Dar es Salaam CPA REVIEW Center B5-Performance Management CPA (T) DAVID D KIWIA

BACK-FLUSH COSTING

Backflush costing is a product costing system generally used in a just-in-time (JIT) inventory system. In
short, it is an accounting method that records the costs associated with producing a good or service only
after they are produced, completed, or sold. Backflush costing is also commonly referred to as backflush
accounting.
KEY TAKEAWAYS
• Backflush costing is used by companies who generally have short production cycles,
commoditized products, and a low or constant inventory.
• Backflush costing is an accounting method designed to record costs under specific conditions.
• Backflush accounting is another name for backflush costing.
• Backflush costing can be difficult to do and not every company meets the criteria to conduct
backflush costing.
• Back flush costing focuses on output.
Back-flush costing is a way of accumulating manufacturing costs when processing speeds are very fast
or products are being produced in small lots. It by-passes the routine cost accounting entries that are
required in subsidiary records for job order and process cost accumulation, thereby saving considerable
time in processing data.
This mode of recording costs supports the Just in time (JIT) business process.
To better understand the meaning and application of back flush costing, it is advisable to understand just-
in-time (JIT) system.
THE JUST IN TIME (JIT)
the Just in time (JIT) basically involves elimination of waste and excess resources. It also suggests
performing activities only as and when customers need them at the next stage in the process.
The JIT system suggests that, to ensure rapid production, individual materials will spend much less time
in work in progress and accordingly, the total volume of work in progress will reduce
A just-in-time system always encourages production in response to the demand of a product and it
strongly discourages production for creating inventory. It is in clear contrast with traditional production
systems.

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Kiwia, David D. CPA-T, BAF, MFA-OG, PhD - Finance (IP) [email protected] +255 716 734 577
Dar es Salaam CPA REVIEW Center B5-Performance Management CPA (T) DAVID D KIWIA

Comparing JIT with traditional method of manufacturing

Just-in-Time Manufacturing Traditional
Manufacturing
Reduces inventory Increases inventory to protect against
process problems
Reduces lead time Increases lead time as a buffer against
Reduces setup time uncertainty
Disregards setup time as an improvement
Emphasizes product-oriented layout priority
Emphasizes process-oriented layout
Emphasizes team-oriented Emphasizes work of individuals
employee involvement following manager instructions
Emphasizes demand pull manufacturing Emphasizes production push
Emphasizes zero defects manufacturing
Tolerates defects
Emphasizes supplier partners Keeps suppliers at ―arm‘s length,‖
independent entries
In backflush accounting, costs are not associated with units until they are completed or sold. Backflush
accounting is sometimes called delayed costing, which is a helpful name, as costs are not allocated to
production until after events have occurred.
Standard costs are then used to work backwards to flush out manufacturing costs into production, splitting
them between stocks of finished goods (if any) and cost of sales. No costs, whether material or conversion
costs, are allocated to work-in-progress.
Key Point: The process of backflush costing makes it difficult for companies to audit because it doesn't
always adhere to the basic fundamentals of accounting.
The traditional and backflush approaches can be illustrated by Figures 1 and 2 below.
Variants of Backflush Accounting
There are two variants of backflush accounting and they differ according to what are called ‘trigger
points’. Trigger points are the events which cause costs to be moved into inventories.
VARIANT ONE
This is the less radical variant. There are two inventory accounts, raw materials and finished goods, and
there are two trigger points:
1. Purchase of Raw Materials
Dr Materials account
Cr Creditors
2. Cost of Labour and Other Manufacturing Expenses
Dr Conversion Cost Account
Cr Creditors or Cash Account
The cost of labour and other manufacturing expenses are debited to a conversion cost account and credited
to cash or creditors. The conversion cost account can be thought of as a suspense account where amounts
are placed temporarily.
3. On Completion of Units
Dr Finished goods account with the standard cost of goods produced

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Kiwia, David D. CPA-T, BAF, MFA-OG, PhD - Finance (IP) [email protected] +255 716 734 577
Dar es Salaam CPA REVIEW Center B5-Performance Management CPA (T) DAVID D KIWIA

Cr Materials account with the standard cost of materials

Cr Conversion cost account with the standard cost of conversion.
VARIANT TWO
This is more radical because no records are kept of work-in-progress raw materials, so if this method
is to be used, stocks of both raw materials and work-in-progress must be negligible. It has only one trigger
point.
As before, the cost of labour and other manufacturing expenses are initially debited to a conversion cost
account and credited to cash or creditors.
Entries into the finished goods inventory account are made only when goods are completed, and the
journal entries will be:
Dr Finished goods account with the standard cost of goods produced
Cr Creditors with the standard cost of material used in goods produced
Cr Conversion cost account with the standard cost of conversion
Variance Cost Adjustment
Note that at some point the creditors account will have to record correctly what is owing to them so, from
time to time, this will be adjusted by a cost variance. Thus, if the standard cost of raw materials used was
$50,000, but the actual cost of materials was $52,000, an adverse variance of $2,000 has to be recognised
and the creditors account would have two entries Cr $50,000 (and Dr $50,000 to finished goods), then Cr
$2,000 and (Dr $2,000 to profit and loss account).
So, are there any benefits in adopting backflush accounting other than avoiding complex recording and
calculations to value immaterial amounts of inventory? Let’s consider the trigger point found in both
variants: costs are transferred when goods are completed. What would happen if that trigger point were
changed to permit cost transfer only when goods were sold?
That would mean conversion costs would remain as costs until goods were sold, rather then being
transformed into finished stock when goods were completed. Managers would then have no incentive to
make goods unless they were going to be sold imminently, otherwise they would simply be incurring
more expense, and that would make their performance look bad.
The purpose of a manufacturing business is not to make goods; its purpose is to make and sell goods.
Only then is there throughput, and backflush accounting can be set up so that costing records encourage
managers to adopt this goal-orientated behaviour.
Figure 1: Traditional Costing

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Kiwia, David D. CPA-T, BAF, MFA-OG, PhD - Finance (IP) [email protected] +255 716 734 577
Dar es Salaam CPA REVIEW Center B5-Performance Management CPA (T) DAVID D KIWIA

Figure 2: Backflush Costing

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Kiwia, David D. CPA-T, BAF, MFA-OG, PhD - Finance (IP) [email protected] +255 716 734 577
Dar es Salaam CPA REVIEW Center B5-Performance Management CPA (T) DAVID D KIWIA

TOTAL QUALITY MANAGEMENT (TQM)

Total quality management (TQM) is a philosophy of quality management and cost management that
has a number of important features.
• Total – means that everyone in the value chain is involved in the process, including employees,
customer and suppliers
• Quality – products and services must meet the customers' requirements
• Management – quality is actively managed rather than controlled so that problems are
prevented from occurring.
There are three basic principles of TQM:
1. Get it right, first time
TQM considers that the costs of prevention are less than the costs of correction. One of the main
aims of TQM is to achieve zero rejects and100% quality.
2. Continuous improvement
The second basic principle of TQM is dissatisfaction with the status-quo. Realistically a zero-defect
goal may not be obtainable. It does however provide a target to ensure that a company should never
be satisfied with its present level of rejects. The management and staff should believe that it is
always possible to improve next time.
3. Customer focus
Quality is examined from a customer perspective and the system is aimed at meeting customer
needs and expectations.
Quality related costs
• Failing to satisfy customers' needs and expectations, or failing to do so first time, costs the average
company between 15% and 30% of sales revenue.
• A quality-related cost is the 'cost of ensuring and assuring quality' as well as the loss incurred when
quality is not achieved. Quality costs are classified as prevention costs, appraisal cost, internal failure
cost and external failure cost.
1. Prevention cost
Prevention costs represent the cost of any action taken to prevent or reduce defects and failures.
Examples include:
• Customer surveys
• Research of customer needs
• Field trials
• Quality education and training programmes
• Supplier reviews
• Investment in improved production equipment
• Quality engineering.
2. Appraisal costs
Appraisal costs are the costs incurred, such as inspection and testing, in initially ascertaining the
conformance of the product to quality requirements. Examples might be:
• The capital cost of measurement equipment
• Inspection and testing

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Kiwia, David D. CPA-T, BAF, MFA-OG, PhD - Finance (IP) [email protected] +255 716 734 577
Dar es Salaam CPA REVIEW Center B5-Performance Management CPA (T) DAVID D KIWIA

• Product quality audits

• Process control monitoring
• Test equipment expense.
3. Internal failure cost
Internal failure costs are the costs arising from inadequate quality where the problem is discovered
before the transfer of ownership from supplier to purchaser. Examples include:
• Rework or rectification costs
• Net cost of scrap
• Disposal of defective products
• Downtime or idle time due to quality problems.
4. External failure cost
The cost arising from inadequate quality discovered after the transfer of ownership from supplier to
purchaser. Examples include:
• Complaint investigation and processing
• Warranty claims
• Cost of lost sales
• Product recalls.
Conformance costs and non-conformance costs
Appraisal and prevention costs may also be referred to as conformance costs, whilst internal and external
failure costs may be referred to as non-conformance costs.

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Kiwia, David D. CPA-T, BAF, MFA-OG, PhD - Finance (IP) [email protected] +255 716 734 577