Description Amount Percentage of Percentage of Revenues (4)
(1) (2) Total COQ = (2) ÷ $45,000,000
(3) = (2) ÷
$1,820,000
Prevention costs $ 350,000 19.2% 0.8%
Appraisal costs 200,000 11.0% 0.4%
Internal failure costs
Rework 475,000
Scrap 100,000
Total internal failure 575,000 31.6% 1.3%
costs
External failure costs
Customer replacements 450,000
Lost contr. margin from 245,000
customer returns 1
Total external failure costs 695,000 38.2% 1.5%
Total COQ $1,820,000 100.0%
1
Lost contribution margin from customer returns = 35% × Lost sales from customer returns.
= 35% × $700,000
= $245,000
The following table shows the actual COQ at iProtect, as a percentage of total COQ, and
as a percentage of revenues after the change in the production process. Note that as a result of
these changes, lost sales from customer returns decrease by 50% × $700,000 = $350,000, so
sales revenues increase by the same amount. Sales revenues in this case = $45,000,000 +
$350,000 = $45,350,000
Description Amount Percentage of Total Percentage of
(1) (2) COQ Revenues
(3) = (2) ÷ $1,802,500 (4) = (2) ÷
$45,350,000
Prevention costs 1
$ 37.7% 1.5%
680,000
Appraisal costs 11.1% 0.4%
200,000
Internal failure costs
Rework
475,000
Scrap
100,000
Total internal failure costs 31.9% 1.3%
575,000
External failure costs
Customer replacement costs 2
225,000
Lost contr. margin from customer
returns
3
122,500
Total external failure costs 19.3% 0.8%
347,500
Total COQ $1,802,50 100.0%
0
1
Prevention costs = Existing prevention costs + CAD design improvement costs + Machine calibration costs
= $350,000 + $110,000 + $220,000 = $680,000
2
Customer replacement costs = $450,000 × (1 – 0.50) = $225,000
3
Lost contribution margin from customer returns = 35% × Lost sales from customer returns
= 35% × $700,000 × (1 – 0.50)
= 35% × $350,000 = $122,500
Description % Total COQ % Total COQ % of Revenue % of Revenue
BEFORE AFTER BEFORE AFTER
Prevention 19.2% 37.7% 0.8% 1.5%
Appraisal 11.0% 11.1% 0.4% 0.4%
Internal 31.6% 31.9% 1.3% 1.3%
Failure
External 38.2% 19.3% 1.5% 0.8%
Failure
As a result of implementing changes in the production process, prevention costs, which
are 19.2% of the total COQ and 0.8% of revenues, will become 37.7% of the total COQ and
1.5% of revenues. External failure costs, which are 38.2% of the total COQ and 1.5% of
revenues, will become 19.3% of the total COQ and 0.8% of revenues. The changes also result in
a decrease in the total COQ.
The preceding calculations assume that overall sales revenues (other than the additional
sales from fewer returns) will be unaffected by the change in the production process. But quality
improvements could well result in an increase in sales, providing further benefit to iProtect.
Improvements in the production process could also decrease rework costs, resulting in
even more benefits from quality improvement. Better quality could also have other advantages
such as improving employee morale and, therefore, making them proud to work for iProtect.
19-22 Quality improvement, relevant costs, relevant revenues. Pressing Matters
manufactures and sells 18,000 high-technology printing presses each year. The variable and
fixed costs of rework and repair are as follows:
Pressing Matters’ current presses have a quality problem that causes variations in the shade of
some colors. Its engineers suggest changing a key component in each press. The new component
will cost $70 more than the old one. In the next year, however, Pressing Matters expects that
with the new component it will (1) save 14,000 hours of rework, (2) save 850 hours of customer
support, (3) move 225 fewer loads, (4) save 8,000 hours of warranty repairs, and (5) sell an
additional 140 printing presses, for a total contribution margin of $1,680,000. Pressing Matters
believes that even as it improves quality, it will not be able to save any of the fixed costs of re-
work or repair. Pressing Matters uses a 1-year time horizon for this decision because it plans to
introduce a new press at the end of the year.
Required:
1. Should Pressing Matters change to the new component? Show your calculations.
2. Suppose the estimate of 140 additional printing presses sold is uncertain. What is the minimum
number of additional printing presses that Pressing Matters needs to sell to justify adopting the
new component?
3. What other factors should managers at Pressing Matters consider when making their decision
about changing to a new component?
SOLUTION
(25 min.) Quality improvement, relevant costs, and relevant revenues.
1. Relevant costs over the next year of changing to the new component
= $70 × 18,000 copiers = $1,260,000
Relevant Benefits over
the Next Year of Choosing the New
Component
Costs of quality items
Savings in rework costs
$79 × 14,000 rework hours $1,106,000
Savings in customer-support costs
$35 × 850 customer-support hours 29,750
Savings in transportation costs for parts
$350 × 225 fewer loads 78,750
Savings in warranty repair costs
$89 × 8,000 repair-hours 712,000
Opportunity costs 1,680,000
Contribution margin from increased sales
$3,606,500
Cost savings and additional contribution
margin
s
