Quality Costing – Meaning, Types, How to Calculate and More

Quality costing or quality cost or cost of quality (COQ) constitute the costs that a company incurs to come up with a quality product. Or, we can say it is the cost to prevent, detect, and address quality issues in a product. Or, we can say, COQ includes the cost to avoid low-quality production, as well as costs that a company incurs after it produces inferior quality goods.

A point to note is that quality costing does not just mean the cost to upgrade the perceived value of a product or using expensive or very high-quality materials. Instead, its objective is to ensure that the product meets the expectations of the buyer.

For example, if a customer buys a budget smartphone, they would not expect it to have premium features, such as 5-6 cameras, long battery life, more storage, etc. Instead, the user would at least expect it to work correctly.

Quality Costing – How it Arises?

Quality issues can come up in any company, and these issues result in quality costing. The problems may be due to a problem or an error by one or more departments. For instance, a flaw in product design would render the whole process useless.

Issues can also arise because of errors at the time of production or if the supplier sends wrong or inferior material. Additionally, incorrect entry of a customer order could also result in quality cost, as it would mean the product reaching the wrong customer or the customer getting the faulty product.

Categories or Types of Quality Costs

There are four categories of quality costs:

Prevention Costs

As the name suggests, these costs help a company to prevent or minimize quality issues from occurring. These are the most effective and relevant. It is because avoiding a problem at the initial stage results in the saving of labor and manufacturing overheads needed for producing that defective unit (or units).

These costs include the cost of training employees, statistical process control, supplier certification, strengthening product designing, and more. Employees get training in production processes. It helps to eliminate any manufacturing malfunctions. Such costs also help reduce scrap costs as there is no or less scrap. A few more examples of prevention costs are quality circles, technical support to suppliers, an audit of the quality system, and more.

Appraisal Costs (or Inspection Costs)

Appraisal costs include inspections to prevent quality issues from occurring. For instance, allowing or encouraging the production employees to inspect the parts and raw materials when they arrive. Also, they need to examine the elements when they leave their production floor. Such inspection ensures timely catching of issues, if any. Other examples of appraisal costs are depreciation of test equipment, cost of the test run, the salary of testing staff, quality control inspections, and more.

Quality Costing

Internal Failure Costs

Internal failure costs include tangible costs after a company produces a defective or inferior product. In this case, the shipment does not happen to the customer. Internal failure results in more scrap, waste, and spoilage costs. It includes the cost of direct material, direct labor, manufacturing overheads, cost of reworking the products, disposal of defective products, and more.

External Failure Costs

External failure cost includes both tangible and intangible costs on a product despatched to a customer. In such a case, the company will have to incur extra customer support, product recall cost, lawsuit cost (if any), and warranty costs. Additionally, the company would also have to bear the cost of a bad reputation and the cost of losing customers. These costs could prove very expensive for the company and may even bring the company down.

The first two – prevention and appraisal costs – are the cost of good quality (CoGQ). Internal failure costs and external failure costs are the cost of poor quality (CoPQ). It is because the first two types prevent inferior quality production, while the last two classes are the result of quality issues with the company.

Also, a company needs to classify costs correctly – into prevention, appraisal, and internal and external failure costs. It would ensure the optimal allocation of funds among different quality control initiatives.

How to Calculate?

There is a simple formula to calculate the cost of quality (COQ). It is the cost of control plus the cost of failure of control.

Cost of control includes prevention cost plus appraisal cost, while the cost of failure of control includes internal failure cost plus external failure cost.

Generally, the lower the cost of quality costing is, the better it is. However, this is not always possible as COQ depends on the cost of control and the cost of failure of control. Both these costs usually move in the opposite direction. It means that if the cost of control is more, then the cost of failure of control is less. And, if the cost of control is less, then the cost of failure of control could be more.

We can quickly compute the COQ in terms of the number of hours or days. However, the better way would be to quantify COQ or calculate it in monetary terms. Even better would be to calculate COQ as a percentage of the total cost. Having COQ in percentage terms would make it easier to compare it with other projects or companies.

Experts recommend that a person responsible for calculating and reporting COQ should be external to the project. It would help to ensure impartiality, as well as accuracy.

How to Improve Quality?

There are a few common strategies that could help a company improve the quality of its product and services. These are:

  • Develop a healthy relationship with the suppliers. It means involving supplies in the production process, auditing suppliers, scoring suppliers, and more.
  • Explain the relevance of quality to the employees. Explain how the right quality products would boost their performance and pay, and vice versa.
  • The company should ensure that quality and compliance information and the process is visible across the company and various departments.
  • Make use of technological developments to better quality tools and production processes.

Final Words

Quality costing is very crucial for a company. It could help a company avoid massive expenses it would incur if it produces sub-quality products. Thus, we can say that it not only helps a business to boost profitability but also ups customer satisfaction and retention.

Continue reading about other Types of Cost Classified on Different Basis.

Sanjay Borad

Sanjay Bulaki Borad

MBA-Finance, CMA, CS, Insolvency Professional, B'Com

Sanjay Borad, Founder of eFinanceManagement, is a Management Consultant with 7 years of MNC experience and 11 years in Consultancy. He caters to clients with turnovers from 200 Million to 12,000 Million, including listed entities, and has vast industry experience in over 20 sectors. Additionally, he serves as a visiting faculty for Finance and Costing in MBA Colleges and CA, CMA Coaching Classes.

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