Should I include faulty inventory items in production orders or write-offs?

When we do packaging of our products there are sometimes misprinted labels, bad caps etc.
Does it make more sense to just add these faulty items into the production order (so it adds into the cost of the finished items as there will always be some misprints, faults caps etc) or is it better to make an inventory write off for every production order for all faulty items?

I think I like the idea of adding into the production order but I don’t know if that is bad accounting wise.

1 Like

That is bad accounting. A write-off will go down as an expense, which faulty items are. And it will deduct their cost from Inventory on hand. A production order would increase the cost of the produced item. That is not appropriate, because the expense was incurred before the production order was ever written.

Imagine adding the cost of faulty parts to a finished item that sits in inventory for a year. You would still be carrying its cost as an asset, which misrepresents its position. More importantly, you would not see the deduction associated with the write-off until the finished item is sold, when it would show up in Inventory - cost. Thus, you will pay more income tax in the current period than you should, because you will not have taken the deduction for the bad items.

I see your point. But could it not be useful in order to get the actual cost of making the product rather than the theoretical cost. The faulty items (caps/labels/bottles) are pretty consistent so rather than counting the cost of 1 bottle per product it would be 1.04 (as an example).

Such a process would only give you an estimated cost, based on your guess of how many items were faulty. That is not accounting. What happens when your suppliers improve their product yield? Even if you are trying for better product management, fault rates are not applicable to finished goods recorded via production orders. They are applicable to the input goods. Now, if your own manufacturing processes have imperfect yields and you want to allow X+1 or X+2 input items to produce X output items, that is a different story. (Of course, if your own processes improve, you will then be faced with making inventory adjustments when you don’t use your overage allowances.)

1 Like