What are Appraisal Costs?

Appraisal costs are the costs that a company incurs to detect defective inventory before it is shipped to customers. These costs must be incurred in order to keep defective goods from being sold to customers. It is less expensive to incur appraisal costs than to lose customers who are frustrated by the receipt of low-quality goods from the seller. The cost associated with a lost customer comprises not only the marketing cost to initially attract the customer, but also all subsequent profits over what would have been the term of the relationship with the seller.

Examples of Appraisal Costs

There are many examples of appraisal costs, which differ by industry. Here are several examples:

Incoming materials inspection. A common appraisal cost is incurred during the inspection of materials delivered from suppliers. In this situation, the receiving staff spends time reviewing the quality of inbound raw materials and components, especially when there have been customer complaints about faulty products.
Work-in-process inspection. A business might spend large amounts of time inspecting work-in-process materials, because there are concerns about worn-out equipment producing a wide range of part tolerances.
Finished goods inspection. The same situation can arise for finished goods, where inspections are performed to ensure that a product works as expected.
Inventory destroyed during inspections. The testing function might have to destroy inventory as part of its testing process.
Supervision costs. Supervisors are needed to oversee the testing staff. The compensation, benefits, and related costs of these people are all appraisal costs.
Depreciation costs. If the cost of testing equipment exceeds the capitalization threshold of a business, then the depreciation on that equipment is considered an appraisal cost.
Maintenance costs. Test equipment may require maintenance from time to time, and more so when it is being used frequently to conduct tests.

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Timing of Appraisal Costs

You should design an inspection program so that it catches defects as early in the manufacturing process as possible, before any additional materials or labor are added; thus, finding a defective product once the entire production process has been completed results in the loss of the entire product, whereas spotting a problem at the receiving dock would have saved all of the subsequent value added cost.

Another view of the cost of inspections is that they should be intensively concentrated in front of the bottleneck operation, on the grounds that defective items found after the constrained resource have just negatively impacted the total throughput of the production facility.

The best alternative to incurring appraisal costs is to work on increasing the quality of the production processes of all suppliers and the company itself, so that the entire process is inherently incapable of producing defective parts.