Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 43

Cost of Quality: Financial Reporting Issues

Consider adapting the cost of quality framework to financial reporting issues. Assign costs to one of four categories: prevention (P), appraisal (A), internal failure (IF), and external failure (EF), where the categories refer to financial reporting activities and the consequences of poor, or even illegal, financial reporting.

Required

Classify the following costs incurred for financial reporting activities into the four categories.

a. Extra work done by external auditors to complete the audit because new employees made a lot of errors.

---

b. Effects of bad publicity on stock prices because publication of financial statements was delayed in order to correct errors in the statements.

---

c. Employee training: new accounting regulations.

---

d. Drop in stock price from bad publicity after the chief executive gets sentenced to 10 years in prison.

---

e. Fines for failing to comply with accounting regulations.

---

f. Design of information systems to keep out hackers.

---

g. Design of internal control systems to minimize errors in data entry.

---

h. Internal auditors’ review of internal controls in item (g) above.

Step 1 of 9

Cost accounting system

This is a system designed for inhouse or internal managers and their decision making. Cost accounting information is not needed for comparison with other companies. This information is commonly used in financial accounting also, but it is primarily used by company managers for their decision making. It is important that cost accounting information is relevant for the decision making of the manager.

Prevention costs

These costs are incurred to prevent the defects in the products or services like material inspection, process inspection, equipment inspection, training, product design and process control.

Appraisal costs

These costs are incurred to detect the defects in the products post production or identify the products not meeting the specifications like sampling at the end of process, testing on field etc.

Internal failure costs

These costs are incurred for correction or repair when any defect is found in the product before delivery to customer like material wasted, rework done to fix the problem, testing conducted post rectification etc.

External failure costs

These costs are incurred to fix the problems related to defective products, after delivery to customer like after warranty repairs, paying for product failure, trying to improve company image damaged due to faulty delivery, improving sales etc.