Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 34

Relevant Cost Analysis—Quality Improvements Destin Company produces water control valves, made of brass, which they sell primarily to builders for use in commercial real estate construction. These valves must meet rigid specifications (i.e., the quality tolerance is small). Valves that, upon inspection, get rejected are returned to the Casting Department, i.e., to stage one of the four-stage manufacturing process. Rejected items are melted and then recast. As such, no new materials in Casting are required to rework these items. However, new materials must be added in the Finishing Department for all reworked valves. As the cost accountant for the company, you have prepared the following cost data regarding the production of a typical valve:

Cost	Casting	Finishing	Inspection	Packing	Total
Direct materials	$200	$12	$-0-	$8	$220
Direct labor	110	120	20	20	270
Variable manufacturing overhead	100	150	20	20	290
Allocated fixed overhead	70	80	40	1 0	200
	$480	$362	$80	$58	$980

The company, spurred by intense price pressures from foreign manufacturers, recently initiated a number of quality programs. As a result, the rejection rate for valves has decreased from 5.0 percent to 3.5 percent of annual output (equal in total to 15,000 units). The reduction in reject rates has enabled the company to reduce its inventory holdings from $400,000 to $250,000. Destin estimates that the annual financing cost associated with inventory holdings is 12 percent.

Required Provide a dollar estimate of the annual cost savings associated with the recently enacted quality improvements. Show calculations.

Step 1 of 6

Management and Control of Quality

Quality is explained as a term associated with customer satisfaction. It is the total level of satisfaction any customer gets from any organization’s products or service. There are two components of quality- Design Quality and Performance Quality. There are various approaches to setting quality related expectations and among those alternatives one is the Cost of Quality (COQ) Reporting. It provides relevant cost and revenue data used for decision-making purposes.