Question

Q 1      Salem Corporation is producing product A. The company had problems related to quality. Customers have been returning the product in the last months.

            ABC costing method and ABM can be used to manage quality.

a.   Define each type of quality-related activity and give one example of each activity type.

b.   Suppose the managers implement an ABC system to measure the costs of quality. How could they use information from this system to improve the product?

Answer 1

Sound economy and assured profitability of an organization entirely depend upon effective control of nonquality costs generated in the organization. Through simple economic model with parato and cause effect analysis of different elements of quality costs, e.g. Prevention, Appraisal costs conformance costs and internal and external failure costs – non conformance costs, total quality costs can be controlled resulting considerable savings. This paper discusses how quality has an impact on the costs of goods and services in an organization and “Return on Investment (ROI)” is linked with “Return on Quality (ROQ)”. In the interest of customers and minimizing national loss due to proof quality of products and services, it should be obligatory for organizations to correctly report “Quality costs” in their annual reports like Balance Sheets and Profit and Loss Accounts.

We have to properly identify and measure the costs associated with non-quality in any organization for basic three reasons: to quantify the size of quality problem, to help in satisfying a quality improvement effort and to guide the development of that effort, and to track progress in improvement activities. In any organization, all business activities and programmes are finally decided on the basis of their relative capabilities for contribution to profit. Knowledge of quality costs helps executives to justify the investment in quality improvement programme and assists them in monitoring the effectiveness of the efforts made. Quality costing expresses an organization’s quality performance in the language of “Money” which is well appreciated by the board of management and stakeholders operators and line supervisors are also found to react positively when nonconformance data, in addition to the normally expressed measure of numbers and percentages, are presented in monetary terms. This happens when they have the opportunity to compare the costs of non-conformance with their salaries. The organizational goal is “Total Quality Management” and the process of quality improvement is the means of reaching this goal. It is important for an organization to understand that in today’s markets customers’ requirements are becoming more rigorous and at the same time it is likely that their competition will also be increasing. Consequently there is a need for the process of quality improvement to be continual and total. TQM should always be referred to as a process not a programme. Committing huge expenditure in quality improvement activities without some measure of its cost – effectiveness can be considered a blind act of faith and is contrary to the way in which Western business operate. In Japanese business organizations investment in quality improvement initiatives over a long period of time without thought of immediate benefits appears to be accepted without questions by senior managers, stakeholders and financial institutions. In addition to the quality of product and service, organizational need to be competitive on cost and delivery. This is termed as “QCD”. If the organizations are to survive in their respective business in global competitive market, they are bound to achieve substantial cost reduction for their operations. In many instances quality-related costs are a major potential source of the necessary savings. Quality costing is one of several tools and techniques, which can assist companies with improving quality of product and service. It is also important that reducing the level of quality costs should not be the main reason for an organization starting a process of quality improvement. Along the TQM journey for an organization as a first step quality costing may be considered useful. For becoming a total quality organization it is necessary to have first – hand experience on the benefits of measuring quality costs. Hence, a number of world – class quality organizations employed measuring quality costs which is an indicator for their internal quality performance.

In accounting, activity-based management (ABM) is a method of internal analysis that identifies business activities within a company and evaluates them based on the costs incurred by the activities and the value added by the activities. The idea is to analyze the activities related to the company’s operations and to identify opportunities to improve efficiency and profitability.

The analysis involves classifying business activities as either value-added or non-value-added. Value-added activities increase the customer’s perceived value of the company’s products. Non-value-added activities incur costs but do not increase the customer’s perceived value of the company’s products. Once activities have been identified as being either value-added or non-value-added, the company can focus on enhancing the value-added activities and reducing or eliminating the non-value-added activities. Company’s utilizing ABM may rank value-added activities on a scale of 1-5 or 1-10 in order to demonstrate different degrees of the customer’s perceived value added by each value-added activity.

Activity based management builds off of an activity-based costing system. Once a company has developed and implemented an activity-based costing system, implementing activity-based management involves three steps:

1. Classify activities as either value-added or non-value-added
2. Rank value-added activities in terms of added customer-perceived value
3. Enhance value-added activities and eliminate or reduce non-value activities

A company should only implement ABM if the benefits of doing so exceed the costs. Implementing ABC and ABM can be costly in terms of time and resources. Implementing ABM is recommended for company’s facing intense price competition. It is also recommended more for companies with many complex products and processes as opposed to companies with simple products and processes.

Activity-based costing (ABC) is an accounting method that identifies the activities that a firm performs and then assigns indirect costs to products. An activity-based costing (ABC) system recognizes the relationship between costs, activities and products, and through this relationship, it assigns indirect costs to products less arbitrarily than traditional methods.

Some costs are difficult to assign through this method of cost accounting. Indirect costs, such as management and office staff salaries are sometimes difficult to assign to a particular product produced. For this reason, this method has found its niche in the manufacturing sector.