Backflush costing is a strategy that involves delaying the costing process until the production of goods or services is completed. Once the production cycle is finished, the costs are then applied to the operation, making it possible to determine the costs associated with manufacturing the products and to set the sale price accordingly. One of the benefits of this strategy is that there is no need to closely track costs as they occur, thus simplifying the accounting process while the production process is in progress. While this approach is relatively easy, the lack of detail can sometimes create issues at a later date.
The concept of backflush costing is often associated with a just-in-time or JIT operation. With this approach, one of the goals is to keep the inventory of raw materials as low as possible. Thus, orders for raw materials are scheduled so that the goods arrive just before the production commences. By the time the invoicing for the materials is received, the goods are produced, costs are calculated, and the products are sold at a rate that covers the expenses. All relevant postings in the company’s accounting books are made at that point, thus keeping the books balanced and factual, but without the need to make multiple postings all through the production process.
One of the drawbacks of backflush costing is that the strategy is not widely considered to be in compliance with generally accepted accounting principles. This is because the inventory is likely to be undervalued during the course of production, since the actual cost for recently arrived inventory is not posted until the production is finished. This situation is sometimes structured to allow the posting of a standard cost for the raw materials when they are purchased. There are also some objections to not recognizing the finished goods until the point of sale, rather than accounting for them in a finished goods inventory, as is the case with other accounting methods.
While backflush costing does work well with a just-in-time inventory approach, the lack of detail can sometimes create issues during an audit of the company’s financial records. This can lead to situations where it becomes necessary to use existing documentation to reconstruct the chain of events involved in the production process, rather than simply following the sequence of events as recorded in the accounting records. For this reason, the use of backflush costing may generate more work than would have been necessary by following a more traditional accounting approach.