Backflush Costing PDF

Preview

Summary

Costing is the back...

Description

Module in Backflush Costing

Backflush Costing

Backflush costing or backflushing is a shortcut approach to accounting for the flow of manufacturing operations. Backflush costing refers to a variety of simplified cost accumulation methods that tend to be used by companies that adopt JIT systems. Most cost systems that include the backflush method are periodic inventory systems because perpetual inventory records are eliminated. Four Main Ways to Account for Manufacturing Costs at the End of the Period 1. Capitalize all manufacturing costs in the inventory as in full absorption costing. The applicable cost of direct materials, direct labor, variable overhead and fixed overhead are deferred in the ending inventory. 2. Capitalize only variable manufacturing costs in the inventory as in direct costing. Only the applicable direct materials, direct labor and variable overhead are deferred in ending inventory while fixed manufacturing costs are charged to expense. 3. Capitalize only direct materials costs in inventory as in throughput costing. Only the applicable direct materials costs are deferred in the ending inventory while all conversion costs are charged to expense. 4. Expense all manufacturing costs. No manufacturing costs are deferred in the inventory. This is the opposite of full absorption costing.

For EVSU Accountancy Students Use Only

Page

In backflush systems, the usual inventory accounts are replaced with a simplified set of accounts. Typically, the Materials and Work in Process accounts are combined into an account referred to as Raw and in Process Inventory (RIPI) account. The payroll and overhead accounts are replaced by a single account for Conversion Costs (other books use the Cost of Goods Sold account for the cost of conversion). The other accounts in the system include the familiar Finished Goods and Cost of Goods Sold accounts.

1

Backflush costing omits recording some or all of the journal entries relating to the stages from the purchase of direct materials to the sale of finished goods. Since some stages are omitted, the journal entries for a subsequent stage use normal or standard costs to work backward to “flush out” the costs in the cycle for which journal entries were not made.

Module in Backflush Costing

During an accounting period, the purchases of direct materials, along with direct labor and overhead costs are charged to the cost of goods sold account as incurred. The usual entries are omitted including the entries to transfer the cost of goods manufactured from one department to the next and ultimately to finished goods. The perpetual records are not maintained. Instead, materials and conversion costs are charged directly to Cost of Goods Sold. Then, at the end of the period, the remaining finished and partially completed units are counted and inventory costs are charged in a backward direction from Cost of Goods Sold to Finished Goods, RIPI and Conversion Cost accounts.

Essential Concepts in Backflush Costing Backflush costing is a streamlined cost accounting method that speeds up, simplifies, and minimizes accounting effort in an environment that minimizes inventory balances, requires few allocations, uses standard costs, and has a minimal variance from standard.

•

Backflush costing is used in companies with little or no inventory balances. Products are typically produced only after an order has been placed.

•

Often used by companies that has adopted a just-in-time (JIT) system regarding inventory control.

•

Backflush costing compliments JIT because it simplifies the costing of products. A traditional costing system tracks cost as they are incurred, but backflush costing delays recording of some cost information. It treats the detailed recording of inventory data as a non-value-added activity.

•

In backflush costing, the product costs are flushed out of the accounting system and are attached to the products only after they are completed.

•

Backflush costing is a costing system that focuses on output and works backward through the system to allocate costs to cost of goods sold and inventory.

•

It is designed to simplify accounting and save recordkeeping time and expense.

•

Its purpose is to reduce the number of events that are measured and recorded in the accounting system. Page

2

•

For EVSU Accountancy Students Use Only

Module in Backflush Costing

•

The main advantage to backflush costing is simplicity. A disadvantage is the inability of the accounting system to pinpoint the uses of resources at each step of the production process.

•

Backflushing is an instance of accountants reducing non-value-adding costs by reducing recordkeeping. Much of the analysis and work that management accountants have performed in recordkeeping has to do with reducing the volume of transactions by eliminating recording that is non-value-adding, while preserving information needed for managing operations.

Features of Backflush Costing •

Work in process is usually eliminated. In JIT system, there may be no separate materials inventory. Instead, materials received are put immediately into production, so materials and work in process are combined in single account RIPI.

•

Direct labor and factory overhead are expensed at the cost of goods sold account. The estimated conversion cost components of the RIPI to FGI account balances are adjusted at the end of each month with offsetting entry made to the COGS account.

•

Raw materials cost is backflushed from RIPI to FGI and from FGI to COGS based on the monthly physical counts.

•

Journal entries to inventory accounts may be delayed until the time of product completion.

•

Standard costs are used to assign costs to units when journal entries are made, i.e., to flush costs backward to the point at which inventories remain.

Backflush Costing vs Traditional Costing Traditional normal costing system uses sequential tracking, which is a costing system in which recording of the journal entries occurs in the same order as actual purchases and progress in production. Costs are tracked sequentially as products pass through each of the following four stages: Stage C

Production Resulting in Work in Process

Completion of Production of Goods

For EVSU Accountancy Students Use Only

Stage D Sale of Finished Goods

3

Purchase of Direct Materials

Stage B

Page

Stage A

Module in Backflush Costing

A sequential tracking costing system has four trigger points, corresponding to stages A, B, C, and D. Trigger point refers to a stage in the cycle from the purchase of direct materials (Stage A) to sale of finished goods (Stage D) at which journal entries are made in the accounting system. Backflush costing is a costing system that omits recording some of the journal entries relating to stages from Stage A to Stage D. When journal entries for one or more stages are omitted, the journal entry for a subsequent stage use normal costs to work backward to “flush out” the costs in the cycle for which journal entries are not made. When inventories are minimal, backflush costing simplifies the costing system without losing much information as a result of simplification. The following examples illustrate backflush costing. They differ in the number and placement of trigger points:

Example 1

Number of Journal Entry Trigger Points 3

Example 2

2

Example 3

2

Location in Cycle when Journal Entries are Made Stage A: Purchase of direct materials Stage C: Completion of production of goods Stage D: Sale of finished goods Stage A: Purchase of direct materials Stage D: Sale of finished goods Stage C: Completion of production of goods Stage D: Sale of finished goods

In all three examples, there are no journal entries in the accounting system for work in process (Stage B) because JIT production results in minimal work in process.

Page

4

Hence, backflush costing differs from traditional costing with regard to the accounts used and the timing of the cost recording. Specifically, three major differences exist. First, instead of using separate accounts for RMI and WIPI, backflush costing combines these into RIPI account. The rationale is that the amount of work in process at any particular time will be low. Second difference is that since direct labor is usually a minor cost item in a JIT setting, no separate account for DL in backflush costing is created. Rather, DL is directly charged to COGS account. The third difference relates to the application of OH. In backflush costing, OH is not applied to products until they are completed.

For EVSU Accountancy Students Use Only

Module in Backflush Costing

Common Journal Entries 1. To record purchase of RM from suppliers: Raw and in Process Inventory (RIPI) AP/Cash

xxx xxx

2. To record use of indirect materials: FOH Control Supplies

xxx xxx

3. To record other FOH costs: FOH Control Various accounts

xxx xxx

4. To record incurrence of DL and IL: COGS FOH Control SWP/ Accrued Payroll

xxx xxx xxx

5. To expense OH to COGS: COGS

xxx FOH Control

xxx

6. To backflush RM cost from RIPI to FGI: FGI

xxx RIPI

xxx xxx (xxx) xxx Page

5

Material in RIPI beginning balance Material received from supplier Material in RIPI ending balance Amount to be backflushed from RIPI to FGI

xxx

For EVSU Accountancy Students Use Only

Module in Backflush Costing

7. To backflush material cost from FGI to COGS: COGS

xxx FGI

xxx

Material in FGI beginning balance Material backflushed from RIPI Material in FGI ending balance Amount to be backflushed from FGI to COGS

xxx xxx (xxx) xxx

8. Establish ending balances in inventory accounts by adjusting the conversion costs components. • • •

Actual conversion costs may be underallocated or overallocated in an accounting period. If a conversion cost component had decreased during the month, an inventory account would be credited. If a conversion cost component had increased during the month, an inventory account would be debited.

Demonstration Problem: The following example shows one way to record events using a backflush costing system. Beginning inventories Materials and components purchased and put into process Labor and overhead costs incurred Units completed Units sold

None P250,000 180,000 40,000 35,000

Because materials are put into process almost immediately after being received, backflushing factories do not need two separate accounts for materials and work in process. They might record material purchases in the following manner: 250,000 AP or Cash

Page

Conversion costs are collected in a single account as follows:

250,000

6

RIPI

For EVSU Accountancy Students Use Only

Module in Backflush Costing

COGS

180,000 Various accounts

180,000

At the end of the period, the company records the cost of ending inventory of finished units and the cost of units sold. FGI

250,000 RIPI

COGS

250,000 218,750

FGI

218,750

An adjusting entry for conversion cost component of FGI will also be prepared to establish the correct ending balance of FGI. FGI

22,500 22,500

Page

7

COGS

For EVSU Accountancy Students Use Only

Module in Backflush Costing

PROBLEMS Problem 1 ABC Company uses a raw and in process (RIP) inventory account and expenses all conversion costs to the cost of goods sold account. At the end of each month, all inventories are counted, their conversion cost components are estimated, and inventory account balances are adjusted accordingly. Raw material cost is backflushed from RIP to finished goods. The following information is for the month of June: Beginning balance of RIP account, including P1,400 of conversion cost Raw materials received on credit Ending RIP inventory per physical count, including P1,800 conversion cost estimate

P31,000 367,000 33,000

Required: Compute the amount to be backflushed from RIP to Finished Goods.

Problem 2 XYZ Company produces only for customer order and most work is shipped within thirtysix hours of the receipt of an order. XYZ uses a raw and in process (RIP) inventory account and expenses all conversion costs to the cost of goods sold account. Work is shipped immediately upon completion, so there is no finished goods account. At the end of each month, inventory is counted, its conversion cost component is estimated, and the RIP account balance is adjusted accordingly. Raw material cost is backflushed from RIP to Cost of Goods Sold. The following information is for the month of August:

P12,300 246,000 12,100

Page

Required: a. Compute the amount to be backflushed from RIP to Cost of Goods Sold. b. Compute the amount of Cost of Goods Sold after all transactions and adjustments were made.

8

Beginning balance of RIP account, including P1,300 of conversion cost Raw materials received on credit Ending RIP inventory per physical count, including P2,100 conversion cost estimate

For EVSU Accountancy Students Use Only

Module in Backflush Costing

Problem 3 The following transactions for March were provided for ABE Company which uses a JIT costing system: a. Raw materials were purchased, P97,000. b. All materials purchased were requisitioned for production. c. Direct labor costs of P77,000 were incurred. d. Actual factory overhead costs amounted to P225,000. e. Applied conversion costs totaled P300,000. This included P77,000 of direct labor. f. All units were completed. Required: a. Compute the March 31 balance in the conversion cost. b. Compute the March 31 balance in the Finished Goods account.

Problem 4

JCO Industries, which uses JIT system, has the following transactions for August: a. Raw materials were purchased at the cost of P950,000. b. All materials purchased were requisitioned for production. c. Direct labor costs of P2,500,000 were incurred. d. Actual factory overhead costs amounted to P6,000,000. e. Applied conversion costs totaled P8,100,000. This included P2,500,000 of direct labor. f. All units were completed.

Page

9

Required: a. Compute the amount to be backflushed from RIP to Finished Goods. b. Compute the amount of Finished Goods after all transactions have been completed.

For EVSU Accountancy Students Use Only...