Backflush accounting

Definition

Backflush accounting is a cost accounting system which focuses on the output of an organization and then
works backwards to attributed costs to stock and cost of sales.

This system records the transaction only at the termination of the production and sales cycle. The emphasis
is to measure cost at the beginning and at the end with greater emphasis on the end or outputs. Since back
flushing is usually employed in parallel with JIT, there is no work-in-progress to considered nor, does
work in-progress materially fluctuate. What is essential, however, is an accurate bill materials goods
measures of yield generally effective production control and accurate engineering change notice when
yields do change.

The principle of a just-in-time system is that production is pulled by customer demand and this in turn
pulls the purchasing procedures. Thus, theoretically there are zero stocks of raw materials. Work-in-
progress and finished goods. For such a situation to exist there needs to be an excellent system of
production planning ad communication with materials suppliers.

The philosophy of traditional cost accounting methods

Traditional cost accounting methods are based upon the principle that value is obtained by the creation of
the assets known as stock. As a consequence this value must be measured and cost accumulation systems
are used for this purpose. In modern JIT based production, stock does not exist and therefore such cost
accumulation techniques are unnecessary. Instead costs are recognized at the point of sale rather tan at the
point of production.

The variants of Backflush accounting

There are a number variants of the Backflush system, each differing as to the trigger points at which costs
are recognized within the cost accounts and thus associated with products. All variants, however, have the
following common features :

the focus is on output costs are first associated with output (measured as either sales or
completed production ) and then allocated between stocks and costs of goods sold by working
back.

Conversion costs (labour and overheads) are never attached to products until they are complete
(or even sold ) thus the traditional WIP account doesnt exist. Materials are recognized at
different points according to the variant used, but only to the extent of being either stock of raw
materials or part of the cost of stock of finished goods. Again, materials are not attached to WIP.
Two variants of the Backflush system are summarized below. Note that in each as conversion costs (labour
and overheads) are incurred they will be recorded in a conversion cost (CC) account.
Variant 1
This has tow trigger points (TP) :

TP 1 - purchase of raw materials / components. A raw and in process (RIP) account will be debited
with the actual cost of materials purchased, and creditors credited.

TP 2 completion of good units. The finished goods (FG) account will be debited with the standard
cost of unit produced and the RIP and CC account will be credited with the standard cost.
Under this variant, then, there will be two stock accounts :
raw materials (which may, in fact, be incorporated into WIP )
finished goods

Variant 2

This as only trigger point the completion of good units. The FG account is debited with the standard cost
of units produced, with corresponding credits to the CC account and the creditors account.

Thus the cost records exclude :
raw materials purchased but not yet used for complete production
the creditors for these materials (and any price variance )
and there is only stock account, carrying the standard cost of finished goods stock.

Other variants include those using the sale of complete goods units as a trigger point for the attachment of
conversion cost to unit -- thus there is no finished goods account, just a raw materials stock account,
carrying the materials cost of raw materials, WIP and finished goods.

It should be seen that as stock of raw materials, WIP and finished goods are decreased to minimal levels,
as in a pure JIT system, these variants will give the same basic results.

Backflush accounting -- example

The following example will be used to illustrate the first two variant outlined above.
The manufacturing cost information for March for a division of XYZ plc is as follows :

Cost incurred in March 000
Purchase of raw materials 4,250
Labour 2,800
Overheads 1,640


Activity in March Units (000)

Finished goods manufactured during the period 180
Sales 145

Standard cost per unit
Materials 20
Labour 15
Overhead 9

44

There were no opening stocks of raw materials, WIP or finished goods. It should be assumed that there are
no direct materials variance for the period.

Variant 1

The double entry would be as follows Dr. Cr.
000 000

1. RIP account 4,250
Creditor 4,250


2. CC account 4,440
Cash 2,800
Cash/ creditor 1,640

3. FG account (180 X 44) 7,920
RIP account (180 X 20 ) 3,600
CC account (180 X 24 ) 4,320

4. COGS (145 X 44 ) 6,320
FG account 6,380

The ledger would appear as follows

Raw and in process materials

000 000

Creditor 4,250 FG 3,600

Bal c/d 650

4,250 4,250


Bal b/d 650

Conversion costs

000 000

Cash/creditor 4,440 FG 4,320

Bal c/d 120
-
4,440 4,440


Bal b/d 120


Finished goods

000 000

RIP 3,600 COGS 6,380

CC 4,320 Bal c/d 1,540

7,920 7,920


Bal b/d 1,540

Cost of goods sold

000 000

FG 6,380
The stock balances at the end of March would be

000
Raw and in process materials 650
Finished goods 1,540

2,190

The balance on the conversion cost account would be carried forward and written off at the end of the year.

Variant 2
The accounting entries where there is only one trigger point (on completion of units) would be simpler.
DR CR
000 000

1. CC account 4,440
Cash 2,800
Cash/creditors 1,640


2. FG account (180 X 44 ) 7,920
Creditors (180 X 20 ) 3,600
CC account (180 X 24 ) 4,320


3. COGS 6,380
FG account 6,380

This variant is thus only suitable for JIT system with minimal raw materials stocks.

Suitability of Backflush accounting

Both variance illustrated above eliminate the WIP account. If stocks are low in general a large proportion
of manufacturing costs will be attributable to cost of goods sold. Te principle of Backflush costing is that
in these circumstances, the work involved in tracking costs through WIP, COGS and FG is unlike to be
benefit. As noted above, the stock and cost of goods sold values will be close to those derived from a
conventional costing system, with a considerably reduced volume of recorded transactions.

Another theory on Backflush Accounting

Traditional cost accounting systems track the sequence of raw materials and components moving
through the production systems, and as a consequence are called sequential tracking system As JIT is an
entirely different system it requires its own accounting system. The absence of stocks makes choice about
stock valuation systems unnecessary and the rapid conversion of direct materials into cost of goods sold
simplifies the cost accounting system. The approach is know as Backflush accounting.

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. There are two events that
trigger the records kept in most Backflush accounting systems.

The first is the purchase of raw materials. In a true JIT system where absolutely no raw materials
stock is held even this trigger is not relevant and raw materials are flushed when the second trigger
is activated.

The second trigger is either the transfer of goods to finished goods stock or, in a true JIT system, the
sale of goods. Two examples of possible Backflush accounting systems are given below.
Table 1: System 1

A small stock of raw materials is held no finished goods stock.
Dr. Cr.

1. Raw materials are purchased -- 3,200

Stock control 3,200
Creditors control 3,200


2. Conversion costs are incurred -- 3,000

Conversion cost control 3,000
Individual a/cs. 3,000


3. Goods sold -- 6,000 worth at standard cost

Cost of goods sold 6,000
Stock control 6,000

4. Under or over allocation of conversion costs

Conversion cost allocated 3,100
Cost of goods sold 100
Conversion costs control 3,000


Figure 1 : Ledger accounts for system 1


















This is the system used by Toyota in its UK factory. In true Japanese it manipulates employees to behave in
a certain way. Firstly employees must concentrate on achieving sales because cost of sales is the trigger
nothing gets recorded until the sales is made. Secondly there is no benefit in producing foods for stock. In
traditional system which have a finished goods stock managers can increase in finished goods stock
reduces the cost of sales in traditional financial accounts.

The model just described may be to cope with in progress in the system by using a raw and in progress
account (RIP) in place of the stock control account All other entries remain the same.


Table 2 : System 2

No raw material stock is held but some finished goods is held.
The figures are the same as for system 1, but the transfer to finished goods is assumed to be 6,000 and the
cost of goods sold is 5,900 leaving a finished goods stock of 100.

Dr. Cr.

1. Raw materials are purchased no entry

2. Conversion costs are incurred -- 3,000

Conversion cost control 3,000
Individual a/cs 3,000

Stock control

1. 3,200 3. 2,900
Bal c/d 300

Materials
Cost of good sold

3. 6000 4. 100


Conversion cost allocated

4. 3,100 3. 3,100
Conversion cost control

2. 3000 4. 3000
Labour and
overhead
3. Finished goods units produced 6,000

Finished goods control 6,000
Creditors control 2,900
Conversion costs allocated 3,100

4. Finished goods sold -- 5,000
Cost of goods sold 5,900
Finished goods control 5,900

5. Under or over allocation of conversion costs
Conversion costs allocated 3,100
Cost of goods sold 100
Conversion costs control 3,100


Figures 2 Ledger accounts for system 2
























The Backflush accounting model cannot be used by all organisation. It can only be used where a JIT type
system is in operation. Where it is used it does have advantages. The traditional system is time consuming
and expensive to operate, as it requires a considerable amount of documentation, such as materials
requisitions and time sheets to support it in order to maintain the WIP records and job cards. If a company
operates with low stock levels the benefits of operating the traditional costing system are few. By
introducing a Backflush system a considerable amount of clerical time is saved.

From the Backflush accounting examples it can be seen that JIT eliminates direct labour as cost category.
Instead labour is treated as in indirect cost and is included in conversion cost with the overheads. This is
because production is only required when demand requires it and so production labour will be paid
regardless of activity. All indirect cost are treated as a fixed period expenses. With JIT failed or rework
must be almost eliminated if the system is to work and so no accounts for this will exist in Backflush
accounting whereas they are required in traditional systems.

The Backflush accounting model does not conform to the accepted financial accounting procedures for
external reporting in the UK. This is because work in progress is treated as an assets in the amount does.
This can be countered by claming, quite rightly, immaterial. If only one tenth of one days production is
held in work in progress then it is immaterial. It can also be claimed that it is immaterial if the work in
Finished goods
stock control

3. 2,900 4. 5,900
3. 3,100 Bal c/d 100
Cost of goods sold

4. 5,900 5. 100
Creditors
control
Conversion cost allocated

5. 300 3. 3,100
Conversion cost control

2. 3,000 5. 3000
progress does not change from one period to the next as opening and closing stock will cancel each other
out.

Backflush accounting can be criticised because of the lack of information that it provides. Some argue
quite rightly, that in reality it is impossible to eliminate all stock as a truck arriving with raw materials
creates stock until it is moved to an used in production. If Backflush accounting is used in a system where
a substantial amount of stock is held, a physical stock-take will be needed, because the system does not
record the quantity of stock. Instead it is derived on paper by the difference between the standard cost of
materials in the foods sold and the amount of materials purchased. This must be checked by a physical
stock-take from time to time.