Accounting for Quality

CAs can use their measurement skills to make total quality management a practical possibility for their clients.

Total Quality Management

TOTAL QUALITY MANAGEMENT (TQM) and continuous improvement are fast becoming important issues in both the private and public sectors. Organizations that passed up many of the previous management fads are now turning to TQM with much fervour. (see “The rites of service,” Camagazine, July, p.20.) Business journals are reporting many successes – and failures – in implementing such programs. Yet little is really understood about the impact these programs are having, because they haven’t been in operation long enough.

What sets TQM apart from previous fads is the requirement for continuous and accurate measurements of every process that exists within the organization (for example, the time needed to perform a certain task, or the volume of waste produced in the manufacturing process). As a result, one of the main weaknesses in implementing TQM programs is the failure to recognize the need to make these measurements.

This brings an exciting challenge to the accounting profession – how to help organizations ” account for quality.” This new approach to accounting must go beyond the traditional reporting of profits, expenses, quarterly and departmental budgets, controllable and non-controllable expenses, and so forth. Organizations are looking to accountants to help them develop ways to measure the actual processes involved in converting to a quality system.

Simply put, total quality management is a system for creating competitive advantage by focusing the organization on what is important to the customer. Total quality management itself can be broken down into:

  • “Total”: that is, the whole organization is involved and understands that customer satisfaction is everyone’s job.
  • “Quality”: the extent to which products and services satisfy the requirements of internal and external customers.
  • “Management”: the leadership, infrastructure and resources that support employees as they meet the needs of those customers.

One of the cornerstones of total quality management is that before any problem can be solved, it must first be measured.

TQM is supported by two key beliefs: that quality is what the customer says it is, and that it must be thoroughly integrated into the very fabric of the organization, including its basic strategies, culture and management systems.

Traditionally, when organizations had problem to solve, they immediately made certain assumptions about the problem and then developed solutions based on those assumptions. But one of the cornerstones of total quality management is that before any problem can be solved, it must first be measured. (For example, if a machine is not working properly, the effects- in terms of time lost and so on – should be measured and translated into dollar terms.) If a problem can’t be measured, then we can only assume it has been corrected, because we cannot determine if the solution has brought any measurable gains.

When an organization implements a TQM program, therefore, it begins to develop detailed flow charts of every single process in every department. These charts highlight the amount of rework required, the amount of waste produced and any bottlenecks or duplications of work. Essentially, the organization starts to look at the sources of some of its problems. Some problems may have more than one cause. That is why, when a problem does occur, it is necessary to conduct a systematic investigation in which the most likely root cause is discovered. From there, possible solutions can be developed and analysed in cost/ benefit terms. This makes it possible to select the most appropriate.

Let’s look at a couple of cases where TQM was used to solve a particular problem. Invariably, the root cause of a problem is not what everyone initially assumes it is. For example, a metal plating company was having trouble cutting circular pieces out of a large rectangular slab of steel. More and more of the pieces were coming out in shapes that were not exactly circular. Those entrusted with solving the problem believed that the fault probably lay with the new computer program that controlled the cutting machine. Traditionally, this explanation would have been accepted. Under TQM, how ever, all of the possible sources of problem had to be investigated to determine the root cause. The company set up an interdepartmental investigating team, which discovered that the track the cutting machine sat on was not even. They also found that the circle’s edge was ragged because of disturbances to the machine during cutting. It also turned out, on further investigation, that the track, which was made from an inexpensive, less-than-durable material, had been damaged by steel shards, resulting in a bumpy ride for the cutting machine.

In this particular case, therefore, the problem had several causes. But what was missing was the measurement. No one knew how to measure the problem itself – in terms of time lost, pieces damaged, and so on. As a result, they would have no way of knowing how effective any of the potential solutions were. The finance department in the company consisted of a credit manager(who was a CA) and a bookkeeper. Neither was sure how to measure the problem, so they turned to the company’s accounting firm for assistance. The request fell so far out of traditional boundaries of measurement reporting that the firm asked whether I , as a TQM consultant, could make some suggestions.

After examining the case, I worked with the firm and the company to develop an appropriate measurement system. Once this was done, we were able to develop solutions to the root causes and assess their effectiveness in solving the problems. This form of measurement is often referred to as the “cost of quality” – the price the organization has to pay for not doing things right the first time.

The purest definition of quality itself is “zero defects.” And in an effort to ensure that there are no defects in the products or service that customer receives, many companies have set up quality controls, quality departments or quality assurance departments, all of which are focused on the end product.

But let me give you an illustration to explain why these traditional quality control and standards are not the most effective way of dealing with problems.

I recently worked with a pulp and paper plant. At the end of my plant tour, the managers told me that they had received many complaints about their product. Their solution had been to establish a quality assurance program.
Customers had complained that many rolls of newsprint had obviously been broken in production, which was evident by the number of visible seams in the paper on the roll. The paper was of variable thickness, which increased the chances of breakage during production. As well, some of the rolls had no visible seams, but the paper thickness varied nonetheless. In addition, some customers had received rolls that were damaged because of poor packaging.

It became obvious that every roll of newsprint needed to be inspected before leaving the plant. Rolls that had more than one seam, that were of varying degrees of thickness or packaged poorly would not be sent to the customer.
The results were immediate. Customer complaints waned and once-threatened sales continued. Management felt confident that he new quality assurance program was a tremendous success. Essentially it meant zero defects for the customer. But the plant had a warehouse full of newsprint rolls rejected on the basis of quality. While recycling them back through the system meant nothing was wasted, how could the managers account for this new step?

They included it as part of their cost of production. Though they didn’t make as much per roll, the quality had improved tremendously. Because the overall production cost was so high, however, they ran full production only three out of every four weeks. And when I spoke specifically to top managers at the company’s head office, they knew only that the cost of production was high. They didn’t know why. They had no specific measurements of the various points in the production process where problems were occurring. So they had no idea how to improve the overall process.

The TQM Solution

Management’s strategy, adding a final inspection step and then adding this cost to the overall production costs, was traditionally correct. But what management had failed to do was to look into the root causes of the problem. For example, why did the paper break when spun onto the roll? Why was the paper thickness inconsistent? Why were rolls improperly packaged prior to shipping?

I recommended that the company implement a total quality management system. Employees were trained to work effectively in teams. They were then presented with the problems, not the solutions. The teams would use a structured problem-solving process to measure the problems, find the root cause or causes, and determine the appropriate solutions.

One of the root causes of the inconsistent paper thickness and breaking was found to be the type of wood used in the pulp. Employee carelessness and poor equipment were the main factors in the packaging problems. Measurement helped them to determine the best solution for each. The quality control figures reported to head office as part of the cost of productions were in fact the cost of re-work. And a system that accounts for quality needs to report them as such. The only figures that should ever be included in the cost of production are those that relate directly to the cost of producing a zero-defect end product. All waste, recycling, and the like should be included as a cost of rework. They can then be shown as problems that have been measured and whose root causes can be investigated, so that sound solutions can be developed and implemented.

The quality assurance program used by the pulp and paper plant ensured that the end product that went to the customer was of high quality; but it also entailed considerable internal cost and waste. The total quality approach ensured that the entire process of producing the paper was of high quality, providing the customer with an excellent product, with less internal cost and zero waste for the company.

The accounting profession is excellent at applying root cause analysis. Accountants always apply this technique to ” out of balance” accounts, balance sheet, income statements, and so on, in an effort to find out ” why the numbers aren’t working”. And accountants continuously improve the way organizations interpret their quarterly and yearly balance statements.

But root cause analysis goes much deeper. As accountants, you are frequently asked to advise companies that are looking for ways to improve their bottom line and efficiency, and pull them-selves out of a downward spiral. It’s your job to help them determine the root causes and measure the impact these problems are having, before they take any drastic “solutions” to problems they haven’t fully understood.

You can help companies measure the cost of quality as well as the cost of rework, waste, redundancy, returns and complaints. These must be investigated and resolved if your clients are going to survive the 90’s. Your can start to develop accounting systems that will track, on an ongoing basis, all of these costs.

Studies by J.M Juran, a leading authority on TQM, have revealed that quality- related costs are much larger than currently shown in accounting reports. For most companies, these cost run anywhere from 20% to 40% of sales. And theses costs are not simply the result of production or service operations; the support operations are also major contributors. Such expenses are usually included in the cost of ensuring ” quality standards, ” but they are in fact avoidable.

Nevertheless, no one seems to have a clear responsibility for actions to reduce them. Neither is there any structured approach for doing so. The accounting profession needs to take the lead in finding ways to resolve these issues and make total quality a practical possibility.

Accounting for quality will strongly affect the role of the accounting profession. It will change your approach to accounting systems – the way you report costs and expenses and profits within all the companies you advise.

Michael Stanleigh

Michael Stanleigh, CMC, CSP, CSM is the CEO of Business Improvement Architects. He works with leaders and their teams around the world to improve organizational performance by helping them to define their strategic direction, increase leadership performance, create cultures that drive innovation and improve project and quality management. Michael’s experience spans public and private sector organizations in over 20 different countries. He also delivers presentations to businesses and conferences throughout the world. In addition to his consulting practice and global speaking he has been featured and published in over 500 different magazines and industry publications.

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