12 Costs of Quality and Other Cost Management Issuesjacobl.docx

12 Costs of Quality and Other Cost Management Issues
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Learning Objectives
After studying Chapter 12, you will be able to:
• Explain relationships among the costs of quality categories.
• Understand the concepts of target costing and kaizen costing.
• Distinguish between value-added and nonvalue-added
activities.
• Describe various types of nonfinancial performance measures.
• Identify nonfinancial performance measures for multinational
companies.
• Comprehend the elements of a balanced scorecard.
• Describe benchmarking techniques to improve productivity
and quality.
• Explain strategies to enhance productivity such as downsizing
and business process reengineering.
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Chapter Outline
12.1 Costs of Quality
Cost Categories
Diagramming Costs of Quality
Continuous Improvement
Sources of Costs of Quality Data—ABC and Customer Inputs
Service Applications
12.2 Cost Management in Design and Production Stages
Target Costing
Kaizen Costing
12.3 Activity Analysis
12.4 Nonfinancial Performance Measures
Measures of Manufacturing Productivity
Productivity of Labor
Product Quality
Inventory Reduction
Machine Maintenance
Delivery Performance
12.5 Nonfinancial Measures for the Multinational Company
12.6 Balanced Scorecard
12.7 Benchmarking
12.8 Strategies to Enhance Productivity
Downsizing

Business Process Reengineering
Ethical Considerations
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TQM and the Need to Measure Quality Costs
Pete Moss, considered the ace troubleshooter for DeKalb
Fertilizer Company, was sent to
its Georgia regional office by “Big Dan” DeLion, president of
DeKalb, about 15 months ago.
What he found was “big trouble.” The region was losing about
$400,000 per month—mostly
from waste, low productivity, and customer warranty claims.
Revenues were declining,
and too many customers were unhappy. This was Spring 2018,
long after Total Quality
Management (TQM) was a cliché and a norm in most firms.
Yes, DeKalb had a TQM program
that “Big Dan” had announced in late 2019. Signs had been
posted about quality being
“No. 1.” A consulting firm had conducted seminars for workers,
statistical control charts
were maintained, and managers had increased inspections.
Faster response to warranty
claims had been implemented through a costly system to
guarantee a 24-hour response to
any customer problem.

Yet, productivity declined, scrap was up, and warranty costs
soared. Workers saw the TQM
program as a management project. Managers blamed much of
the problem on the lack of
union cooperation and of employee concern. No specific quality
goals were set. Everyone
lacked a sense of urgency. Pete’s arrival brought a sudden
change: meetings with line
workers quickly pointed to key production problems, warranty
claims were grouped to
identify failure causes, landscape designers and on-site
supervisors were brought together to
analyze failures, and certain changes were made “overnight.” A
goal of cutting scrap by 50%
in three months was set.
At every step, the same question came up: “What’s this costing
us?” Pete, knowing that this
question was key at other plants, sought out Rose Bush, the
plant cost accountant. Rose was
in the middle of an ABC study and had begun to define new
activity centers and cost drivers.
While not an easy task, Rose was able to modify her system
rather quickly to identify quality
costs: which, where, and how much. Pete and Rose became
allies, promoting each other’s
views to managers and employees alike. Within two months,
Rose gave Pete a 2019 costs of
quality analysis. These costs totaled a surprising 15% of
revenues. Of this, little was spent on
prevention, about 30% was spent on appraisal, nearly 45% went
to fixing internal failures,
and the rest were external failure costs. Lost revenues because
of bad product weren’t
captured or estimated. In addition to many nonfinancial quality

measures, the quality cost
reports helped Pete measure the impact of his recovery program.
Pete is now gone, off to another problem plant. The Georgia
plant is now at breakeven. But
the quality job is just now paying dividends. Rose’s latest costs
of quality report shows total
costs still high at 12% of revenues. But, the cost composition
had changed already: 30%
prevention, 30% appraisal, 25% internal failure, and 15%
external failure. The target for
2021 was 10% of revenues with percentages of 40, 40, 15, and
5, respectively. Long-term
goals are 6% of revenues and a percentage mix of 70, 20, 10,
and 0, respectively. Incidentally,
revenues are rebounding.
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Section 12.1 Costs of Quality
In the last decade, the competitive environment has forced a
changed and improved focus
on every business. Heightened customer service expectations,
development of integrated
systems, demands for cost reductions, advances in information
technology, access to inter-
national markets, and speed of competitor reactions have all
increased the demands on

managerial accountants for relevant and timely data for
decisions. This chapter examines a
set of the more important areas of change in managerial
accounting. These topics are heav-
ily influenced by international competitors, particularly the
Japanese. Product quality and
process improvement have allowed Japanese automakers,
electronics firms, and other con-
sumer goods producers to capture major shares of international
markets. Disciplined and
team-oriented approaches brought market and financial success.
Soon others, particularly
U.S. firms, began to adopt and adapt similar concepts and
strategies. JIT, quality circles, and
continuous improvement programs are examples.
In this chapter, we focus on several of these topics that have
strong managerial accounting
ramifications. Specifically, measuring and monitoring quality
costs are major parts of any
total quality management program. Team approaches to design,
costing, production plan-
ning, and process improvement have yielded huge dividends.
These approaches have focused
on linking customer needs to the design process, on identifying
and eliminating any activity
that does not add value to the product, and on organizing
planning and control activities that
truly measure performance. Many more topics could be included
and more pages added on
a weekly basis. Old accounting tools are redesigned, some are
abandoned, and new concepts
are tried and tested. The pace of change is exciting.
12.1 Costs of Quality
“Quality is free” is a favorite saying of many who argue for

efforts to improve quality. It may be
difficult to accept the concept that spending more on quality
improvement efforts will lower
costs. But the facts tell an exciting story:
• Increased training of workers will reduce scrap and rework
costs.
• Higher-quality products and services improve customer
satisfaction and generate
higher sales.
• Narrower control limits force improved processes and greater
utilization of capacity.
• With reduced waste, more product can be generated with the
same equipment and
workers.
• “Designing in” quality prevents production problems and the
need for engineering
changes to create “fixes.” An error of $1 in design can easily
cause $10 in production
problems.
• Empowering employees through quality circles and other
participation techniques
to give them control over quality-related production decisions
increases total
commitment.
• Employee satisfaction from eliminating rework, downtime,
and scrap increases pro-
ductivity and further commitment to improvement, particularly
if the benefits are
shared with the employees.

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These results reduce quality costs and, therefore, product costs.
Quality efforts come in many
forms and names, including:
• Total quality management (TQM)—an integrated effort of
training, process con-
trols, incentives, employee empowerment, product engineering
and design, supplier
involvement, and customer satisfaction measurement to achieve
quality goals.
• Statistical quality control—the use of statistical techniques on
processes to mea-
sure, monitor, and evaluate performance based on goals, control
ranges, and perfor-
mance percentages.
• Continuous improvement programs—efforts to establish
quality targets that
represent improvement over current performance through
worker involvement in
evaluation processes.
• Quality control through the guidance of quality experts—
specific approaches to

quality management promoted by internationally recognized
leaders such as Dem-
ing, Juran, Crosby, and Taguchi.
All of these focus on management commitment to bringing
about a change in attitude and
changes in processes.
Methods vary, but all emphasize heavy management
commitment to change. One Michigan
firm’s management, tired of customer complaints and nagging
productivity problems, intro-
duced an array of techniques to impress employees and
managers with the need to work
toward zero defects in its output. Every work station was made
responsible for approving
the quality of its work before sending it to the next station.
When defects were detected, the
entire line was halted, horns sounded, the problem diagnosed,
and responsibility for the solu-
tion identified. The initial result was that very little was
shipped from that plant for nearly
two weeks because of the nearly constant stoppage of the line.
But within two months, pro-
ductivity was above any prior period and continued to rise. The
costs of the early stoppages
were nearly fatal to the firm, but the payoffs are substantial
both internally and to customers,
many of whom are automotive related and are using vendor
certification programs to pro-
mote quality, delivery, and cost goals, and to eliminate
nonperforming suppliers.
Cost Categories
Four categories of costs are commonly identified. These
categories are related and can be

considered tradeoffs for each other. They, along with examples,
are:
• Prevention costs are incurred to prevent the production of
products or ser-
vices that do not meet specifications. As these costs increase,
failure costs should
decrease. These costs, often spent prior to production, include:
Job training Quality training
Supplier evaluation and approvals Preventive maintenance
Development of specifications and standards Promotion of
quality
Employee quality circle teams New equipment to reduce waste
Design and process engineering
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• Appraisal costs are incurred to monitor and inspect
production. These costs are
intended to detect products or services that do not meet
specification during the
production process. As these costs increase, failure costs should

decrease. Included
are:
Inspections of materials Quality control activities
Inspections during production Production testing
Inspections of finished products Statistical quality control
Line personnel’s self-checking activities Calibration of test
equipment
Internal auditing activities
• Internal failure costs are incurred after defective or
substandard product or ser-
vice is detected but before it leaves the plant. These costs
increase as the number of
defective units detected increases. Included are:
Rework, retesting, and rescheduling Scrap
Lost production Downtime
Lost contribution margin on defective units* Increased
inventory
* These items are measurable only by making estimates of
external impacts and are rarely
part of a costs of quality accounting report. They are the most
subjective of all quality
costs yet, perhaps, the most important in a strategic sense.
• External failure costs are incurred when the defective product
or service gets to
the customer. These costs increase as customers find defective

units and reject them.
These costs include two important groups: costs of handling
customer complaints
and costs of future lost sales because of poor quality and
customer dissatisfaction.
Included are:
Repairs Logistics of returned units
Warranties (estimated and actual) Processing recall programs
Contribution margin on replacement
units
Lost contribution margin from
damaged product reputation*
Liability claims Complaint departments
Lost contribution margin from price
reductions*
Product service departments
* These items are measurable only by making estimates of
external impacts and are rarely
part of a costs of quality accounting report. They are the most
subjective of all quality
costs yet, perhaps, the most important in a strategic sense.
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513
While these lists seem straightforward, much judgment goes
into the typical quality cost anal-
ysis. If a person’s duties are part production and part
inspection, what percentage should be
considered to be quality costs? Each firm must decide on its
own definitions. Also, as time
passes, processes change, greater understanding of quality
issues evolves, and accounting
systems change. One danger behind this discussion is that an
impression is created that cost
measurement is precise and easily performed. Activity-based
costing, special studies, and
improved charts of accounts have certainly detailed the trail of
costs.
Traditionally, these costs have been buried in other cost
categories. Prevention costs are “lost”
in administrative overhead. Appraisal costs are spread among
the many locations. Internal
failure costs show up in efficiency and quantity variances and
allowances for “normal scrap.”
External failure costs are selling and administrative costs or not
captured at all. In many firms,
it takes a major effort to identify, measure, and track these costs
with reasonable accuracy.
Prevention and appraisal costs are considered tradeoffs to
internal and external failure costs.
Thus, stronger training programs are viewed as important costs
that help reduce internal and
external failure costs. Also, a stronger appraisal program should

reduce both internal and
external failure costs. Yet, in the long run, spending on
prevention costs may allow a company
to reduce both failure costs and appraisal costs. Better-trained
employees will produce much
higher-quality products that require less testing and inspecting,
a result of producing few if
any defective units. Implicitly, failure costs fall to near-zero
levels.
Diagramming Costs of Quality
Figure 12.1 illustrates the interaction of the four costs of
quality categories. The horizontal,
or x-axis, reflects either a decreasing defect rate or an
increasing quality assurance rate. As
can be seen, an optimal cost level can be drawn. The
presumption is that increased prevention
and appraisal spending will lower failure costs (internal plus
external). We must be careful
not to oversimplify the relationships here. For example:
• The optimal spending level can be drawn but can rarely be
measured accurately.
Also, this optimal level of spending implies that we should be
satisfied with this level
of quality (defects).
• This static drawing of the four cost categories reflects general
trends but implies
that they are equally important and are of approximately equal
size. Rarely is this
the case.
• The cost curves imply that cost functions can be defined
quantitatively to allow
these costs to be plotted at various levels of quality assurance.

While cost relation-
ships do exist, they are difficult to quantify accurately.
• Too often, managers assume that by merely spending money
on quality prevention
and appraisal activities their quality goals can be achieved.
Some TQM programs
have been successful and sustainable; many others have
achieved neither their qual-
ity nor cost reduction goals.
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Any manager or managerial accountant who advocates finding
the optimal spending and fail-
ure cost level and operating at that level fails to understand the
interrelationships that exist.
For example, prevention costs (i.e., training, education, and
quality-enhancing investments)
are in effect current investments in future defect reductions.
More spending on training and
vendor certification programs, for example, should reduce
internal and external failure rates
in the future. A highly trained workforce should reduce the need
for inspections in the future.
As an offbeat example of this idea, compare the teenage driver

accident rate in the United
States with Japan. In the U.S., most teenagers take a short
driver’s training course with very
limited coverage of driving laws, driver etiquette, and hands-on
skill development. In Japan,
compulsory driver education courses cost approximately $5,000
per person because of the
amount of training required. Car accidents do occur but at a
much lower level as compared
to U.S. experiences. (To test the idea, survey your current class.
Odds are that well over half
of your fellow students have had an auto accident before they
reached 20 years of age.) Japan
has traded accident costs for training costs. Other social impacts
must be considered; for
example, many persons might not drive because they cannot
afford the $5,000.
As a numerical example of Figure 12.1, assume that 100,000
units are produced with six
possible levels of spending on prevention and appraisal efforts.
The contribution margin is
$10 per unit. Of the defects, 60% is detected internally; and
40% is discovered externally. All
defects must be reworked at a cost of $8 per unit. External
failures cause a loss of future sales
at a ratio of three units of lost sales for each external defect
found, or $30 of lost contribution
margin for each external defective unit. All dollar and unit
amounts are in thousands (adapted
from Godfrey & Pasewark, 1988, p. 72).
Internal Failure Costs
External Failure Costs
Prevention Costs

Appraisal Costs
Total Cost of Quality
Low $
High $
Costs
of
Quality
High
High
Low
Low
Defect Rate
Quality Assurance Rate
Figure 12.1: Costs of quality
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To explain these numbers, the first row assumes that 5% of the

100,000 units produced is
defective. Also, we are now spending $100,000 each on
prevention and appraisal costs. It will
cost $8 per unit to rework the 5,000 defective, units or $40,000.
Lost contribution margin is
found by taking the external failures (40% × 5,000 units) times
the contribution margin of
three lost units (3 × $10)—a lost sales cost of $60,000 in
contribution margin. The total costs
of quality are $300,000.
Based on these numbers, the managerial accountant would
recommend that the current opti-
mal cost level is $240,000. This assumes that we can quantify
the relationship between higher
prevention costs and lower defective percentages. It also
assumes that appraisal costs can be
reduced accordingly. Internal and external discovery rates for
defective units and lost sales
figures are clearly estimates. Contribution margins and rework
costs are reasonably solid
data. This, however, is a static picture of quality costs. As time
passes, these relationships will
change, resulting in a new optimal spending pattern.
Continuous Improvement
Can any firm be satisfied with a static quality level? No!
Markets are demanding higher and
higher quality assurance levels. Japanese auto quality levels of
the 1980s well exceeded U.S.
capabilities. U.S. firms now exceed those levels, but Japanese
carmakers have moved to still
higher levels. Competition demands continuous improvement.
Prior to the implementation of a TQM program, appraisal costs
and combined failure costs

will likely be very high. For example, the mix of quality costs
at the start of a major quality
effort in a machine manufacturer was:
Defect
Rates
Prevention
Costs
Appraisal
Costs
Rework Costs Lost Contribution Margin
Units Costs Units Costs
Total Quality
Costs
5.00% $100 $100 $8 × 5.0 $40 $30 × 2.0 $60 $300
3.50 120 80 8 × 3.5 28 30 × 1.4 42 270
2.25 140 65 8 × 2.25 18 30 × 0.9 27 250
1.25 160 55 8 × 1.25 10 30 × 0.5 15 240
0.50 190 50 8 × 0.5 4 30 × 0.2 6 250
0.10 240 48 8 × 0.1 0.80 30 × 0.04 1.20
290
Prevention costs 4.5%
Appraisal costs 41.7

Internal failure costs 53.4
External failure costs .4 (excluding lost sales estimates)
Total costs of quality 100.0%
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Total costs were approximately 8% of total sales. As part of
management efforts to get
employee “buy in,” figures were presented to show the impact
on employee profit sharing if
the percentage decreased to 6%.
As time passes, Figure 12.1 will be revised to reflect
improvements in quality and changed
cost relationships. Movement will be toward higher quality
assurance and lower defect levels.
Cost patterns will shift from failure to prevention. Even
appraisal costs may decrease as more
confidence is gained in the production processes. Figure 12.2
incorporates a sequence of Fig-
ure 12.1 diagrams and reflects this change in patterns over a
series of years.
Figure 12.2: Annual shifts in the total costs of quality line

Low $
High $
Costs
of
Quality
High
High
Low
Low
Defect Rate
Quality Assurance Rate
Year 1
Year 2
Year 3
Year 4
Year 5
A line linking minimum cost points should always be shifting
downward and to the right.
Whether the company is ever at the exact optimal point each
year or month is questionable.
But aggressive TQM programs have produced results following
this pattern. As an illustration

of the shifting cost patterns, a set of summarized biannual data
from a film studio appears in
Figure 12.3. The data are in millions and include an
approximate 10% increase in sales each
year. Definitions of what costs belong in each category rests
with company personnel.
Notice that, at the start of the total quality management
program, internal failure is the high-
est percentage category; two years later, appraisal costs are the
highest percentage; and
finally, prevention costs become the highest percentage. Of
particular note is the steadily
declining percentage of quality costs to sales. While significant
reductions in these percent-
ages are rather consistent, company management feels that the
TQM program training effort
is approaching a steady state. The forecast for 2021 shows a
further dramatic decline in the
costs to sales percentage and in total quality costs. These
challenges have been met in the
past, but the 2021 goal is particularly rigorous. Managerial and
employee efforts will deter-
mine the result.
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Sources of Costs of Quality Data—ABC and Customer Inputs
Most traditional costing systems will find it difficult, if not
impossible, to collect the type of
data needed for the preceding analyses. ABC has been a timely
innovation. Activity centers
that focus on quality issues (i.e., training, rework and scrap,
inspections, and quality assurance
program costs) can separate these activities and the resources
they consume. Cost drivers can
help identify relationships between failure costs and their
causes. Thus, ABC increases the
ability to identify quality costs, focuses attention on costly
activities, and even helps recognize
cause-and-effect linkages.
Many companies must extend even ABC data to capture more
quality costs. This might include
account analysis, discussed in Chapter 6. With certain costs,
allocations may be needed, which
introduce difficulties when measuring improvement. As
improvements occur, costs must be
reallocated, often introducing arbitrariness.
The tough measurement is still lost sales, part of external
failure. Numerous firms have made
customer satisfaction surveys important and routine parts of
their marketing, service, and
product planning and design functions. Quality councils have
included both suppliers and
customers to add critical external views of internal quality
levels and efforts. In the past, lost
sales estimates were only vague guesses, but greater articulation
of customer and potential
customer inputs can push this figure toward a more valid
estimate.

Service Applications
While TQM programs are often linked to manufacturing and its
quality, service organizations
also find quality just as critical to customer satisfaction and to
their long-term survival. The
same categories of costs of quality apply to all organizations.
Xerox, for example, has devel-
oped significant quality programs for its manufacturing, sales,
and service activities. Training
to increase service employee competence, to improve
interactions with customers, and to
raise the quality of services provided is similar to
manufacturing tradeoffs. The focus is more
heavily on customer satisfaction since providing the service, in
many cases, is at the customer
contact point. Lost sales, service reputation, and attributes such
as “friendliness” are difficult
to measure in a financial context. Yet, measuring costs of
improving and sustaining quality
Figure 12.3: Shifting patterns of costs of quality over time
Cost Categories
Prevention
Appraisal
Internal Failure
External Failure
Total Costs
Cost as a % of sales
2013 2015 2017 2019 2021
$ 2.5
6.0
6.2

2.3
$ 17.0
14.7
35.3
36.5
13.5
100.0
$ 3.5
6.8
5.6
2.2
$18.1
19.3
37.6
30.9
12.2
100.0
$ 5.9
4.8
4.4
1.2
$16.3
36.2
29.4
27.0
7.4

100.0
$ 5.7
3.9
3.6
0.8
$14.0
40.7
27.9
25.7
5.7
100.0
$ 4.5
2.9
2.1
0.4
$ 9.9
45.5
29.3
21.2
4.0
100.0
Forecast
18.0% 15.8% 11.7% 8.3% 4.9%
Costs % Total % Total Costs Costs Costs%Total %Total Costs

%Total
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Section 12.2 Cost Management in Design and Production
Stages
and of eliminating service failures is critical. Hospitals, for
example, have an obvious need for
high levels of quality control activities. Monitoring quality
costs, while important, becomes
secondary to the need for assuring extremely high levels of
operating quality regardless of
cost. Yet, because of huge increases in health care costs,
national health care policies will
require measuring and analyzing operating costs, including
costs of quality.
12.2 Cost Management in Design and Production Stages
Companies have traditionally emphasized cost management in
the product production phase,
while neglecting the design and development stages. Managers
now recognize that most of
the costs incurred in the production stage are, in fact,
determined in the design and develop-
ment stages. Accordingly, many companies are adopting target
costing, a system initiated in
Japan, to manage costs in the design and development stages for
new (or redesigned) prod-

ucts. Another Japanese system known as kaizen costing is used
to manage costs in the prod-
uct manufacturing stage.
Target Costing
Historically, U.S. manufacturers have set their pricing strategies
by adding required profit
margins to the costs of already designed products. Target
costing reverses this process. After
a target selling price and a target profit are established, an
allowable cost consistent with
these targets is obtained for the product. The company then
designs the product based on
the allowable (target) cost. Figure 12.4 compares the target
costing approach to the tradi-
tional approach.
Figure 12.4: Target costing compared to the traditional
approach
Target
Costing
Traditional
Approach
Design the
product
Obtain the target
selling price
Determine the
cost
Deduct the target

profit margin
Add a required
profit margin
Obtain the
target cost
Obtain the required
selling price
Design the product
based on target cost
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Section 12.3 Activity Analysis
In target costing, the process begins with a general plan to
produce a product based on mar-
keting research. This marketing research also suggests a target
selling price by estimating
what consumers will pay for the product. The company then
determines the amount of profit
that would be expected by management for this product. From
this target price and target
profit, a target cost is obtained:
Target cost = Target selling price – Target profit

This overall target cost is then decomposed into specific cost
elements for materials, subas-
semblies, direct labor, various manufacturing overhead
categories, and various nonmanufac-
turing categories such as distribution and customer service.
Finally, the design department
establishes a blueprint according to the target cost for each
element.
As an example of the target costing approach, suppose that
Lylatove Sleepwear is considering
the production of a new line of pajamas. Based on preliminary
market research, management
has decided that each pair of pajamas should be priced at $20.
Furthermore, management
believes that the profit margin should be 12% of sales revenue.
Hence, the target profit would
be $2.40 (0.12 × $20). The target cost, therefore, would be
$17.60 ($20 – $2.40).
Kaizen Costing
Kaizen costing is a system to support cost reduction beyond the
design and development
stages. “Kaizen” is a Japanese word that refers to “continuous
accumulations of small better-
ment activities rather than innovative improvement” (Monden &
Hamada, 1991, p. 17). Inno-
vative improvements are usually introduced in the design and
development stages. In kaizen
costing, the actual cost for the previous period becomes the
kaizen cost target for the current
period. To promote continuous improvement, these kaizen cost
targets must be reduced in
each successive period. For instance, suppose a company’s
shipping costs are $10,000 for

2020 and that its kaizen cost reduction targets are 3% per year
for the next two years. So, for
2021, its kaizen cost target would be $9,700 (.97 × $10,000),
and for 2022, it would be $9,409
(.97 × $9,700).
These techniques have allowed many Japanese firms to
overcome the effects of the increased
value of the yen in international markets. Lower costs and
improved products have offset less
competitive yen exchange rates.
To achieve cost reduction, many companies are adopting an
activity-based management
(ABM) approach. ABM is an outgrowth of activity-based
costing (ABC) that emphasizes man-
agement of activities through ABC, activity analysis, and
performance measurement. We dis-
cussed ABC in Chapter 4; the latter topics are discussed in the
following sections.
12.3 Activity Analysis
Companies are monitoring their activities to assess which
activities add value to the cus-
tomer, which, in turn, should add profit to the company. This
technique is referred to as activ-
ity analysis. An emphasis on activities can help identify
nonvalue-added costs and eliminate
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520
the activities that cause them. Any resource-using activity that
does not add value is often
called waste. Having value implies that a consumer would be
willing to pay for the results of
the activity. A key goal of production managers is to eliminate
waste and, thereby, to have an
efficient and productive operation.
Time is perhaps the most valuable resource. Study of nonvalue-
added time in operations
takes five forms: process time, inspection time, move time, wait
time, and storage time.
Process time is the time during which a product is undergoing
conversion activities that
transform raw materials into finished products. Although most
people view process time as
the sum of many value-added activities, the presence of
inefficiency or other nonproductive
activities represents nonvalue-added time. Managers must
continually review processes to
catch inefficiencies that can creep in over time.
Just-in-time (JIT) production concepts are fundamental building
blocks for reducing process
time. Many companies have physically reorganized their
factories to encourage faster process
time. Figure 12.5 compares a JIT layout to a traditional factory
layout. The traditional plant
has large inventories, much materials movement within the
plant, and a mixing of fabricat-
ing and assembly tasks. The JIT plant produces only when parts

and products are needed,
carries low amounts of inventories, has a north-to-south flow of
production, and organizes
production around product families (similar production
requirements). The implication is
that greater output can be achieved with the same equipment,
people, and space—waste is
reduced.
Figure 12.5: Traditional factory versus just-in-time factory
layouts
Fabricating & Assembly Areas
Raw Materials Inventory
Receiving Dock
Shipping Dock
Finished
Goods
Inventory
In-Process
Inventory
Finished Goods Inventory
Raw Materials Inventory
Receiving Dock
Shipping Dock
Fabricating
Areas & Cells

Work
Units
Product Family Cells
Traditional Factory Layout With
Large Materials, In-Process,
and Finished Goods Inventories
Just-In-Time Factory Layout With a
Pull-Through Flow, Few Inventories,
and Integrated Manufacturing
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Inspection time is the amount of time spent ensuring that the
product is of high quality. Typ-
ically, materials and components are inspected upon arrival.
Then inspection occurs at vari-
ous points during and at the conclusion of the production
process. It is difficult to determine
whether inspection procedures result in nonvalue-added costs
without detailed knowledge
of the production technology and inspection procedures.

However, many companies are striv-
ing to reduce the costs of maintaining product quality and are
working virtually to eliminate
the costs of reworking defective products. Consequently, zero
defects and total quality control
programs sensitize employees to the need for eliminating
spoiled and defective units. The
argument is that quality is built into and not inspected into the
product. Unless otherwise
stated, we presume that inspection is a nonvalue-added activity.
Move time is the time spent moving raw materials, work in
process, or finished products
between operations within the plant. This includes the activities
associated with receiving
materials, moving them into storage, moving materials and
components to the first produc-
tion operation, moving partially completed products from one
work center to the next, and
moving the completed product to the finished goods storage
area to await shipping. Many
companies refer to these activities as materials-handling
operations. Move time is a non-
value-added activity. A certain amount of move time is
necessary in any production process,
but proper sequencing of operations and tasks and implementing
automation technologies
can significantly reduce move time. Figure 12.5 illustrates the
importance of an efficient flow
through the factory to minimize materials movement.
Wait time is the amount of time that materials or work in
process spend waiting for the next
operation. This includes the time that materials, components,
and partially completed prod-
ucts remain in queues immediately preceding an operation and

in holding areas located near
each department waiting for the next production operation. Wait
time potentially represents
a significant nonvalue-added cost. A company’s working capital
is tied up in work in process,
and space is unnecessarily wasted on numerous production
queues and holding areas. Even
in the simple diagrams in Figure 12.5, we see that space
released from having inventory wait
for the next production step can be used to expand production.
The ultimate goal of the JIT
philosophy is to eliminate wait time completely. Companies
using JIT systems have proven
that remarkable reductions in in-process inventories can be
made. For example, a car assem-
bly plant producing 70 cars per hour may have less than one
hour’s supply of car seats in the
plant at any time. When a car begins its two-hour trip along an
assembly line, an electronic
message is received in a supplier’s seating plant to trigger
assembly of that car’s seats. The
seats are built and delivered to the car assembly line minutes
before the car arrives at the seat
installation point.
Storage time is the time during which finished products are held
in stock before shipment
to customers. It includes the time products spend in storage and
the time spent packaging
the products for shipment. Traditionally, companies have stored
large inventories of finished
products to avoid stockouts. Similar to waiting time, storage
time ties up a company’s working
capital in inventories and requires large amounts of space
devoted to storage activities. While
not applicable to all manufacturing operations, produce-to-order

is a goal—manufacture prod-
ucts only after a sales order is received. Improvements in order
entry systems and shortened
lead times in production scheduling can give the appearance of
a produce-to-order operation.
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Section 12.4 Nonfinancial Performance Measures
The time required for an average unit to go from the beginning
of the production process to
completion and shipment is often referred to as throughput time.
This time is equal to pro-
ductive processing time plus nonvalue-added time. More
specifically, it is the sum of all five
activities previously discussed: process time, inspection time,
move time, wait time, and stor-
age time. Suppose that the manufacturing of a particular
cellphone began at 9 a.m. It spent
two hours on the various assembly lines and another 15 minutes
of inspection. In addition,
there were three moves between assembly lines and two moves
involving storage areas, all
totaling 20 minutes. The phone spent a total of 30 minutes
waiting at four different work sta-
tions before work was initiated in those areas. Before shipment
to the customer, the phone
was stored in the warehouse for three hours. The throughput

time amounts to 6.08 hours
(2 + .25 + .33 + .5 + 3).
Contemporary Practice 12.1: Activity Analysis at Cater-
pillar’s Marketing & Product Support Division (MPSD)
The activity-based management process starts by “searching for
low- and no-value
activities within each office process to eliminate or
significantly reduce the cost of
these activities. It ends by identifying the supply source for
each office process. For
MPSD, this meant examining the core competencies of its
global operations, deciding
what to keep doing internally and what to source from outside
vendors. . . . Because
Caterpillar has locations around the world, MPSD was able to
address the services
it provided to both internal (other Caterpillar divisions) and
external (dealers and
customers) organizations to leverage the global footprint by
taking ABM-optimized
processes and sourcing them where it made the most sense to
provide each service.”
Source: DeFreitas, D.G., Gillett, J.W. & Fink, R.L. (2013,
January). Getting lean and mean with Caterpillar with ABM.
Strategic Finance, 24–33.
12.4 Nonfinancial Performance Measures
As changes occur in the operating environment, traditional
measures of performance are
being reexamined. New measures are being adopted to better fit
the concepts of activity-
based management. In addition, accountants are measuring
performance in new areas of

operations, areas that have normally been outside of the
accountants’ domain or are new
because of needs that innovative and automated environments
create. This section gives a
glimpse of some of the critical changes taking place.
Accountants have traditionally focused on financial measures of
performance, such as varia-
tions from budgeted or standard costs. Such measures are still
important, but a broader eval-
uation including nonfinancial measures is necessary. For
example, physical measures such
as throughput time, value-added labor ratio, and defective
product rates are playing greater
roles in helping managers achieve high-quality and competitive
operations. Let’s look at some
nonfinancial performance measures that are commonly being
used.
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Measures of Manufacturing Productivity
Increasing pressure from global competition has caused many
companies to focus on better
measures of productivity. Traditionally, accountants have
associated productivity with vari-
ances calculated for quantity, efficiency, mix, yield, and

capacity. The goal was cost minimi-
zation. Other productivity measures commonly used were
nothing more than quantities of
output divided by quantities of input. Today, we are looking for
more detailed, meaningful
measures. Activity-based costing can pinpoint high-cost
activities. Engineers can design for
greater production efficiency and defect elimination. For
example, a machine manufacturer
might determine the number of machines produced per day per
employee. A car assembly
operation might ascertain the square footage required per day
per car. An electrical generat-
ing plant might keep track of the tons of coal required to
generate a thousand kilowatt-hours
of electricity. The measures are oriented toward specific
activities and evaluate management
control over these activities.
Manufacturing cycle efficiency (MCE) is a measure of the
amount of throughput time that
consists of process time. It is the following ratio:
Manufacturing cycle efficiency =
Processing time
Throughput time
Remember that throughput time is the sum of process time,
inspection time, wait time, move
time, and storage time. Assuming that inspection time is
nonvalue-added time, then MCE
measures the portion of throughput time which is value-added
time. The goal is to have MCE
as high as possible, with 100% as the theoretical ideal.

Another widely used productivity measure is the first-pass
yield. This measures the percent-
age of nondefective items that have gone through the production
process one time only (i.e.,
without needing any rework).
Computer-integrated manufacturing (CIM) is an attempt to
optimize the entire plant’s pro-
duction by planning which departments will produce which
parts and products, in what order,
and when. Formerly, each department’s efficiency was
measured, and keeping all depart-
ments running at full speed was the goal. Now in CIM, certain
departments may be idled until
their resources are needed. This is “pull through” production
and part of the JIT philosophy.
Produce only what is needed immediately. Performance
measures must therefore evaluate a
unit based on its production assignment, not necessarily its
capacity. Responsibility for pro-
ductivity is now moved to higher management levels and away
from the individual activity
center or cost center manager.
The total labor expended for the benefit of a product or service
is segregated into direct and
indirect labor. Direct labor is all labor that can be specifically
identified with a product or
service in an economically feasible manner. Value-added direct
labor is that portion of direct
labor that changes raw materials into a finished product or
service that is delivered to a cus-
tomer. For example, value-added direct labor fabricates,
assembles, and finishes products.

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524
Nonvalue-added direct labor moves, inspects, stores, examines,
or otherwise handles the
products without adding customer value. Indirect labor is labor
that is not readily traced to
a product or service. Indirect workers supervise, repair, manage,
purchase, inspect, record,
advise, or otherwise support the direct workers. Traditionally,
indirect workers are consid-
ered nonvalue-added labor. In labor-intensive activities, one
measure of performance for
labor is the value-added labor ratio or ratio of value-added time
to total time:
Value-added labor ratio =
Value-added direct labor time
Total direct and indirect labor time
The ratio also may be computed in terms of number of
employees or payroll. One goal is to
reduce the number of supervisors, managers, clerical staff,
accountants, engineers, inspec-
tors, and all others that are nonvalue-added workers. This is
part of empowering workers to
work as teams and to assume responsibility for production.

In many operations, direct labor is being replaced by automated
equipment, and indirect labor
now includes technicians needed to program, set up, and
maintain the equipment. Often, the
distinction between direct and indirect labor is blurred or
eliminated. Team approaches to
production (work units or product family cells as shown in
Figure 12.5), guaranteed wage
labor contracts, and broader job classifications have further
eroded the importance of direct
labor as a cost group. A labor-related performance measure that
does not distinguish between
direct and indirect labor is the percentage of total labor cost in
the total product cost, called
the labor content percentage:
Labor content percentage =
Total labor cost
Total product cost
The goals are to reduce this percentage and to increase the
productivity of all labor dollars.
Product Quality
Earlier in this chapter, we discussed financial measures of
product quality. Costs of quality
enable us to aggregate various aspects of quality by using a
common unit of measure—dollars.
Furthermore, costs of quality allow us to assess the impact of
quality on the company’s profits.
However, knowing the costs of quality does not enable us to
pinpoint specific sources of quality
problems. To diagnose and correct specific problems relating to
quality, we need a variety of

nonfinancial measures of quality.
Four categories of nonfinancial measures are helpful in
assessing and maintaining quality.
The first, customer acceptance measures, focuses on the extent
to which a company’s custom-
ers perceive its product to be of high quality. It includes such
measures as counts of customer
complaints, warranty claims, incidence of failures at customer
locations, products returned,
and repeat sales.
Design quality assesses how well a product has been designed.
Frequency of engineering
change orders is an important measure of design quality. Other
measures include the number
of parts in the product and the percentage of common versus
unique parts. Since simplicity is
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525
desirable; the fewer the number of parts and the higher the
percentage of common parts, the
better the design quality.
In-process quality measures look at product quality during
production. Rework, defects, and

scrap measures are used to keep these items to a minimum.
Products are also selected for
testing at random, or statistically sampled during the various
stages of production. Defect
rates are measured, and corrective actions specified.
A fourth area of quality measurement relates to purchased
materials and parts. Pressure is
on purchasing agents to acquire high-quality inputs to meet
materials requirements at low
costs and on a timely basis. Common vendor performance
measures include percentage of
defects in the delivery (in terms of dollars as well as number of
items), percentage of orders
filled, and percentage of orders delivered on time. Many
companies are now computing an
overall rating of suppliers based on the quality of their
materials, delivery performance, and
customer service. Also, waste, scrap, and defects occurring
during production that are trace-
able to materials are identified with specific suppliers. A
growing number of companies now
have vendor certification programs, where managers may
purchase from only those vendors
who have met the company’s quality standards.
Inventory Reduction
Inventory investments, ordering costs, and carrying costs often
include significant amounts
of nonvalue-added costs. To remain price competitive, effort is
necessary to reduce or elimi-
nate inventories. Many companies use an approach called
economic order quantity, which
utilizes a mathematical formula to minimize the total costs of
ordering and storing invento-
ries. The JIT philosophy focuses on keeping inventories at low

or zero levels for materials
and parts at every stage of production. Therefore, inventory
control measures are used to
minimize nonvalue-added costs. Such measures may include
average inventory values, aver-
age time various categories of materials are held or inventories
are standing in a production
operation, and inventory turnovers (cost of goods sold divided
by average inventory). Mea-
sures like manufacturing cycle efficiency also relate to
inventory reduction because nonpro-
cessing time—inspection, move, wait, and storage times—is
much of the reason why inven-
tories exist.
Machine Maintenance
If our efforts to reduce inventories are successful, we shift our
focus to the company’s capabil-
ity of producing goods quickly. We must keep production
equipment and machinery operat-
ing. Therefore, performance measures will look at unscheduled
machine downtime, equip-
ment repair time, tooling turnaround time, engineering change
time, machine availability, and
adherence to maintenance schedules. Some companies even
make a distinction between bot-
tleneck and nonbottleneck machinery. A bottleneck operation is
one that limits the production
capacity of the entire facility. It is vital that the machinery in
bottleneck operations be avail-
able 100% of the time, excluding time for routine required
maintenance. Managing bottleneck
operations has received considerable attention in recent years
and has become a central com-
ponent of a management philosophy known as the Theory of
Constraints. This philosophy

emphasizes planning around constraining factors and working to
relax the constraints.
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As a final point, assume that we have done a super job of
reducing many nonvalue-added
activities and eliminating others. Still, we are not successful
until quality products are deliv-
ered on time and at the right place to the customer. This is
especially important for customers
who have JIT systems.
Some companies have a goal of filling 100% of their orders on
time. Common measures of
delivery performance include the percentage of orders filled, the
percentage of on-time deliv-
eries, and the average time between the receipt of a customer
order and the delivery of the
goods. Monitoring customer backorders also tells how many
orders were not filled from stock
or on time and how long a customer had to wait for an order. A
desirable piece of informa-
tion often impossible to measure is business lost because of
delivery failure. Many manag-
ers believe that the “competitive ballgame” is won or lost with

product quality and delivery
performance.
In Figure 12.6, we summarize the nonfinancial performance
measures previously discussed.
Figure 12.6: Summary of nonfinancial performance measures
Manfacturing Productivity
Output per day per employee
Output per square foot of space
Energy required per unit of output
Manufacturing cycle efficiency
First-pass yield
Value-added labor ratio
Labor content percentage
Inventory Reduction
Average inventory values
Average time inventories are held
Inventory turnovers
Machine Maintenance
Unscheduled machine downtime
Equipment repair time
Tooling turnaround time
Engineering change time
Machine availability
Adherence to maintenance schedules
Percentage of orders filled
Percentage of on-time deliveries
Time from customer order to delivery

Product Quality
Customer acceptance:
Number of customer complaints
Number of warranty claims
Incidence of failures at customer locations
Number of returned products
Repeat sales
Design:
Frequency of engineering change orders
Number of parts in the product
Percentage of common vs. unique parts
In-process:
Amount of rework
Defect rates
Amount of scrap
Materials and parts:
Percentage of defects in the delivery
Percentage of orders filled
Percentage of orders delivered on time
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Section 12.6 Balanced Scorecard
12.5 Nonfinancial Measures for the

Multinational Company
Multinational companies are increasingly using nonfinancial
performance measures in evalu-
ations. Common ones for international operating units are:
1. Increasing market share and market size
2. Relationship with host country government
3. Quality assurance
4. Productivity improvement
5. Customer development
6. Innovation
7. Cooperation with other company units and the parent
8. Environment compliance
9. Employee training and development
10. Employee safety
11. Labor turnover
12. Community service
Notice that for some of these measures a company will have
difficulty attaching numerical
values. These measures are very important in comparing
performances, particularly over
time and against planned target levels.
The implication is that the corporate office is in close touch
with the international operation,
can assess budget and planning targets astutely, and can link
successful performance in the
local environment with global economic goals of the
corporation.
12.6 Balanced Scorecard
Many companies are integrating financial and nonfinancial
performance measures into a

tool that has become known as a balanced scorecard.
Historically, companies’ operational
and management control systems have been built around short-
term financial measures that
have not been linked to long-term strategic objectives. A
balanced scorecard attempts to over-
come this deficiency by using a set of performance measures
that serve to link a company’s
long-term strategy with its short-term actions. The scorecard
communicates the long-term
strategy to all levels of the organization so that both
departmental and individual objectives
are aligned with the company’s goals.
Typically, a balanced scorecard consists of the following four
categories of performance
measures:
• Financial—measures that describe economic consequences and
are of most interest
to shareholders.
• Customer—measures that relate to the customer’s perspective
and to the market
segment in which the company competes.
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528
Section 12.6 Balanced Scorecard

• Internal business process—measures that describe the internal
processes (i.e., the
means) needed to provide value for customers and shareholders.
• Learning and growth—measures that define the capabilities
needed to create long-
term growth and innovation.
A balanced scorecard is not simply a collection of performance
measures. These measures are
derived from the company’s mission, strategy, and objectives
and represent a balance among
the four measurement perspectives. In the financial category,
the strategic themes often
include revenue enhancement, cost minimization, and asset
utilization. Examples of these
financial measures, as well as measures for the other three
categories in the balanced score-
card, can be found in Figure 12.7. Strategic themes for the
customer category often include
market share growth, customer retention, customer acquisition,
and customer satisfaction.
In the internal business process category, the strategic
objectives relate to increasing the effi-
ciency and effectiveness of operations. The objectives for the
learning and growth category
relate to the ability to innovate and improve.
Figure 12.7: Examples of measures in a balanced scorecard
Financial
Revenue enhancement:
Revenue growth from prior period
Product profitability
Cost minimization:

Product cost per unit
Cost per customer
Asset utilization:
Return on investment
Residual income
Economic value added
Customer
Market share
Number of new customers
Percentage of returned products
Customer survey ratings
Percentage of customers paying early
Internal Business Process
Percentage of defective units
Manufacturing cycle efficiency
First-pass yields
Output per square foot of space
Supplier ratings
Learning and Growth
Employee satisfaction ratings
Training hours per employee
Number of new brands introduced
Inventory of cross-functional employee skills
Percent of revenue from new products
The frequency of measurement varies depending on the type of
performance measure. For
instance, operating measures such as machine downtime or
percentage of orders filled may
be measured daily. Other operating measures such as
manufacturing cycle efficiency or
amount of rework may be measured weekly. Yet others such as
inventory turnovers and num-

ber of warranty claims may be measured quarterly. Some
measures such as economic value
added (EVA) and number of new products introduced may be
measured annually. Generally,
nonfinancial measures are reported more frequently than
financial measures.
As a result of introducing the balanced scorecard, some
companies have reduced their empha-
sis on short-term incentive compensation systems. Instead, they
are linking bonuses to bal-
anced scorecard measures. One particular oil company decided
to base 60% of its executive
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Section 12.7 Benchmarking
bonuses on the achievement of targets relating to four financial
factors: return on capital,
profitability, cash flow, and operating cost. The remaining 40%
is based on indicators of cus-
tomer satisfaction, dealer satisfaction, employee satisfaction,
and environmental responsibil-
ity (Kaplan & Norton, 1996).
Contemporary Practice 12.2: Balanced Scorecard
at Store24

“Store24 is a privately held convenience store retailer in New
England. . . . Store24 used
a balanced scorecard-based performance measurement system.
The company collected
information on a variety of performance measures at various
levels of the organization and
at various frequencies. Management collected store-level
financial performance metrics
quarterly. It monitored store-level customer measures less
frequently.”
Source: Campbell, D., Datar, S.M., Kulp, S.L., & Nayayanan,
V.G. (2015). Testing strategy with multiple performance
measures: Evidence from a balanced scorecard at Store24.
Journal of Management Accounting Research, 27(2), 39–65.
12.7 Benchmarking
To improve both quality and productivity, many companies are
turning to benchmarking.
This technique identifies activities as standards (“benchmarks”)
by which similar activities
should be judged. Simply put, it is a process of finding better
practices. Benchmarking can be
done with internal sources—other parts of the company—or
with other companies, includ-
ing competitors. The external candidates are often obtained by
examining lists of companies
cited in trade and business journals for excellence in their
business practices.
Aside from trade and business publications, performance
benchmarks can be gathered from
electronic databases, professional conferences and trade
conventions, commissioned studies,
and site visits to companies. Benchmarking utilizes both
financial and nonfinancial perfor-

mance measures. But this information says nothing about the
changes needed to improve
quality and efficiency. Therefore, those doing the benchmarking
must also obtain an under-
standing of these “best practices” so that they can implement
them in their own organizations.
To promote ethical benchmarking, the International
Benchmarking Clearinghouse and the
Strategic Planning Institute Council on Benchmarking have
adopted a common Code of Con-
duct. These rules of conduct cover such areas as:
• Legal matters (e.g., collusion to restrain trade)
• Integrity
• Confidentiality
• Proper use of information and names
• Contacting policies
• Preparation for benchmarking
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Section 12.8 Strategies to Enhance Productivity
12.8 Strategies to Enhance Productivity
To achieve gains in productivity, many companies have turned
to various strategies in recent
years. Two of these strategies are downsizing and business
process reengineering.

Downsizing
For many companies, particularly in service industries, a major
portion of costs are labor-
related costs. These include not only the wages and salaries of
employees but also fringe ben-
efits and overhead costs to support labor such as telephone
expenses and office space. Thus,
when companies look to reduce costs and improve efficiency, a
prime candidate becomes the
reduction of their work force. This phenomenon, sometimes
referred to as downsizing, can
involve outsourcing one or more functions, consolidating
certain functions, initiating across-
the-board cuts in personnel, or eliminating business segments
such as product lines or geo-
graphical territories.
While downsizing may reduce costs and improve efficiency in
the short run, it can harm
the company’s long-run competitiveness and well-being.
Remaining employees sometimes
become overburdened, making more mistakes and declining in
productivity. Morale suffers.
Employees fear for their jobs, and company commitment takes a
back seat to personal inter-
ests. Therefore, if downsizing is deemed necessary, it must be
done with extreme care.
Often, downsizing is accompanied by fundamentally changing
the way a company operates.
This strategy is called business process reengineering.
Business Process Reengineering
A business process is a series of activities that are linked to
perform a specific objective. Busi-

ness processes include both manufacturing as well as
nonmanufacturing processes such as
purchasing materials or handling customer inquiries and
complaints. Business process
reengineering (BPR) refers to changes made in management,
organizational structure, and
work practices to achieve significant improvements in quality,
cost, speed, and service. BPR is
not merely a marginal changing of processes; rather, it involves
major restructuring of orga-
nizational forms, management procedures, job descriptions,
work flows, control systems, and
organizational cultures.
One of the main principles of BPR is to organize work around
processes and outcomes rather
than around tasks and departments. Instead of having a
specialist for each separate task, one
person or group is responsible for an entire process. This has
led to the replacement of func-
tional departments like sales and production with
interdisciplinary teams that focus on per-
forming an entire process. For instance, at IBM Credit
Corporation, the credit approval pro-
cess formerly involved five different individuals. Credit
requests were forwarded to someone
to check the applicant’s credit, then to another person to set the
interest rate, and so on. IBM
Credit reengineered this process so that one individual, called a
deal structurer, completely
processes an application.
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531
Summary & Resources
Summary & Resources
Chapter Summary
The focus on quality has caused the analysis of the costs of
quality to become an important
managerial task. These costs are broken into four components:
prevention, appraisal, inter-
nal failure, and external failure. Often it is difficult to define
these costs clearly. The goal is
to reduce total quality costs. Often this is done by increasing
prevention and appraisal costs
to reduce or nearly eliminate failure costs. ABC systems have
aided the measurement and
reporting of these costs significantly. Quality costs and
documentation are the management
accountant’s responsibility.
Recognizing that most costs of production are determined when
products are developed and
designed, many companies are turning to a technique known as
target costing. After a target
selling price and a target profit are established, a target cost is
obtained for the product. The
company then designs the product based on the target cost. To
promote continuous improve-
ment in the manufacturing stage, kaizen cost targets are reduced
in each successive period.
Activity analysis involves reviewing activities and eliminating

those that do not add value to
the product. Throughput time is composed of process time,
inspection time, move time, wait
time, and storage time. The most common place to look for
nonvalue-added activities is in
inspection, move, wait, and storage time.
Traditional measures of performance are being reexamined.
New measures are being adopted
to better fit the concepts of activity-based management. These
are largely nonfinancial mea-
sures relating to manufacturing productivity, labor productivity,
product quality, inventory
reduction, machine maintenance, and delivery performance.
Many companies are beginning
to integrate nonfinancial measures with financial measures into
a balanced scorecard. Com-
panies are also benchmarking their performance against best
practices from other organiza-
tions. To achieve gains in productivity, many companies have
turned to strategies such as
downsizing and business process reengineering.
Ethical Considerations
Enhancing productivity via downsizing or business process
reengineering can be traumatic
for individuals in the organization. Therefore, management must
be careful to conduct these
changes in an ethical manner. A key consideration should be to
communicate the changes
in an honest way. Decisions as to who gets terminated and how
it is done can be subject to
serious abuses. Those whose job duties are changed should be
properly informed about new
expectations and should be trained adequately for their new
roles.

Major downsizing or business process reengineering can
sometimes affect entire communi-
ties. Such is often the case with plant closings. Should
management consider the impact of a
plant closing on the welfare of the surrounding community?
Many people believe that there is
an ethical responsibility to do so.
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Summary & Resources
Key Terms
activity analysis Monitoring activities
to assess which activities add value to the
customer, which, in turn, should add profit
to the company.
appraisal costs Costs of quality that are
incurred to monitor and inspect production.
balanced scorecard A tool that integrates
financial and nonfinancial performance
measures.
benchmarking Comparing operations,
costs, and productivity with world-class
performers.

business process reengineering
(BPR) Changes made in management,
organizational structure, and work practices
to achieve significant improvements in qual-
ity, cost, speed, and service.
continuous improvement programs
Efforts to establish quality targets that
represent improvement over current per-
formance through worker involvement in
evaluation processes.
downsizing Removing entire layers of
management to make the organization “lean
and mean.”
economic order quantity A technique that
utilizes a mathematical formula to mini-
mize the total costs of ordering and storing
inventories.
external failure costs Costs of quality that
are incurred when the defective product or
service gets to the customer.
first-pass yield The percentage of good
product that passes through the production
process without needing rework.
inspection time The amount of time spent
ensuring that the product is of high quality.
internal failure costs Costs of quality that
are incurred after defective products or
services are detected but before they reach

the customer.
kaizen costing A system to support cost
reduction after the design and development
stages. The actual cost for the latest period
becomes the kaizen cost target for the cur-
rent period.
labor content percentage Total labor costs
expressed as a percentage of total product
costs.
manufacturing cycle efficiency (MCE)
A measure of what part of throughput time
consists of process time.
move time The time spent moving raw
materials, work in process, or finished goods
between operations.
prevention costs Costs of quality that
are incurred to prevent the production
of products or services that do not meet
specifications.
process time The time during which
the product is undergoing the conversion
activities that transform raw materials into
finished products.
statistical quality control The use of sta-
tistical techniques on processes to measure,
monitor, and evaluate performance based
on goals, control ranges, and performance
percentages.

storage time The time during which mate-
rials, partially completed products, or fin-
ished products are held in stock before fur-
ther processing or shipment to customers.
Theory of Constraints A philosophy that
emphasizes planning around constraining
factors and working to relax the constraints.
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Summary & Resources
throughput time The time it takes for an
average unit to go from the beginning of
the production process to completion and
shipment.
total quality management (TQM) An inte-
grated effort of training, process controls,
incentives, employee empowerment, prod-
uct engineering and design, supplier involve-
ment, and customer satisfaction measure-
ment to achieve quality goals.
value-added labor ratio The ratio of value-
added time to total time.
wait time The amount of time that materi-

als or work in process spend waiting for the
next operation.
Problem for Review
The following accounts were listed among the chart of accounts
for Arbiser Machine Tooling:
Warranty Repairs
Supplier Training and Certification Programs
Cost Accounting Salaries
Engineering Design Reviews
Customer Returns and Allowances
Scrap
Depreciation on Machinery
Final Product Testing
Rework Time
Planned Machine Maintenance
Emergency Machine Repairs
Purchased Materials Inspection
Direct Labor
Required:
Classify these accounts according to the appropriate costs of
quality category: prevention,
appraisal, internal failure, or external failure. Not all accounts
will be included.
Solution
:

Prevention costs:
• Supplier Training and Certification Programs
• Engineering Design Reviews
• Planned Machine Maintenance
Appraisal costs:
• Final Product Testing
• Purchased Materials Inspection
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Summary & Resources
Internal failure costs:
• Scrap

• Rework Time
• Emergency Machine Repairs
External failure costs:
• Warranty Repairs
• Customer Returns and Allowances
Cost Accounting Salaries, Depreciation on Machinery, and
Direct Labor may include elements
of quality costs, but they are not normally considered costs of
quality accounts. If quality costs
are included in these accounts, they should be segregated by
creating new expense accounts
to track these costs directly.
Questions for Review and Discussion
1. Identify four categories of costs of quality. Give an example
of each.
2. Greg Orian, Controller of Calendar Creators, sees the four
categories of costs of qual-
ity as substitutions for each other. Explain why he might believe
this.

3. Why might the task of measuring, reporting, and analyzing
costs of quality be dif-
ficult? Can these costs be easily benchmarked across firms?
Explain.
4. Discuss the possible linkage between monitoring quality by
measuring quality costs
and by using nonfinancial measures of quality performance.
Comment on which is
most important.
5. For most firms, is it possible to eliminate failures and,
therefore, failure costs? Is it
possible to push total quality costs to zero? Explain.
6. How is target costing different from the traditional approach
of setting costs and
prices?
7. What is meant by the term “nonvalue-added costs?” Provide
three examples.
8. Explain the value-added labor ratio.
9. Why are nonfinancial measures of quality needed in addition
to costs of quality?

10. Describe the four types of nonfinancial measures related to
product quality.
11. What are the common external sources for obtaining
performance benchmarks?
12. Explain business process reengineering.
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Summary & Resources
Exercises
12-1. Costs of Quality Categories. The following accounts and
their costs are from Kes-
sler Textiles.
Questions:

1. Classify these costs by the four costs of quality categories.
2. If sales were $4,600,000, show the costs of quality as a
percentage of sales for each
category and in total.
Customer design verification $ 5,000
Machine testing after machine setup 10,000
Employee training 40,000
Raw materials testing 12,000
Scrap loss net of scrap sales 30,000
Materials reprocessing 28,000
Customer complaints and returns 40,000
Final product testing 20,000
In-process inspection 45,000

Routine machine maintenance 25,000
Nonroutine machine repairs 50,000
Discounts for missed delivery dates 33,000
Price reductions for product quality downgrades 68,000
Idle labor—downtime due to machine repairs 37,000
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Summary & Resources
12-2. Costs of Quality Trends. Haber & Blass, an architectural
firm, recently studied its
costs over the past three years. The partners of the firm have
been promoting total

quality management programs to its clients for years. They
finally decided to apply
the same concepts to their own business. After much discussion,
they adopted cer-
tain definitions of quality costs and began to monitor them.
They did acknowledge
that internal failure costs also included costs of nonvalue-added
activities that were
not technically failure costs. Now, three years later, they show
the following data as
highly summarized results of their efforts.
2019 2020 2021
1st Half 2nd Half 1st Half 2nd Half 1st Half 2nd Half
Prevention costs $ 5,000 $ 20,000 $ 50,000 $ 60,000 $
50,000 $ 55,000
Appraisal costs 40,000 60,000 65,000 70,000 72,000
70,000
Internal failure costs 120,000 130,000 120,000 123,000
110,000 105,000

External failure costs 43,000 30,000 25,000 26,000 18,000
15,000
Client billings have gone up modestly over the three years,
perhaps 20% in total.
Questions:
1. For each cost category and each time period, determine its
percentage of total costs
for that time period.
2. Comment on the changes over the three-year time period and
the results of the
three-year effort.
12-3. Analysis of Quality Costs. Goldin Realtors has reported
the following data for 2020:
Prevention costs $374,000
Appraisal costs 615,600
Internal failure costs 651,400

External failure costs 27,100
Question:
Comment on the following thoughts:
a. Prevention and appraisal spending has eliminated nearly all
customer quality
problems.
b. More should be spent on prevention to even the spending
among the three inter-
nal cost categories.
c. A goal of reducing costs in each category by 10% (or by some
specific dollar
amount) should be set in next year’s profit plan.
d. A good job has been accomplished if the sum of the four
costs as a percentage of
sales declines somewhat.
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Summary & Resources
12-4. Classifying Costs of Quality. Paul Miller, controller of
Meta Medical, has reviewed
the costs of quality records for the past year. Meta Medical
provides calibration and
maintenance services for sophisticated medical equipment in the
Midwest. Training,
testing, and service calls are major costs that seem to grow each
year. Miller is trying
to measure possible ways of reducing the total costs of quality
as part of a review of
all processes and activities within the firm. He assembled the
following costs.
Miller is aware of two contracts that were cancelled this past
year because of client
complaints about poor service response. These contracts totaled
$60,000.

Questions:
1. Classify these costs according to prevention, appraisal,
internal failure, and external
failure.
2. Comment on the difficulty that Paul Miller likely has in
analyzing these and other
costs that might be costs of quality.
12-5. Target Costing. Janet Harris, general manager of Banks
Bus Service, is considering
adding a new route. Based on preliminary market research, she
has decided that the
fare should be $3.50.
Question:
If the company’s profit margin is 20% of revenues, what should
the target cost be?
12-6. Kaizen Costing. In 2019, Heights High School incurred
the following costs in its
athletic department:

Parts warranty, including replacement labor $ 92,000
Emergency trips to service client machines 86,000
Rental of substitute equipment to cover client downtime 43,000
Training of repair technicians (time and travel) 196,000
Inspection of finished repairs 45,000
Testing and certifications of calibration equipment 15,000
Development of client testing processes and diagnostics 31,500
Event
Cost per
Event
Track meet $600
Swim meet 950
Soccer game 820

Water polo match 980
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Summary & Resources
The school has recently begun a system of kaizen costing.
Accordingly, the principal,
Janet Orr, has asked Jim Nasium, the head of the athletic
department, to reduce costs
by 2% each year for the foreseeable future.
Question:
Assume that Jim Nasium reduces costs according to the plans
set by Janet Orr. Compute the
projected kaizen cost targets in 2023 for each of the preceding

events.
12-7. Value-Added and Nonvalue-Added Activities. Loretta
Love Clothiers manufac-
tures denim jeans in a process that passes through three
departments. The output of
each department is immediately transferred to the next
department to await further
work. Output from the last department in the process represents
the completed
product, which goes to finished goods inventory to await
shipping. Specifically, dyed
denim cloth bales are released from the storeroom (materials
inventory) and moved
to the Cutting Department where the fabric is cut to patterns.
The cut pieces are
sorted into sets of jeans. Any miscut pieces are scrapped. The
sets move to the Stitch
and Form Department where the pieces are sewn together.
Thread, zippers, and
snaps are added during this process to make the completed
jeans. The jeans are sent
to the Inspection and Finishing Department. Inspection makes
certain that jeans
meet quality standards; spoiled and defective jeans are removed

from the process.
Spoiled jeans go to the scrap pile. Inspectors must determine the
extent of defect in
those jeans considered defective. If the defect can easily be
corrected, the jeans go
back into the process where the work will be done. If the defect
cannot be corrected,
the jeans are treated as seconds and are sold unlabeled in
factory outlets and dis-
count stores. Those jeans successfully passing inspection move
to the labeling tables
where brand labels are stitched on each pair of jeans. The
completed jeans move to
the warehouse where they become part of the finished goods
inventory.
Questions:
1. Identify the activities in the denim jeans production process
that fall into process
time, inspection time, move time, wait time, and storage time.
2. List the activities in the denim jeans production process that
are candidates for
nonvalue-added activities.

12-8. Value-Added Labor. Natasha Company produces air
pumps in a small factory about
30 kilometers south of Moscow, Russia. The company employs
eleven people with
nine direct and two indirect laborers. The plant manager, Boris
Badinov, describes
the tasks of the nine direct workers as follows:
a. Three fabricators who cut and grind metal parts from raw
steel, aluminum, and
brass
b. One parts inspector who examines and approves parts
produced
c. One warehouse stocker who keeps parts in inventory and fills
bins used by
assembly workers
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Summary & Resources
d. One molder who makes vinyl seals and plastic fittings by
using an injection
molder
e. Two assemblers who assemble parts into product
f. One product inspector who approves the final product
Questions:
1. Categorize each of the nine workers as a value-added or
nonvalue-added worker.
2. Compute the value-added labor ratio.
12-9. Nonvalue-Added Costs in a Doctor’s Office. Dr. Steve
Rosenthal has his own
medical practice. He specializes in the treatment of diabetics.
His staff consists of a
receptionist, two nurses, a lab technician, and a dietitian. As
patients enter the outer

office, they check in with the receptionist. The patient then
waits until called by a
nurse. When called, the patient moves from the waiting room to
the inner offices.
The patient must weigh in and is then assigned a room for the
rest of the work and
conferences. The nurse assigning the patient to a room gathers
all the personal data
for updating the medical records, such as insulin dosage,
medication, illnesses since
last visit, and so forth. The nurse also takes an initial blood
sample for blood sugar
testing and performs a blood pressure test. The patient then
waits until the doctor
comes in. After the doctor’s conference, the nurse returns to
take more blood sam-
ples, depending on what is ordered by the doctor. The patient
then waits until the
dietitian comes to review eating habits and talk about how to
improve meal plan-
ning and weight control. The patient returns to the receptionist
to pay for the office
visit and to schedule the next visit.
Questions:

1. Identify the activities in the doctor’s office that fall into
process time, inspection
time, move time, wait time, and storage time.
2. List the activities in the doctor’s office that are candidates
for nonvalue-added activi-
ties. Explain why you classify them as nonvalue-added
activities.
12-10. Downsizing, Kaizen Costing, and Ethics. Biltmore
Insurance Corporation insti-
tuted kaizen costing in 2019 for all of its divisions. During
2018, the Claims Division
incurred costs of $5.6 million. Seeking to dramatically reduce
costs, the manager of
the Claims Division, Gail Norman, thought about cutting
$200,000 in payroll costs
for 2019 by eliminating all part-time claims adjuster positions.
However, she soon
realized that her kaizen cost target for 2020 would then be $5.4
million. Therefore,
she decided to institute her reforms much more slowly and,
consequently, reduced
payroll costs by only $40,000 during 2019.

Question:
Discuss the ethical dimension of Gail Norman’s dilemma.
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Summary & Resources
12-11. Balanced Scorecard. Nemeth’s Pizza Shops (“Seven days
without pizza makes one
weak”) operates in 55 locations throughout Pennsylvania and
Maryland. The CEO,
Eddie Berger, wants to institute a performance measurement
system based on a bal-
anced scorecard. The following measures are being considered:
a. Percentage of pizzas delivered on time i. Number of customer

complaints
b. Percentage of sales growth j. Number of pizzas per labor hour
c. Pounds of pizza scrapped k. Hours of community volunteer
work
d. Production cost per pizza l. Return on invested capital
e. Packaging materials cost per month m. Cost per delivery
f. Percentage of repeating customers n. Throughput time
g. Employee turnover percentages o. Suggestions per employee
h. Response time to customer inquiries p. Safety incident index
Question:
Classify the performance measures into the four categories
contained in a balanced scorecard.
Problems
12-12. Trends in Quality Costs. Kal Held Properties sells time
sharing for its condomini-

ums in Florida. Michael Leader, the controller, has just finished
a study of its quality
costs. Based on recent accounting reports, quality costs for the
2018 fiscal year are
as follows:
Prevention costs $100,000
Appraisal costs 300,000
Internal failure costs 400,000
External failure costs (including lost sales) 300,000
These costs are 11% of sales. The firm plans to implement a
program called “TQM
Victory” to reduce quality costs in total and as a percentage of
sales. Sales are
expected to expand by 10% per year. By 2020, it expects to
spend $300,000 on
prevention costs by substantially expanding employee training.
Improved inspection
efforts will add $100,000 to appraisal costs. By 2020, each
failure cost category will

be reduced by 10%.
By 2022, continued efforts will hold prevention and appraisal
costs constant; but
external failure costs are expected to drop to 1% of sales.
Internal failure costs will
drop 30% from 2020 levels.
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Summary & Resources
By 2024 (the target year of the TQM effort), prevention costs
should fall to $200,000;
appraisal costs could be cut in half from 2020 levels. Internal
failure costs should
drop another 40% from their 2022 levels. And, external failure
costs are targeted to

be no higher than 0.3% of sales.
Questions:
1. What are total quality costs targeted to be in 2024?
2. Can the firm get to a 4% of sales target by 2024? Explain.
3. Comment on at least three key assumptions you see from the
data provided.
12-13. Analyzing Quality Costs Over Time. Management of
Spero Software Services (SSS)
has recently implemented a TQM program to eliminate a serious
level of “program
bugs” that has plagued its recent product releases. The
following activities and their
costs were taken from SSS’s records. The data are for 2018 (the
year prior to the
TQM program) and 2020 (the year after the start of the TQM
program).
2018 2020
Design documentation standards development $ 0 $100,000
Software testing—prerelease 50,000 140,000

Documentation of customer training process 0 20,000
Documentation of changes to software 5,000 20,000
Customer training 100,000 130,000
Software testing—customer site 130,000 80,000
Telephone “on-line” customer problem support 90,000 60,000
Software corrections and redesign 50,000 20,000
Field “troubleshooting” for customer support 140,000 80,000
Costs of contract cancellations 180,000 30,000
Revenues lost due to delivery date delays 0 120,000
Training for systems designers/programmers 100,000 250,000
Training for sales staff 10,000 80,000
Questions:

1. Categorize the costs of quality for both years.
2. Evaluate the two years. Develop a scenario to explain the
major differences in costs
between the two years. In other words, what happened?
3. If 2018 showed an operating loss and 2020 showed a small
operating profit, would
this change your scenario in Part 2 or confirm it? Explain.
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Summary & Resources
12-14. Business Process Reengineering. Fishwrap, Inc. owns a
chain of 20 similar-sized
newspapers. A decentralized purchasing system is used,
whereby each newspaper

obtains its own newsprint. On average for all newspapers, 70%
of the newsprint is
delivered on time.
The following average cost data per newspaper have been
obtained for the past
year:
Costs of newsprint $980,000
Purchasing Department salary costs 240,000
Other Purchasing Department costs 125,000
Of the above newsprint, an average of $7,200 turned out to be
defective.
Because of the decentralized purchasing system, Fishwrap has
been unable to take
advantage of quantity discounts. Therefore, the company
reengineered the purchas-
ing process by introducing a corporate Purchasing Department.
Each newspaper
continued to purchase its own newsprint from approved
vendors. However, the

corporate controller, Diane Green, began to track the purchases
of all 20 newspa-
pers and used that data to negotiate quantity discounts and
resolve problems with
vendors. The on-time delivery rate improved to 85%. The defect
rate (in terms of
dollars) decreased by 60%. The average quantity discount
amounted to 2.8% of
newsprint cost. After reengineering, the average salary and
other purchasing costs
for the local departments decreased from $365,000 to $190,000.
The annual costs of
the centralized Purchasing Department are $1,800,000.
Question:
Evaluate whether reengineering the purchasing process was
worthwhile.
12-15. Nonfinancial Performance Measures. Jagoda Hair
Products manufactures a wide
range of shampoos and conditioners. The company has the
reputation for delivering
high-quality products on time. Each month the CFO, Ricky
Kaplan, issues a produc-

tion efficiency report. The data compiled on these reports for
the third quarter are
as follows:
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Summary & Resources
Question:
Categorize each of the preceding nonfinancial performance
measures as one of the following:
a. Manufacturing productivity
b. Product quality
c. Delivery performance
d. Inventory control
e. Machine maintenance

12-16. Cost of Breakage and Defective Customer Service.
Bangkok Trucking Co. hauls
goods throughout Thailand. The company guarantees arrival at
the designated place
within an agreed two-hour period. Penalty for late arrival is
10% off the shipping
rate. The penalty for being a day late is 20% off shipping rates.
Each additional day
costs an additional 20%. The following portion of shipments
will arrive late:
July August September
Manufacturing cycle efficiency 94% 96% 92%
Total setup time (hours) 62 60 58
Overtime hours 70 73 76
Power consumption in kilowatt-hours (000s omitted) 802 832
838
Machine downtime (hours) 15 10 20

Number of unscheduled machine maintenance calls 0 0 1
Inventory value/Sales revenue 4% 4% 5%
Number of defective units received in raw materials orders 2 1 0
Number of defective units—in-process 35 40 55
Number of defective units—finished goods 18 12 24
Percentage of customer orders filled 100% 100% 100%
Percentage of on-time orders delivered 99% 98% 94%
Number of products returned by customers 0 0 1
More than 2 hours but less than 1 day late 3%
1 day late 2%
2 days late 1%
Breakage of shipped goods results in additional costs related to
replacing the goods,
reshipping them to their destination, and the disruption of the

customer’s business.
The company follows the policy of paying replacement costs on
all broken goods,
refunding shipping charges on damaged shipments, and paying a
30% surcharge on
the replacement cost for business interruption. Approximately
1% of goods shipped
(in sales value) will be damaged in shipment.
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Summary & Resources
During July, Bangkok Trucking expects to make 642 shipments
with total revenues
(before breakage and slow service costs) amounting to
6,420,000 baht. The average
shipment is expected to have an 8,000 baht replacement cost.

The variable costs are
70% of the billed shipping rate. Fixed costs are 900,000 baht
per month.
Questions:
1. Prepare an estimate of the penalties, or revenues lost, from
late shipments during
July.
2. Prepare an estimate of the costs of shipments with breakage
payments.
3. Assume the company can make systems changes and
implement training programs
that will reduce the late shipments to:
More than 2 hours but less than 1 day late 2%
1 day late 1%
More than 1 day 0%
The percentage of goods shipped that would be damaged would
be cut in half. How

much could the company afford to pay for such changes and
programs?
12-17. Nonfinancial Measures of Product Quality. Howard Pen
Company manufactures
expensive calligraphy pens in two of its Ohio plants. One plant
is located in Cleve-
land, and the other is in Columbus. The pens produced are
similar but not identical.
Moe Howard, the president, wishes to evaluate the quality of
production in each
plant. He has asked the two plant managers, Larry Fine of
Cleveland and Jerome
(Curly) Howard of Columbus, to provide certain performance
measures for the most
recent year. After he threatened to tear out their tonsils, he
received the following
data from his two plant managers:
Cleveland
Plant
Columbus
Plant

Number of pens produced and sold 20,000 20,000
Number of parts in each pen 7 5
Number of unique parts in each pen 3 1
Percentage of pens returned by customers 2% 5%
Dollar amount of scrap $250 $370
Percentage of defects in parts received 3% 4%
Dollar percentage of defects in parts received 3.5% 3.2%
Number of warranty claims 22 39
Amount of pens that needed rework 950 1,400
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Summary & Resources
Question:
Provide an analysis of product quality performance for the two
plants.
12-18. Nonfinancial Performance Measures. Robert Newman
Associates manufactures
transducers in one of its plants. The number produced and sold
between 2019 and
2021 has remained steady. Specific performance data for these
three years are pro-
vided by the plant’s general manager, Howie Lee, as follows:
2019 2020 2021
Time from customer order to delivery 3 weeks 2.5 weeks 2.2
weeks
Number of failures at customer locations 76 88 91
Transducers produced per day per employee 25.6 29.1 30.6

Number of returned transducers 111 114 142
Manufacturing cycle efficiency 80% 89% 90%
Costs of scrap $1,897 $1,995 $2,066
Percentage of customer orders filled 85% 89% 91%
Average time inventories are held 20 days 26 days 28 days
First-pass yield 77% 72% 68%
Unscheduled machine downtime 10 hrs. 9.5 hrs. 8.5 hrs.
Number of engineering change orders 5 3 2
Costs of rework $8,144 $8,993 $9,857
Percentage of defects in delivered components 1.5% 1.9% 2.2%
Questions:
1. Did product quality improve from 2019 to 2021? Explain.
2. Did manufacturing productivity improve from 2019 to 2021?

Explain.
3. Did inventory control improve from 2019 to 2021? Explain.
4. Did delivery performance improve from 2019 to 2021?
Explain.
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Summary & Resources
Case: Murray’s Donut Heaven
Murray’s Donut Heaven manufactures donuts that are available
fresh every day at several
stores throughout Memphis. Donuts left over at the end of the
day are packaged and sold
at a reduced price as day-old donuts. Donuts not sold by the end
of the second day are
contributed to the local food bank. The production process

consists of the following steps:
a. Ingredients such as flour, sugar, and cooking oil are received,
inspected, and
placed in the storeroom until requisitioned by production.
b. Upon requisition, the ingredients are transported from the
storeroom to the
production area and staged at the mixing area.
c. Ingredients are blended into a dough mixture in 40-pound
batches by six heavy-
duty mixers.
d. The dough is rolled on large boards and left to rise in a
holding area.
e. When the dough is ready, the boards are moved to the cutting
machines; and
the donuts are cut. Leftovers from each cutting are accumulated,
re-rolled on
another board, and processed through the cutting machine. At
the end of the
production day, leftovers and unprocessed dough on boards are
thrown into the

trash.
f. The cut donuts and donut holes are placed on wire trays and
taken to the
cooking area, where the trays are stacked until ready for
cooking.
g. The cooks empty the trays into large vats of hot cooking oil
where the donuts
and donut holes are, in effect, fried in a sea of oil.
h. The cooked products are removed from the vats and placed on
drying pads
that absorb the excess oil from the donuts. While the product is
drying, it is
inspected. Misshaped donuts are removed and set aside for
disposal. What the
crew doesn’t eat is thrown out at the end of the production shift.
i. After drying, the products are placed on large square boards
and moved to
the finishing area where they will be coated with glaze, icing,
powdered sugar,
coconut, candy chips, etc.

j. After the coating settles or dries, whichever is the case, the
donuts are placed in
boxes of four dozen each. Donut holes are packed in boxes with
100 donut holes
per box. The boxes are moved to the shipping area to await the
trucks that will
deliver them to the various retail outlets.
k. Each morning the delivery trucks return the unsold donuts
delivered the
previous day. (For some reason donut holes are always sold
out.) The day-old
donuts are repackaged in plastic bags. Each bag contains one
dozen donuts and
is marked “day-old.” The packages are then returned to the
retail outlets. On the
second day, any unsold packages are returned to the shipping
area. At the end of
the day, these packages are delivered to the food bank.
Questions:
1. Identify the activities in the donut production process that
fall into process time,
inspection time, move time, wait time, and storage time.

2. List the activities in the donut production process that are
candidates for nonvalue-
added activities. Explain your rationale.
sch84920_12_c12_507-546.indd 546 8/1/17 2:02 PM
eResources
Chapter
Exercise
Page*
PDF Page*
Lane et al.
7
8
268
268
11

269
269
12
269
269
Illowsky et al.
6
60
385
393
66
385
393
76
387
391
88

389
397
7
62
426
434
70
428
436
96
433
441
* Page numbers are approximated due to version control of the
eResources, especially for Illowsky et al.

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