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. !hat is essential, howe"er, is an accurate bill of materials, good measure
of yields, generally effecti"e production control and accurate engineering change notice when yields do
change.
The principle of a #ust-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. !ork-in-
progress and finished goods. $or such a situation to e%ist there needs to be an e%cellent system of
production planning and communication with materials suppliers.
The philosophy of traditional cost accounting methods
Traditional cost accounting methods are based upon the principle that "alue is obtained by the creation of
the assets known as stock. &s a conse'uence this "alue must be measured and cost accumulation systems
are used for this purpose. In modern JIT based production, stock does not e%ist and therefore such cost
accumulation techni'ues are unnecessary. Instead costs are recognized at the point of sale rather than at the
point of production.
The variants of Backflush accounting
There are a number of "ariants 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. &ll "ariants, howe"er,
ha"e 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.
-on"ersion costs +labour and o"erheads, are ne"er attached to products until they are complete +or
e"en sold, thus the traditional !I. account doesn)t e%ist. /aterials are recognized at different
points according to the "ariant used, but only to the e%tent of being either stock of raw materials or
part of the cost of stock of finished goods. &gain, materials are not attached to !I..
Two "ariants of the Backflush system are summarized below. 0ote that in each as con"ersion costs +labour
and o"erheads, are incurred they will be recorded in a con"ersion cost +--, account.
Variant 1
This has two trigger points +T.,*
T. 1 - purchase of raw materials 2 components. & (raw and in process +3I.,) account will be debited
with the actual cost of materials purchased, and creditors credited.
T. 4 completion of good units. The finished goods +$5, account will be debited with the standard
cost of unit produced and the 3I. and -- account will be credited with the standard cost.
6nder this "ariant, then, there will be two stock accounts *
raw materials +which may, in fact, be incorporated into !I. ,
finished goods
Variant 2
This has only trigger point the completion of good units. The $5 account is debited with the standard cost
of units produced, with corresponding credits to the -- account and the creditors account.
Thus the cost records e%clude *
raw materials purchased but not yet used for complete production
the creditors for these materials +and any price "ariance ,
and there is only stock account, carrying the standard cost of finished goods stock.
7ther "ariants include those using the sale of complete goods units as a trigger point for the attachment of
con"ersion cost to unit -- thus there is no finished goods account, #ust a raw materials stock account,
carrying the materials cost of raw materials, !I. and finished goods.
It should be seen that as stock of raw materials, !I. and finished goods are decreased to minimal le"els, as
in a (pure) JIT system, these "ariants will gi"e the same basic results.
Backflush accounting -- example
The following e%ample will be used to illustrate the first two "ariant outlined abo"e.
The manufacturing cost information for /arch for a di"ision of 89: plc is as follows *
-ost incurred in /arch ;)<<<
.urchase of raw materials =,4><
?abour 4,@<<
7"erheads 1,A=<
&cti"ity in /arch 6nits +(<<<,
$inished goods manufactured during the period 1@<
Sales 1=>
Standard cost per unit ;
/aterials 4<
?abour 1>
7"erhead B

==
There were no opening stocks of raw materials, !I. or finished goods. It should be assumed that there is
no direct materials "ariance for the period.
Variant 1
The double entry would be as follows Cr. -r.
;)<<< ;)<<<
1. 3I. account =,4><
-reditor =,4><
4. -- account =,==<
-ash 4,@<<
-ash2 creditor 1,A=<
D. $5 account +1@< 8 ==, E,B4<
3I. account +1@< 8 4< , D,A<<
-- account +1@< 8 4= , =,D4<
=. -75S +1=> 8 == , A,D4<
$5 account A,D@<
The ledger would appear as follows
Raw and in process materials

;)<<< ;)<<<
-reditor =,4>< $5 D,A<<
Bal c2d A><

=,4>< =,4><

Bal b2d A><
onversion costs

;)<<< ;)<<<
-ash2creditor =,==< $5 =,D4<
Bal c2d 14<
-
=,==< =,==<

Bal b2d 14<
!inished goods

;)<<< ;)<<<
3I. D,A<< -75S A,D@<
-- =,D4< Bal c2d 1,>=<

E,B4< E,B4<

Bal b2d 1,>=<
ost of goods sold

;)<<< ;)<<<
$5 A,D@<
The stock balances at the end of /arch would be
;)<<<
3aw and in process materials A><
$inished goods 1,>=<

4,1B<

The balance on the con"ersion 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.
C3 -3
;)<<< ;)<<<
1. -- account =,==<
-ash 4,@<<
-ash2creditors 1,A=<
4. $5 account +1@< 8 == , E,B4<
-reditors +1@< 8 4< , D,A<<
-- account +1@< 8 4= , =,D4<
D. -75S A,D@<
$5 account A,D@<
This "ariant is thus only suitable for JIT system with minimal raw materials stocks.
"uita#ility of Backflush accounting
Both "ariance illustrated abo"e eliminate the !I. 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 in"ol"ed in tracking costs through !I., -75S and $5 is unlike to be
benefit. &s noted abo"e, the stock and cost of goods sold "alues will be close to those deri"ed from a
con"entional costing system, with a considerably reduced "olume of recorded transactions.
$nother theory on Backflush $ccounting
Traditional cost accounting systems track the se'uence of raw materials and components mo"ing
through the production systems, and as a conse'uence are called (se'uential tracking system) &s JIT is an
entirely different system it re'uires its own accounting system. The absence of stocks makes choice about
stock "aluation systems unnecessary and the rapid con"ersion of direct materials into cost of goods sold
simplifies the cost accounting system. The approach is known as Backflush accounting.
Backflush accounting delays the recording of costs until after the e"ents ha"e taken place, then
standard costs are used to work backwards to (flush) out the manufacturing costs. There are two e"ents 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 e"en this trigger is not rele"ant and raw materials are (flushed) when the second trigger
is acti"ated.
The second trigger is either the transfer of goods to finished goods stock or, in a true JIT system, the
sale of goods. Two e%amples of possible Backflush accounting systems are gi"en below.
Table 1* System 1
& small stock of raw materials is held no finished goods stock.
Cr. -r.
; ;
1. 3aw materials are purchased -- ;D,4<<
Stock control D,4<<
-reditors control D,4<<
4. -on"ersion costs are incurred -- ;D,<<<
-on"ersion cost control D,<<<
Indi"idual a2cs. D,<<<
D. 5oods sold -- ;A,<<< worth at standard cost
-ost of goods sold A,<<<
Stock control A,<<<
=. 6nder or o"er allocation of con"ersion costs
-on"ersion cost allocated D,1<<
-ost of goods sold 1<<
-on"ersion costs control D,<<<
$igure 1 * ?edger accounts for system 1
This is the system used by Toyota in its 6F factory. In true Japanese it manipulates employees to beha"e in
a certain way. $irstly employees must concentrate on achie"ing sales because cost of sales is the triggerG
nothing gets recorded until the sales are made. Secondly there is no benefit in producing foods for stock. In
traditional system which ha"e a finished goods stock managers can increase in finished goods stock
reduces the cost of sales in traditional financial accounts.
The model #ust described may be to cope with in progress in the system by using a raw and in progress
account +3I., in place of the stock control account &ll other entries remain the same.
Table 4 * System 4
0o raw material stock is held but some finished goods are held.
The figures are the same as for system 1, but the transfer to finished goods is assumed to be ;A,<<< and the
cost of goods sold is ;>,B<< lea"ing a finished goods stock of ;1<<.
Cr. -r.
; ;
1. 3aw materials are purchased no entry
4. -on"ersion costs are incurred -- ;D,<<<
-on"ersion cost control D,<<<
Indi"idual a2cs D,<<<
Stock control

1. D,4<< D. 4,B<<
Bal c2d D<<

/aterials
-ost of goods sold

D. A<<< =. 1<<

-on"ersion cost allocated

=. D,1<< D. D,1<<
-on"ersion cost control

4. D<<< =. D<<<
?abour and
o"erhead
D. $inished goods units produced ;A,<<<
$inished goods control A,<<<
-reditors control 4,B<<
-on"ersion costs allocated D,1<<
=. $inished goods sold -- ;>,<<<
-ost of goods sold >,B<<
$inished goods control >,B<<
>. 6nder or o"er allocation of con"ersion costs
-on"ersion costs allocated D,1<<
-ost of goods sold 1<<
-on"ersion costs control D,1<<
$igures 4 ?edger accounts for system 4
The Backflush accounting model cannot be used by all organisations. It can only be used where a JIT type
system is in operation. !here it is used it does ha"e ad"antages. The traditional system is time consuming
and e%pensi"e to operate, as it re'uires a considerable amount of documentation, such as materials
re'uisitions and time sheets to support it in order to maintain the !I. records and #ob cards. If a company
operates with low stock le"els the benefits of operating the traditional costing system are few. By
introducing a Backflush system a considerable amount of clerical time is sa"ed.
$rom the Backflush accounting e%amples it can be seen that JIT eliminates direct labour as cost category.
Instead labour is treated as in indirect cost and is included in con"ersion cost with the o"erheads. This is
because production is only re'uired when demand re'uires it and so production labour will be paid
regardless of acti"ity. &ll indirect cost are treated as fi%ed period e%penses. !ith JIT failed or rework must
be almost eliminated if the system is to work and so no accounts for this will e%ist in Backflush accounting
whereas they are re'uired in traditional systems.
The Backflush accounting model does not conform to the accepted financial accounting procedures for
e%ternal reporting. This is because work in progress is treated as an asset. This can be countered by
claiming, 'uite rightly, immaterial. If only one tenth of one day)s production is held in work in progress
$inished goods
stock control

D. 4,B<< =. >,B<<
D. D,1<< Bal c2d 1<<
-ost of goods sold

=. >,B<< >. 1<<

-reditors)
control
-on"ersion cost allocated

>. D<< D. D,1<<
-on"ersion cost control

4. D,<<< >. D<<<
then it is immaterial. It can also be claimed that it is immaterial if the work in progress does not change
from one period to the ne%t as opening and closing stock will cancel each other out.
Backflush accounting can be criticised because of the lack of information that it pro"ides. Some argue
'uite rightly, that in reality it is impossible to eliminate all stock as a truck arri"ing with raw materials
creates stock until it is mo"ed to be 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 'uantity of stock. Instead it is deri"ed 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.
Difculties of Backfush costing :
1. Backflush costing does not strictly adhere to generally accepted accounting principles of e%ternal
reporting.

4. The critics of backflush costing .rimarily emphasise on the absence of audit Trails.

D. It does not pinpoint the use of resources at each step of the production process.

=. Backflush costing is suitable only for JIT .roduction system with Hirtually no direct material
in"entory and minimum work-in-process in"entories. It is less $easible 7therwise.