Cost of quality reporting in accounting

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.” – Warren Buffet. Reputation is very important for organizations because it leads to a sustained competitive advantage by making the organization more attractive to its stakeholders (e.g., customers, employees, suppliers, business partners). There are multiple factors that can destroy reputation. One of them is low-quality products and services. In this article, we will discuss costs that are reported as part of cost of quality reporting.

1. Cost of quality reporting (COQ)

When organizations incur costs to prevent, detect, and “fix” the outcomes of the low-quality production, they incur cost of quality.

In general, quality costs can be grouped into two categories: costs of conformance and cost of nonconformance.

Costs incurred to conform with quality standards are called conformance costs and include prevention and appraisal costs.

Costs incurred as the result of nonconformance with quality standards are called nonconformance costs and include internal and external failure costs.

Costs of Conformance

Prevention costs are the costs incurred to prevent the production of products and services that do not meet quality specifications.  These costs include:

  • Reporting costs (e.g., costs incurred to measure, report, and audit compliance with quality standards)
  • Employee training costs
  • Prevention program costs
  • Process design/redesign costs
  • Supplier evaluation costs
  • Quality planning costs

Appraisal costs are the costs incurred to appraise (determine/detect) whether products or services conform to quality specifications.  These costs include:

  • Product testing or inspection costs
  • Raw materials, parts, components, and work-in-process inspection costs
  • Testing equipment and tools costs
  • Process inspection costs<
  • Costs to verify supplier quality

Costs of Nonconformance

Internal failure costs are the costs of defective (low-quality) products or services that are in process or completed but before they are delivered to customers:

  • Cost of corrective actions
  • Rework costs
  • Overtime costs
  • Scrap costs
  • Retesting costs
  • Loss from process disruption or downtime

External failure costs are the costs incurred to correct quality defects after products or services are delivered to customers:

  • Sales returns and allowances
  • Lost sales
  • Recall costs
  • Warranty repairs
  • Replacements
  • Litigation
  • Penalties
  • Product liability insurance

There is a trade-off between conformance and nonconformance costs. When organizations spend more on prevention and appraisal costs, they spend less on internal and external failure costs.

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