Backflush Costing: Definition, Benefits & Implementation

Backflush costing is an accounting method that records costs after a good is sold or a service is completed. Backflush costing is common among companies that use a Just-in-Time inventory management systemJust in Time (JIT) MethodThe Just in Time (JIT) style of inventory management – also sometimes referred to as the Toyota Production System (TPS) – is a strategy of managing. It avoids the costly and complicated reporting of all expenses as they occur, and instead “flushes” all expenses in a single entry once the production process is completed.

Summary

• Backflush costing is an accounting method that records costs after a good is sold or a service is completed.
• The backflush costing method uses a standard cost per unit and multiplies this cost by the number of units produced to determine the expense amount.
• Backflush costing is especially valuable to companies with many costs involved in production; however, it isn’t suited to companies that sell customizable products.

How it Works

Companies will estimate the cost to produce each unit of a particular product, assigning a standard cost per unit. At the end of a production cycle, the number of units produced will be multiplied by the standard cost to determine the expense journal entryJournal Entries GuideJournal Entries are the building blocks of accounting, from reporting to auditing journal entries (which consist of Debits and Credits). The journal entry will be recorded once at the end of the production cycle.

For example, a manufacturer who estimates a standard cost of $5 per product and produces 1,000 units during the production cycle will make an expense journal entry of $5,000 at the end of the cycle.

When is Backflush Costing Used?

Backflush costing is generally used by companies that keep low levels of inventoryInventoryInventory is a current asset account found on the balance sheet, consisting of all raw materials, work-in-progress, and finished goods that a and experience high turnover in inventory. It is because costs are still recorded relatively close to the day they are incurred. Companies with slow inventory turnover tend to record costs as they are incurred, as the product may remain unsold for a longer duration of time.

The backflush costing method works particularly well, where many different costs go into the production of a good. In such an instance, it can simplify the accounting process significantly. As a result, many manufacturing companies with complex production processes use backflush costing. However, companies that sell more customized products are less suited to a backflush costing method, as the unit cost will vary.

Advantages and Disadvantages of Backflush Costing

Backflush costing allows companies to easily assign costs to corresponding inventory. Only one journal entry needs to be made at the end of the production process to account for all costs designated to the product. Such a process saves companies time needed to record costs during the production process, which lowers accounting costs.

However, companies with slower inventory turnover often can’t use a backflush costing system, as the cost will be recorded too long after it was incurred. Such a costing method often doesn’t conform to GAAPGAAPGAAP, Generally Accepted Accounting Principles, is a recognized set of rules and procedures that govern corporate accounting and financial, and therefore can’t always be used. Additionally, it can make a company more difficult to audit.

If an auditor is trying to determine all of the costs linked to a specific product, backflush costing will not be able to provide the information in enough detail. Companies that use the costing method will typically assign a standard cost to each unit of production. The standard cost can vary from reality and may need to be reconciled in future accounting entries.

Journal Entry

The journal entry for backflush costing is a single entry at the end of the production period based on a standard cost and the number of units produced.

The entry below shows how using other accounting methods can be much more time-consuming. The entries would continue over the life of the production process as costs arise.

Example

A cellular device manufacturer wants to use the backflush costing method to record costs for the development of a new cellphone model. On the first day of the year, they purchase $1,000 of Component A, and $500 of Component B. The labor to assemble the phones is $1,000 over the course of the month. The units are shipped to the wholesaler on January 31^st.

Using backflush costing, a debit of $2,500 to expenses and $2,500 to cash would be recorded on January 31^st.

More Resources

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In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Activity-Based Costing CalculatorActivity-Based Costing CalculatorThis Activity-based costing calculator template is a great tool to break-down overhead costs through Activity Based Costing.
• Cost of Goods Sold (COGS)AccountingOur Accounting guides and resources are self-study guides to learn accounting and finance at your own pace. Browse hundreds of guides and resources.
• Inventory Turnover RatioInventory Turnover RatioThe inventory turnover ratio, also known as the stock turnover ratio, is an efficiency ratio that measures how efficiently inventory is managed. The inventory turnover ratio formula is equal to the cost of goods sold divided by total or average inventory to show how many times inventory is “turned” or sold during a period.
• Target CostingTarget CostingTarget costing is not just a method of costing, but rather a management technique wherein prices are determined by market conditions, taking