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Quality management and the role of the accountant.

Quality Management And the Role of The Accountant

"In Search of Excellence"

It is now widely accepted that excellently managed companies achieve their reputation and profitability by delivering high-quality products and services. There is also a general recognition that a massive effort to improve quality is a prerequisite to improving and regaining the competitiveness of U.S. industry in world markets. Quoting Peters again, "Quality, not volume, will become number one for the U.S. - in manufacturing and service sectors alike - or else!"

Consider the potential for improvement: "We believe quality improvement will reduce quality costs by 50 percent, and this means billions of dollars in profit and quality leadership." (John Akers, IBM chairman); "Our objective is a ten-fold quality improvement in 5 years." (William Weisz, president, Motorola); "Our incentive for quality improvement is a powerful one - survival as a successful business entity." (Paul Allaire, president, Xerox).

The opportunities for improvement are monumental. Yet it is not unfair to say that many, if not most, companies have not organized to take advantage of the opportunities presented. Our experience in management seminars with executives from over 100 companies shows that they rate their own quality management programs, on the average, at something less than optimal. Given the scale (top, next page) of 1 (crisis management) to 4 (maturity), the average rating is 2.6.

At an October 1988 symposium in Washington, D.C. for some 175 chief executive officers of major U.S. corporations, the major issue was quality improvement and the information systems to support that effort. The importance of information systems was summarized by Richard Crandall, CEO of COMSHARE: "By defining measures, by making sure the information systems are delivering to these measures, you are sending a signal into the company as to what's important." William McGowan, chairman and CEO of MCI Communications, said, "The clarity of the information flow gives workers the confidence to resolve things right as they come up, when they come up."

Historically, the special accomplishment of accounting has been the design of information systems based on financial and accounting data, historical in most cases. Recently, the discipline and the profession have come under increasing criticism for the lack of relevance to managerial issues. One of its harshest critics is Robert Kaplan, a professor of accounting at Carnegie-Mellon University and the Harvard Business School. In the book "Relevance Lost," coauthored with fellow accounting professor Thomas Johnson, Kaplan writes, "Today's management accounting information, driven by the procedures and cycle of the organization's financial reporting system, is too late, too aggregated, and too distorted to be relevant for managers' planning and control decisions." The two accountants go on to summarize the consequences of this lack of relevance:

* Accounting information provides little help for reducing costs and improving productivity and quality. Indeed, the information might even be harmful.

* The systems do not produce accurate product costs for pricing, sourcing, product mix, and responses to competition.

* The system encourages managers to contract to the short-term cycle of the monthly profit-and-loss statement.

Management accounting systems should be designed to support the operations and strategy of the company, two dimensions in which quality plays the dominant role. Despite the widespread conclusion that we are in the "information age," most accounting systems would be labeled inadequate by managers seeking to support company operations and strategy through quality improvement.

Productivity and quality are two sides of the same coin. By improving quality you reduce costs across the board, not only in the manufacturing or production processes, but in service, administrative, and white-collar costs as well. Lack of a high-quality cost system can result in between 15 and 30 percent of your annual revenue being lost in poor-quality cost. An additional 30 percent of your white-collar cost is the result of errors, or the cost of checking the output of employees to make sure they are not delivering errors to the next person in the company.

Most companies promote quality as the central customer value and make it a key concept of company strategy. In our own experience, few employees or managers can adequately define quality, but it remains a central concept nevertheless.

The importance placed on quality is not surprising, since the customer's purchasing decision is a function of price and quality. The purchase equation is therefore: purchasing decision=price x quality; quality being whatever the customer perceives as value. Thus we have conformance quality (appropriate product specifications and service standards that provide measures in the production or transformation process) and perceived quality (appropriate specifications and service standards that meet customer needs and desires). Conformance quality does not necessarily mean perceived quality. Indeed, most companies, and most books, focus on one or the other, but not both.

Achieving both conformance and perceived quality has a number of key advantages. Conformance quality means a lower cost of quality and thereby a lower overall cost. Moreover, it is often one of the criteria used by the customer in the purchase decision. It follows that meeting both types of specifications and standards provides a double-edged sword with which to beat the competition.

The Strategic Planning Institute gathers performance data on almost 3,000 diverse businesses on a continuing basis. The conclusion relating strategy to performance and profitability is that in the long run, the most important single factor affecting a business unit's performance is the quality of its products and services relative to those of competitors. These studies leave little doubt that superior quality goes with profitability. And this increased profitability gives you three choices:

* Charge a higher price and let the premium go directly to the bottom line.

* Invest the premium in R&D (product and cost) to ensure quality and market share for the future.

* Gain market share by offering the customer better value, but at the same price as your competitors.

A basic question to ask in strategic planning is "How do I differentiate my product or service?" Because differentiation is in the mind of the customer, it is necessary to determine the customer's perceived value and concept of quality. And the more nearly your product or service approaches commodity status, the more important quality becomes.

Other benefits of quality include: Stronger customer loyalty, less scrap and rework, more repeat purchases, lower labor costs, higher selling price, higher margin, fewer returns and warranty costs, higher price for your stock, fewer service calls, less vulnerability to price wars, and productivity increases.

Philip Crosby and W. Edwards Deming both have been influential in promoting the need for quality improvement to counteract the withering incursion by foreign competitors into once-safe U.S. markets. Crosby's Quality College in Orlando, Florida has been host to hundreds of executives seeking the answer to quality improvement. His book provides a 14-step program that is followed by a number of U.S. companies. H. J. Harrington, author of "The Improvement Process," provides an even more detailed program for the improvement process.

It is beyond the scope of this article to examine the many actions needed for a comprehensive process of quality improvement and the role of the accountant in each action. However, there is one accounting responsibility about which there is unanimous agreement and that is the cost of quality.

Traditionally, quality control systems have established an acceptable quality level (AQL) for inspecting incoming items from suppliers and inspection of outgoing products to customers. But trying to inspect quality in, rather than building it in, led to excessive field failures and warranty costs, scrap, high levels of inventory, rejects, and so on. These were the costs of quality - the expense of doing things wrong.

Today's well-managed companies do it right the first time, adopting the philosophy and methods of total quality control. This concept tries to achieve quality throughout the life cycle of the product from market research through design, from purchasing through production, and from usage through service. The standard of performance is "zero defects," a statistical impossibility but nevertheless a target to shoot for. Another popular standard is "parts per million."

The first step in a comprehensive quality program is the calculation and subsequent planning and control of the cost of quality (COQ). This is where the accountant comes in. As Phil Crosby says, "Quality is free but no one is ever going to know if there isn't some system of measurement." The first step that leads to control and improvement is measurement. If you can't measure something, you can't understand it, and if you can't understand you can't control it. Many people will argue that quality is an intangible and therefore not measurable. The answer, of course, is that quality (and the cost of quality) is measurements - cold, hard cash.

There are three fundamental reasons for measuring the cost of quality:

* To get and sustain the attention of top management.

* To indicate major opportunities for corrective action and measures of progress.

* To provide incentives for improvement.

Why should the accounting department produce and track COQ? First, it ensures the integrity of the operation. Second, by having accounting establish these costs, it provides measures that can be a part of accounting information system design.

The common denominator is dollars, but the phrase "poor-quality cost" or "cost of low quality" better defines what it is. The cost is generally classified as prevention cost (all the cost incurred to prevent errors from happening), appraisal cost (all the costs incurred when output is evaluated to ensure that it is good) and failure cost (all the costs resulting from output that does not meet customer expectations).

In our experience with dozens of managers from as many manufacturing companies, most will readily admit that all of the costs listed in the table to the left are incurred in their operations.

Notice that the cost classifications relate to product manufacturing. But what about service and indirect costs; those related to the activities of white-collar workers? Studies have shown that these people spend 20 to 35 percent of their time either checking to make sure that their output is correct or redoing incorrect output. This means that one dollar out of four is spent doing things over.

Finally, there are the "strategic" costs of lost market share, reduced competitive edge, and dissatisfied customers. If your car fails under warranty, the automaker may pay for the new part and/or labor, but you pay for inconvenience, lost time, travel expense, time away from the job and general frustration. What is the cost to the automaker or dealer of a silent dissatisfied customer? A recent Business Week survey indicates that 44 percent of adults believe that businesses would knowingly sell inferior products; 76 percent would then boycott the company's products by refusing to buy them. Quality-conscious companies understand that in the 1990s the most significant determinant of market share, competitive edge, and profitability is improved quality. Remember, for every two dollars spent on gaining a new customer, it costs only one dollar to keep one.

Although activities and functions are the building blocks of an organization, these are not a collection of independent activities. They are a system of interdependent and related activities that are connected by linkages and relationships. For example, purchasing from a low-quality supplier may lead to redesign, rework, scrap, increased field service, and direct labor variance. These linkages are difficult to recognize and are often overlooked. Nor is the conventional accounting system equipped to separate the cost of quality in these linked activities. Accounting classifications usually group activities along functional lines. Virtually all accounting systems force the reporting of quality costs into several general expens categories such as salaries, depreciation, training, etc. Analyzing the accounts can produce estimates of quality costs but unless the costs are designed into the system, they will be elusive at best. These costs are of strategic importance, and only explicit and routine reporting within the accounting system will ensure the management oversight required.

As a first step leading to the design of a planning and control system, it is useful to identify those activities and linkages between activities where costs occur. It is necessary to get organized. For this purpose we suggest some form of organization chart, such as the one shown on page 12, adapted to meet your particular needs. Illustrative activities are arrayed on the left side of the chart. Across the top are the control activities or functions involved in controlling the cost of quality. A number (1 for primary responsibility or 2 for coordinating responsibility) can be entered at the intersection of the cost of quality category and the activity or function involved.

We believe that this is an excellent way to get started with the task of identifying and accumulating the cost of quality. Revisions to the accounting system may include a new ledger account titled "Cost of Quality" to accommodate postings from the relevant responsibility centers. The objective is to heighten the role of the accountant in quality management.
COPYRIGHT 1990 Institute of Industrial Engineers, Inc. (IIE)
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

Article Details
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Author:Ross, Joel E.; Wegman, David E.
Publication:Industrial Management
Date:Jul 1, 1990
Words:2146
Previous Article:A manager's guidelines for implementing successful operational changes.
Next Article:Leadership, communication, and integrity in the 1990s.
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