What it means
Appraisal costs are the price of finding out. They pay for measurement rather than improvement, so a business that inspects heavily is buying information about defects rather than stopping them from occurring in the first place.
The cost of quality framework puts appraisal in the middle of a chain. Prevention costs stop defects arising, appraisal costs detect them, internal failure costs are the scrap and rework of defects caught inside the business, and external failure costs are the returns, warranty claims and lost customers when a defect escapes.
The classic pattern is that spending more on prevention pulls down both appraisal and failure costs, because there is less to find and less to fix. Cutting appraisal on its own is usually a false economy, since defects then reach customers, where they cost several times more to resolve.
Appraisal costs are treated as ordinary operating expenses in the accounts, with inspection labour in a factory normally forming part of production overhead. Very few businesses report them as a separate line, which is precisely why they are hard to manage.
Because they are scattered across departments, the first useful step is simply to add them up. Expressing total quality costs as a percentage of revenue gives a single number that boards can track over time and compare against the cost of prevention work being proposed.
In practice
Real-world examples.
Example
A dairy processor tests 40 batches a week at $180 per laboratory test, spending 40 x $180 = $7,200 a week, or $7,200 x 52 = $374,400 a year on release testing alone. The finance director had never seen the figure in one place because it was spread across three cost centres.
Example
A software company employs six quality assurance testers on an average package of $85,000, giving 6 x $85,000 = $510,000 of appraisal cost before tooling. When the team argues for investment in automated tests, it is really proposing to convert appraisal spending into prevention spending.
Example
An online retailer inspects 3,000 customer returns a month at roughly $4 each, or 3,000 x $4 = $12,000 a month, to decide what can be resold. Tracing the returns back to two suppliers cut the volume, which reduced both the inspection bill and the refunds behind it.
Formula
Calculation
Total cost of quality = prevention + appraisal + internal failure + external failure
Appraisal cost per unit = total appraisal spend / units inspected
A components manufacturer produces 250,000 units a year. Its appraisal spending consists of inspector wages of $180,000, depreciation on test equipment of $60,000, laboratory supplies of $35,000 and supplier audits of $25,000, totalling $180,000 + $60,000 + $35,000 + $25,000 = $300,000. That is $300,000 / 250,000 = $1.20 of appraisal cost per unit.
Setting appraisal alongside the other three categories gives prevention of $120,000, appraisal of $300,000, internal failure of $260,000 and external failure of $520,000, a total cost of quality of $1,200,000. On revenue of $24,000,000, that is $1,200,000 / $24,000,000 = 5% of sales spent on getting quality right and putting it wrong.Case study
Seen in the real world.
This is a fictional illustration. Pellworth Fasteners, an invented engineering business, measured its cost of quality for the first time and found prevention of $120,000, appraisal of $300,000, internal failure of $260,000 and external failure of $520,000, a total of $1,200,000 against revenue of $24,000,000, or 5% of sales. The instinctive response from the operations director was to cut the inspection team.
The quality manager argued the opposite and won a $150,000 increase in prevention spending, taking it to $120,000 + $150,000 = $270,000, funding operator training, better tooling and a supplier qualification programme. Over the following year appraisal fell to $210,000 because there was less to reject, internal failure fell to $150,000 and external failure fell to $180,000.
The new total was $270,000 + $210,000 + $150,000 + $180,000 = $810,000, a saving of $1,200,000 - $810,000 = $390,000 and a drop to $810,000 / $24,000,000 = 3.375% of revenue. The fictional company's warranty claims fell alongside the numbers, which the sales team valued more than the accounting saving.
Watch out
Common mistakes.
- Cutting inspection to save money without doing anything about the underlying defect rate, which simply moves the cost to customers as returns and warranty claims.
- Counting only the inspectors' wages and ignoring test equipment, calibration, sample destruction and the management time spent on supplier audits.
- Treating appraisal cost as a quality department problem, when most of it is created by decisions made in design, purchasing and production.
Questions
People also ask.
Are appraisal costs the same as prevention costs?
No, prevention costs stop defects happening while appraisal costs find defects that have already happened, and the usual aim is to shift spending from the second towards the first.
Can appraisal costs ever be reduced to zero?
Not realistically, because customers, regulators and safety requirements demand evidence that products conform, but they can fall a long way as process capability improves.
Where do appraisal costs appear in the financial statements?
They are absorbed into production overhead and operating expenses rather than shown separately, so they normally have to be pulled out through a dedicated cost of quality exercise.
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