Cost Accounting (14th Edition)

726 CHAPTER 20 INVENTORY MANAGEMENT, JUST-IN-TIME, AND SIMPLIFIED COSTING METHODS
Extending Example 3, backflush costing systems could use the sale of finished goods
as the only trigger point. This version of backflush costing is most suitable for a JIT production
system with minimal direct materials, work-in-process, and finished goods inventories.
That’s because this backflush costing system maintains no inventory accounts.
Special Considerations in Backflush Costing
The accounting procedures illustrated in Examples 1, 2, and 3 do not strictly adhere to
generally accepted accounting principles (GAAP). For example, work in process inventory,
which is an asset, exists although it is not recognized in the financial accounting system.
Advocates of backflush costing, however, cite the generally accepted accounting principle
of materiality in support of the various versions of backflush costing. As the three examples
illustrate, backflush costing can approximate the costs that would be reported under
sequential tracking by varying the number of trigger points and where they are located. If
significant amounts of direct materials inventory or finished goods inventory exist, adjusting
entries can be incorporated into backflush costing (as explained next).
Suppose there are material differences in operating income and inventories based on
a backflush costing system and a conventional standard-costing system. A journal entry
can be recorded to adjust the backflush number to satisfy GAAP. For example, the backflush
entries in Example 2 would result in expensing all conversion costs to Cost of
Goods Sold ($1,188,000 at standard costs + $72,000 write-off of underallocated conversion
costs = $1,260,000). But suppose conversion costs were regarded as sufficiently
material in amount to be included in Inventory Control. Then entry (D2) in Example 2,
closing the Conversion Costs accounts, would change as follows:
Original entry (D2) Conversion Costs Allocated 1,188,000
Cost of Goods Sold 72,000
Conversion Costs Control 1,260,000
Revised entry (D2) Conversion Costs Allocated 1,188,000
Inventory Control (1,000 units * $12) 12,000
Cost of Goods Sold 60,000
Conversion Costs Control 1,260,000
Decision
Point
How does backflush
costing simplify
traditional inventory
costing?
Learning
Objective 8
Understand the
principles of lean
accounting
. . . focus on costing
value streams rather
than products, and limit
arbitrary allocations
Critics say backflush costing leaves no audit trails—the ability of the accounting system to
pinpoint the uses of resources at each step of the production process. However, the
absence of sizable amounts of materials inventory, work-in-process inventory, and finished
goods inventory means managers can keep track of operations by personal observations,
computer monitoring, and nonfinancial measures.
What are the implications of JIT and backflush costing systems for activity-based costing
(ABC) systems? Simplifying the production process, as in a JIT system, makes more of
the costs direct and reduces the extent of overhead cost allocations. Simple ABC systems
are often adequate for companies implementing JIT. These simple ABC systems work well
with backflush costing. Costs from ABC systems yield more-accurate budgeted conversion
cost per unit for different products in the backflush costing system. The activity-based cost
information is also useful for product costing, decision making, and cost management.
Lean Accounting
Another approach for simplified product costing in JIT (or lean production) systems is
lean accounting. Successful JIT production requires companies to focus on the entire
value chain of business functions (from suppliers to manufacturing to customers) in
order to reduce inventories, lead times, and waste. The emphasis on improvements
throughout the value chain has led some JIT companies to develop organization structures
and costing systems that focus on value streams, which are all the value-added
activities needed to design, manufacture, and deliver a given product or product line to
customers. For example, a value stream can include the activities needed to develop and
engineer products, advertise and market those products, process orders, purchase and
receive materials, manufacture and ship orders, bill customers, and collect payments.
The focus on value streams is aided by the use of manufacturing cells in JIT systems that
group together the operations needed to make a given product or product line.