Backflush Costing: Definition and How System Works for Inventory

Activity-Based Costing (ABC) frameworks can further refine overhead allocation by identifying precise cost drivers. Once the production cycle is completed, the business will multiply the number of units that have been produced by the standard cost per unit to find the expense that they will record in their journal entry. The use of backflush costing provides an efficient and accurate method for managing inventory costs. By streamlining accounting processes, reducing administrative tasks, and minimizing errors, businesses can optimize their inventory management systems and focus more on strategic decision-making. Several conditions are required before a business can reliably use backflush costing.

What is backflush costing?

Businesses need to think about this when choosing their cost accounting methods. If a company isn’t ready or if it’s done wrong, accounting complications are sure to pop up. These complications might cause errors in cost allocation and manufacturing expenses. This method depends on a precise bill of materials (BOM) and detailed scrap records. Backflush costing is generally used by companies that keep low levels of inventory and experience high turnover in inventory.

As a result, backflush accounting results in recording very little in a company’s Work in Process accounts. Traditional costing methods often require detailed tracking of raw materials, work-in-progress, and finished goods. In contrast, backflush costing reduces the need for such granular tracking by consolidating inventory records.

Possible Accounting Complications

Backflush costing aligns well with just-in-time (JIT) and lean manufacturing principles, offering efficiency and simplicity. However, it may face challenges in accurately reflecting the true costs of production, and the effectiveness relies heavily on the backflush costing accurate identification and implementation of trigger points. Usually the first approach (scanning at the withdrawal) is used for materials which are piece goods. If the materials are not piece goods (bulk material, yard ware), then the workplace has to report the consumed quantities after it has finished its job on a particular production order.

Editorial Process

Backflushing comes with a challenge; it lacks a detailed audit trail that meets GAAP standards. Auditors need clear pathways to follow transactions, but backflushing simplifies the process by skipping steps in documentation. This costing system is best used for processes with short production times that utilize just in time inventory systems. At the end of the accounting period, differences between estimated and actual costs are adjusted through variance accounts. For example, if actual overhead costs exceeded applied overhead by $500, the variance would be debited to Cost of Goods Sold (COGS) and credited to the Overhead Variance account. These adjustments ensure financial statements accurately reflect true costs.

Backflush Costing and its Benefits in Just-In-Time Environments

• Generally, businesses that have a slow turnover rate for their inventory record their costs as they occur due to the fact that their products tend to take longer to sell.
• Also, custom orders typically don’t use this system as management would have to create a separate bill for each set of materials used.
• Only one journal entry needs to be made at the end of the production process to account for all costs designated to the product.
• That means that any residual book inventory quantity that may exist in the ERP system, assigned to the shop floor and to that specific HU is reported as consumed and issued to a distinct cost center.
• However, it also requires that the standard costs used in backflush costing are accurate and reflective of actual production conditions to avoid significant variances that could distort financial results.
• Without carefully recorded costs at each stage, auditors may struggle to verify the numbers.

At that time, the number of units completed is multiplied by the related bill of materials to arrive at the standard amount of raw materials that should have been used during the production process. Backflush costing works especially well when the production process is relatively short, so there is only a minimal period of time when the accounting database does not accurately reflect the actual location of raw materials. With less time and resources spent on detailed cost tracking and inventory management, companies can allocate more resources to activities that directly generate cash flow.

Companies will estimate the cost to produce each unit of a particular product, assigning a standard cost per unit. At the end of a production cycle, the number of units produced will be multiplied by the standard cost to determine the expense journal entry. The journal entry will be recorded once at the end of the production cycle.

It is because costs are still recorded relatively close to the day they are incurred. Companies with slow inventory turnover tend to record costs as they are incurred, as the product may remain unsold for a longer duration of time. A business would like to use backflush accounting for recording the costs of manufacturing a new model of speaker.

• Closing entries also transfer balances from temporary accounts, like WIP, to permanent accounts such as Finished Goods Inventory.
• This streamlined approach reduces the complexity of tracking costs throughout various production stages.
• These costs are assigned using allocation bases such as machine hours or labor hours.
• This starts with analyzing the bill of materials (BOM), which details the components and quantities required for each product.
• Advanced software systems automate these calculations, ensuring accurate and timely estimates.
• They purchased parts costing $20,000 for the production process on March 7, $15,000 on March 15, and $15,000 on March 22.

Backflush Costing: Definition And How System Works For Inventory

The journal entry for backflush costing is a single entry at the end of the production period based on a standard cost and the number of units produced. Backflush costing allows companies to easily assign costs to corresponding inventory. Only one journal entry needs to be made at the end of the production process to account for all costs designated to the product. Such a process saves companies time needed to record costs during the production process, which lowers accounting costs. It can be argued that backflush accounting simplifies costing since it ignores both labor variances and work-in-process.

Companies must establish robust data collection and validation processes to ensure that the information used for cost recording is reliable. This involves regular audits and cross-checks to verify that the data aligns with actual production activities. Accurate data not only enhances the reliability of financial reports but also aids in making informed business decisions. This last idea is part of the just-in-time method of inventory management. By the time Company XYZ has to pay the invoices for those raw materials (say, 90 days), it will have already sold or at least finished producing the widgets and will thus have much more cash on hand to pay those invoices.