Backflush Costing - School purposes PDF

Preview

Summary

School purposes...

Description

BACKFLUSH COSTING/ACTIVITY BASED COSTING A unique production system such as JIT often leads to its own unique costing system. Such system is referred to as Backflush costing. Conditions present in JIT Environment 1. Organizing manufacturing cells 2. Reducing defects and manufacturing lead time, 3. Ensuring timely delivery of materials to enable purchasing, production and sales to occur in quick succession with minimal inventories. The absence of inventories makes choices about cost-flow assumptions (such as weighted – average or first - in, first – out) or inventory costing methods (such as absorption costing or variable costing) unimportant - all manufacturing costs of the accounting period flow directly into cost of goods sold. The rapid conversion of direct materials to finished goods that are immediately sold simplifies job costing. Simplified Normal or Standard Job Costing Traditional normal and standard costing system use sequential tracking, which is any product costing method where recording of the journal entries occurs in the same order as actual purchases and progress in production. These traditional systems track costs sequentially as products pass through the following four stages in a cycle going from purchases of direct materials to sale of finished goods A sequential tracking costing system has four trigger points, corresponding to separate journal entries being made at stages. The term trigger point refers to a stage in the cycle going from purchases of direct materials to sale of finished goods at which journal entries are made in the accounting system. An alternative approach to sequential tracking is backflush costing. Backflush costing is a costing system that omits recording some or all of the journal entries relating to the cycle from purchases of direct materials to the sale of finished goods. Where journal entries for one or more stages in the cycle are omitted, the journal entries for a subsequent stage use normal or standard costs to work backward to flush out the cost in the cycle for which journal entries were not made. The following three examples illustrate backflush costing. To underscore basic concepts, we assume no direct materials variances in any of the examples. The three examples differ in the number and placement of trigger points at which journal entries are made in the accounting system:

Example 1

Number of Journal Entry Trigger Points 3

Example 2

2

Example 3

2

1. 2. 3. 1. 2. 1. 2.

Location in Cycle Where Journal Entries Made Purchase of direct materials Completion of good finished units of product Sale of finished goods Purchases of direct materials Sale of finished goods Completion of finished units of product Sale of finished goods

In all three examples, there are no journal entries in the accounting for work in process. These 3 examples of backflush costing are typically used where the amounts of work in process are small. With JIT production, sizeable reductions in work in process have occurred. Example 1: Trigger points are purchases of direct materials, Completion of good finished units of product, and sale of finished goods.

This example uses three trigger points to illustrate how backflusing can eliminate the need for a separate Work in Process account. Problem 1 Silicon Valley Computer (SVC), which produces keyboards for personal computers. For April, there were no beginning inventories of raw materials. Moreover, there is zero beginning and ending work in process. SVC has only one direct manufacturing cost category ( raw materials) and one indirect manufacturing cost category (conversion costs). All manufacturing labor costs are included in conversion costs. From its bill of materials (description of the types and quantities of materials) and an operations list (description of operations to be undergone), SVC determine the April standard direct material costs per keyboard unit of P19 and the standard conversion costs of P12.

SVC had two inventory accounts: Type Combined materials inventory materials in work in process Finished goods

and

Account Title Inventory Raw and In-Process Control Finished Goods Control

Trigger point 1 occurs when materials are purchased. These costs are charged to Inventory: Raw and In-Process Control. Actual conversion costs are recorded as incurred under backflush costing, just as in other costing systems, and charged to Conversion Costs Control. Conversion costs are allocated to products at trigger point 2 – the transfer of units to Finished Goods Control. Trigger point 3 occurs at the time finished goods are sold. Under-or overallocated conversion costs are written off to cost of goods sold monthly. 100,000 good keyboard units were manufactured in April and 99,000 were sold in April. Purchases of raw materials in April P1,950,000, Conversion costs; P1,260,000 Step 1: Record the Direct materials Purchased Step 2: Record the Incurrence of Conversion Costs During the Accounting Period Step 3: Determine the Number of Good Finished Units Manufactured During the Accounting Period. Step 4: Compute the Normal or Standard Costs per Finished Unit. Step 5: Record the cost of Goods Finished Goods Completed During the Accounting Period Step 6: Record the Cost of Goods Sold During the Accounting Period. Step 7: Record the Under-or Over-allocated Conversion Costs. Problem 2 Assume the same information in problem 1 except that trigger point are purchases of direct materials and sale of finished goods. And there is only one account for inventory Inventory Control Account. Problem 3 Assume the same information in problem 1 except that trigger points are completion of good finished units of product and sale of finished gods. Special Consideration of Backflush Costing The accounting procedures illustrated in Problem 1 do not strictly adhere to generally accepted accounting principles. For example, work in process (an asset) exists but is not recognized in the financial statements. Advocates of backflush costing, however, cite the materiality concept in support of these versions of backflushing. As the three backflush examples illustrate, backflush costing can sometimes approximate the costs that would be reported under sequential costing methods by varying the number of trigger points and their location. If material amounts of raw materials inventory or finished goods inventory exist, adjusting entries can be incorporated into backflush costing.

Backflush costing is not restricted to companies adopting JIT production methods. Companies that have fast manufacturing lead times, or those that have very stable inventory levels from period to period, may find that a version of backflush costing will report cost numbers similar to what a sequential costing approach would report. Criticisms of backflush costing focus mainly on the absence of audit trails – the ability of the accounting system to pinpoint the uses of resources at each step of the production process. The absence of large amounts of materials and work in process inventory means that managers can keep track of operations by personal observations, computer monitoring, and nonfinancial measures. Problem 4: The Lee Company seeks to streamline the costing system at its Singapore plant. It will use a backflush costing system with three trigger points:  Purchases of raw materials  Completion of good finished units or product  Sale of finished goods There are no beginning inventories. The following data pertain to April 2000. Raw materials purchased:P880,000, Raw materials used: P850,000, Conversion costs incurred: P422,000, Conversion costs allocated: P400,000, Costs transferred to finished goods:P1,250,000, Cost of goods sold: P1,190,000. Required: 1. Prepare summary journal entries for April (without disposing of under-or overallocated conversion costs). Assume no direct material variances. 2. Under an ideal JIT production system, how would the amounts in your journal entries differ from those in requirement 1? Problem 5 The Action Corporation manufactures electrical meters. For August, there were no beginning inventories of raw materials and no beginning and ending work in process. Action uses a JIT production system and backflush costing with three trigger points for making entries in the accounting system. Purchases of raw materials – debited to Inventory: Raw and In-process Control, Completion of good finished units of product – debited to Finished Goods Control. Sale of finished goods. Action’s August standard cost per meter is direct materials, P25; conversion costs, P20. The following data apply to August manufacturing: Raw materials and components purchased: P550,000, Conversion costs incurred: P440,000, Number of finished units manufactured: 21,000, Number of finished units sold: 20,000. Required 1. Prepare summary of journal entries for August (without disposing of under-or over allocated conversion costs). Assume no direct materials variances. 2. Post the entries in requirement 1 to T-accounts for Inventory; Raw and Inprocess Control, Conversion Costs Control, Conversion Costs Allocated, and Cost of goods sold. Problem 6 The Ronowski Company produces telephones. For June, there were no beginning inventory of raw materials and no beginning and ending work in process. Ronowski uses a JIT production system and backflush costing with three trigger points for making entries in its accounting system: Purchases of direct (raw materials), Completion of good finished units of product, Sale of finished goods. Ronowski’s standard cost per unit of telephone in June is direct materials, P26; conversion costs, P15. There are two inventory accounts: Inventory: Raw and In-Process Control, Finished Goods Control. The following data apply to June manufacturing: Raw materials and components purchased: P5,300,000, Conversion costs incurred: P3,080,000, Number of finished units manufactured: 200,000, Number of finished units sold: 192,000. Required: 1. Prepare summary journal entries for June (without disposing of underoroverallocated conversion costs). Assume no direct materials variances

2. Post the entries in requirement 1 to T – accounts for inventory; ACTIVITY-BASED COST SYSTEMS 1. Why are external performance measures preferred to internal performance measures in American businesses today? ANSWER: External performance measures are appropriate because businesses are now oriented to external goals. For example, many firms are very concerned with providing high-quality products and outstanding customer service. If these are appropriate goals, consumer-based (external) measures must be employed to determine if the goals are being achieved. 2. In activity-based costing, how are cost drivers selected? ANSWER: Cost drivers are selected based on their underlying relationship to organizational costs. Ideally, a causal relationship exists between the cost driver and a cost pool. Once identified, cost drivers are used to allocate organizational costs to activities and products and are the focus of cost control efforts. 3. Discuss the characteristics of a company for which ABC would be useful. ANSWER: Companies having the following characteristics find ABC useful: (1) hard-to-make products that show large profits and easy-to-make products that show losses; (2) profit margins that are difficult to explain; (3) considerable automation that makes it difficult to assign overhead to products that use machine hours or direct labor as bases; (4) substantial overhead costs that are not in proportion to the number of products; and (5) a wide variety of services or products. 4. ABC has been criticized for a variety of reasons. Discuss these criticisms. ANSWER: One criticism is that ABC does not promote total quality management and continuous improvement. Another criticism of ABC is that ABC does not adhere to generally accepted accounting principles. An ABC system might allocate nonproduct costs (research and development) to products, while not allocating some traditional product costs (factory depreciation on machines) to products. A third criticism of ABC relates to the cost of implementation. An ABC system takes considerable time to implement, and therefore, it is very costly. 5. How has the increase in product variety affected the costs of American business? ANSWER: The increase in product variety has increased the overhead costs of American firms. These costs include significant setup costs to switch from the production of one product to another, costs of additional technology, inventory carrying costs, purchasing costs, and scheduling costs. 6. Discuss the four different levels of costs that are now being identified. How should these types of costs be treated under ABC? ANSWER: The four different levels are unit-level costs, batch-level costs, product- or process-level costs, and organizational or facility costs. Unit-level costs include direct material, direct labor, and some traceable machine costs. These are incurred once for each item produced and are considered part of total product cost. Batch-level costs include machine setup, material handling, and purchasing or ordering costs. These are incurred once for each batch of items produced and are allocated over the total number of units in the batch. These are also considered part of total product cost. Product- or process-level costs include engineering changes, design, and development costs. These are allocated to the total number of units produced in the product line and are considered part of total product cost. Organizational or facility costs include building depreciation, administrative salaries, and organizational advertising. These costs are not product-related and should be deducted from net product revenue.

7. Box Co. manufactures hand-made pine storage boxes for a variety of clients. As production manager, you have developed the following value chart: Operation Average Number of Days Receiving materials 1 Storing materials 2 Handling materials 3 Cutting/measuring materials 6 Assembling materials 4 Building boxes 7 Attaching hinges 2 Inspection 1 a. Determine the value-added activities and their total time. b. Determine the non-value-added activities and their total time. c. Calculate the manufacturing cycle efficiency. ANSWER: a.

Value-added activities Cutting/measuring materials Assembling materials Building boxes Attaching hinges Total production time (days)

Time 6 4 7 2 19

b.

Non-value-added activities Receiving Storing Handling Inspection Total nonproduction time (days)

Time 1 2 3 1 7

c.

Total lead time = 19 + 7 = 26 days MCE = 19/26 = 73.1%

8. TriCo would like to institute an activity-based costing system to price products. The company’s Purchasing Department incurs costs of P550,000 per year and has six employees. Purchasing has determined the three major activities that occur during the year. Allocation # of Total Activity Measure People Cost Issuing purchase orders # of purchase 1 P150,000 orders Reviewing receiving # of receiving 2 P175,000 reports reports Making phone calls # of phone calls 3 P225,000 During the year 50,000 phone calls were made in the department; 15,000 purchase orders were issued; and 10,000 shipments were received. Product A required 200 phone calls, 150 receiving reports, and 50 purchase orders. Product B required 350 phone calls, 400 receiving reports, and 100 purchase orders. a. Determine the amount of purchasing department cost that should be assigned to each of these products. b. Determine purchasing department cost per unit if 1,500 units of Product A and 3,000 units of Product B were manufactured during the year. ANSWER: a. P150,000/15,000 = P10 per purchase order P175,000/10,000 = P17.50 per receiving report P225,000/50,000 = P4.50 per phone call Product A 50 purchase orders ×P10 P 500 100 purchase orders × P10

Product B P1,000

150 receiving reports × P17.50 400 receiving reports × P17.50 200 phone calls × P4.50 350 phone calls × P4.50 Total cost b.

2,625 7,000 900 P4,025

1,575 P9,575

Product A= P4,025/1,500 = P2.68 per unit Product B= P9,575/3,000 = P3.19 per unit

MULTIPLE CHOICE 1. An objective of activity-based management is to a. eliminate the majority of centralized activities in an organization. b. reduce or eliminate non-value-added activities incurred to make a product or provide a service. c. institute responsibility accounting systems in decentralized organizations. d. all of the above 2. Which of the following is/are part of activity-based management? Activity analysis Cost driver analysis a. yes yes b. no yes c. no no d. yes no 3. Which of the following falls under the Activity-Based Management umbrella? Continuous Business process Activity-based improvement reengineering costing a. no no yes b. yes no no c. yes yes yes d. no yes no 4. The sum of the non-value-added time and the value-added time equals a. inspection time. c. the product life cycle. b. production time. d. cycle time. 5. Which of the following add customer value? a. setup time b. storage time c. idle time

d. processing time

6. Lead time minus production time is equal to a. idle time. b. storage time c. non-value-added time. added time.

d.

value-

7. When a firm redesigns a product to reduce the number of component parts, the firm is a. increasing consumer value. b. increasing the value added to the product. c. decreasing product variety. d. decreasing non-value-added costs. 8. Non-value-added activities that are necessary to businesses, but not costs that customers are willing to pay for are known as a. business-value-added activities. c. short-term variable activities. b. long-term variable activities. d. superior business activities. 9. Which of the following would not be considered a value-added activity in the preparation of a tax return? a. printing a copy of the return for the client b. printing a copy of the return for the BIR c. installing tax software d. checking for accuracy

10. Which of the following is considered a value-added activity? Idle time Inspection time Transfer time a. yes yes no b. no no no c. yes no yes d. no yes yes 11. A process map a. should indicate only value-added activities. b. is also known as a detailed flowchart. c. should indicate only those steps/processes that are obvious in the production of goods/services. d. is also known as a value chart. 12. A value chart should include which of the following? Service time Inspection time Transfer time a. yes no yes b. no no yes c. yes yes no d. yes yes yes 13. The actual time it takes to perform a specific task is called a. inspection time. b. service time. c. transfer time 14. 15.

Manufacturing cycle efficiency is a measure of a. bottlenecks. b. effectiveness. c. efficiency.

d. quality time.

d. quality.

Which of the following is typically regarded as a cost driver in traditional accounting practices? a. number of purchase orders processed b. number of customers served c. number of transactions processed d. number of direct labor hours worked

16. When a company is labor-intensive, the cost driver that is probably least significant would be a. direct labor hours. c. machine hours. b. direct labor peso. d. cost of materials used. 17. An activity driver is used for which of the following reasons? To measure demands To measure resources consumed a. yes yes b. yes no c. no yes d. no no 18. The term cost driver refers to a. any activity that can be used to predict cost changes. b. the attempt to control expenditures at a reasonable level. c. the person who gathers and transfers cost data to the management accountant. d. any activity that causes costs to be incurred. 19. Cost allocation bases in activity-based costing should be a. cost drivers. c. activity centers. b. value-added activities. d. processes. 20. Costs that are common to many different activities within an organization are known as ____________ costs. a. product- or process-level c. batch-level b. organizational-level d. unit-level...