Professional accountants spend a lot of time thinking about and analysing quality in the context of cost.
Whether the business uses high quality to differentiate itself from rivals (Waitrose, Mercedes-Benz, The Savoy) or whether threshold quality at a low cost is the business objective (Bic, Daewoo, Aldi) – ensuring customer expectations are met is an essential component of organisational success and the modern management accountant pays an integral role in this process.
Traditionally, organisations would employ “quality control” (QC) to check outputs for quality levels. People in white coats carrying clipboards would patrol the finished goods production line, sample checking products to ensure the required quality levels had been achieved. To some extent this still takes place but in modern organisations the emphasis has moved away from a retrospective, reactive inspection of the outputs. Instead the focus is on the inputs and the processes trying to eliminate the root causes of quality failures proactively, before they manifest themselves in finished goods. This is often referred to as “quality assurance” (QA) to distinguish it from QC.
So how do management accountants contribute to the quality of products and services?
Appraisal costs include the costs of employing quality inspectors to check that materials, processes and products throughout the production line conform to pre-determined standards or expectations. Reviewing supplier performance and bench-marking suppliers against each other may also fall under this category. Management accountants can assist by establishing standards using their analytical skills: traditional variance reports can be used to establish materials efficiency standards in production which QA can then judge new inputs against. For example, “last month, using Supplier A, we made 30 products from 400kg of material but this month, using Supplier B, we made 27 products from 420kg of material”. The accountant could also assist in looking at the sensitivity of increasing materials costs to increase materials efficiency or yields in production. Such as,“this month we switched to Supplier C, who charges 15% more than either Suppliers A or B, but we made 37 products from just 375kg of material”.
Prevention costs are the upfront costs associated with training to ensure quality problems don’t develop. In some ways it is the opposite of QC as the focus is all on the inputs, before production even begins. Accountants can help convince management of the benefits of investing in this by producing and presenting cost/benefit analysis showing the before and after costs compared to outputs. For example, “last year, as a result of quality problems, we were incurring warranty costs and reworking costs of £220,000; this year we invested £45,000 in a detailed training programme for all staff and the warranty/rework costs fell to £170,000”. This could be made more detailed by including estimates of the time value of money (money invested up front has a higher present value than warranty costs in the future) or of the intangible costs of customer disappointment from higher warranty issues.
Internal costs are the costs associated with rectifying quality problems. This could include enforced overtime payments or double shift patterns to remake faulty goods which have been rejected on the production line or the cost of waste disposal if materials have to be scrapped due to errors. Accountants can highlight the impact of this cost on profitability through detailed linked-budgeting and cost analysis. Careful liaison with the Human Resources department and the Production department to build a rolling budget showing cost over-runs and updated margins will be required to quantify the cost of the internal failures on profitability and performance. This may then be supplemented by the accountant’s calculations on potential investments in new factory equipment or labour to eliminate the cause. Net present value calculations (NPVs) or internal rate of return calculations (IRRs) to demonstrate the net gain in quality-focused assessments could also be required.
External costs are the worst kind of quality-costs to incur. This is where the internal failures noted above have not been picked up in the QC/QA process within operations and the faulty goods have reached the customer. This could have devastating consequences. The product could be food or drink, medicine, children’s toys or mobile phones which self-combust which will not only harm profitability in the short term through warranty claims, refunds and reworks but potentially ruin the business’ reputation. The accountant could conduct sensitivity analysis or scenario planning budgets to show the potential outcomes of revenue dips or cost increases based on projected reductions in demand and revenue for products. In the worst case scenarios, breakeven calculations could show the threat posed by the reputational damage on the organisation as a going concern, or potentially highlight fixed costs which would need to be cut to preserve breakeven points.
Andy Booth is a trainer for AAT Mastercourses on Financial Performance, Management Reporting, and Budgeting topics.