ASQ CQA – 4. Audit Program Management and Business Applications Part 6

11. 4B1 Auditing as a Management Tool

Section four of the CQA body of Knowledge is audit, program management and business applications. This basically consists of two parts audit Program Management and Business application. Section four A was Audit program Management which we have talked earlier and now we are in four B which is Business and Financial impact. In this we will be talking about three main topics which are auditing as a management tool, which is this current lecture. And then later on we will talk about interrelationship of business processes and the cost of quality principles.

Let’s start with auditing as a management tool. Now here what we will be looking at is what are the benefits of auditing, how does audit helps management? How audit is a tool for managing an organization. So what does audit do? Is audit helps in improving company’s efficiency and profitability and how does this happen? That is done by helping management better understand the working of the organization, how the organization is working, where are the opportunities, where are the strengths of the organization.

This is how auditing helps management in understanding the organization and which helps in increasing the profitability and the efficiency of the company. So here we have a list which tells that how auditing supports management. Now auditing supports management by improving internal controls. So you have some internal rules and regulations related to running an organization. Audit helps in identifying whether the organization is running as per the set rules or not. These rules are set and as you go as the time passes, these rules improve to improve the efficiency.

So once you have as your set rules, set policies, set instructions, then auditing makes sure that everyone is acting as per that and if there is any need for improving, those are identified and the systems and procedures are improved. And that helps in improving the company’s performance. So this is the first point that auditing helps in improving the internal controls. Auditing also helps in reducing the possibilities of fraud or wrongdoing. It helps in improving processes which we have talked earlier. So to improve the processes, you need to have some processes in place first. So you set up some rules, you make your systems and procedures, you start following them and once you improve, you keep on changing your procedures or instructions.

And then auditing helps in reducing the cost of quality. We will be talking about the cost of quality principles in this section of business and financial impact. So there we will talk more about the cost of quality and how auditing helps in reducing the cost of quality. Auditing helps in meeting customer requirements. So you do audit as per customer requirements. What does customer requires and what are we giving to the customer and which of course will help in improving the customer satisfaction. When we do second party audit, when we audit our suppliers, that helps us in identifying gaps in what we are expecting from suppliers and what suppliers are actually supplying us so that way we can manage our suppliers better.

Auditing also helps in managing risk. We have already talked about risk and Auditing, how risk affects the audit program and how Audit program helps in reducing risk. We have already talked about that earlier. And then Audit provides independent view of how the company is running, how the company’s strategic plan is being implemented. So management is interested in seeing that as well. So this gives an independent view of the organization.

12. 4B2 Interrelationship of Business Processes

In the topic of business and financial impacts. The next topic is interrelationships of business processes. At the very early stage of this course, we talked about three types of audits the product audit, the process audit, and the system audit. Let’s talk about process and system audits. Here the process audit is for a specific process, let’s say process related to designing a product, let’s say process related to producing a product or process of selling a product. Here we are looking at one particular process and we are auditing that in the process audit, when it comes to system audit, we look at number of processes and here we also look at the interrelationship of these processes. This is what we talked earlier as well, that in system audit you not only look at various processes, but you also look at the interrelationship of processes. Now, in the topic of interrelationship of business processes, let’s understand what is a system?

A system is a group or a combination of things or parts forming a complex or unitary whole. This is a combination of number of things in the context of auditing. A system audit is the audit of various processes and this also covers the interrelationship between these processes. Now, what we do in system audit is we keep our focus on the big picture of the organization, not on specific processes or specific work being done. Another thing as an audit program manager, you need to understand is that you can make a process more efficient by doing auditing. You can make one particular process more efficient, but that does not help if making one process efficient makes another process inefficient. So when you are doing audit of a process and you want to improve that process, make sure that you look at the effect of that improvement on other processes as well. Look at the bigger picture, not just on a specific process or a specific product. Let’s take example of designing something. Let’s say I’m designing this mouse. Now in designing this mouse, if I don’t think about the supplier capabilities from where I get all these parts for this mouse, or I’m not aware of the production issues, how this particular item will be produced once I design this and how this will be sold, what will be the price of this, what will be the cost of making this.

So if I am not aware of that, if I’m just focusing on the design part without looking at the interrelationship with other processes, this might be a failure because I might design a product which is difficult to make and which is impossible to sell. And this is what is the essence of this topic, which is interrelationship of business processes. So let’s look at a simple example here. This is an organization where a product is designed. So once the product is designed, then they need some inputs, and for that the purchasing is done to buy inputs for production. And then the production is done, then the item is sold and then there’s a field support.

Now we just want to see how these things are interrelated. So if you do audit of each of these separately and make each of these efficient, that will not help because that will not improve the overall organization. We have already talked about designing. Designing depends on purchasing. If I design something, how the inputs for that particular item will be purchased and then how this item will be produced, used, how and at what price this item will be sold and what are the issues related to field support in designing? You need to look at other associated components in the organization as well. So in the audit, once you look at the numbers, the QPIs, KPIs or the matrices related to number of things, make sure that these reflect the bigger picture rather than just showing improvement in the small area.

13. 4B3 Cost of Quality (COQ) Principles

Start with the understanding of cost of poor quality. So cost of poor quality is any cost which is related to the poor quality of the product or service which you provide. Here important thing to understand is the visible and invisible cost. Visible cost is something which you can see. So if you make a poor quality product, then there will be costs related to rejection, rework, repair cost and the cost of reinspect action. So these are some of the costs which are visible that if you make something bad, you will need to spend this much money for rejection, rework and repair. But then in addition to the visible cost, there is a lot of hidden cost which is invisible cost. And these invisible costs are the customer dissatisfaction which will lead to the loss of sale, which will lead to excess inventory getting built in because you are not able to sell something.

You need to put some additional controls and procedures because the quality was poor. And then you need to do some complaint investigation, there will be some fines, legal fee, et cetera. So these are hidden fees or invisible costs. So the cost of poor quality is similar to an iceberg. If you see an iceberg, you see only the tip of that above the sea level and then there’s a lot of big iceberg which is hidden in the sea. Similar thing applies to the cost of poor quality as well. What you see is a very small part of the cost, the much bigger part of the cost is hidden. So this is one basic concept which you need to understand. The next is the classification of cost of quality. So let’s look at that. The cost of quality is classified into these four categories the prevention cost, the appraisal cost, the internal failure and external failure costs. So these are the four types of cost which will be happening and these are related to the good quality and bad quality. The first two costs which are the prevention and appraisal, these are basically the cost of good quality. We will talk about the examples and we will explain these costs later on as we go further into this lecture. And then the cost of poor quality is the failure cost. Failure could be internal inside the organization or failure could be external which will be outside the organization or in the hands of the customer.

Let’s look at these four costs. The first one is the prevention cost. Prevention cost is the cost related to preventing the problem from happening and how do you prevent that? You prevent through planning. If you do proper quality planning that will prevent problems. You educate your workers, you train them, you conduct the design review, you do the supplier review and supplier selection so that you get the right product from those suppliers. And then you do quality system audit, then the process planning and control. So here, in regards to the audit, the quality system audit, which you do, is a prevention cost because by doing quality system audit, you look at all the processes, you look at the system, you look at the interrelationship between processes, and you see that where improvement can be done, where the problems are, that basically helps in preventing the problem. So the quality system audit is the prevention cost, the cost which you incur to avoid the problem. To prevent the problem. The next type of cost is appraisal cost.

Appraisal is related to checking, testing. Now, whatever testing and inspection you do during the receiving stage, during the in process or the final, these are appraisal cost. Appraisal costs are also when you do the inspection of the items which you receive from supplier. So if you do a product audit to check whether your product is meeting the requirements of the customer or meeting the legal requirements, that will be the appraisal cost because here your focus is on the product. Another thing which is related to appraisal cost is the cost of calibration because calibration is linked to testing and inspection. So these are some of the examples of appraisal costs.

These are just few examples. The examples in your industry might be different but think of the prevention and appraisal cost as the cost which you incur to prevent the problem is prevention cost. If you do some testing and checking this is the appraisal cost. So these two things, the prevention and the appraisal are the cost of good quality. These things make sure that you produce good quality product. Then the next two things which are internal and external failure costs. These are costs of the bad quality. Let’s look at the example of internal failure cost where the failure happens within the organization. So if you are making something and then that particular piece does not meet the dimensional requirement then you either have to rework that to make it right or you might have to scrap that the cost of that will be internal failure cost.

Troubleshooting and repairing design changes which you make additional inventory required to support the poor process yield and rejected lots. So if you make poor quality product, those pieces are lying in the form of inventory for getting repaired. The cost of maintaining that inventory is your internal failure cost. Few other examples are reinspection and retesting of reworked item. So if you repaired something or you reworked on something then you need to reinspect that. The cost of that reinspection is also internal failure cost. Internal failure cost also includes downgrading where you downgrade your product from top quality to let’s say low quality product and you sell that product as a low quality product. The loss which you incur because of that will be your internal failure cost. Now with this, let’s move on to the fourth category of quality cost which is external failure cost. These are the most serious costs. You need to avoid these costs because the damage done by external failure will be much bigger than anything else. Let’s look at the examples of external failure costs. These are sales returns and allowances. Because the customer is not happy the product is defective, then the losses incurred because of sales return is the external failure cost. Service level agreement penalties you agreed on a certain level of service level. Let’s say my website, they said that my website will be running 99. 99% times if they fail to maintain that, if they fail to meet that agreement requirement, the penalties which they pay will be their external failure cost. Complaint Handling because customer is not happy, the cost because of that is external failure. You need to set up a separate department which deals with all the complaints, the salary of those people, all the costs related to that department is external failure cost, field service cost, labor cost, part cost because something was wrong and you need to send the technician to correct that that cost is external and failure cost.

Other failure costs are recall the product, recall the legal claims and the lost customer and lost opportunities. So these are some of the examples of external failure cost. And as I earlier said, this is the cost we need to avoid. Now, what is the best level, how much we should spend in prevention, how much in the appraisal and how much is the failure cost? There is no direct answer to that. Each organization, each industry has different level. So if you maintain cost of these, the cost of these will depend on industry to industry. Some will have high appraisal cost, some will have high prevention cost. There is no direct answer to that. But when it comes to the cost of quality, something which you need to do is that if you can spend more on prevention, you spend more because that will help you in reducing the failure cost. Whatever it is, it is but only thing which you can do is make sure that in your organization you spend more on the prevention and maybe a little bit on appraisal so that you can reduce the failure costs.

Now, there are two models related to cost of quality. Let’s look at these two models. The model on the top is the Past model and the model at the bottom is the model of quality cost. Let’s look at the Past model which is here number one here what this model says is that as the quality level increases so here the quality level is increasing in this direction. As the quality level increases, the failure cost goes down. So this is what I can see that failure cost is going down because the quality is improving, the prevention cost goes up. To improve the quality you need to spend more on the prevention. So prevention is going up. So with these two costs so if we add them, then this is the total cost. What this model was telling was that as you keep on spending money in prevention your failure cost will go down.

But at a certain level, at one particular level you will have the least to total cost. So this is the optimum level where the cost will be least. So basically this model was telling that you need to achieve some basic level of quality and then you need to stop that you don’t need to improve further because improving further will be a loss to the organization. But this model is no more valid. Now, what people are looking at is this model number two. What does this model tell is that as the quality improves, here is the quality of conformance. As the quality improves, the failure cost goes down when the conformance is 100%. When your product meets the requirement 100%, then the cost of quality is zero.

Similarly the cost of prevention plus appraisal keeps on rising and then this is the total cost. So total cost keeps on decreasing and is minimum when the quality is at 100% conformance level. This model doesn’t tell that you need to stop at a particular point. This model, basically the second model tells that you need to achieve 100% conformance, conformance to the customer requirement, conformance to the legal requirement and that will be the point where the cost will be minimum. Now, after talking about the cost of quality and those two models, now let’s look at the quality program’s effect on the cost of quality. If you run an audit program, how does that affect the cost of quality?

So if you have an audit program in place, what will that do? Is the prevention cost will go up because if you are doing system audit you are spending money on that. Because of that your prevention cost will go up. Similarly your appraisal cost will also go up. And when we talked about appraisal cost there, we talked about product audits. So if you do system audit, product audit then these two costs will go up. But then there will be much much significant effect in the decrease of internal and external failure costs because by doing the system audit and the product audit your internal and external failure costs will decrease the.