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Main Findings
Backflush costing - an accounting method that records the costs of producing a good or service only after they are produced, completed, or sold by using a standard cost per unit. Advantages of backflush costing - it saves time, reduces accounting costs, eliminates the need for work-in-process accounts, provides a clear link between costs and revenues, and aligns with the lean manufacturing philosophy. Examples of backflush costing - some companies that use backflush costing are Toyota, Dell, and Starbucks. They use this method to simplify their costing process and reduce their inventory levels.
Backflush costing is an accounting method that records the costs of producing a good or service only after they are produced, completed, or sold by using a standard cost per unit.
It is used by companies that adopt a just-in-time (JIT) inventory system, where inventory levels are kept low, and products are made to order.
Backflush costing simplifies the accounting process by eliminating the need to track and allocate costs during each stage of production. Instead, all costs are "flushed" to the income statement at the end of the production cycle.
Why Use Backflush Costing?
Backflush costing has several advantages for companies that use a JIT inventory system. Some of them are:
- Backflush costing saves time and reduces accounting costs by avoiding the complex and tedious reporting of costs as they occur.
- Backflush costing eliminates the need for work-in-process (WIP) accounts, which can be difficult to measure and value accurately.
- Backflush costing provides a clear and direct link between costs and revenues, which can improve decision-making and performance evaluation.
- Backflush costing aligns with the lean manufacturing philosophy of minimizing waste and maximizing efficiency.
However, backflush costing also has some disadvantages and limitations. Some of them are:
- Backflush costing lacks a sequential audit trail and may not comply with generally accepted accounting principles (GAAP).
- Backflush costing requires an accurate estimation of standard costs per unit, which can be challenging in some industries or markets.
- Backflush costing may not capture the variances between actual and standard costs, which can affect product quality and profitability.
- Backflush costing may not be suitable for companies that sell customized or differentiated products, as the unit cost may vary significantly.
Formula for Backflush Costing
The formula for backflush costing is:
Total Production Cost = Standard Cost per Unit x Number of Units Produced
The total production cost is recorded as an expense in the income statement at the end of the production cycle.
The standard cost per unit is determined by adding up all the expected costs involved in producing one unit of product, such as raw materials, labor, overheads, etc.
The number of units produced is the actual quantity of products that are completed and ready for sale.
How to Calculate Backflush Costing
To calculate backflush costing, follow these steps:
- Estimate the standard cost per unit by adding up all the expected costs involved in producing one unit of product.
- Multiply the standard cost per unit by the number of units produced to get the total production cost.
- Record the total production cost as an expense in the income statement at the end of the production cycle.
- Adjust for any variances between actual and standard costs, if necessary.
For example, suppose a company produces widgets using a JIT inventory system. The company estimates that it costs $10 to produce one widget, which includes $4 for raw materials, $3 for labor, and $3 for overheads.
The company produces 1,000 widgets during the production cycle. The company uses backflush costing to record its production costs as follows:
Standard cost per unit = $10
Number of units produced = 1,000
Total production cost = $10 x 1,000 = $10,000
The company records $10,000 as an expense in the income statement at the end of the production cycle.
If the company finds out that its actual costs are different from its standard costs, it will need to adjust for the variances. For example, if the actual raw material cost was $4.50 per unit instead of $4, the company will need to record a $500 unfavorable material variance ($4.50 - $4) x 1,000) in the income statement.
Examples of Backflush Costing
To illustrate how backflush costing works, let's look at some examples of companies that use this method.
Toyota
Toyota is one of the pioneers of the just-in-time inventory system and backflush costing. Toyota produces cars based on customer orders and keeps a minimal inventory of raw materials and finished goods.
Toyota uses a standard cost-per-car model and multiplies it by the number of cars produced to determine the total production cost. Toyota also tracks the variances between the standard and actual costs and adjusts them periodically.
Dell
Dell is another company that uses backflush costing for its computer products. Dell allows customers to customize their computers online and then manufactures them according to their specifications.
Dell uses a standard cost per computer component and multiplies it by the number of components used to calculate the total production cost. Dell also monitors the variances between the standard and actual costs and makes adjustments as needed.
Starbucks
Starbucks uses backflush costing for its coffee products. Starbucks roasts and grinds its coffee beans in large batches and then distributes them to its stores.
Starbucks uses a standard cost per pound of coffee beans and multiplies it by the number of pounds used to determine the total production cost. Starbucks also compares the standard and actual costs and corrects any discrepancies.
Limitations of Backflush Costing
Backflush costing has some limitations that need to be considered before adopting it. Some of the limitations are:
Lack of detail
Backflush costing does not provide detailed information on the costs incurred at each stage of production. This may make it difficult to identify and eliminate waste, inefficiencies, or errors in the production process.
Non-compliance with GAAP
Backflush costing may not comply with the generally accepted accounting principles (GAAP), which require costs to be matched with revenues in the same period. Backflush costing may result in understating or overstating inventory, cost of goods sold, or income in some periods.
Difficulty in auditing
Backflush costing may make it challenging to audit the production costs, as there is no sequential record of the costs incurred. Auditors may have to rely on estimates, assumptions, or samples to verify the accuracy of the costs.
Variance analysis
Backflush costing requires frequent variance analysis to compare the standard and actual costs and make adjustments accordingly. This may increase the accounting workload and complexity.
Conclusion
Backflush costing is an accounting method that records the costs of producing goods or services only after they are sold or completed. It is used by companies that adopt a just-in-time inventory system, have short production cycles, produce standardized products, and maintain low inventory levels.
Backflush costing simplifies the accounting process, saves time, and reduces costs. However, backflush costing also has some drawbacks, such as lack of detail, non-compliance with GAAP, difficulty in auditing, and variance analysis.
References
- Investopedia: https://www.investopedia.com/terms/b/backflush-costing.asp
- Corporate Finance Institute: https://corporatefinanceinstitute.com/resources/accounting/backflush-costing/
- WallStreetMojo: https://www.wallstreetmojo.com/backflush-costing/
FAQ
The primary purpose of Backflush Costing is to reduce the administrative costs associated with traditional costing systems. It simplifies the costing process by delaying the costing activities until the production of goods is completed.
Unlike traditional costing methods that track costs as they occur, Backflush Costing only assigns costs to products after they are produced. This eliminates the need for complex tracking and allocation processes during production.
Businesses with streamlined and highly automated production processes typically use Backflush Costing. These businesses often produce large volumes of similar products where the costs of individual production stages are not significantly different.
While Backflush Costing simplifies the costing process, it may not provide detailed cost information for each stage of production. This can make it difficult to identify inefficiencies or cost overruns in specific production stages.
Yes, Backflush Costing can be used in conjunction with other costing methods. For example, a business might use Activity-Based Costing to allocate overhead costs, and then use Backflush Costing to simplify the tracking of direct materials and labor costs.
