Back-Flush Accounting

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2 Intro: This Study Guide discusses: 1) The process of back-flush accounting and contrast with traditional process accounting 2) The implications of back-flush accounting on performance management and the control of a manufacturing process 3) The benefits of introducing back-flush accounting 4) The decision to switch to back-flush accounting from a traditional process control Process of back-flush accounting & contrast with traditional process accounting Just in time: Encourages production in response to demand and not to build inventory (pull system). Eliminates waste & excess resources; defects and WIP kept to a minimum In practice, applies only to repetitive manufacturing processes e.g. production & assembly of automobiles & appliances. Receipts at standard Stores Kanban Conversion cost R-I-P control Back-flush at standard cost Back-Flush Accounting Back-flush accounting: Costing system related to JIT. Focusses on output. Makes accounting entries only when goods are completed. Reduces number of entries and thereby saves time considerably. Assigns costs to products that are sold & to units in ending inventory. Finished goods a/c Cost of sales A4.1

3 JIT manufacturing Reduces inventory. Reduces lead time. Reduces set-up time. Emphasises product-oriented layout. Emphasises team-oriented employee involvement. Emphasises demand pull manufacturing. Zero defects. Treats suppliers as partners. Traditional manufacturing Maintains inventory to protect against process problems. Increases lead time as a buffer against uncertainty. Disregards set-up time as an improvement priority. Emphasises process-oriented layout. Emphasises work of individuals following manager instructions. Emphasises production push manufacturing. Tolerates defects. Treats suppliers as arm s length, independent entities. No inventory Inventory

4 Accounting procedure in back-flush accounting A -Trigger points: purchase of material, completion and sale of finished goods Purchase Conversion cost RIP Finished goods Cost of goods sold Record cost of finished goods Dr Finished goods a/c Cr RIP a/c Cr Conversion cost a/c Record cost of sales Dr Cost of goods sold a/c Cr Finished goods a/c B -Trigger points: purchase of materials and sale of finished goods Conversion cost Purchase Purchase of direct material Dr Inventory control a/c Cr Payable a/c Cost of goods sold Incur conversion cost Dr Conversion cost a/c Cr Payable a/c Back-Flush Accounting A4.3

5 Sale of finished goods Dr Cost of goods sold a/c Cr Inventory Control account a/c Cr Conversion Cost (as allocated) a/c C - when trigger point is finished goods completion is different from the above two procedures to the extent that Conversion cost Purchase Finished goods Cost of goods sold Purchase of raw material Dr Inventory control a/c Cr Payable a/c Incur conversion cost Dr Conversion cost a/c Cr Payable a/c Production of finished goods 1) Dr Finished Goods Inventory a/c Cr Inventory Control a/c Cr Conversion Cost (as allocated) a/c 2) Dr Cost of goods sold a/c Cr Finished Goods Inventory a/c

6 Switch to back-flush to traditional accounting Traditional process of accounting Focusses on the movement of products from direct materials through WIP to finished goods. Direct labour costs are part of prime costs and distinguished from indirect labour costs. Only fixed costs are treated as period costs. Failed product is tolerated ideally and accounted for. Back-flush accounting Focusses on the output and works backwards (no separate accounting for WIP). Direct labour costs are not part of prime cost & considered as indirect labour cost included in conversion cost. All the overheads (both fixed and variable) are treated as period costs. In this case, failed product is not tolerated ideally and not accounted for. The benefits of introducing back-flush accounting Saves documentation Avoids a considerable amount of documentation. Reduces substantially the time required in accounting entry. Production for inventory is discouraged by the system. It is simpler. There is no separate accounting for WIP. Back-Flush Accounting A4.5

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