Backflush Costing

Backflush Costing

A product costing system generally used in a just-in-time inventory environment. 

Backflush costing delays the costing process until the production of goods is completed. 

Costs are then "flushed" back at the end of the production run and assigned to the goods. This eliminates the detailed tracking of costs throughout the production process, which is a feature of traditional costing systems.

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. 

Alternatives to Backflushing when using the Push-strategy

'Make To Order - MTO'

A business production strategy that typically allows consumers to purchase products that are customized to their specifications. The make to order (MTO) strategy only manufactures the end product once the customer places the order.

The make to order (MTO) strategy relieves the problems of excessive inventory that is common with the traditional make to stock (MTS) strategy. Dell Computers is an example of a business that uses the MTO production strategy.

Pull-Through Production

A method used in just-in-time manufacturing processes to order production inputs and schedule manufacturing at the time a customer places an order. By basing purchase orders and manufacturing schedules on actual, rather than anticipated, orders, pull-through production helps control inventory costs. 

Pull-through production also facilitates product customization. Since products are made as they are ordered, it may be possible to cost-effectively tailor an order to a customer's specific needs, instead of only offering a generic product. 

THROUGHPUT COSTING

Throughput costing treats all costs as period expenses except for direct materials. It is also called super-variable costing. It is very suitable for those companies where labor and overheads are fixed costs.  Assembly-line and continuous processes that are highly automated are most likely to meet this criterion. In such company, workers are usually well-educated engineers or technicians employeed on permanent basis.

Throughput philosophy cannot be termed as a costing technique as it is not providing a new way of cost classification and accumulation for any of the three major elements of cost i.e. direct material, direct labour and overheads. Therefore, it is termed as throughput accounting instead of throughput costing.

According to throughput theory, managing the business with a view to maximize profit is not only ignoring the much important variables (like customers demands, needs and affordability) but also push the organizations towards inter-departmental conflicts.

According to throughput accounting, management should be concentrating on maximizing cash flows instead of maximization of profits. And this does make sense that profits can be maximized by increasing the price or quantity sold but one major thing ignored in “profit maximization” methodology is that no answer is given regarding the tangible translation of profits i.e. cash. Unless we do not realize the profits in cash form, then all the theoretical profits and feasibility reports have no value at all. Thus, management should work towards maximization of sales, which will prove generation of cash and thus indirectly increasing the profits.

As now we can understand that by merely producing items and having them in the store in the finished goods form does not promise profits. We earn profits ONLY when goods change hands i.e. actual sales take place.

And that is also the meaning of the word throughput. Under this technique we do not emphasize on increasing profit, instead we emphasize on generation of cash inflows by increasing sales which will automatically push profits to increase.

Absorption, variable and throughput costing are alternative product-costing methods. The difference is treatment of certain cost elements. Under absorption or full cost method, all manufacturing costs are treated as product costs. In financial accounting, this method is used in inventory valuation and is acceptable to tax authorities.In fact all annual accounts are prepared on this basis to facilitate inter-company comparison or calculation of industrial ratios.

Variable costing covers only variable costs while all fixed costs are treated as period costs. This type is more suitable for operational decisions as fixed cost, being committed, is irrelevant for most decisions.

In present high tech, environment, direct labour has disappeared. Generally, a few engineers operate the plant. Hence, the only throughput costs (raw material costs) vary with the change in production. This would reduce the incentive to over produce to cut down cost per unit.