This amount, however, is likely to be negligible in quantity and therefore not material in terms of value. Thus, a backflush accounting system simplifies the accounting records by avoiding the need to follow the movement of materials and work-in-progress through the manufacturing process within the organisation. The backflush accounting system is likely to involve the maintenance of a raw materials and work-in-progress account together with a finished goods account. The use of standard costs and variances is likely to be incorporated into the accounting entries. Transfers from raw materials and work-in-progress account to finished goods (or cost of sales) will probably be made at standard cost. The difference between the actual inputs and the standard charges from the raw materials and work-in-progress account will be recorded as a residual variance which will be recorded in the profit and loss account. Thus, it is essential that standard costs are a good surrogate for actual costs if large variances are to be avoided.
Backflush accounting is ideally suited to a just-in-time philosophy and is employed where the overall cycle time is relatively short and inventory levels are low. Naturally, management will still be eager to ascertain the cause of any variances which arise from the inefficient usage of materials, labour, and overheads. However, investigations are far more likely to be undertaken using non-financial performance indicators as opposed to detailed cost variances.
The following example illustrates the preparation of accounts using a system of backflush accounting under two variants. 'Trigger points' determine when entries are recorded in the accounting system. Variant 1 (Table 1) has two trigger points, variant 2 (Table 3) has only one. Wallace plc manufactures a single product called the 'Grommit'. The transactions for the month of March 2004 were as follows:
Purchase of raw materials $2,420,000
Conversion costs incurred during the month:
Labour $770,000
Overheads $1,158,000
Finished goods completed during the month 120,000 Grommits
Sales for the month 118,000 Grommits
There were no opening inventories of raw materials, work-in-progress or finished goods at 1 March 2004. The standard and actual cost per unit of output is $36 ($20 materials and conversion costs of $16, of which labour comprises $6.40).
Variant 1
* Trigger point 1: The purchase of raw materials
* Trigger point 2: The manufacture of finished goods.
Table 1
Dr $ Cr $
1 Raw material inventory a/c 2,420,000
Creditors 2,420,000
2 Conversion costs 1,928,000
Bank 770,000
Creditors 1,158,000
3 Finished goods inventory 4,320,000
Raw materials inventory a/c 2,400,000
Conversion costs:
- labour 768,000
- overheads 1,152,000
4 Cost of sales (118,000 x $36) 4,248,000
Finished goods inventory 4,248,000
Table 2 shows the ledger accounts in respect of the above transactions. The inventory balances as at 31 March 2004 are:
$
Raw materials 20,000
Finished goods 72,000
92,000
The balance of £8,000 on the conversion costs account would be debited to the profit and loss account.
Table 2
Raw materials inventory
1 Creditors $2,420,000 3 Finished goods $2,400,000
Balance c/fwd $20,000
$2,420,000 $2,420,000
Finished goods inventory
3 Raw materials $2,400,000 4 Cost of sales $4,248,000
Conversion costs $1,920,000 Balance c/fwd $72,000
$4,320,000 $4,320,000
Conversion costs
2 Bank $770,000 3 Finished goods $1,920,000
Creditors $1,158,000 Balance c/fwd $8,000
$1,928,000 $1,928,000
Cost of sales
4 Finished goods $4,248,000 To profit and loss a/c $4,248,000
$4,248,000 $4,248,000
Variant 2
This is the most simple variant of backflush accounting which has only one trigger point that we shall assume is the completion of a 'Grommit'. Conversion costs are debited as the actual costs are incurred by Wallace plc. The accounting entries under this variant are shown in Table 3.
Dr $ Cr $
1 Finished goods inventory a/c (120,000 x $36) 4,320,000
Creditors 2,400,000
Conversion costs 1,920,000
2 Cost of sales (118,000 x $36) 4,248,000
Finished goods inventory 4,248,000
At the end of March 2004 there will be a balance of $72,000 in the finished goods inventory account (2,000 Grommits at $36). As far as raw materials are concerned then $20,000 of raw materials have been purchased but are yet to be converted into Grommits (ie finished goods), and therefore will not have been recorded in the internal costing system of Wallace plc. Consequently, this amount will not be incorporated within the value of inventory at the end of March 2004.
The variants illustrated above eliminate the need to record movements in work-in-progress. Proponents of backflush accounting argue that, in situations where inventory levels remain low, the preponderance of manufacturing costs will form part of cost of sales. This is as opposed to being deferred into inventory. As a consequence, there is little benefit in tracking the costs of stock movements through work-in-progress, cost of sales, and finished goods inventory. Here lies the considerable benefit of the application of backflush accounting in that its application greatly reduces the volume of accounting transactions which would be recorded in a conventional costing system. In keeping with a just-in-time philosophy the recording of such transactions can be regarded as a non-value added activity.
Reference:
Drury, C Management and Cost Accounting 5th edition (Thompson Learning Press, 2000)
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