Answers
1
To: CEO of Thyme
From: A Accountant
Date: September 2016
Subject: Reporting performance and quality issues at Thyme Engine Products
This report analyses the positive features of the award winning dashboard identifying some areas which specifically apply to Thyme.
The role of the management accountant in providing information for integrated reporting is explained. Then, the target cost gap for the new engine is calculated and an evaluation is provided of the use of this target cost within the TQM approach. Finally, issues associated with the costs of quality at Thyme are addressed.

(i) Positive features of the award winning dashboard
The following are features of the dashboard which will have weighed in the assessors’ minds when making the award. They are placed in a priority order of most important first and then there are a few specific comments about the possible use of such a template at Thyme.

Achievement of the objectives and strategies of the business
The critical measure of whether the dashboard is fit for its purpose is whether it answers the question: has the businessachieved its key objectives?
The dashboard measures all of the key objectives of the business growth of the firm:
1. shareholder wealth and returns through EVA^TM and TSR; and
2. growth through revenue and market share growth.
It also measures the strategies used to achieve these results:
1. world-class engineering to design engines through the class leading design specifications;
2. high quality production through fault rates in manufacturing and delivery; and
3. customer service through those same fault rates and market share (an indirect indicator).

Balanced view
The report presents a balanced view of the business’s performance. It deals with various perspectives (shareholders (TSR), customers (market share), internal business (fault rates) and innovation (design position)) which are used in the balanced scorecard approach. This is also achieved using both internal and external data (fault rates and average sector growth). It presents both the results and the determinants of those results by giving financial and non-financial indicators. For example, revenue growth will be driven by the customers’ view of product and service, so design and manufacturing quality measures are important. Short and longer term measures are given such as profit margin and economic value added.

Planning and control
The dashboard should allow the board to perform both its vital functions in planning and controlling the business. The forecasts for next year (budgets) are given and also, as noted above, there are non-financial determinants of performance such as design and customer service which will drive the future short-term competitive position of the business.
The control activities of the board are served by providing historic trends and also current budget variances. The major headings are provided for under the financial headings with activity measured by revenue, profit by the margin and shareholder wealth by economic value added.

Presentation
The dashboard is kept brief as the board will have an opportunity prior to the board meeting to use it to identify issues requiring further analysis at the meeting. There is a short narrative commentary which deals with the major commercial points arising from the dashboard and also, gives further external market data as context for the figures (e.g. average sector growth). It is also worth noting that the narrative picks up on strategic issues of risk and opportunity which can more difficult to capture in numerical form. Hence, the commentary appears appropriate to assist in an annual review of the business.

Specific issues at Thyme
There are certain issues particular to Thyme which may be added to the example dashboard, though if these are deemed short term, then they may not necessarily appear on this main dashboard view. The example dashboard does not show measures of cash flow performance (such as free cash flow generated) nor gearing ratio, both of which would be important for future fund raising. There are no measures associated with governance and ethics which in the light of the bribery scandal may have a higher priority at Thyme. Ethical training costs may give a measure of this area.

(ii) Integrated reporting
There is no standard format for integrated reporting. However, there are changes in focus of the company’s reporting which will require the input of the management accountants of that business. Integrated reporting has a focus on opportunities and risk, how resources are allocated and performance both recent historic and expected in the future. There are six capitals involved in value creation including traditional tangible and financial assets but also including human, intellectual, environmental and social assets.

For the management accountant, these newer forms of capital will require information systems capable of capturing andprocessing such non-financial measures. The forward-looking nature of such reporting will require more information of aforecast nature (with the accompanying requirement to understand their estimating assumptions). The more strategic view which integrated reporting intends to give also requires reporting on factors which drive long-term performance. A key part of the integrated report is linking performance to strategic goals and the ability to create value.
This will require a less structured and more contingent approach to reporting. In other words, proforma reporting must be better tailored to the specific business’s situation. However, it is considered a key requirement of such reporting that it is concise and so the management accountant must help to ensure that only the key information is reported. It can be seen that the dashboard discussed in the above section of this report achieves many of these requirements.

(iii) New jet engine: target costing and TQM
Workings:
$’000
Target cost　　　　　　　　 2,125
Production costs　　　　　　1,825
Design and development　　　 100
Sales and marketing　　　　　 500
　　　　　　　　　　　　　––––––
Current cost　　　　　　　　 2,425
　　　　　　　　　　　　　––––––
Target cost gap 300 (12% of current cost)
The target cost for the new engine is $2·125m and the current estimated cost is $2·425m. Therefore, there is a need to cut costs by 12% to achieve the target profit margin. It is common for the initial costs to be higher than the target cost and for cost savings to be achieved as the product reaches maturity in its lifecycle. It should be noted that even at this higher initial cost, the engine will be making a small $0·075m profit per unit (a 3% margin).
Target costing involves setting a selling price based on what will be competitive in the market then deducting a target profitmargin to obtain the target cost. An estimate is made of the cost of the engine based on the current design specification. The gap between this cost and the target cost is the target cost gap and opportunities to bridge this gap are sought by amending the product design or cutting costs in production.
Total quality management (TQM) is a management approach which seeks to have no defects in resource or relationshipmanagement. It aims to have a culture of continuous improvement in the organisation.
In this new engine project, the TQM philosophy will fit well with the need to cut a relatively small amount of costs in order to meet the target. By small but frequent improvements as the production team climb the learning curve associated with such a new product, it would be expected that such cost savings would be made.
Given the size of the cost gap, it does not seem that a major redesign of the engine is required.

(iv) Quality costs
There are four categories of quality costs:
– Prevention costs are costs to prevent the production of engines which fail to meet specifications;
– Appraisal costs are costs incurred in inspecting products to ensure that they meet specifications;
– Cost of internal failure are costs associated with making good products which are identified as sub-standard before delivery to the customer; and
– Cost of external failure are costs associated with making good products which are identified as sub-standard after delivery to the customer.
Working:
$m
Prevention 139 (= 11 + 92 + 36)
Appraisal 138 (= 110 + 28)
Costs of internal failure 95
Costs of external failure 279 (= 223 + 56)
––––
Total 651

Comments on results
The total quality costs are 5·7% of revenue which seems surprisingly low for an organisation which recognises this as a key competitive advantage; notable is the large size of the external failure costs of 2·4%.

Possible other relevant costs
Overall, there are likely to be administrative costs associated with many of these categories and some attribution of overhead should be undertaken beyond the customer complaint handling mentioned.
Appraisal costs include performance testing of final assembly and performance testing of subcomponents from suppliers. There may also be costs associated with inspection of raw materials inward since these make a difference to quality (shown by the higher purchase costs).
Internal failure costs include costs of re-inspection after repairs after final assembly testing. There must also be costs associated with repairing faulty goods identified at final testing and possibly also scrapping failed products. It is possible that there is idle time costs due to work held up by internal identification of faulty products.
External failure costs include customer complaint handling and replacements under warranties. There is also the cost ofdamage done to Thyme’s brand by such problems although many customers will accept that these are inevitable and provided they are infrequent and covered by warranty, they need not be important.
New products such as the new jet engine will likely generate additional failure costs while production methods are optimised.

Relative importance of categories
Given the high cost of external failure and the importance of reputation for Thyme, the most important category is prevention.
It would be appropriate for Thyme with a TQM approach to be spending heavily in this area. This will still need to be combined with warranty spending in order to protect the reputation of Thyme when problems do occur. As prevention succeeds, so the importance of the other categories will decline. It is worrying that external failure costs are more than twice internal failure costs, which suggests that final testing is not identifying a significant number of the faults in production.