CHAPTER 20

INVENTORY MANAGEMENT, JUST-IN-TIME, AND

BACKFLUSH COSTING
LEARNING OBJECTIVES
1.

Identify five categories of costs associated with goods for sale

2.

Balance ordering costs with carrying costs using the economic-order-quantity (EOQ) decision model

3.

Identify and reduce conflicts that can arise between EOQ decision model and models used for
performance evaluation

4.

Use a supply-chain approach to inventory management

5.

Differentiate materials requirements planning (MRP) systems from just-in-time (JIT) systems for
manufacturing

6.

Identify the features of a just-in-time production system

7.

Use backflush costing

8.

Describe different ways backflush costing can simplify traditional job-costing systems

CHAPTER OVERVIEW
Chapter 20 looks at a specific aspect of accounting for productsthat of inventory. Both the accounting
for products from the perspective of the retailer as well as that of the manufacturer are examined.
Resources represented by inventory account for the largest cost in many retail companies. Managers
understand the effect they have upon profitability. Management accountants provide necessary
information for the managing of inventory. Basic types of information are described within the chapter:
types of costs associated with inventory, key decisions about managing goods, challenges in estimating
costs and their effects, and manufacturing systems to better manage inventory. The two key questions for
a retailer for managing inventory are those of how much to order and when to order. These same
questions are crucial for a manufacturer but are placed in terms of the supply chain with the manufacturer
dependent upon that retailer, causing some differences in how to manage under conditions of uncertainty.
The chapter provides a look at the accounting system for manufacturing products using a just-in-time
(JIT) processing system. The manufacturing system is described and the accounting for such a system is
detailed using the concept of backflush costing. This study provides another example of how the
accounting system describes the underlying operations for the manufacturing of a product. The just-intime system is compared to the system of materials requirements planning (MRP), a push-through
systems as opposed to the demand-pull system of JIT. A section on Enterprise Resource Planning has
been added. These systems are examined by their effect(s) on inventories managed by a company.

CHAPTER OUTLINE
I.

Inventory management

A. Inventory management: an important part of profit planning for manufacturing and

merchandising companies
B. Materials costs often account for more than 40% of total costs in manufacturing companies and
more than 70% of total costs in retail companies
II. Inventory management in retail organizations
A. Inventory management: the planning, coordinating, and control activities related to the flow of
inventory into, through, and from an organization
1. Costs of goods sold is largest single cost item for some retailers
2. Better decisions regarding the purchasing and managing of goods for sale can cause large
percentage increases in net income when net income is small percentage of revenues
B. Costs associated with goods for sale
Learning Objective 1:
Identify five categories of costs associated with goods for sale
1. Purchasing costs: costs of goods acquired from suppliers including incoming freight or
transportation costs
a. Usually largest cost category of goods for sale
b. Affected by discounts for different purchase-order sizes and supplier credit terms
2. Ordering costs: include costs of preparing purchase orders and receiving goods
3. Carrying costs: costs of holding inventory of goods for sale
a. Include opportunity cost of investment tied up in inventory
b. Include costs associated with storage (space rental, insurance, obsolescence, spoilage)
4. Stockout costs: costs arising when a customer demands a unit of product and that unit is not
on hand
a. Costs of expediting order from supplier
b. Costs (opportunity costs) of lost contribution margin and customer ill-will
5. Quality costs: costs of product or service not in conformance with a preannounced or
prespecified standard
6. Advances in information-gathering technology increasing reliability and timeliness
a. Increasing reliability and timeliness of inventory information

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270

b. Reducing costs in the five cost categories

Do multiple choice 1.

Assignment after L. O. 2.

C. Major decisions in managing goods for sale

Learning Objective 2:
Balance ordering costs with carrying costs using the economic-order-quantity (EOQ) decision model
1. How much to order of a given product
a. Economic order quantity (EOQ): decision model that calculates optimal quantity of
inventory to order under a set of assumptions (balancing ordering and carrying costs)
i.

Same quantity ordered at each reorder point

ii. Demand, ordering costs, and carrying costs known with certainty as is purchase-order
lead time: time between placing an order and its delivery
iii. Purchasing costs unaffected by quantity ordered
iv. No stockout occurs
v. Quality costs only considered to extent they affect ordering or carrying costs

b. EOQ formula:
i.

EOQ

2DP
C

D = demand in units for a specified time period

ii. P = relevant ordering costs per purchase order

iii. C = relevant carrying costs of one unit stock for the time period used for D
iv. EOQ increases with demand and ordering costs/decreases with carrying costs
c. Annual relevant total costs (RTC) for any order quantity formula
i.
ii.

RTC

D
Q

x P

Q
2

x C

DP
Q

QC
2

[Exhibit 20-1]

Annual relevant costs at minimum amount where relevant ordering costs and relevant
carrying costs are equal (EOQ)

2. When to order, assuming certainty

a. Reorder point

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271

i.

Definition: quantity level of the inventory on hand that triggers a new order

ii. Formula: Reorder point = Number of units sold per unit of time x Purchase-order lead
time [Exhibit 20-2]
b. Safety stock [Exhibit 20-3]
i.

Definition: Inventory held at all times regardless of the quantity of inventory ordered
using the EOQ model

ii. Used as a buffer against unexpected increases in demand, uncertainty about lead time and
unavailability of stock from suppliers
iii. Computed using demand forecastsusually based on experience
iv. Computed to minimize sum of annual relevant stockout costs and carrying costs
III. Estimating inventory-related costs and their effects
A. Considerations in obtaining estimates of relevant costs
1. Obtaining accurate estimates of the EOQ cost parameters
a. Relevant incremental costs
i.

Cost behavior in relation to changes in quantity of inventory held

ii. Alternative uses of cost factors, such as space and people

b. Relevant opportunity costs of capital (key input in EOQ decision model)
i.

Choice not taken provides basis of opportunity costs

ii. Lost contribution margin for missed opportunity

2. Cost of prediction error: when actual relevant costs differ from the estimated relevant cost for
decision making
a. Three-step approach to calculation of cost of prediction error
i.

Step 1: Compute the monetary outcome from the best action that could be taken, given
the actual amount of the cost input

ii. Step 2: Compute the monetary outcome from the best action based on the incorrect
amount of the predicted cost input
iii. Step 3: Compute the difference between the monetary outcomes from steps 1 and 2
b. Square root in EOQ model reduces sensitivity of the ordering decision to errors in
predicting its parameters

272 Chapter 20

Learning Objective 3:
Identify and reduce conflicts that can arise between EOQ decision model and models used for
performance evaluation
B. Evaluation of managers and goal congruence issues
1. Opportunity cost of investment tied up in inventory a key input in EOQ decision model
2. No opportunity costs recorded in financial accounting system so inconsistency in decision
model of EOQ and performance evaluation model using financial accounting numbers
3. Can include opportunity costs when evaluating managers, so EOQ decision model consistent
with performance evaluation model
Do multiple choice 2 6.

Assign Exercises 20-16, 17, 18, 19, 20, and Problems 20-26, 27, 28.

IV. Just-in-time purchasing

A. Definition: purchase of goods or materials so that delivered just as needed for production
B. JIT purchasing and EOQ model parameters
1. EOQ cost parametercarrying cost
a. Cost of carrying inventory considered by some to be underestimated in the past
b. Opportunity costs of investment tied up in inventory to be considered
2. EOQ cost parameterplacing a purchase order
a. Reduction in cost due to long-run purchasing arrangements defining price and quality
terms over an extended period
b. Reduction in cost due to using electronic links to place purchase orders
c. Reduction in cost due to use of purchase order cards that do not require traditional laborintensive procurement approval mechanisms
3. EOQcombination of relevant carrying costs increasing and relevant ordering costs per
purchase order decreasing [Exhibit 20-4]
a. Smaller EOQ amounts (size of order)
b. More frequent orders
C. Relevant benefits and relevant costs of JIT purchasing
1. Compared to EOQ model

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273

a. EOQ model designed to only emphasize trade-off between carrying costs and ordering
costs
b. Inventory management includes purchasing costs, stockout costs, and quality costs
2. Illustrated by comparison of traditional policy with JIT purchasing [Exhibit 20-5]
D. Supplier evaluation and relevant costs of quality and timely deliveries
1. Timely delivery of quality product crucial to JIT purchasing
2. Selection and development of long-run supplier partnerships
3. Consideration of relevant costs of quality and also the relevant costs of failing to deliver on
time
4. Sales of high-quality merchandise has nonfinancial and qualitative benefits
5. Illustration to compare suppliers: issues and concerns [Exhibit 20-6]
Assign Exercises 20-21 and 20-22 and Problems 20-29 and 20-30.
IV. Inventory management and supply-chain analysis [Surveys of Company Practice]
Learning Objective 4:
Use a supply-chain approach to inventory management
A. Level of inventories held by retailers influenced by demand patterns of customers and supply
relationships with distributors, manufacturers, and suppliers to suppliers and so on
1. Flow of goods, services, and information from initial sources of materials and services to
delivery of products to consumerssupply chain [Chapter 1, Enhancing the Value of
Management Accounting Systems, Exhibit 1-5]
2. Variability of demand quantities throughout supply chain called bullwhip effect or
whiplash effect and, consequently, higher levels of inventory held at all stages in supply
chain
3. Supply chain approach allows companies to coordinate their activities and reduce inventories
through the supply chainsome companies have supplier or vendor-managed inventory
B. Inventory management and manufacturing companies
Assign Problems 20-31 and 20-32.

Learning Objective 5:
Differentiate materials requirements planning (MRP) systems from just-in-time (JIT) systems for
manufacturing

274 Chapter 20

1. Materials requirement planning (MRP)

a. Definition: a push-through system that manufactures finished goods for inventory on
the basis of demand forecasts
i.

Inputs for MRP

Master production scheduledemand forecasts for final products taking into

account specifics of quantity and timing of each item to be produced

Bill of materialsdetailing of materials, components, and subassemblies for

each final product

Inventory recordsquantities of materials, components, and product inventories

to determine the necessary outputs at each stage of production

ii. Output of each department pushed through the production line whether it is needed or not
iii. Result of push-through approach may be accumulation of inventory at workstations not
yet ready to process next group
b. Challenge in MRP system is inventory management
i.

Management accountant aids in MRP by maintaining accurate records of inventory and

its costs

ii. Management accountant also helps in estimates of setup cost for production lines

Costs of setting up a production run analogous to ordering costs in EOQ model

Costs of setting up matched with size of batches to balance costs of setups with
costs of carrying inventory (large costs, large batch sizes or small costs, small
batch sizes)

Costs of downtime matched with running time of production line (high downtime
costs, continuous production)

2. Just-in-time (JIT) production (also called lean manufacturing production)

a. Definition: a demand-pull manufacturing system because each component in a
production line is produced as soon as and only when needed by the next step in the
production line
i.

Demand triggers each step of the production process, starting with customer demand for
finished product at the end of process and working all way back to demand for direct
materials at beginning of process
ii. Demand-pull feature achieves close coordination among workstations in the process

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275

iii. Aims to simultaneously achieve three effects

Meet customer demand in a timely way,

With high quality products, and

At the lowest possible total cost.

Learning Objective 6:
Identify the features of a just-in-time production system
b. Five main features in JIT production system [Concepts in Action]
i.

Organizing production in manufacturing cells: grouping of all different types of

equipment used to make a product

ii.

Hiring and training multi-skilled workers

iii.

Emphasizing total quality management

iv.

Reducing manufacturing lead time and setup time

v.

Building strong supplier relationships

c. Enterprise resource planning (ERP) systems

i.

Comprises a single database that collects and feeds data into applications supporting
all of a companys business activities

ii.

Responds to changes in supply and demand because operating information

accessible within the company and across the supply chain

iii.

Available as standard software packages that can be customizedwithout

customization strategic advantage may not be available

d. Financial benefits of JIT and relevant costs

i.

Lower carrying costs of inventory due to lower inventories

ii. Greater transparency of production process

iii. Heightened emphasis on eliminating specific causes of rework, scrap, and waste
iv. Lower manufacturing lead time
e. Performance measures and control in JIT production
i.

276 Chapter 20

Personal observation timely, intuitive, and easy to understand measure of plant

performance

ii. Financial performance measures

iii. Nonfinancial performance measures of time, inventory, and quality
iv.

Feedback that is rapid and meaningful necessary to detect and solve problems
quickly due to lack of buffer from inventories

Do multiple choice 7.
f.

JITs effect on costing systems

i.

Reduces overhead costs

ii. Facilitates direct tracing of some costs usually classified as indirect

C. Backflush costing: job costing system that dovetails with JIT production
Learning Objective 7:
Use backflush costing
1. Backflush costing: costing system that omits recording some or all of the journal entries
relating to the cycle from purchase of direct materials to the sale of finished goods
a. Absence of inventories makes unimportant choices about cost-flow assumptions or
inventory costing methods important
b. Rapid conversion of direct materials into finished goods that are immediately sold
simplifies job costing; JIT production leads to large reduction in work in process
Learning Objective 8:
Describe different ways backflush costing can simplify traditional job-costing systems
2. Simplified normal or standard job costing
a. Traditional systems use sequential tracking to track costs sequentially as products pass
through four stages in a cycle going from purchase of direct materials to sale of finished
goods
i.

Stage A: Purchase of direct materials

ii. Stage B: Production resulting in work in process

iii. Stage C: Completion of a good finished unit of product
iv. Stage D: Sale of a finished good
b. Trigger point: refers to a stage in the cycle going from purchase of direct material (Stage
A) to sale of finished goods (Stage D) at which journal entries are made in the accounting
system

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3. Examples to illustrate backflush costing

a. Assumptions of no direct materials variances and no work in process
b. Examples differ in number and placement of trigger points
c. Three examples from text
i.

Example 1 with three trigger points [Exhibits 20-7 and 8, Panel A]

Stage A: Purchase of direct materials (raw materials)

Stage C: Completion of good finished units of product

Stage D: Sale of finished goods

ii. Example 2 with two trigger points [Exhibits 20-7 and 8, Panel B]

Stage A: Purchase of direct materials (raw materials){only inventory account}

Stage D: Sale of finished goods

iii. Example 3 with two trigger points [Exhibits 20-7 and 8, Panel C]

Stage C: Completion of goods finished units of product

Stage D: Sale of finished goods

4. Examples to illustrate backflush costing: comparison to sequential tracking

a. Example 1: Costs reported similarly to sequential tracking when WIP minimal
i.

Two inventory accounts: (1) Materials and In-Process and (2) Finished Goods

ii. Actual conversion costs recorded in Conversion Costs (allocated to products at trigger
points)
iii. Steps to assign costs to units sold and to inventories

278 Chapter 20

Step 1: Record the direct materials purchased during the accounting period

Step 2: Record conversion costs incurred 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 good finished goods completed during the accounting
period

 Namebackflush costingcomes from this step

Costs not recorded sequentially with flow of product through production
Output trigger point reaches back and pulls standard costs into entry

Step 6: Record the cost of goods sold during the accounting period

Step 7: Record underallocated or overallocated conversion costs

iv. Accounting for variancesbasically same under all standard costing systems
b. Example 2: Costs reported similarly to sequential tracking when WIP and finished goods
minimal
i.

One inventory account: Inventorycombines direct materials and any direct materials in
WIP and finished goods
ii. Conversion costs treated as period costs, not inventoried
iii. Accounting justified for two reasons

To remove incentive for managers to produce for inventory

To increase focus of managers on selling units

c. Example 3: Costs reported similarly to sequential tracking when direct materials and
WIP minimal
i.

Could be used with only one trigger pointStage D: Sale of finished goods

ii. Could be used with only one trigger pointStage D: Sale of finished goods
maintains no inventory accounts so used with JIT system with minimal inventories
5. Special consideration of backflush costing
a. Accounting procedures illustrated in Examples 1, 2, and 3 do not strictly adhere to
generally accepted accounting principles (use constraint of materiality)
b. Adjusting entries used to account for material amounts in inventory, if needed
c. Adopting of backflush costing not limited to JIT production methods
d. Absence of audit trails focus of criticism
e. Compatible with activity-based costing
i.

Simplifying production process makes more of the costs direct and reduces extent of
overhead cost allocations

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279

ii. Using ABC systems gives more accurate budgeted conversion costs per unit for different
products in backflush costing
Do multiple choice 8 10.

Assign Exercise 20-23, 24, 25, and Problems 20-33, 34, 35, and 36.

CHAPTER QUIZ SOLUTIONS: 1.b

280 Chapter 20

2.d 3.b 4.a 5b. 6.a 7.b 8.d 9.d 10.c

CHAPTER QUIZ
1. Which of the following categories of costs are important when managing inventories of goods for sale
according to the authors of the text?
a.
b.
c.
d.

purchasing, ordering, supply, spoilage, and opportunity

purchasing, stockout, carrying, ordering, and quality
buying, holding, invoicing, opportunity, and investment
supply, obsolescence, holding, stockout, and transportation-in

The following data apply to questions 2-6.

Liberty Celebrations, Inc., manufactures a line of flags. The annual demand for its flag display is
estimated to be 100,000 units. The annual cost of carrying one unit in inventory is $1.60, and the cost to
initiate a production run is $50. There are no flag displays on hand but Liberty had scheduled 60 equal
production runs of the display sets for the coming year, the first of which is to be run immediately.
Liberty Celebrations has 250 business days per year. Assume that sales occur uniformly throughout the
year and that production is instantaneous.
2. [CMA Adapted} If Liberty Celebrations does not maintain a safety stock, the estimated total carrying
cost for the flag displays for the coming year is
a. $2,667.

b. $2,000.

c. $1,600.

d. $1,333.

3. [CMA Adapted] The estimated total setup cost for the flag displays for the coming year is
a. $2,000.

b. $3,000.

c. $8,000.

d. $12,500.

4. [CMA Adapted] If Liberty Celebrations were to schedule 30 equal production runs of the flag display
for the coming year, instead of 60 equal runs, the sum of carrying costs and setup costs for the coming
year would increase (decrease) by
a. $(166).

b. $-0-.

c. $166.

d. $1,500.

5. [CMA Adapted] The number of production runs per year of the flag displays that would minimize the
sum of carrying costs and setup costs for the coming year is
a. 50.

b. 40.

c. 30.

d. 20.

6. [CMA Adapted] A safety stock of a 3-day supply of flag displays would increase Liberty
Celebrations planned average inventory in units by
a. 1,200.

b. 800.

c. 400.

d. zero.

7. Which of the following is not a major feature of a just-in-time production system?

a.
b.
c.
d.

Workers are trained to be multi-skilled.

Emphasis is placed on increasing setup time and manufacturing lead time.
Production is organized in manufacturing cells.
Total quality management is aggressively pursued.

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281

The following data apply to questions 810.

Sit-On-It began operations in January 2002. Sit-On-It manufactures vehicular seat covers using a just-intime production system supported by a backflush costing system. This system has two trigger points: (1)
the purchase of raw materials, and (2) the sale of finished good units. Standard unit costs are $40 for raw
materials and $25 for conversion costs. Sit-On-It writes off any under- or overallocated conversion costs
immediately. The following data were available for January 2002:
Production in good units
Sales of good units
Purchases of raw materials [20,000 units at $40]
Conversion costs incurred

19,800
19,750
$800,000
$496,000

8. The journal entry to record the manufacture of finished good units is

a. Finished Goods Control
Inventory: Raw and In-Process Control
Conversion Costs Allocated

1,287,000

b. Finished Goods Control

Conversion Cost Variance
Inventory: Raw and In-Process Control
Conversion Costs Control

1,287,000
1,000

c. Inventory: Raw and In-Process Control

Conversion Costs Allocated
Conversion Cost Variance
Various assets and liabilities

792,000
495,000

792,000
496,000
800,000
495,000
1,000
1,296,000

d. No entry.
9. The January ending total for all inventory balances is
a. $16,250.

b. $12,250.

c. $11,250.

d. $10,000.

c. $1,286,000.

d. $1,296,000.

10. The January cost of goods sold is

a. $1,283,750.

282 Chapter 20

b. $1,284,750.

WRITING/DISCUSSION EXERCISES
1.

Identify five categories of costs associated with goods for sale

Compare costs included for Cost of Goods Sold in financial accounting with costs
associated with goods for sale in the chapter. In financial accounting, costs included in the
Cost of Goods Sold section of a multiple-step income statement would be the purchase costs as
described in this chapter. The other four categories of ordering costs, carrying costs, stockout costs, and
quality costs would not be found within the Cost of Goods Sold category for financial accounting.
Ordering and carrying costs would be included in operating expense. Stockout costs of expediting might
be chargeable to the customer or absorbed in operating costs. Lost contribution margins are an
opportunity cost and not included in the normal accounting system. Quality costs could be added to
purchase costs in some instances or be part of operating costs.
2.

Balance ordering costs with carrying costs using the economic-order-quantity (EOQ) decision
model

Using an exercise or illustration from the text, show the costs of carrying and ordering
for different order quantities to highlight how EOQ balances those costs.
Using the Self-Study Problem at the end of the chapter, the following could be shown:
Number of Deliveries
Carrying costs [(5200 # of Del.)/2] x $5.00
Ordering costs
# of Del. x $250
Sum of costs
EOQ

7.2

$2,166

$1,857

$1,800

$1,787

$1,590

$1,500
$3,666

$1.750
$3,607

$1,800
$3,600
*

$2,000
$3,787

$2,250
$3,840

As noted in the text problem, the number of deliveries would be eight because deliveries have to be made
in total, not in part. The company would use eight deliveries rather than seven deliveries in consideration
of stockouts.
3.

Identify and reduce conflicts that can arise between EOQ decision model and models used for
performance evaluation

Why arent opportunity costs included in the accounting system? One of the key
management accounting guidelines in Chapter 1 was different costs for different purposes. The
characteristics that define and govern financial accounting lead to accounting for what was. Management
accounting includes financial accounting though it extends beyond that particular arena to provide
relevant information for making decisions, both of a financial and a nonfinancial nature. The accounting
system would not include accounting for what might have been. Management accountants would
include such opportunity costs in reports to managers for making decisions in which those costs were
relevant.

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4. Use a supply-chain approach to inventory management

Isnt it risky to share so much information with a supplier (in using the supply-chain
approach to inventory management)? A business faces the tension of sharing too much
information, becoming vulnerable to competitors, and of not sharing enough information, driving up costs
and risking the loss of customers. By using the guideline of cost-benefit, managers may make decisions
as to the potential costs in a given situation against the possible benefits in deciding what information to
share and how much. In the situation of inventory management and supply-chain analysis, the benefit of
reducing the level of uncertainty and the level of inventory may outweigh the cost of information that
may be revealed to a competitor about costs and operations.
4. Differentiate materials requirements planning (MRP) systems from just-in-time (JIT) systems
for manufacturing

Can a company adopt a just-in-time system for inventory management and have a
materials requirements planning approach to operations? Does the inventory
management system become a broad management tool also? Materials requirements
planning and just-in-time were originally considered for managing inventory. Because inventory is an
integral part of the manufacturing system, these approaches expanded to company-wide planning and
control activities. Inventory management requires the answers to the key questionshow much
(quantity) and when (timing). MRP is one side of the cointhe need to do good planningand JIT is the
other side of the same cointhe need to do good execution. A company has to understand which system
is most appropriate to their use. Hybrid systems can be developed using aspects of each of the two, MRP
or JIT.
5. Identify the features of a just-in-time production system

In this chapter, just-in-time was used to describe purchasing, an approach to inventory

management, and a production system. In previous chapters, activity-based was the
term used to describe various company activities, such as costing, budgeting, and
management. When looking at the major features of either of these ways of planning
and control, what should guide top management in deciding to implement a new
approach to managing some aspect or all of the organization? As noted in the text, tone at
the top is critical to the success of plans and activities undertaken within the organization. Support must
come from top management who can allocate the necessary resources and establish policies as to rewards
and incentives. A helpful guideline for top management in investigating a different approach is that of
cost-benefit. The cost of implementing a new system must be exceeded by the benefit it would generate
for the organization. In some instances, wiser use of the current system would generate far more benefit
for little cost.

284 Chapter 20

6. Use backflush costing

Discuss the use of the term backflush to describe this costing system.
As noted in Step 5 for assigning costs to units completed (Example 1 illustrating backflush costing in the
chapter), the output trigger point reaches back and pulls the standard costs of direct materials from
Inventory: Raw and In-process and the standard conversion costs for manufacturing the finished goods.
Journal entries would have been made for conversion costs actually incurred. (Dr. Conversion Costs
Control; Cr. Various accounts) The completion point is the first point in the accounting system to
recognize conversion costs as part of the cost of the producta delayed costing. The delay occurs in
recording changes to the status of a product being produced until good finished units appear. When the
good finished units appear, budgeted or standard costs are used to work backward to flush out
manufacturing costs for the units produced. The credit to Conversion Costs Allocated in the entry at
completion reflects the use of budgeted or standard costs. Comparing the Conversion Costs Allocated
account to the Conversion Costs Control account determines the variance.
Entries may have been made when direct materials were purchased if that was a trigger point. If the
purchase of direct materials was not a trigger point, an entry would not have been made for their purchase
(Example 3 with the one trigger point is such a case.). This accounting is appropriate when the lag time
between the receipt of the direct materials and the output of the completed unit is very short. The
accounting for purchases of direct materials is not suspended under backflush, but is abbreviated to reflect
the change in the production process. Similarly, the lack of journalization for work in process is not
omission but recognition that inventories are almost nonexistent.
8.

Describe different ways backflush costing can simplify traditional job-costing systems

How can backflush costing account for the conversion of a raw material into a finished
product when only one journal entry is made in the costing system?
Significant changes to the production process, such as adoption of just-in-time, should signal possible
changes to the accounting system that tells the story of that process. Backflush costing developed in
response to streamlined production processes. Companies wanted a simple accounting system rather than
detailed tracking of direct costs through each step of the production process. With changes to the
production process that virtually eliminated inventories, managers did not want to spend resources
tracking costs through the accounts Work in Process, Finished Goods, and Cost of Goods Sold. Also,
backflush costing and sequential tracking produce approximately the same results when inventory is
present, provided inventories maintain stable values. Managers wanted to eliminate nonvalue-added
activities from the cost accounting systems and sequential tracking was nonvalue-added accounting
activity. Generally accepted accounting principles do not require companies track work in process when
the amounts involved are immaterial.
Backflush costing does require that each product have a set of budgeted or standard costs in order to be
used.

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285

SUGGESTED READINGS
Alles, M., Datar, S. and Lambert, R., Moral Hazard and Management Control in Just-in-Time Settings,
Journal of Accounting Research (Vol. 33 Supplement 1995) p.177 [28p].
Balakrishnan, R., Linsmeier, T. and Venkatchalam, M., Financial Benefits from JIT Adoption: Effects of
Customer Concentration and Cost Structure, Accounting Review (April 1996) p.183 [23p].
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