Defects cause costs, which can be classified into prevention costs, appraisal costs, internal failure costs, and external failure costs. Prevention costs are incurred to keep defects from happening. Appraisal costs are incurred to ensure that defective products, once made, are not shipped to customers. Internal failure costs are incurred as a consequence of detecting defective products before they are shipped to customers. External failure costs are the consequences (in terms of repairs, servicing, and lost future business) of delivering defective products to customers. Most experts agree that management effort should be focused on preventing defects. Small investments in prevention can lead to dramatic reductions in appraisal costs and costs of internal and external failure.

Quality costs are summarized on a quality cost report. This report shows the type of quality costs being incurred and their significance and trends. The report helps managers understand the importance of quality costs, spot problem areas, and assess the way in which the quality costs are distributed.

Learning Objectives

Identify and give examples of each of the three basic manufacturing cost categories.

Distinguish between product costs and period costs and give examples of each.

Prepare an income statement including calculation of the cost of goods sold.

Prepare a schedule of cost of goods manufactured.

Understand the differences between variable costs and fixed costs.

Understand the differences between direct and indirect costs.

Define and give examples of cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.

(Appendix 2A) Properly account for labor costs associated with idle time, overtime, and fringe benefits.

(Appendix 2B) Identify the four types of quality costs and explain how they interact.

(Appendix 2B) Prepare and interpret a quality cost report.