Backflush Costing Methods: Alternative Accounting System for JIT Inventory

Backflush costing is based on the concept of inventory not being an activity that adds value to a company. It works best with just-in-time inventory systems that do not use a work-in-process account. It can also be used in conjunction with activity-based costing systems. It is an attractive accounting system to use because it greatly simplifies the process of managing inventory during the production phase. The final cost of the product is the only consideration, being backflushed to the inventory account at the end of the run instead of being tracked continually in a work-in-process account.

Backflush costing methods: Who should use them

Backflush costing makes the most sense for private companies with just-in-time inventory systems or those that use activity-based costing. As mentioned above, backflush costing is not consistent with GAAP and cannot be used by public companies that are subjected to strict reporting requirements. Companies that must be audited, either internally or by independent third-party auditors, may not be able to use backflush costing because it does not leave much of an audit trail. It is not possible to report an accurate inventory value at most points in the production process. If the inventory cycle is long, backflush costing will greatly undervalue the inventory during most of the year. When the products are finally sold, the backflush of costs can make a product that seemed profitable into a money loser for the company.

Backflush costing methods: Different variations

The actual method of backflush costing can vary between companies, depending on their individual procedures. Many types of backflush costing systems simply flush all costs back into the inventory account at the end of a production run, skipping the step of placing everything in a work-in-process account first. Other backflush costing methods record the raw materials when they are purchased by the company. At the end of production, these raw materials are converted to inventory costs. Yet other companies simplify the accounting system even more and only record the product cost when it is sold instead of using a finished goods inventory account.

Backflush costing methods: Disadvantages

There are some drawbacks to using the backflush costing method of accounting for inventory. By eliminating the work-in-process account, backflush costing may produce a more accurate view of a particular company's inventory, but this difference often makes the method go against generally accepted accounting principles (GAAP). The main concern is that inventory is undervalued during some phases of production because there is no work-in-process account to catch those costs.