What Is Backflush Costing: Example, Journal Entries

The accounting team must use standard costing to allocate costs to completed items since journal entries were not recorded when inventory was used. In this way, the production expenses are "flushed back" into the cycle and allocated to the appropriate commodities and categories. 

In order to track expenditures throughout the production process, a distinct journal entry would typically be needed for each stage of manufacture. For a single product, this may build up to hundreds of entries. But what happens if your company manufactures a thousand goods. There is a significant amount of extra accounting tasks created as a result. 

How do you handle that? The answer is backflush costing! Let’s discuss backflush costing in-depth and how this method benefits your business!

Key Takeaways

• Backflush costing, often referred to as backflush accounting, involves recording expenses after a good or service has been sold or done.
• Backflush costing is a technique where a standard cost per unit is employed, and this expense is multiplied by the number of units generated to determine the costs.
• Backflush pricing is often beneficial for businesses with a complex production process. Backflush costs, however, typically do not function effectively for businesses that sell customizable items.

What is Backflush Costing?

Backflush costing refers to an accounting approach where costs are recorded after a product or service is sold or rendered. The necessity of maintaining work-in-process accounts while manually allocating charges to various production phases is eliminated by this approach. This costing strategy is typically used by businesses using just-in-time (JIT) inventory systems. The computer manages every aspect of this fully automated pricing system. 

It does away with the expensive and labor-intensive practice of reporting each expense as it arises and instead "flushes" each expense into a single entry when the production process is complete. As a result, backflush costing can be more straightforward and more cost-effective for companies as they are not required to report every expense as it happens. 

👉 Read More: What Is Cash Conversion Cycle: Formula, Example, Calculator 

👉 Read More: What Is Cycle Stock: Formula And Example

Features of Backflush Costing

• In backflush costing, the cost of the materials is added directly to the completed product account rather than being computed separately.
• It is impossible to monitor work in the process, and there is no work account is kept independently.
• When production or sale occurs, journal entries from inventory accounts are postponed, and when they are passed, the usual costing process is utilized to allocate units.
• Based on the operating time of the workforce, the conversion cost is split with the completed items inventory account.
• Backflush pricing is improper when a produced good consists of multiple pieces with low or high variable consumption in addition to the main product.
• The finished items are moved to the material account and the material cost is subtracted from inventory once the goods are finished.

How does Backflush Costing Work?

When using backflush costing, a business must first estimate the value of manufacturing each unit of a given item before assigning this price as the standard unit cost for that specific item. Once the manufacturing cycle is complete, the standard cost is multiplied by the quantity produced to determine whether the expenditure journal entry is accurate. At the conclusion of the manufacturing cycle, this journal entry is once recorded. 

When processing an order, just the most basic details—such as amount, product code, and delivery date—are submitted. After the production process is complete, backflushing is used. For instance, a manufacturer who projects a standard cost of $10 per item and puts out 2,000 items over the course of the manufacturing cycle will record an expense of $20,000 in the expense journal. 

The management utilizes standard or normal costing afterward and works backward to assign a cost to the items or services because no journal entries are originally or sometimes made. In this way, the expenditures are "flushed back" to the manufacturing cycle that has already ended. Despite the fact that this approach is entirely automated, the cost is assigned using a formula. 

👉 Read More: What is Cycle service level: Formula and Example

The Process of Backflush Costing

1. When a business receives an order, it enters just the necessary details—such as quantity, item code, and delivery date—into the system. This information is used to create the list of supplies required to fulfill the order.
2. The business accepts shipment of the raw materials and moves them to the manufacturing floor as soon as production is set to begin.
3. All of the parts are now handled by software for that production order. The decision of which components and the quantity to push in is still up to the cost manager.
4. The operator inputs all relevant data about the item into the system following the completion of the process of production. The production report is then generated by the program.
5. The operator assigns the cost of materials to the production order based on that information in a single transaction.

You can see a brief process of backflush costing through the graph below:

When is Backflush Costing Applied?

Typically, businesses with low quantities of inventory and high levels of inventory turnover employ backflush costing. It is due to expenses are still noted very soon after they have arisen. Because an item may go unsold for a prolonged period of time, businesses having sluggish inventory turnover have a tendency to record expenses as they have arisen. 

When several expenses are involved in manufacturing a product, the backflush costing approach performs very effectively. It can greatly ease the accounting procedure in such a case. Thus, backflush costing is applied by so many manufacturing companies with complicated manufacturing processes. 

On the contrary, this approach is less ideal for businesses that sell more customized goods since the unit cost will frequently fluctuate. 

👉 Read More: What is Goods Receipt? Process and Template

What are the limitations of Backflush Costing?

• Since the cost will be reported too late after it has already been incurred, it is useless for businesses with poor inventory turnover.
• Because this accounting approach does not follow GAAP, it is not recommended to utilize it all the time.
• The standard cost utilized in this approach may change over time, making subsequent accounting entries inaccurate.
• Due to the burdensome requirement of creating an outstanding bill for each product, it is not helpful for companies who sell customized products.

What are the Pros and Cons of Backflush Costing?

Pros

Companies with complicated products or those with multi-stage production processes benefit more from using this costing strategy. For such businesses, it would need many journal entries for each stage of manufacturing to adequately document the cost. 

For a single product, it may lead to dozens of entries, which would make accountants' tasks incredibly difficult. The accounts team won't need to submit journal entries during the process of production if the business implements backflush costing. Thus, we may conclude that this system streamlines accounting and costing operations without significantly sacrificing information. 

Another advantage of this method is:

• It makes checking the production ingredients comparatively simpler.
• simplifies post-production issuance
• It makes tracking the inventory simpler.
• It prevents the reverse issuance of materials when handling bulky items.

Cons

The fact that this costing approach does not adhere to GAAP (standing for "generally accepted accounting principles"), which makes it challenging to audit, is one of its major drawbacks. Because this costing approach allocates costs after the completion of manufacturing, it frequently charges the product with standard expenses. The real expenses thus could differ. 

Therefore, in reality, businesses need to be aware of these variations. By contrasting the labor cost given to the production with the real cash outflow for the labor expenditures, for instance, one may see the variance. Other disadvantages with this backflush costing system include:

• Implementation of this approach is a bit challenging.
• This technology requires a precise production count in order to produce accurate results. The finished product count is one of two inputs in the calculation above. Therefore, if this number is off, the final number will also be off.
• The precision of the bill of materials is another factor that affects its performance. The list of all the parts and materials which an item will need can be found in the bill of materials. Therefore, the backflush costing will allocate the wrong quantity of raw materials and parts if there is a mistake in the bill of materials.
• Accurate reporting for scrap is also necessary. Typically, the manufacturing process produces a lot of scraps. This scrap is not taken into account in the bill of materials. For the inventory to reflect reality, these leftovers must be eliminated.
• This technique allows the rapid production cycle time because work-in-process inventory is not recorded. Inventory is not recorded in this costing method until after manufacturing is complete.

As a result, the records will be incomplete during this period. The manufacturing cycle must be shortened or accelerated in order to guarantee that records are updated promptly.

Backflush Costing Journal Entries

When employing backflush costing, businesses will make one journal entry at the conclusion of the manufacturing cycle with the standard cost and the quantity produced. An example of a typical journal entry with several entries and backflush costs is shown below.

Backflush Costing

Journal Entries

The following journal entries were accepted for backflush costing:

• Payments are recorded to be credited and costs are recorded to be debited. If you pay with a bank account or cash, your bank account or cash will be credited. Likewise, if you buy the material on credit, your creditor's account will be credited.
• The cost determined in the preceding stage is deducted from the finished products account together with it.
• The cost of the products will be moved into the account for the COGS during the sale of completed goods, and the completed products account will be credited.

The entries that follows demonstrates just how much time-consuming it may be to use different accounting techniques. As expenses increase during the process of production, the entries would resume.

Backflush Costing Example

A company wants to utilize backflush accounting to track the expenses associated with producing a new type of headphone. The startup plans to produce 500 pairs of headphones at a typical cost per unit of $100. On March 7, May 10, and May 17, they bought parts for the manufacturing process that cost $20,000, $15,000, and $15,000 respectively. 

On May 31, they completed the manufacture of the headphones. If the business employs backflush costs,  they would enter a $50,000 debit to costs and a $50,000 credit to cash on May 31.

- Read More: Order Management System: Definition, Process And Value 

- Read More: Order management system for Ecommerce: Definition, Key Effect, Benefit

Conclusion

The backflush costing approach, which is a streamlined method of tracking expenses made in product production, accounts for all costs after a period of time has passed since they were incurred. This method can be applied in a hybrid system when several production accounting techniques are implemented. 

However, it could show to be a conceptually elegant approach for sophisticated accounting solutions. It might not be appropriate for a business with a longer manufacturing process. Hope you have a good time with Efex.