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 company. 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 are:
- The inspection of materials delivered from suppliers
- The inspection of work-in-process materials
- The inspection of finished goods
- The supplies used to conduct inspections
- The inventory destroyed as part of the testing process
- Supervision of the inspection staff
- Depreciation of test equipment and software
- Maintenance of test equipment
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.
Appraisal costs are also known as inspection costs.