Reference no: EM132874654

Problem - Danna Wise, president of Tidwell Company, recently returned from a conference on quality and productivity. At the conference, she was told that many American firms have quality costs totaling 20 to 30% of sales. The quality experts at the conference convinced her that a company could increase its profitability by improving quality. However, she was of the opinion that the quality of Tidwell Company was much less than 20%-probably more in the 4 to 6% range. However, because the potential for increasing profits was so great if she was wrong, she decided to request a preliminary estimate of the total quality costs currently being incurred. She asked her controller for a summary of quality costs, with the costs classified into four categories: prevention, appraisal, internal failure, or external failure. She also wanted the costs expressed as a percentage of both sales and profits. The controller had his staff assemble the following information from the past year, 20X1:

a. Sales revenue, $37,240,000; net income, $4,000,000.

b. During the year, customers returned 40,000 units needing repair. Repair cost averages $9 per unit.

c. Twelve inspectors are employed, each earning an annual salary of $80,000. The inspectors are involved only with final inspection (product acceptance).

d. Total scrap is 200,000 units. Of this total, ninety percent is quality related. The cost of scrap is about $10 per unit.

e. Each year, approximately 800,000 units are rejected in final inspection. Of these units, seventy-five percent can be recovered through rework. The cost of rework is $1.80 per unit.

f. A customer cancelled an order that would have increased profits by $600,000. The customer's reason for cancellation was poor product performance.

g. The company employs 10 full-time employees in its complaint department. Each earns $48,600 a year.

h. The company gave sales allowances totaling $180,000 due to substandard products being sent to the customer.

i. The company requires all new employees to take its 4-hour quality training program. The estimated annual cost of the program is $120,000.

Required - Compute the quality cost-sales ratio. Also, compare the total quality costs with total profits. Should Danna be concerned with the level of quality costs?