Backflush costing: Definition, benefits, and examples

What is backflush costing?

Backflush costing is a streamlined accounting approach designed primarily for manufacturing environments that implement Just-In-Time (JIT) production systems. Here, the recording of costs is delayed until after the goods are produced or sold. Thus, this method streamlines the accounting process. Traditional costing systems record costs at each production stage, but backflush costing takes a simplified approach.

Why is it Important?

1. Efficiency: It significantly reduces the administrative burden associated with tracking costs at each production stage.
2. Alignment with JIT Production: Backflush costing is particularly effective in JIT environments, where inventory is minimized and products are rapidly manufactured and sold.
3. Cost Management: It helps manage costs more effectively by focusing on the end product, aligning with lean manufacturing principles.

Advantages and Disadvantages of Backflush Costing?

Here’s why backflush costing is significant:

1. Simplified Accounting: Reduces the complexity of the accounting process in manufacturing.
2. Reduced Record-Keeping: Less detailed tracking of raw materials and work-in-progress reduces record-keeping work.
3. Focus on Production Efficiency: Encourages efficient production processes by aligning with JIT principles.

Despite its advantages, it has its limitations:

1. Inaccuracy in Complex Environments: It may not provide accurate cost data in complex manufacturing environments with multiple production stages and varying costs.
2. Potential for Overlooking Costs: There’s a risk of overlooking some costs, as it focuses on larger batches rather than individual units.
3. Not Suitable for All Companies: This method may not be suitable for companies that do not have a streamlined production process or those that require detailed cost tracking for each production stage.

How to compute Backflush Costing: An Example

To illustrate backflush costing, let’s consider a manufacturer or wholesaler scenario:

Imagine a company that manufactures LED lights. In a traditional costing system, costs would be tracked and recorded at each stage. For example, from acquiring raw materials (like diodes, circuits, housing) to the final assembly. However, with backflush costing, the costs are accumulated. They are recorded only at the point of completion or sale of the LED lights.

Here’s a simplified example:

1. Raw Materials and Production Costs: Let’s say the raw materials and production costs per unit are $10, and fixed overheads for the period are $5,000.
2. Production Volume: Assume 1,000 LED lights are produced.
3. Backflush Accounting: Instead of recording costs at each stage, the total cost is flushed back at the end of the production cycle.
   • Total production cost: 1,000 units x $10 = $10,000
   • Add fixed overheads: $10,000 + $5,000 = $15,000
4. Cost Per Unit: The total cost of $15,000 is then divided by the number of units produced, giving a cost of $15 per LED light.

Backflush costing simplifies the accounting process in this scenario by focusing on the costs associated with the completed products. This aligns closely with the efficiency goals of modern manufacturing practices. It’s particularly beneficial for wholesalers or manufacturers with streamlined production processes and minimal inventory holding.

Further reading

• Accounting Glossary
• Supply Chain – definition, elements, stages, types, models 
• Understanding Retail Inventory Method: Pros and Cons