PROCESS COSTING IN JIT SYSTEM (BACKFLUSH COSTING)

ANKUR CHOURAGADE 09IM3017

WHAT IS BACKFLUSH COSTING?

Non-traditional type of costing that complements just-in time inventory Based on the philosophy that inventory is a not a value adding activity Method of costing a product that works backwards: Standard costs are allocated to finished products on the basis of the output

KEY FEATURES
Costs are flushed back through the production process to the point at which inventories remain Avoids detailed transactions as no separate accounts for W.I.P.
In backflush costing, first focus is on the output of the organization and it works backward to allocate costs between costs of goods sold and inventories.

COMPARISON
TRADITIONAL Sequential Tracking Recording of journal entries follow the same order in which the four stages of purchases of materials, W.I.P., finished goods and sales take place BACKFLUSH Does not track costs in order Delay in recording of certain costs Absence of WIP account

Direct Materials Direct Labor Manufacturing Overhead

Materials Inventory Work in Process Inventory

TRADITIONAL COSTING
Finished Goods Inventory Cost of Goods Sold

BACKFLUSH COSTING
Direct Materials Raw & Work in Process Inventory Finished Goods Inventory

Conversion Costs (Direct Labor & Manufacturing Overhead)

Cost of Goods Sold

Trigger Points
Each trigger point refers to a point at which costs are recognized within the cost accounts and thus associated with products

STAGES
Stage A: Purchase of direct materials
Stage C: Completion of good units of product

Stage B: Production resulting in work in process

Stage D: Sale of finished goods

Trigger Points
Assume trigger points A,C and D. This company would have two inventory accounts:

Type Account Title 1. Combined materials 1. Inventory: and materials in work Raw and In-process in process inventory Control 2. Finished goods 2. Finished Goods Control

Backflush Costing Example

The manufacturing cost information for March for a division of XYZ Company:
COST INCURRED IN MARCH Purchase of Raw Materials Labour Overheads $ (THOUSANDS) 4250 2800 1640

. Example Contd.
ACTIVITY IN MARCH Finished Goods Manufactured
Sales STANDARD COST/UNIT Materials Labour Overhead Total

UNITS (THOUSANDS) 180

145 $ 20 15 9 44

Trigger Points
Journal entry for trigger point A : Inventory: Raw and In-process Control Accounts Payable 4250

4250

To record direct material purchased during the period

Trigger Points
Journal entry to record conversion costs? Conversion Costs Account Cash (Labour) Cash (Overhead) 4440

2800 1640

To record the incurrence of conversion costs during the accounting period

Trigger Points
Journal entry for trigger point C : Finished Goods (180*44) Inventory: Raw and In-Process Control(180*20) Conversion Costs (180*24) 7920 3600 4320

To record the cost of goods completed during the accounting period

Trigger Points
Journal entry for trigger point D : Cost of Goods Sold Finished Goods Control 6380

6380

To record the cost of goods sold during the accounting period

SUMMARY
DEBTORS Inventory: Raw and In-process Accounts Payable Conversion Costs Account Cash Cash/ Creditor Finished Goods (180*44) Inventory (180*44) Conversion Costs (180*44) 4250 4250 4440 2800 1640 7920 3600 4320 6380 CREDITORS

Cost of Goods Sold 6380 Finished Goods Control The stock balances at the end of March would be Raw and in process materials 650 Finished goods 1,540 2,190

When appropriate?
Most appropriate when used to complement a just-in-time inventory management system This is due to the fact that back flush costing simplifies the costing process in these situations Backflush accounting is inappropriate when production process is long and this has been attributed as a major flaw in the design of the concept.

ADVANTAGES
Less entries have to be passed so it saves time. (major benefit) Less costly as less documentation have to be maintained. It uses JIT environment which saves holding cost of inventory

Provides reasonably accurate results if: 1. Material Inventories are low 2. Production Cycle times are short

DISADVANTAGES
One of the main disadvantages of the system is that it only works under some quite strict requirements
Standard costs must be reliably estimated and variances kept to a minimum Build up of work in progress or finished goods needs to be avoided Detailed information for management purposes may not be available where needed, and the production control therefore need to be all the stronger.

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