What is the cost of quality in accounting?

July 13, 2012

Ever wondered what the cost of quality is? This article explains what such cost is and provides examples of prevention costs, appraisal costs, internal failure costs, and external failure costs.

1. Definition of the cost of quality

Cost of quality (COQ) represents costs incurred by an entity to prevent poor quality and costs incurred as the result of poor quality.

In other words, cost of quality is the cost of poor quality (that may or does exist). Poor quality could result in the loss of sales. Reducing or eliminating poor quality, on the other hand, could increase sales and profits.

To reduce or eliminate poor quality, a company can prevent or improve poor quality. Prevention costs are “good” costs because they are incurred before defects occur. Costs incurred after a failure occurs are “bad” costs because they arise as the result of a defect that could have been prevented.

Cost of quality could be classified as follows:

Cost of Quality

Examples

Prevention costs (“good”): costs incurred to prevent defects

  • Preventive maintenance
  • Product design reviews
  • Materials inspection
  • Production reviews
  • Engineering analysis
  • Specification reviews
  • Employee training
  • Vendor planning (e.g., supplier evaluation, training)

Appraisal costs (“bad”): costs incurred to check that products and processes conform to quality standards. Appraisal costs are incurred after a failure occurs but before the products are shipped to customers.

  • Products inspection
  • Process control
  • Quality testing
  • Quality audits
  • Vendor surveillance

Internal failure costs (“bad”): costs incurred to correct problems identified during appraisal (e.g., quality inspection, testing). In other words, internal failure costs are incurred during the production process before the products are shipped to customers.

  • Time spent correcting the problem
  • Re-inspection
  • Machine downtime
  • Machine repair costs due to poor maintenance
  • Engineering changes
  • Safety stock (i.e., excess inventory)
  • Poor quality materials
  • Rework
  • Scrap
  • Disposal costs

External failure costs (“bad”): costs incurred as the result of product failure detection by customers. In other words, external failure costs are incurred after the products are shipped.

  • Handling customer complaints
  • Returns and allowances
  • Delivery delay
  • Warranty claims
  • Legal liability
  • Costs of customer dissatisfaction
  • Lost market share

Even though the loss of current and potential customers as well as the loss of reputation and goodwill are cost of quality (i.e., external failure costs), they might not be reported as such because it is difficult to measure them.

As the company improves its product quality, the “bad” quality costs should decrease while the “good” costs (i.e., prevention costs) might increase. Prevention costs, however, might be reduced if an entity does not adopt a quality program: the value of the prevention costs might not be readily visible (or measurable) in the short run, and the entity might cut them first. Prevention costs are an example of discretionary costs. To learn more about discretionary costs, read the article on What are discretionary cost?

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