle time.

Production Overheads – recent historic cost analysis has revealed the following production overhead data:

Fixed production overheads are absorbed on an assembly hour basisbased on normal annual activity levels. In a typical year 240,000assembly hours will be worked by Edward Limited.

Required:

(c) Calculate the expected cost per unit for the radio and identify any cost gap that might exist.

Additional question on quality

Relationship between cost and quality

Required:

Explain how management accounting/managementtechniques such as total quality management, just in time, valueanalysis, activity based costing and the balanced scorecard couldcontribute towards the analysis of the relationship between costs andquality.

Answer:

Total Quality Management (TQM)

TQM is an approach that seeks to ensure that all aspects ofproviding goods and services are delivered at the highest possiblestandard, and that standards keep improving The underlying principle isthat the cost of preventing deficient quality is less than the costs ofcorrecting poor quality. This denies the idea that improved quality canonly be secured with greater expenditure, but adopts the approach thatimproved quality will reduce costs.

Quality related costs are concerned with both achieving quality and failure to achieve quality.

Quality costs can categorised as:

• Prevention costs – communicating the concept, training, establishing systems to deliver quality services
• Appraisal costs – e.g. inspection and testing
• Internal failure costs – wasted materials used in rejects, down time resulting from internal service quality failures, resources devoted to dealing with complaints
• External failure costs – loss of goodwill and future business, compensation paid to customers and rectification costs

The TQM view is that by getting it right first time and every time,the prevention and appraisal costs will be outweighed by the savings infailure costs, hence lower costs and improved quality are congruentgoals. TQM requires everyone in the organisation to have identifiedcustomers, whether external or internal, so that a continuous servicequality chain is maintained all the way through the organisation to thefinal customer.

Just In Time (JIT)

JIT is a manufacturing and supply chain process that is intended toreduce inventory levels and improve customer service by ensuring thatcustomers receive their orders at the right time and in the rightquantity. The system should facilitate a smooth workflow throughout thebusiness and reduce waste. Goods are produced to meet customer needsdirectly, not for inventory.

Cost reductions should arise from:

• Lower raw material and finished goods inventory levels, therefore reduced holding costs
• Reduced material handling
• Often a reduction in the number of suppliers and lower administration and communication costs
• Guaranteed quality of supplies reduces inspection and rectification costs

Quality improvements should arise from:

• Fewer or even single sourcing of supplies strengthens the buyer–supplier relationship and is likely to improve the quality.
• The absence of customer stockholding compels the supplier (if they want continued business) to guarantee the quality of the material that they deliver.
• The necessity to work regularly and closer with hauliers strengthens the relationship with them. The deliveries become high priority and more reliable.
• Customers are not faced with the traditional problems of having to wait until their suppliers inventories are replenished. The system is designed to respond to customers' needs rapidly.
• Direct focus on meeting an identified customer's need, production is merely to add to an anonymous pile of inventory.

Value Analysis

Value analysis is concerned with concentrating on activities thatadd value to the product/service as perceived by the customer. Itexamines business activities and questions why they are being undertakenand what contribution do they make to customer satisfaction. Valueadded activities include designing products, producing output anddeveloping customer relationships. Non-value added activities includereturning goods, inventory holding, and checking on the quality ofsupplies received. Wherever possible eliminate the non-value addedactivities.

Value analysis commences with a focus on customers. What do theywant? What do they regard as significant in the buying decision:function, appearance, longevity or disposal value? This is concernedwith identifying what customers regard as quality and then providing it:do not expend effort on what they regard as unimportant. It is aboutclarifying what the constituents of quality are on the Costs and Qualitydiagram. Having decided this there is a need to develop alternativedesigns, estimate costs and evaluate alternatives.

Activity Based Costing (ABC)

ABC is concerned with attributing/assigning costs to cost units onthe basis of the service received from indirect activities e.g. publicrelations, recruitment, quality assurance general meetings. Theorganisation needs to identify cost drivers – the specific activitiesthat cause costs to arise e.g. number of orders taken, telephone callsmade, number of breakdowns or the number of visitors to an attraction.

ABC intends to avoid the arbitrary allocation of overheads toproducts/services by identifying a causal link between costs, activitiesand outputs. Because of higher degrees of automation, the increasingsignificance of overheads in the cost make up of output intensifies theneed to improve the apportionment of them. Accountants can contributetowards providing better cost information to the value analysis referredto above. Product managers need to know what they are getting for theirmoney – what is the real cost of quality? What are the cost drivingactivities that do not impact on quality? What activities that generateminimal costs have a significantly favourable impact on quality?

The Balanced Scorecard (Kaplan and Norton)

The Balanced Scorecard provides a framework for a business toachieve its strategic objectives include both financial andnon-financial objectives. The approach claims that performance has fourdimensions: financial, customer, internal business, and innovation andlearning. The customer perspective asks: How does the business appear tothe customers? The internal business perspective asks :What do we needto do to satisfy shareholders and customers, including the monitoring ofunit costs? The innovation and learning perspective looks at howproducts and processes should be changed and improved.

The scorecard is concerned with monitoring and measuring thecritical variables that comprise the customer and internal perspective.The choice of variables for inclusion in the scorecard is significantbecause the scorecard report is a design for action. Inappropriateindicators will trigger damaging responses. For example, theorganisation needs to monitor what factors customers regard ascontributing to improved quality, not what the business thinks it shouldprovide. Therefore the scorecards would be suitable for inclusion asquantifiable indicators on the axis on the Costs and Quality diagram.The Balanced Scorecard attempts to improve the range and relationshipbetween alternative performance measures, in the case under discussion,costs and quality.

7 Section - Quality in management information systems

7.1 Features of a quality system

Test your understanding 10

Explain the consequences of failing to include these four features in a management information system.

7.2 Designing a quality system

Designing a quality system

In order to ensure that the system fulfils the quality criteria offunctionality, reliability, usability and build quality a structuredapproach to development should be used. One such approach is the systemsdevelopment life cycle (SDLC):

8 Chapter summary

Test your understanding answers

Test your understanding 1

Higher quality can help to increase revenue and reduce costs:

• Higher quality improves the perceived image of a product or service. As a result, more customers will be willing to purchase the product/service and may also be willing to pay a higher price.
• A higher volume of sales may result in lower unit costs due to economies of scale.
• Higher quality in manufacturing should result in lower waste and defective rates, which will reduce production costs.
• The need for inspection and testing should be reduced, also reducing costs.
• The level of customer complaints should fall and warranty claims should be lower. This will reduce costs.
• Better quality in production should lead to shorter processing times. This will reduce costs.

Test your understanding 2

Advantages

• Recognised standard - the company's reputation for quality will be enhanced since ISO is a recognised international standard of quality.
• Marketing - ISO certification will act as an excellent marketing tool. It will help to differentiate the company, on the grounds of quality, in the customers' eyes.
• Improved profitability - fulfillment of the ISO criteria should help the company to improve quality. This, in turn, should reduce costs and improve quality.
• International competitiveness - ISO certification is becoming increasingly useful in international markets and may help the company to compete on a world stage.

Disadvantages

• Cost - fees are upward of £1,000 depending on the size of the company.
• Time - documentation can be time consuming to produce.
• Bureaucracy - the scheme encourages bureaucracy with lots of form filling and filing rather than positive actions.
• Rigid policies - these might discourage initiative and innovation and may therefore hinder the quality process.
• Not all embracing - ISO certification will form a small part of a quality practice such as TQM.

Test your understanding 3

The 8 principles of ISO 9001:2005 should result in quality improvements as follows:

• Customer focus - quality may be defined as 'the product/service meeting the customer's needs' and therefore a customer focus should improve quality.
• Leadership - leaders should communicate the importance of quality and drive a culture of quality.
• Involvement of people - everyone in the organisation should have a quality focus.
• Process approach - related activities and resources should be managed in an integrated quality process.
• Systems approach to management - groups of related processes should be managed in an integrated quality system.
• Continual improvement - quality management is not a one off process, but is the continuous examination and improvement of processes.
• Factual approach to decision making - quality procedures should be documented and applied consistently.
• Mutually beneficial supplier relationships - long-term links should be established with suppliers in order to ensure a reliable and high quality service.

Test your understanding 4

Prevention costs

• Cost of designing products and services with built in quality.
• Cost of training employees in the best way to do their job.
• Cost of equipment testing to ensure it conforms with quality standards required.

Appraisal costs

• Inspection and testing, for example of a purchased material or service.

Internal failure costs

• Cost of scrapped material due to poor quality.
• Cost of re-working parts.
• Reinspection costs.
• Lower selling prices for sub-quality products.

External failure costs

• Cost of recalling and correcting products.
• Cost of lost goodwill.

Test your understanding 5

Test your understanding 6

Suggestions could include

• Pre-preparing plated servings of perishable desserts which are not ordered and need to be thrown away – over-production.
• Poor kitchen layout which could lead to unnecessary movement of staff and result in waste from motion and from transportation of material or lead to accidents and spillages and waste in processes and methods.
• Poorly trained cooking staff who produce sub-standard meals which cannot be served – product defects.
• Producing too many pre-prepared components such as sauces to be incorporated in dishes which are then not needed – waste from inventory.
• Poor scheduling in the kitchen leading to serving staff waiting for meals to be ready – waste from waiting time.

Test your understanding 7

Advantages of JIT

• Lower stock holding costs means a reduction in storage space which saves rent and insurance costs.
• As stock is only obtained when needed, less working capital is tied up in stock.
• There is less likelihood of stock perishing, becoming obsolete or out of date.
• Avoids the build up of unsold finished products that occurs with sudden changes in demand.
• Less time is spent checking and re-working the products as the emphasis is on getting the work right first time.

The result is that costs should fall and quality should increase. This should improve the company's competitive advantage.

Disadvantages of JIT

• There is little room for mistakes as little stock is kept for re-working a faulty product.
• Production is very reliant on suppliers and if stock is not delivered on time or is not of a high enough quality, the whole production schedule can be delayed.
• There is no spare finished product available to meet unexpected orders, because all products are made to meet actual orders.
• It may be difficult for managers to empower employees to embrace the concept and culture.
• It won't be suitable for all companies. For example, supermarkets must have a supply of inventory.
• It can be difficult to apply to the service industry. However, in the service industry a JIT approach may focus on eliminating queues, which are wasteful of customers' time.

Test your understanding 8

• The provision of data at all stages in the process.
• Providing expertise in the identification of appropriate output, input and process measures (financial and non-financial) and ways to collect the data.
• Analysis of data.
• Evaluation of possible solutions.
• Identification of performance measures for the control process and monitoring after changes have been implemented.
• Taking part in multi-disciplinary Six Sigma teams.

Test your understanding 9

(a)The target costing process should be undertaken as follows:

(b)The benefits are as follows:

• Target costing has an external focus, i.e. it considers how much customers will pay/competitors will charge.
• Cost control can occur earlier in the design process and the required steps can be taken to reduce the cost gap.
• The performance of the business should be enhanced due to better management of costs.
• The focus will be on getting things right first time which should reduce the development time.

(c)W1 Production overhead (using high low method)

• Variable overhead = $80,000 ÷ 4,000 = $20 per hour
• Total cost $700,000 = fixed cost + variable cost ($20/hour × 23,000). This gives a monthly fixed cost of $240,000. (Note: the total cost at the low level of production could also be used to find the fixed cost).
• Annual fixed cost = $240,000 × 12 = $2,880,000
• Overhead absorption rate (OAR) = $2,880,000 ÷ 240,000hours = $12 per hour

Cost card and cost gap calculation

Test your understanding 10

• Poor functionality and reliability - may result in:
  • user dissatisfaction, e.g. because the system does not perform the desired task
  • additional costs, e.g. to correct inaccurate reports.
• Poor usability - may result in:
  • staff dissatisfaction
  • excessive staff training
  • excessive time spent by staff trying to operate the system.
• Poor build quality - will result in difficulties maintaining and upgrading the system which will impact long-term profit.

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