Backflush accounting is a subset of management accounting focused on types of "postproduction issuing;" It is a product costing approach, used in a Just-In-Time (JIT) operating environment, in which costing is delayed until goods are finished. Backflush accounting delays the recording of costs until after the events have taken place, then standard costs are used to work backwards to 'flush' out the manufacturing costs. The result is that detailed tracking of costs is eliminated. Journal entries to inventory accounts may be delayed until the time of product completion or even the time of sale, and standard costs are used to assign costs to units when journal entries are made. The backflushing transaction has two steps: one step of the transaction reports the produced part which serves to increase the quantity on-hand of the produced part and a second step which relieves the inventory of all the component parts. Component part numbers and quantities-per are taken from the standard bill of material (BOM). This represents a huge saving over the traditional method of a) issuing component parts one at a time, usually to a discrete work order, b) receiving the finished parts into inventory, and c) returning any unused components, one at a time, back into inventory.
It can be argued that backflush accounting simplifies costing since it ignores both labor variances and work-in-process. Backflush accounting is employed where the overall business cycle time is relatively short and inventory levels are low.
Backflush accounting is inappropriate when production process is long, and this has been attributed as a major flaw in the design of the concept. It may also be inappropriate if the bill of materials contains not only piece goods but also many parts with more or less variable consumption. If the parts with variable consumption are just a few, like grease or the ink used to print product-labels, the consumed quantities can be assigned to product-independent cost centers at the withdrawal from stores (preproduction issuing) and can eventually be broken down afterwards to specific products or product groups, just like any other indirect or overhead expense. Difficulties maintaining correct inventories on shop floor may also appear if it is usual practice to use alternative materials and/or quantities without needing derogation. Therefore, in case of a more complex production system, it is a better approach to use a Manufacturing Execution System (MES) which gathers real production data and is able to deliver exact data to the accounting software or Enterprise resource planning-system where the goods issue is recorded. Thus, variances in consumption, in comparison to the standard bill of materials, are taken into account and assigned to the correct product, production order and workplace. Another advantage of using a MES is that it implements also the Production Track & Trace and the status of work in progress is also known in real time. A disadvantage of MES is that it is not suitable for small series or prototype production. Such type of production should be segregated from the series production and mass production.
Meaning of backflushing From a financial accounting perspective, backflushing is a technique of the perpetual inventory system. Small businesses which have a low variety of items in their inventory still use periodic inventory management. A periodic inventory system does not require day-to-day tracking of physical inventory. Purchases, cost of goods sold, and inventory on hand cannot be tracked until the end of the accounting time period when a physical inventory is performed and ending inventory is compared against the sum of beginning inventory and purchases. Cost of ending inventory can be calculated by using the LIFO or FIFO inventory accounting methods, or other less common methods. The end of the accounting period is considered usually the end of each month because otherwise some taxes like the VAT (value added tax) cannot be charged. The monthly stock-taking is the main disadvantage of the periodic inventory system. Another disadvantage is that it requires also monthly a reconciliation between the records of the management accounting and the financial accounting.
The main difference between the periodic inventory and the perpetual inventory is that the perpetual inventory does not keep the inventory-balance by using the inventory accounts, instead the entire input is booked immediately on the expense accounts. The principle is the following: output= initial inventory + input - final inventory
At the end of the accounting period the inventory is assessed through stock-taking: inventory asset account = expense account
At the beginning of the accounting period the stock is canceled using the opposite booking: expense account = inventory asset account
During the accounting period any input is booked directly to the expense account. For example, if we buy materials the bookings are:
material account = supplier account
material expense account = material account
At the end of the accounting period, at the stock-taking the booking will be material account = material expenses account
Development of more sophisticated computer scanning of inventory has allowed regular use of perpetual inventory systems by companies. According to the generally accepted accounting principles (GAAP), companies can use either perpetual inventory systems or periodic inventory systems. Perpetual inventory management is a system where store balances of inventory are recorded after every transaction. It eliminates the need for the store to close down constantly for inventory stock-taking as perpetual inventory systems allow for continuous stock-taking. Perpetual inventory systems keep a running account of the company's inventory. Perpetual inventory systems involve more record-keeping than periodic inventory systems. Every inventory item is kept on a separate ledger. These inventory ledgers contain information on cost of goods sold, purchases, and inventory on hand. Perpetual inventory management systems allow for a high degree of control of the company's inventory by management. Perpetual inventory management is generally used by companies who have the ability to scan the inventory items.
In the context of perpetual inventory, backflushing is automatic accounting of material consumed for production, at the time of confirmation of the production, e.g., when a 4-wheeler automobile is rolled out from assembly line, 4 wheels and tires are deemed to be consumed and issued to production order automatically by way of back flushing by the system. Typically, the assembly line has its own limited stock of materials as work in process. This stock is replenished by transferring materials from a warehouse (store) into the assembly lines own designated location, e.g., a supermarket. At goods receipt the consumed materials are posted automatically from the location designated to the issuing production line. In other words, back flushing refers only to materials which are already withdrawn from the inventory of the warehouse (store) and were delivered to the shop floor. Parts are issued from stores to Work-In-Process inventory, but not based on a job order or for a specific production order. They are issued in quantities estimated to cover requirements of individual work centers and production lines. The issuing may be used to cover a period of time or to fill a fixed—size container. But unlike the traditional approach, also known as "preproduction issuing," where the costs are assigned to the product order at the withdrawal of materials from the stores and after completion of production any excess material is given back to the stores, backflushing delays that until the goods receipt of the finished product or assembly is issued. The remaining quantity of unused material left on the shops is still held in the system as floor stock and so material will not be ordered incorrectly through the Manufacturing resource planning (MRP). By eliminating work-in-process accounts, backflush costing simplifies the accounting process. However, this simplification and other deviations from traditional costing systems mean that backflush costing may not always conform to generally accepted accounting principles (GAAP). Another drawback of this system is the lack of a sequential audit trail. The main advantage of postproduction issuing, not necessarily of backflushing, is that there is no need to update the store balances of inventory at the withdrawal of the materials from stores and recording the excess material through reverse posting (storno). This is especially useful in series or mass production where it is no need to give back excess material to the stores because it is used for the next production order. Even if excess material is given back to stores it does not involve any update to the inventory balance in the financial accounting (stock accounts). It involves only a stock transfer in the inventory management or warehouse management. Only the materials reported as consumed through the method of backflushing or by the MES imply an update to the inventory balance:
material account = material expenses account