Back flush Costing

• Backflush accounting is a certain type of “postproduction issuing”, it is a product costing approach, Used in a Just-In-Time (JIT) operational environment, when costing is postponed until the items are completed. Backflush accounting delays cost recording until after the events have occurred, at which point standard costs are utilized to work backwards to ‘flush’ out the manufacturing costs. As a consequence, precise expense tracking is removed. Journal entries to inventory accounts may be deferred until the product is completed or even sold, and standard costs are utilized to assign costs to units when journal entries are made. The backflushing transaction consists of two steps: the first reports the created part, which increases the amount on hand of the produced item, and the second relieves the inventory of all component components. The standard bill of material (BOM) is used to determine component part numbers and quantities per unit. This significantly reduces costs compared to the old practice of assigning individual component components to work orders.
• b) Receive completed parts into inventory. c) Return unneeded components to inventory one at a time.
• Backflush accounting may be claimed to simplify costs by ignoring both labor fluctuations and work-in-process. Backflush accounting is used in situations when the total business cycle time is short and inventory levels low.
• Backflush accounting is improper when the manufacturing process is lengthy, and this has been identified as a key fault in the concept’s design. It may also be incorrect if the bill of materials includes a large number of components with variable consumption. If there are only a few parts with variable consumption, such as grease or ink used to print product labels, the consumed quantities can be assigned to product-independent cost centers during withdrawal from stores (preproduction issuing) and later broken down to specific products or product groups, just like any other indirect or overhead expense. Difficulties in keeping accurate inventory on the work floor may also arise if it is common practice to utilize alternative materials and/or amounts without derogation. As a result, in the event of a more complicated production system, it is preferable to utilize a Manufacturing Execution System (MES) that collects actual production data and can transmit precise data to the accounting software or enterprise resource planning system where the products problem is documented. Thus, variations in consumption relative to the normal bill of materials are considered and allocated to the appropriate product, production order, and workplace. Another benefit of adopting a MES is that it includes Production Track & Trace, and the status of work in progress is available in real time. One downside of MES is that it is not appropriate for small-series or prototype manufacturing. This sort of manufacturing should be distinguished from series and mass production.
• Backflush costing is an accounting approach that captures expenses after a product is sold or a service is rendered. Backflush costing is widespread in businesses that employ Just-in-Time inventory management systems. It avoids the expensive and laborious reporting of all expenditures as they occur and instead “flushes” all charges in a single entry after the manufacturing process is concluded.
• Features
• Backflush pricing becomes unsuitable when the product made has multiple components with high or low variable consumption.
• Backflush costing does not compute the cost of materials separately; instead, it transfers it straight to the final product account.
• When the units of products are finished, the material cost is subtracted from the inventory and the finished items are transferred to the material account.
• Journal entries in inventory accounts are deferred until the moment of production or sale, and the normal costing mechanism is utilized to allocate units when journal entries are passed.
• The conversion cost is divided with the completed products inventory account depending on worker operating time.
• Work cannot be tracked throughout the process, and no additional work accounts are kept separate.
• Process
• When a firm receives an order, it merely enters the required information into the system, such as the amount, delivery date, and item code. Based on this, a list of supplies required to fulfill the order is created.
• When manufacturing is set to begin, the business takes receipt of the raw material and moves it to the production floor.
• Now, software handles the routing of all components for that manufacturing order. The cost manager still has a choice in which pieces and how much quantity are pushed in.
• Following the completion of the manufacturing process, the operator inputs all product information into the computer. The program then generates a production report.
• In a single transaction, the operator assigns material costs to production orders based on that report.
• Journal Entry for Backflush Costing
• A simple entry is made by debiting the costs account and crediting the payment account, which may be a bank or cash account, or a creditor account if the item was bought on credit.
• Finished Goods A/c is debited for all expenses incurred in point 1, with matching credit above Cost A/cs such as Direct Material Cost, Processing Cost (labor), and so on.
• During sales, the cost of the matching products sold is transferred to the cost of goods. Sold with credit to Finished Goods Account.
• Backflush accounting is fully automated, with a computer managing all transactions. To calculate the number of raw material units taken from stock, multiply the number of units produced by the unit count stated in the bill of materials for each component.
• Issues with Backflush Accounting
• Needs a quick manufacturing cycle time. Backflushing does not remove things from inventory until after a product has been finished, therefore inventory records will be incomplete until the backflushing takes place. As a result, a quick manufacturing cycle time is the ideal option to maintain this gap as short as feasible. Backflushing systems do not record the quantity of work-in-process inventory.
• Needs an exact production count. The quantity of completed items produced is the multiplier in the backflush calculation, therefore an erroneous count will result in an incorrect amount of components and raw materials being released.
• Needs an exact bill of materials.The bill of materials gives a detailed list of the components and raw materials required to build a product. If the items on the bill are wrong, the backflush calculation will remove an erroneous quantity of components and raw materials from inventory.
• Requires outstanding scrap reporting.There will certainly be unexpected volumes of waste or rework in a manufacturing process that are not anticipated in a bill of materials. If you do not segregate these things from inventory, they will stay in the inventory records since the backflush calculation does not account for them.
• Companies adopting backflush costing often satisfy three conditions:
• Short manufacturing cycle: Backflush costing should not be utilized on things that take a long time to produce. As time passes, it becomes more difficult to appropriately assign standard costs.
• Customizable products: The procedure is unsuitable for the manufacturing of bespoke items since it necessitates the preparation of a unique bill of materials for each item produced.
• Material inventories are either low or steady. When a company’s inventories, or the number of completed items on hand, are low, the majority of production expenses pass into the costs of goods sold rather than being delayed as inventory charges.
• Drawbacks of this pricing technique include:
• For the findings to be correct, this method requires an exact production count. One of the two inputs in the following calculation is the total number of completed items. So, if this value is incorrect, the resulting figure will be inaccurate as well.
• It is quite tough to implement.
• Its success is also contingent on the correctness of the bill of materials. A bill of material is a list of all the components and raw materials that a product will need. As a result, if there is an error in the bill of materials, the backflush costing will allocate the wrong quantity of raw materials and components.
• Because this system does not record work-in-process inventories, it requires a quick production cycle time. This costing approach does not record inventories until the conclusion of production. As a result, the records will continue to be incomplete throughout this period. The only method to assure that records are updated fast is to shorten or accelerate the production cycle.
• Scrap reporting must also be correct. There is always a lot of scrap in the manufacturing process. The bill of material does not include this junk. To obtain the correct image, these scraps must be removed from inventory.