Quality costs and outsourcing

Accounting Ahead | Original study resource | accountingahead.com.au

Quality costs and outsourcing

MODULE 6 | PART E.2 | STUDENT COMPANION

Total quality management aims for right first time and zero defects across every department. Quality means

conformance to standards (a variance from standard signals a quality problem) and fitness for the customer's

purpose.

The four categories of quality cost

Prevention

Quality planning, design improvements, training, maintenance,

quality systems

Appraisal

Testing, inspection, supplier monitoring, quality audits

Internal failure

Rework, scrap, re-inspection, corrective action, expediting

External failure

Warranty, complaints and returns, recalls, liability, lost sales,

ill-will

Top: costs of controlling quality. Bottom: costs of failing to control it.

Rules for quality costs

Rule Remember

Classify by nature In-process inspection is appraisal, even if caused by internal failure

Prevention pays Spending on prevention and appraisal usually cuts failure costs by many times as

much

Shift failures inward More appraisal swaps recalls and warranty claims for scrap and rework

Timing Total quality costs may rise at first, before prevention pays off

Rework Non-value-adding, yet sometimes the best economic choice

STRATEGIC MANAGEMENT ACCOUNTING | M6 PART E.2 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Rework or scrap?

Option 1 - scrap the faulty kettle -$8

Option 2 - rework cost -$22

Sale as a factory second +$45

Option 2 net result +$23

Advantage of reworking over scrapping $31

Rework adds no value - but here it is the better economic choice

Case note: in September 2016 Samsung recalled about 2.5 million Galaxy Note7 phones after batteries

overheated and caught fire; some replacements failed too, and in October it stopped making the model. Reports

based on Samsung's figures put the cost above US$5 billion. In January 2017 it traced the fires to battery faults

and introduced an eight-point battery safety check - prevention and appraisal.

Outsourcing and offshoring

Item Remember

Offshoring Moving activities to overseas subsidiaries for lower labour or resource costs

Outsourcing Switching supply from an internal unit to an outside vendor (IT, legal, market research,

logistics, call centres, payables, payroll)

Hidden costs Unavoidable fixed overheads remain; redundancy costs; rising dependence; contract

management

Other factors Quality, delivery, data quality and security, after-sales service, lost knowledge, labour

and morale

Service level agreement Selection, monitoring and audit criteria: cost plus % not to spec, late services, dispute

response time

STRATEGIC MANAGEMENT ACCOUNTING | M6 PART E.2 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

What to outsource - and how

Never outsource

Strategic direction

Outsource under tight control

Internal audit, human resources, legal advice

Outsource under service level agreements

Logistics, call centres, data centres, facility management, parts manufacturing

Low outsourcing risk

Payroll, security, catering

Outsourcing: advantages and disadvantages

Advantages

Lower costs and fewer assets

Access to expertise and resources

Flexibility

Focus on core activities

Disadvantages

Long-run costs can rise

Lost skills and knowledge

Reliance on outside parties

Security breaches and quality problems

Many failures come from how the deal was evaluated and negotiated

Case note: in 2020 Qantas outsourced ground handling at ten airports and 1,683 workers lost their jobs. The

Federal Court found the decision breached the Fair Work Act, and the High Court unanimously agreed on 13

September 2023. Qantas agreed to pay $120 million compensation (December 2024) and was ordered to pay a

$90 million penalty (August 2025).

Sources: Samsung statements reported by AP and Al Jazeera (October 2016, 23 January 2017); High Court of Australia (2023); Federal

Court of Australia and media reports (2024-2025).

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Accounting Ahead | Original study resource | accountingahead.com.au

Practice questions

MODULE 6 | PART E.2 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Classify the quality costs

Cost Category

(a) Training staff in a new soldering technique

(b) Testing every tenth unit off the line

(c) Reworking units that fail testing

(d) Replacing products under warranty

(e) Auditing a supplier's factory

(f) Redesigning a part that often breaks

(g) Scrapping a batch of faulty components

(h) Sales lost after poor online reviews

Question 2 - Outsource payroll? (imagined council)

In-house payroll costs $420,000 a year: staff $300,000, software $60,000 and allocated office overhead $60,000

that will not go away. An outside provider quotes $330,000 a year, and redundancies would cost $45,000 once.

(a) Ignoring the time value of money, what is the net saving over three years? (b) List four non-financial factors.

STRATEGIC MANAGEMENT ACCOUNTING | M6 PART E.2 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Worked answers

MODULE 6 | PART E.2 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Classify the quality costs

Cost Answer

(a) Prevention

(b) Appraisal

(c) Internal failure

(d) External failure

(e) Appraisal (supplier monitoring)

(f) Prevention

(g) Internal failure

(h) External failure

Question 2 - Worked answer

Item Answer

Avoidable in-house cost $300,000 + $60,000 = $360,000 a year (the $60,000 overhead stays)

Annual saving $360,000 - $330,000 = $30,000

Three years $90,000 - $45,000 redundancy = $45,000 net saving

(b) Factors Data security and privacy of employee records; service levels and accuracy; staff

morale and industrial relations; dependence and long-run price rises; loss of

in-house knowledge; capacity to manage the contract

STRATEGIC MANAGEMENT ACCOUNTING | M6 PART E.2 | WORKED ANSWERS

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