LY Ltd makes foldable grocery bags (encrusted with jewellery) for fashion-consci
ID: 2535876 • Letter: L
Question
LY Ltd makes foldable grocery bags (encrusted with jewellery) for fashion-conscious environmentalists. Mandy, the general manager, recently attended a conference on quality and productivity, where she learned that many firms had introduced quality improvement programmes, resulting in significantly increased profitability. Some firms had reduced quality costs from 25% of sales to 2% of sales. Mandy was enthused by the potential for improved quality performance ("If this works, I could get a whopper bonus this year!" she thought). Mandy contacted her management accountant (Angela), and requested an estimate of the total quality costs being incurred by LY, as well as a breakdown of those costs into four categories: Prevention; Appraisal; Internal failure; and External failure. Angela gathered the following information from 2017: Sales revenue is $20,000,000 and net profit is $4,000,000 6,000 bags were returned by customers for repair. Repair costs are $70 per bag Ten inspectors (who only do final inspections) each receive a salary of $30,000. 1. iii. iv.30,000 bags are rejected on final inspection each year (on average), due to quality issues. Of these, 80% can be reworked at a cost of $30 per unit. The remaining 20% have to be scrapped, costing $150 per bag on average. A customer cancelled an order that would have increased profits by $500,000. The reason given was poor product performance. The marketing department of LY agreed that other customers have felt the same, and that roughly this amount is lost every year vi. Eight full-time employees are employed in the complaint department, on salaries of vii. LY gave sales allowances totalling $250,000 due to substandard products being sent to viii. All new employees at LY have to participate in a three-hour quality training ix. Inspection of the final product also requires testing equipment, which costs $240,000 for similar reasons. $35,000 each customers programme. The estimated annual cost of the program is $160,000. every year to operate and maintain.Explanation / Answer
L Y Limited COST OF QUALITY REPORT Internal Exiernal Prevention Appraisal Failure Failure ii Repair ofbags returned by customer (6000*$70) $ 420,000 iii Salary of 10 inspectors($30,000*10) $300,000 iv Rejection at final inspection(0.8*30000*$30+0.2*30000*$150) $ 1,620,000 v Loss of profit due to cancellation of order $500,000 vi Salaries of employees of complaint department(35000*8) $ 280,000 vii Sales allowance due to substandard product $250,000 viii Quality training $160,000 ix Testing equipment cost $240,000 SUM Total $ 160,000 $ 540,000 $ 1,870,000 $ 1,200,000 $ 3,770,000 Sales Revenue $20,000,000 Net Profit $4,000,000 Total Cost of Quality $ 3,770,000 Quality costs/Sales 0.1885 Cost of external and internal failure $ 3,070,000 Total cost of quality is 18.85% of Sales Percentage of net profit 20% (4000000/20000000) Total Cost of quality as percentage is amost equal to net profit There is potential to substantially increase net profit by reducing cost of quality 2 Distribution of costs The external and internal failure costs are very high The prevention cost is negligible There should be higher emphasis on prevention through design, implementation and maintenance of quality management system By increasing cost of prevention, the external and internal failure cost will reduce significantly 3 Suggestions: Implementation of Quality management system Use of Statististical Quality Control Reduction of number of inspectors Reduction of complaint department staff 4 Unit No. Measured weight Loss 1 101 $0 2 103 $0 3 111 $150 4 93 $0 5 89 $150 Average Loss for sample of five=$300/5=$60 Hidden Quality cost for the first quarter=10000*60 $ 600,000
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