What is Backflush Costing?
Backflush costing is a product costing system generally used in a just-in-time (JIT) inventory environment. In short, it is an accounting method that records the costs associated with producing a good or service only after they are produced, completed or sold.
“Flushing” costs to the end of the production run eliminates the detailed tracking of expenses, such as raw material and labor costs, throughout the manufacturing process, which is a feature of traditional costing systems. Backflush costing is also commonly referred to as backflush accounting.
How Backflush Costing Works
The complete costs of a production run are recorded all at once, at the end of the process. Companies using backflush costing, therefore, essentially work backward, calculating the costs of products after they're sold, finished, or shipped. To do this, businesses assign standard costs to the goods they produce. Sometimes costs differ, so companies eventually need to recognize the variances in standard costs and actual costs.
Usually, the costs of products are calculated during various stages of the production cycle. By eliminating work-in-process (WIP) accounts, backflush costing is designed to simplify the accounting process and save businesses money.
Companies using backflush costing generally meet the following three conditions:
- Short production cycles: Backflush costing shouldn’t be used for goods that take a long time to manufacture. As more time goes by, it becomes increasingly difficult to assign standard costs accurately.
- Commoditized products: The process is not suitable for the fabrication of customized products since this requires the creation of a unique bill of materials for each item manufactured.
- Material inventory levels are either low or constant. When inventories, the array of finished goods held by a company, are low, the bulk of manufacturing costs will flow into costs of goods sold, and it is not deferred as inventory cost.
Advantages and Disadvantages of Backflush Costing
In theory, backflushing appears to be a sensible way to avoid the many complexities associated with assigning costs to products and inventory. Not logging costs during the various production stages enable companies to save time and reduce their expenses.
However, backflushing can also be difficult to implement and is not an option available to all companies. Moreover, there are some other big caveats: businesses that do backflush costing lack a sequential audit trail and may not always conform to generally accepted accounting principles (GAAP).