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Quality costs, defined as those that arise because poor quality may exist or does exist, have been classified Into the following four categories: Prevention (prevention of poor quality, or quality assurances; Appraisal (inspection and testing); Internal Failure (costs, such as rework or scrapple, for nonconforming products Identified before delivery to customers); External Failure (costs, such as warranty expenses or freight charges, for nonconforming products delivered to customers).

As the case states, in spite of SKI’S commitment to quality improvement, “the changes [in order entry] would not have been so vigorously pursued if cost information had not been presented. COO information functioned as a catalyst to accelerate the improvement effort. ” This is because the cost fugues captured the attention of top management. Other responses might include the following: 1) It made order entry aware of the dollar impact of its errors; 2) It provided a means of proportioning quality improvement efforts.

Prepare a diagram illustrating the flow of activities between the order entry 2. Department and its suppliers, internal customers (those within AS’), and external customers (those external to AS’). There are many possible flows. For example, a sales representative may contact order entry to request a quote for a system for

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a customer. Subsequently, the customer order entry to place the order; order entry then generates and order acknowledge, which is sent to manufacturing, invoicing, and sales administration.

Once the system has been shipped, an invoice is sent to the customer. Ultimately, collections will receive the invoice. Customer support will contact the customer to arrange installation, and will be available to answer questions over the phone. A request for parts from a service representative or directly from a customer would be routed to the stockroom, after which the part would be shipped and the customer would t billed. A request for service would result in an order acknowledgement being sent to the service department.

SUPPLIERS PROCESS OUTPUT CUSTOMERS before delivery to internal or external customers) and external failure (nonconforming “products” delivered to internal or external customers) with respect to the order entry department. For each external failure item, identify which of order entry internal customers (I. E. , other departments within SSI that use information from the order acknowledgment) will be affected. Items 1, 2, 5, 8, 19 and 12 are internal failures; the remaining are external failure items.

Internal customers affected by external failure items are listed below. Item Number Internal Customer(s) Affected 3 Manufacturing, service, stockroom, invoicing Invoicing, accounting (profitability analysis) 7 Shipping, invoicing, collections, customer support 9 Manufacturing, service, stockroom 11 Invoicing, collections, accounting Other examples (not included in Exhibit 1): Error Type Internal Customer(s) Affected Incorrect serial # of system on AAA Service, customer support Duplicate order Stockroom, shipping, manufacturing, sales admit.

Incorrect sales rep. Code Sales administration 4. For the order-entry process, how would you identify internal failures and external failures? Who would be involved in documenting these failures and their associated sots? Which individuals or departments should be involved in making improvements to the order entry process? An initial step would be to interview employees in order entry, as well as its suppliers and internal customers. Based on the interviews, data collection forms can be developed.

For internal failures, order entry staff would keep track of the problems they encounter while preparing quotes and processing orders. For external failures, internal customers of order entry would keep track of the errors they encounter when using information from the quotes or order acknowledgements. Suppliers to order entry, internal customers of order entry, and order entry staff should be involved in making improvements to the order entry process. 5. What costs, in addition to salary and fringe benefits, would you include in computing the cost of correcting errors?

Possible responses include the following: Office equipment and office space Telephone (to clarify problems) Computer costs (making changes on the computer) Supplies (paper for printing new quotes or order acknowledgements) Lost interest and other costs associated from late payments by customers (due to invoicing stakes resulting from order entry errors) Lost sales from new customers (due to delay in preparing quotes) Lost future sales from current dissatisfied customers (due to errors in order entry) Shipping costs on returns Rework costs Frustration and lower morale, possibly leading to poorer quality or high turnover Costs related to duplication in manufacturing Crisis management costs (express shipping) Lost revenues if underpinning 6. Provide examples of incremental and breakthrough improvements that could be made in the order entry process. In particular, identify prevention activities that can e undertaken to reduce the number of errors. Describe how you would prioritize your suggestions for improvement. Students can brainstorm about possible improvements during a class discussion. Possible responses include: Incremental Improvements Empower employees Allow sales representatives to correct errors without approval. Urge order entry to improve communication with manufacturing and other departments.

Provide feedback to order entry on types of errors, numbers of errors, and cost impact. Daily, by computer (suggestions for improvement) Educate sales representatives about effects of errors and about the process. Provide better training for sales representatives. Train sales representatives to develop accurate quotes and take on the order entry function. Have sales representatives take responsibility for the process. Track customer purchases to improve service to customers. Survey customers about problems; use the responses to prioritize problems. Stop the double-entry of information. Get input from order entry on development of forms. Implement checking in order entry to help prevent order acknowledgement errors.

Develop a reward system that motivates error-free performance of sales reps. And order entry. Benchmark. Breakthrough Improvements Develop a computer system to decrease the number of times data are entered. Develop a spreadsheet or computer program to check for inconsistencies between P. O. And quotes. Check for duplication of orders. Check prices. Develop a computer system that allows sales representatives to prepare accurate quotes. Install a computer system linking order entry, manufacturing, invoicing, etc. Use cross-functional teams to manage “large” costs or different segments. Develop a system that allows parts customers to get their own quotes on-line.

Incremental Improvements Made by SSI ) Key information for quotes is now obtained up-front by the sales representative; earlier, the sales representative faxed partial information to order entry and requested a quote. Order entry staff then spent a great deal of time obtaining quote until he/she has supplied key information to order entry staff. This could be considered a prevention activity. 2) Customers are asked to include quotation numbers on their purchase orders. This allows SSI to match orders with quotes and avoid duplication in manufacturing. SSI prepares its manufacturing plan based on the quotes received because they have a seasonably good idea of which ones are likely to become firm orders. 3) Proper tools are provided to the order entry staff: Procedure manuals. Guidelines for sales discounting.

Prior to this, the order entry staff had to call sales to seek clarifications regarding discounts. Printed configuration guides that contain information in the format that order entry requires. Prior to this, the formats did not always match. 4) Order-entry staff members are now responsible for both quotes and orders. Previously, some staff members were responsible for only quotes, and other staff embers were responsible only for orders. This change had an immediate impact, as the person who prepared a quote now had responsibility for processing the subsequent order. 5) A regular feedback system is now in place. Each internal customer department provides feedback to order entry once every quarter.

Benefits: Cycle time for preparing quotes was reduced by 60% and cycle time for processing orders was reduced by 50%. Also, order entry staff experienced greater pride in their work. Breakthrough Improvement Efforts by SSI as of 1993 Many of these improvements are prevention activities. ) SSI began working with a vendor to develop an on-line configuration that would configure their standard systems (order entry staff would avoid keying-in part numbers). 2) SSI planned to acquire a new, more integrated order entry system that can communicate with the configuration and turn a quote into an order acknowledgement when the order comes in. The system will also be able to generate an invoice, thereby avoiding re-keying the information. ) SSI began working towards providing sales representatives with a laptop quotes in the field. The anticipated benefits include a reduction in errors caused by incorrect or plicate part numbers, and a reduction in cycle time for preparing quotes or processing orders and preparing invoices. Proportioning Improvement Activities Three considerations in proportioning improvement activities are the perceived seriousness of the problems, the benefits of improvements, and the costs of the improvements. In this case study, the breakthrough improvement projects involve higher costs than the incremental improvement efforts. To identify the most serious problems, a Parent analysis can be performed.

In SKI’S case, correcting order acknowledgement errors became the highest priority cause of its associated cost of 7% of the salary and fringe benefits budget (see Exhibit 2). Update: Improvement Efforts by SSI as of 1996 The first incremental improvement, a stringent policy of sales representatives filling out quote forms correctly, was abandoned because the forms quickly became obsolete and the policy was unpopular with sales representatives. In addition, the policy slowed the quotation process. The initial vendor’s quote for the desired configuration was Judged unaffordable. After an month search, however, SSI was able to purchase a new integrated information yester (including materials resource planning and accounting) that included a configuration.

In the meantime, SSI developed an in-house configuration program that runs on the sales representatives’ laptop computers. As a consequence, problems with missing, incorrect, or changed part numbers have been greatly reduced. Information on part numbers originates in manufacturing, and is maintained and kept current by the marketing department. A change from line-item pricing (listing each component part with its associated price) to bundling (listing the component parts but providing only a bottom-line price) reduced processing time because customers previously would call for verification if any one of the component prices on the invoice differed from what appeared on the quote.

The current cycle typically runs as follows: Sales representative prepares a quote using laptop computer configuration and emails it to order entry; Order entry reviews the quote and sends a quote packet to send to the customer (Pricing on quote is reviewed by order entry supervisor); When the customer’s order is received by order entry, the order is entered into SKI’S system the order; The order acknowledgement is transmitted electronically to manufacturing; Manufacturing builds the product; The product is shipped; The invoice is generated the same day the product is shipped, with no further review. 7. What nonofficial quality indicators might be useful for the order entry department? How frequently should data be collected or information be reported? Can you make statements about the usefulness of cost-of-quality (COO) information in comparison to nonofficial indicators of quality?

Nonofficial indicators that might be useful in improving quality in the order entry department include: 1) The frequency of the different types of errors; 2) Time spent n correcting problems. Frequency of reporting is an important issue when implementing a COO system. Options for frequency of tracking data and reporting include: 1) Keep track of the information on a daily basis but report monthly. Continue doing this until improvements are made and the information is no longer needed. The assumption is that continuous improvement projects will be undertaken to rectify the situation. 2) Collect sample data for a specified period once every quarter or six-month period, for example, and assess the changes in the magnitude of problems. The assumption s that results from the sample data will be used to make process improvements.

COO information is useful for the following reasons: 1) COO quantifies the financial impact of the errors/problems, thereby providing a universally understood method of assessing the seriousness of the situation. As emphasized in question 1, COO figures can play an important role in alerting top management to the seriousness of quality problems overall or in a particular area. 2) Quality cost systems cut across departmental boundaries, thereby providing a holistic measure of the benefits derived from improvement efforts. COO information should be used in conjunction with nonofficial indicators, as the latter provide the information actually required for making changes to the system. 6-2 Kelsey Hospital The purpose of this case is to have students analyze and categorize costs of quality costing system in a hospital and the development of such a system for two primary treatments (intubations and bronchiolar treatments) performed in the Respiratory Therapy Department of the hospital. A list of items pertaining to quality costs is presented and described for analysis, estimation, and categorization. Teaching Notes In recent years, companies have realized that to be globally competitive, they must focus on the quality of their products and services. Traditionally, the costs relating to quality have been buried in other cost categories (I. E. Administrative overhead). To evaluate the costs and benefits of efforts to enhance quality and also to better control costs relating to quality, the quality costs need to be segregated and properly measured. Therefore, many companies have established cost of quality systems. Cost classification is an important aspect of these systems because different categories re controlled differently, some categories are more serious in terms of future consequences than others, and investment in certain categories is believed to greatly reduce those in other categories. Determining and measuring costs of quality in a service organization are especially challenging.

Manufacturing companies can inspect their products before delivery to customers and quality can be assessed visually or by the use of instruments. In contrast, service organizations cannot assess quality until after the service is rendered and measuring instruments are usually of no use because physical agreements are not applicable. Hence, it is much more difficult to determine and measure the costs of quality in a service organization than in a manufacturing firm. Manufacturing cost of quality cases have been written in settings such as electronics and paper mills. 2 The issues covered in these manufacturing cases are similar to those in the Kelsey Hospital case study, but how the costs are determined and measured in the service setting are more complex.

With products, one can assess the quality of materials, the quality of product design, and the conformance to product specifications. In service settings, however, one is usually assessing quality associated with intangible items, making it a more nebulous exercise to measure quality costs. At least one service case exists in the context of a railroads and involves the use of quality costs relating to environmental management. Kelsey Hospital also differs from most other manufacturing and service settings in that consideration needs to be given to quality perceptions of an outside customer group-third party payers. Furthermore, because health care organizations deal with human lives, quality is even more paramount than in most other types of organizations.

Students should have had prior exposure to some elementary material on costs of quality from either a cost/managerial accounting textbook or Journal article. 5 The case is appropriate for both undergraduate and graduate cost or managerial accounting courses. This case can be covered in a 50-minute class period. Kelsey Hospital has been used several times in undergraduate introductory managerial accounting classes immediately after textbook material on costs of quality has been covered. Lively discussions have ensued about customer perceptions and owe to categorize the various costs. Drawing out additional quality costs from the students (particularly the undergraduate ones) can be challenging and it may be necessary to give some hints to them.

Like most cases, when students are asked to turn in write-ups on this case prior to class discussion, there is a greater level of preparation than otherwise and this improves the quality of class discussion. However, because the case does not have complex technical accounting issues and contains no number crunching, it does not require a lot of advance preparation for dents to meaningfully discuss the case. In fact, on one occasion, students were given 15 minutes of class time to read the case and the resulting class discussion was rather good. Students have reported that the case helps them better appreciate and understand costs of quality because they see it applied in a setting that they are familiar with rather than an obscure factory setting.

While it may seem that some of the medical terminology would be unfamiliar to students, they seem to absorb it well from the case. Furthermore, class discussions tend to be centered around basic lath-care issues and not medical complexities. Suggested solutions for the assignment questions are as follows: 1. What groups and individuals are the “customers” of the respiratory therapy department? Describe the concerns and perceptions about quality that might differ across the different types of customer. Identify the problems that the different customers would want quality control to prevent, detect, or correct. Various “customer” groups include: ; Patients ; Contract physicians ; Third-party payers such as insurance companies, Homos, Medicare, and Medicaid

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