Quality, Environmental and Value Management
Performance
Quality, Environmental and Value Management
Syllabus tag: KASNEB CPA | Advanced Level | CA34S3 Advanced Management Accounting | Topic 8 Quality, Environmental and Value Management
Lesson objectives
By the end of this topic, you will be able to:
- Classify and compute the four categories of quality cost
- Explain total quality management and its cost implications
- Apply value analysis and value engineering
- Explain environmental management accounting
- Describe backflush and just-in-time systems
Why this matters
Traditional cost accounting records the cost of making things and largely misses the cost of making them badly — and the cost of putting them right after the customer finds out. Quality costing makes that visible.
The four quality costs
| Category | Nature | Examples |
|---|---|---|
| Prevention | Stopping defects arising | Training, design review, supplier assessment, maintenance |
| Appraisal | Finding defects before delivery | Inspection, testing, quality audits |
| Internal failure | Defects found before delivery | Scrap, rework, downgrading, downtime |
| External failure | Defects found by the customer | Warranty claims, returns, recalls, lost reputation |
The first two are costs of conformance — spending to achieve quality. The last two are costs of non-conformance — the cost of failing to.
Worked example.
| KES | |
|---|---|
| Prevention | 3,200,000 |
| Appraisal | 1,800,000 |
| Conformance | 5,000,000 |
| Internal failure | 2,600,000 |
| External failure | 6,400,000 |
| Non-conformance | 9,000,000 |
| Total quality cost | 14,000,000 |
External failure is 45.7% of the total — the largest single category, and the worst kind of cost.
The governing relationship: spending on prevention reduces failure costs by more than it costs. Moving 1,000,000 from external failure to prevention is a gain twice over, because it removes the cost and the customer never experiences the defect.
External failure is understated in every system. The recorded figure captures the warranty claim and not the customer who never returns, nor the ones they tell. That is why the conventional cost report makes poor quality look cheaper than it is.
:::checkpoint A company cuts its inspection budget by KES 1,200,000 and reports an improvement in operating cost. Six months later warranty claims have risen KES 2,800,000. Explain which categories moved and what the cost report failed to show. :::
Total quality management
TQM rests on a few propositions:
- Get it right first time. The cheapest defect is the one never made
- Continuous improvement, in Kaizen fashion, rather than a one-off drive
- Everyone is responsible for quality, not a separate inspection function
- Internal customers — each process treats the next as its customer
- Zero defects as the target rather than an "acceptable" defect rate
The last point is the sharpest break with traditional thinking. Classical quality theory computed an optimal defect level where the marginal cost of prevention equalled the marginal saving. TQM rejects the idea that any defect level is optimal, arguing that the true cost of failure — including reputation and lost customers — is never fully measured, so the calculated optimum is always wrong in the same direction.
Value analysis and value engineering
Value analysis examines an existing product to remove cost without reducing what the customer values. Value engineering does the same at the design stage, before cost is committed.
Four kinds of value are distinguished:
- Use value — what the product does
- Esteem value — the prestige of owning it
- Exchange value — what it can be resold for
- Cost value — what it costs to produce
A cost that adds to none of the first three is waste. The discipline is asking of every feature: what does this contribute, and would the customer pay for it separately?
Note the connection to target costing: value engineering is the principal tool for closing a cost gap.
Environmental management accounting
Environmental costs are largely hidden in general overhead, so no product or process is charged with the cost it causes.
Techniques:
- Input-output analysis — what comes in must come out as product or waste; measuring the difference values the waste
- Flow cost accounting — tracking material, energy and system costs through each stage
- Environmental activity-based costing — treating environmental costs as a cost pool with a driver, so they attach to the products causing them
- Life cycle costing, extended to include decommissioning and remediation
The rationale is the same as ABC generally. Where environmental cost sits in general overhead, a clean product subsidises a dirty one and management has no figure telling it so.
Just-in-time and backflush costing
JIT produces to demand rather than to forecast, with minimal inventory. It requires reliable suppliers, short set-up times and high quality — a defect stops the line where there is no buffer stock.
Backflush costing suits it: rather than tracking cost through work in progress, cost is charged at completion or sale by working backwards from output.
The simplification is only defensible where inventory is genuinely minimal. Where it is not, backflush costing understates work in progress materially.
:::checkpoint A company adopts JIT and its quality costs rise sharply in the first year. Explain why this might be expected, and what pattern you would want to see in the second and third years. :::