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Cost Accounting: Customer Returns in Just-in-Time Purchasing

When cost accounting, you need to include customer returns in your just-in-time (JIT) purchasing cost decision. A return happens when a customer buys a product and isn’t satisfied with the product’s performance.

At that point, the customer may check to see whether the product is under warranty. A warranty is a commitment by the seller of a product (well, often the manufacturer, not the retailer) to repair an item at no cost to the buyer. Some products are covered under warranty and some are not; others have limited warranties.

You’ve probably purchased a product with paperwork explaining the warranty. If you buy a car, a refrigerator, or a new computer, the product comes with written warranty information. You know how long the warranty lasts and what repairs are covered.

Warranties are often touted in marketing a product. The best example is car commercials. Maybe you’re told that the car has a “100,000-mile power train limited warranty.” The car company is selling peace of mind: “We’ll fix the car if it breaks, Mr. or Ms. Customer.” (Note that an automobile dealership is a peculiar combination of retailer and manufacturer’s representative. The automaker warranties the work, but the local dealer does the repair.)

A chain of car dealerships uses a great tag line in its commercials. It ends each commercial with “If your car isn’t right, we’ll make it right — free.” That simple line says a lot about quality and service. The car dealers might make a mistake, but they will do everything they can to fix it. The correction won’t cost the customer a dime. That’s what you want to hear from a supplier.

There are other warranties that are less formal. Instead of a detailed written agreement, warranties are assumed or implied. Say you pay $15 for a pair of reading glasses. You go out to your car and notice that the nosepiece on one side of the glasses is broken. So you go back into the drugstore and exchange them.

As a customer, you assume that any item you buy (for any dollar amount) should operate as it should for a reasonable period of time. If a business isn’t willing to fix or replace all items when they don’t work, it loses current and future business. And dissatisfied customers often tell others. (That, unfortunately, is “the kind of advertising that money just can’t buy.”)

Say you manage a chain of sporting-goods stores, and you’re considering the impact of JIT purchasing for baseball bats. Assume your bats have a one-year warranty for any defects. That warranty assumes normal use of the bat. If a customer slams a bat against a tree 1,000 times, that’s probably not considered normal use.

Aside from that, you recognize that some bats can be defective in materials or workmanship. At this point you judge (based on experience) how many bats will be returned under warranty and how much it will cost to repair them or replace them.

You project that 2 percent of 20,000 bats will be returned under warranty (2 percent x 20,000 = 400 bats). Each returned bat is estimated to cost you $40. Your cost for the customer return is 400 bats x $40 = $16,000.

Now, a $40 repair on a $100 retail item seems unreasonable. As the manufacturer, you need to consider changing your bat design or production. That’s because the warranty repair cost is pretty large compared with the retail price of the item.

The repair scenario holds true for many small retailers. Sewing machine centers and vacuum cleaner stores come to mind. They have their own repair facilities “in the back.” For other items, the customer usually sends the broken item to a regional repair facility or the manufacturer.

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