Cost of Quality Definition
Cost of Quality can be termed as the process that measures and determine where and how the resources of organizations are utilized for in maintenance of quality and prevention of delivering poor outputs. This can be regarded as the method of process improvement and quality assurance and prevents internal as well as external audit failures.
- It talks about the costs that the organization bears while trying to achieve and maintain the quality output.
- The companies determine the cost of quality to derive competitive advantage in the industry.
- By investing a fixed amount towards this cost, the business ensures that the failures are reduced, and defects are eliminated.
- It ensures that the business maintains a positive bottom lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. .
- If the company does not incorporate this cost, then the business can incur high failure costs in the form of product returns and costs of warranty, which can, in turn, dampen the bottom line altogether.
There are four broad components, namely prevention costs, internal failure costs, external failure costs, and appraisal costs.
#1 – Prevention Costs
The prevention costs can be regarded as the costs that the business incurs to reduce and minimize defects. The prevention costs are determined at the start of every new process step. The prevention costs are highly regarded as it saves the organization labor costs and manufacturing costs. If the business does not undertake the prevention costs, then it could result in high defect costs at a very later stage, which could prove to be expensive for the business.
#2 – Appraisal Costs
The appraisal costsAppraisal CostsAppraisal costs refer to the expenses incurred on the quality control and check by the organization. It determines that the product or service fulfills the customer expectations, are non-defective and comply with the regulatory norms. can be regarded as the costs that the business incurs when it works towards the identification of defective items. It is done before any product has to be shipped to the end consumer. The quality checks professional generally inspect finished goods, in the process inventory and raw materials.
#3 – Internal Failure
Internal failure costs are termed as the cost that the business or corporate entity has to bear once the defective items are identified before proceeding with the shipment. These costs signify the direct materialDirect MaterialDirect materials are raw materials that are directly used in the manufacturing process of a company's goods and/or services and are an essential component of the finished goods manufactured., manufacturing overhead, and direct labor consumed by each defective item.
#4 – External Failure
The external failure costs are costs that the business has to bear on account of defective items that are shipped to the customers. These costs are often regarded as expensive as they would cause the business to incur high warranty and return costs along with already incurred manufacturing overheadsManufacturing OverheadsManufacturing Overhead is the total of all the indirect costs involved in manufacturing a product like Property Tax on the production premise, Remunerations of maintenance personnel, Rent of the manufacturing building, etc. .
Cost of Quality Formula
It can further be expressed as displayed below: –
- The cost of good quality is represented as CoGQ.
- The cost of poor quality is represented as CoPQ.
- The prevention cost is represented as PC.
- The appraisal costs are represented by AC;
- The internal failure costs are represented by IFC.
- The external failure costs are represented by EFC.
Example of Cost of Quality
Let us take the example of a business that generates $1,000,000 in sales. It incurs $10,200 in Quality checks and inspection. It pays $30,000 for appraising the purchased raw materials. Additionally, it pays $15,000 for repairs on finished items. It maintains a provision of $5,000 for warranty costs and product returns. Help the management determine the cost of quality as the percentage of sales.
Step 1: Calculation of Total CoGQ
Step 2: Calculation of Total CoPQ
Step 3: Calculation of Total CoQ
Step 4: Calculation of cost of quality as the percentage of sales
Here, the inspection checks and appraisal costs on raw materials account for the CoGQ. The costs of repairs, warranty costs, and product returns account for the CoPQ.
Why Measure the Cost of Quality?
The determination of the cost of quality remains to be critical and varies for different organizations. If this cost is not measured and quantified, the organizations working in the competitive industries would never gain the upper hand and survive the ever-changing dynamic environment. Therefore, it becomes necessary to measure it as it helps the business in the maintenance of the healthy and positive bottom line.
- It helps the organization to chalk out wrong and poor-quality output.
- It helps in problem-solving wherein it performs costs and benefits analysis on different initiatives of quality and process improvements.
- The model or cost of quality helps in a single-point evaluation of quality performance.
- It further evaluates of costs of failures and appraises them accordingly.
It is an essential methodology as it allows the business to derive a competitive edge with respect to its peers working in the industry. These costs ensure that problems and root causes that can impact the business be identified at a very early stage, and preventive actions could be undertaken over them.
It also helps the organization devise and determine the corrective actions on any potential failures faced by the organization. It usually happens when an organization identifies defective products before and after shipping to the customers.
Difference Between Cost of Quality and Cost of Poor Quality
- The cost of poor quality (CoPQ) is a subset of the cost of quality.
- The CoPQ is the business cost incurred when the defective products are identified before and after shipping to customers.
- Therefore, the sum of internal and external failure costs can be termed as the CoPQ.
- The CoPQ usually consists of product return costs and warranty costs related to the products.
- The cost of quality, on the other hand, is determined as the CoGQ and CoPQ.
- It is determined as the sum of the cost of good quality and poor quality.
- The cost of quality takes into account prevention costs, appraisal costs, internal failure costs, and external failure costs.
- The prevention costs and appraisal costs do not constitute the CoPQ as such costs attempt to identify defective products at the beginning of the production process.
- The CoPQ arises after the end of the production process and on defective finished goods.
The cost of quality helps the business in deriving competitive edge with respect to its peers working in the industry. It allows the organization to plan for costs that the business has to incur in maintaining quality costs and helps the organization to make provisions over them, which in turn helps the organization to maintain a favorable bottom line.
The cost of quality can be termed as the costs the business has to bear in terms of utilizing its resources to maintain qualitative outputs to their targeted customers. If the business does not employ its resources to adhere to quality metrics, then it sets to lose out on its competitive advantage. Furthermore, if the cost of quality is not incorporated, then it can severely impact the bottom line of the business.
This article has been a guide to the Cost of Quality and its definition. Here we discuss components, goals of cost of quality along with its formula, examples, and its differences from the cost of poor quality. You can learn more about financial analysis from the following articles –