Back flush Costing27th February 2021
Backflush accounting is a certain type of “postproduction issuing”, it is a product costing approach, used in a Just-In-Time (JIT) operating environment, in which costing is delayed until goods are finished. Backflush accounting delays the recording of costs until after the events have taken place, then standard costs are used to work backwards to ‘flush’ out the manufacturing costs. The result is that detailed tracking of costs is eliminated. Journal entries to inventory accounts may be delayed until the time of product completion or even the time of sale, and standard costs are used to assign costs to units when journal entries are made. Backflushing transaction has two steps: one step of the transaction reports the produced part which serves to increase the quantity on-hand of the produced part and a second step which relieves the inventory of all the component parts. Component part numbers and quantities-per are taken from the standard bill of material (BOM). This represents a huge saving over the traditional method of:
a) issuing component parts one at a time, usually to a discrete work order.
b) receiving the finished parts into inventory
c) returning any unused components, one at a time, back into inventory.
It can be argued that backflush accounting simplifies costing since it ignores both labour variances and work-in-process. Backflush accounting is employed where the overall business cycle time is relatively short and inventory levels are low.
Backflush accounting is inappropriate when production process is long and this has been attributed as a major flaw in the design of the concept. It may also be inappropriate if the bill of materials contains not only piece goods but also many parts with more or less variable consumption. If the parts with variable consumption are just a few, like grease or the ink used to print product-labels, the consumed quantities can be assigned to product-independent cost centers at the withdrawal from stores (preproduction issuing) and can eventually be broken down afterwards to specific products or product groups, just like any other indirect or overhead expense. Difficulties maintaining correct inventories on shop floor may also appear if it is usual practice to use alternative materials and/or quantities without needing derogation. Therefore, in case of a more complex production system, it is a better approach to use a Manufacturing Execution System (MES) which gathers real production data and is able to deliver exact data to the accounting software or Enterprise resource planning-system where the goods issue is recorded. Thus, variances in consumption, in comparison to the standard bill of materials, are taken into account and assigned to the correct product, production order and workplace. Another advantage of using a MES is that it implements also the Production Track & Trace and the status of work in progress is also known in real time. A disadvantage of MES is that it is not suitable for small series or prototype production. Such type of production should be segregated from the series production and mass production.
Backflush costing is an accounting method that records costs after a good is sold or a service is completed. Backflush costing is common among companies that use a Just-in-Time inventory management system. It avoids the costly and complicated reporting of all expenses as they occur, and instead “flushes” all expenses in a single entry once the production process is completed.
- If the product manufactured involves not only one single product but also many parts along with it with high or low variable consumption, backflush costing becomes inappropriate.
- In backflush costing, the cost of materials is not separately calculated, but it is transferred directly to the finished product account.
- When the units of goods are completed, the material cost is deducted from inventory, and finished goods are transferred to the material account.
- Journal entries in inventory accounts get delayed until the time of production or sale, and the standard costing mechanism is used to assign to units when journal entries are passed.
- The cost of conversion is shared with finished goods inventory account based on the operating time of labor.
- Tracking work in the process is not possible, and no other work account is separately maintained during the process.
- Once a company gets an order, it records only the essential information into the system, such as quantity, delivery date, and the item code. Based on this, the list of materials needed to complete the order is made.
- When the production is about to start, the company takes the delivery of the raw material and shifts it to the production floor.
- Now software does the routing of all the components for that production order. The cost manager still has a say on what parts and how much quantity to push in.
- After the end of the production process, the operator enters all information about the product into the computer. The software then prepares the production report.
- Based on that report, the operator in a single transaction assign materials cost to the production order.
Journal Entry of Backflush Costing
- Simple entry is passed by debiting expenses account and crediting payment a/c i.e., bank or cash A/c or creditor A/c when purchased on credit.
- Finished Goods A/c is debited with all costs incurred in point 1. With corresponding credit above Cost A/cs like Direct Material Cost, processing cost (labor), etc.
- At the time of sales, the cost of corresponding goods which are sold is transferred to the cost of goods Sold with credit to Finished goods A/c.
Backflush accounting is entirely automated, with a computer handling all transactions. The formula for it is:
Number of raw material units removed from stock = (Number of units produced) x (unit count listed in the bill of materials for each component)
Problems with Backflush Accounting
- Requires a fast production cycle time. Backflushing does not remove items from inventory until after a product has been completed, so the inventory records will remain incomplete until such time as the backflushing occurs. Thus, a rapid production cycle time is the best way to keep this interval as short as possible. Under a backflushing system, there is no recorded amount of work-in-process inventory.
- Requires an accurate production count. The number of finished goods produced is the multiplier in the backflush equation, so an incorrect count will relieve an incorrect number of components and raw materials from stock.
- Requires an accurate bill of materials. The bill of materials contains a complete itemization of the components and raw materials used to construct a product. If the items in the bill are inaccurate, the backflush equation will relieve an incorrect number of components and raw materials from stock.
- Requires excellent scrap reporting. There will inevitably be unusual amounts of scrap or rework in a production process that are not anticipated in a bill of materials. If you do not separately delete these items from inventory, they will remain in the inventory records, since the backflush equation does not account for them.
Companies using backflush costing generally meet the following three conditions:
- Short production cycles: Backflush costing shouldn’t be used for goods that take a long time to manufacture. As more time goes by, it becomes increasingly difficult to assign standard costs accurately.
- Customized products: The process is not suitable for the fabrication of customized products since this requires the creation of a unique bill of materials for each item manufactured.
- Material inventory levels are either low or constant: When inventories, the array of finished goods held by a company, are low, the bulk of manufacturing costs will flow into the costs of goods sold, and it is not deferred as inventory cost.
Drawbacks of this costing system are:
- For the results to be accurate, this system needs an accurate production count. In the formula above, the finished goods count is one of the two inputs. So, if this number is wrong, then the resultant figure will not be accurate as well.
- It is relatively difficult to implement.
- Its success also depends on the accuracy of the bill of materials. A bill of material contains the list of all components and raw materials that a product will require. Thus, if there is a discrepancy in the bill of materials, the backflush costing will assign an incorrect amount of raw materials and components.
- Since this system does not record the work-in-process inventory, it needs a fast production cycle time. This costing system does not record inventory until the end of the production. So, during this timeframe, the records will remain incomplete. The only way to ensure records get updated quickly is to shorten or quicken the production cycle.
- Scrap reporting also needs to be accurate. Usually, in a production process, there is a large amount of scrap. The bill of material does not account for this scrap. It is essential to remove these scraps from the inventory to get the right picture.