Traditional cost accounting systems track the sequence of raw materials and components moving through the production systems, and as a consequence are called ‘ sequential track- ing systems ’ . As JIT is an entirely different system it requires its own cost accounting system. The absence of stocks makes choices about inventory valuation systems unneces- sary and the rapid conversion of direct material into cost of goods sold simplifi es the cost accounting system. The approach is known as backfl ush accounting.
Backfl ush accounting delays the recording of costs until after the events have taken place, then standard costs are used to work backwards to ‘ fl ush ’ out the manufacturing costs. There are two events that trigger the records kept in most backfl ush accounting systems:
● The fi rst is the purchase of raw materials. In a true JIT system where absolutely no raw material inventory is held, even this trigger is not relevant and raw materials are ‘ fl ushed ’ when the second trigger is activated.
● The second trigger is either the transfer of goods to fi nished goods inventory or, in a true JIT system, the sale of goods. Two examples of possible backfl ush accounting sys- tems are given in Tables 10.2 and 10.3 and the corresponding ledger accounts are shown in Figures 10.3 and 10.4 .
Table 10.2 System 1
A small inventory of raw materials is held but no fi nished goods stock
Dr Cr
£ £
1. Raw materials are purchased – £ 3,200
Inventory control 3,200
Payables control 3,200
2. Conversion costs are incurred – £ 3,000
Conversion cost control 3,000
Individual a/cs 3,000
3. Goods sold – £ 6,000 worth at standard cost
Cost of goods sold 6,000
Inventory control 2,900
Conversion costs allocated 3,100
4. Under- or over-allocation of conversion costs
Conversion costs allocated 3,100
Cost of goods sold 100
Conversion costs control 3,000
This is the system used by Toyota in its UK factory. In true Japanese style it manipulates employees to behave in a certain way. First, employees must concentrate on achieving sales because cost of sales is the trigger – nothing gets recorded until the sale is made. Second, there is no benefi t in producing goods for inventory. In traditional systems, which have a
COSTING SYSTEMS
fi nished goods inventory, managers can increase profi t by producing more goods than are sold in a period because an increase in fi nished goods inventory reduces the cost of sales in traditional fi nancial accounts.
The model just described may be altered to cope with work-in-progress in the system by using a raw and in progress account (RIP) in place of the inventory control account. All other entries remain the same.
Table 10.3 System 2
No raw material inventory is held but some fi nished goods inventory is held The fi gures are the same as for system 1, but the transfer to fi nished goods is assumed to be £6,000 and the cost of goods sold is £5,900 leaving a fi nished goods inventory of £100.
Dr Cr
£ £
1. Raw materials are purchased – no entry
2. Conversion costs are incurred – £ 3,000
Conversion cost control 3,000
Individual a/cs 3,000
3. Finished goods units produced £ 6,000
Finished goods control 6,000
Payables control 2,900
Conversion costs allocated 3,100
4. Finished goods sold – £ 5,900
Cost of goods sold 5,900
Finished goods control 5,900
5. Under- or over-allocation of conversion costs
Conversion costs allocated 3,100
Cost of goods sold 100
Conversion costs control 3,000
Inventory control Materials
Labour and overhead
Conversion cost allocated
Conversion cost control
Cost of goods sold 1. 3,200
4. 3,100
2. 3,000 4. 3,000 3. 3,100
3. 6,000 4. 100 3. 2,900
Bal c/d 300
Figure 10.3 Ledger accounts for system 1
COSTING SYSTEMS
The backfl ush accounting model cannot be used by all organisations. It can only be used where a JIT-type system is in operation. Where it is used it does have advantages. The traditional system is time consuming and expensive to operate, as it requires a considerable amount of documentation, such as material requisitions and time sheets to support it in order to maintain the WIP records and job cards. If a company operates with low inven- tory levels the benefi ts of operating the traditional costing system are few. By introducing a backfl ush system a considerable amount of clerical time is saved.
From the backfl ush accounting examples it can be seen that JIT eliminates direct labour as a cost category. Instead labour is treated as an indirect cost and is included in conversion cost with the overheads. This is because production is only required when demand requires it and so production labour will be paid regardless of activity. All indirect costs are treated as a fi xed period expense. With JIT, failed or rework must be almost eliminated if the sys- tem is to work and so no accounts for this will exist in backfl ush accounting whereas they are required in traditional systems.
The backfl ush accounting model does not conform to the accepted fi nancial accounting procedures for external reporting in the UK. This is because work-in-progress is treated as an asset in the fi nancial accounts and in backfl ush accounting it is not shown to exist although in practice a small amount does. This can be countered by claiming, quite rightly, immateri- ality. If only one-tenth of one day’s production is held in work-in-progress then it is immate- rial. It can also be claimed that it is immaterial if the work-in-progress does not change from one period to the next as opening and closing inventory will cancel each other out.
Backfl ush accounting can be criticised because of the lack of information that it pro- vides. Some argue, quite rightly, that in reality it is impossible to eliminate all inventory as a truck arriving with raw material creates inventory until it is moved to and used in pro- duction. If back-fl ush accounting is used in a system where a substantial amount of inven- tory is held, a physical stock-take will be needed, because the system does not record the quantity of inventory. Instead, it is derived on paper by the difference between the stand- ard cost of material in the goods sold and the amount of materials purchased. This must be checked by a physical stock-take from time to time.
Figure 10.4 Ledger accounts for system 2 Finished goods
inventory control Cost of goods sold
Conversion cost allocated Creditors’
control
Conversion cost control
3. 2,900 4. 5,900 4. 5,900 5. 100 3. 3,100
5. 3,100
2. 3,000 5. 3,000 3. 3,100 Bal c/d 100
COSTING SYSTEMS