Question

When production of a product is started you know a % of those are going to fail and be returned to the store which you will have to credit your customer for. When you are spreading out the cost, do you add a set % to your part cost knowing that you are going to have some that fail in the field?

Answer 1

Yes. We have to charge such known failures to the customer if such failure is due to inherent nature of production and beyond the control of manufacturer.

This is what is called Normal Loss and shall be form part of Cost.

For Examples let's say we need to meet a demand of 100 units and we know that 5% of actual production will be failure.

So , In this Case , We need to produce 100 good units and so we have to introduce inputs and efforts for 100/95% = 105.26 Units Then 5% of 105.26 units (5.26 Units ) will be failure and 100 good units can be produced.

Lets say per unit production costs is $1000 and now we have to charge from customer (1000*105.26)/100 = $1052.6/ unit

However , if such loss is due to our negligence and not because of inherent nature of production , then it will be abnormal loss and such loss shall be debited to our costing P & L account instead of charging it to customer. In such a case , we will recover $1000/unit from customer and charge cost relating to such extra units ie., 5.26*1000=5260 to costing p&l account.

Hope this is clear.

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