CHAPTER 5

JUST IN TIME AND BACK-FLUSH ACCOUNTING

TOPIC OVERVIEW:
This chapter explains the definition and characteristics of a JIT system. It also describes the
simplified procedure used to allocate costs between the cost of sales and inventories.

LEARNING OBJECTIVES:
After studying this chapter, the students should be able to:
1. Know and understand the JIT philosophy.
2. Explain the benefits of JIT manufacturing systems
3. Describe back-flush costing.

OBJECTIVES OF JIT MANUFACTURING

The primary objective of JIT manufacturing system is to minimize if not totally eliminate all
manufacturing inventories. Inventories are considered to have an adverse effect on net income
because they tie up funds and storage space that could be made available for more productive
purposes. JIT manufacturing systems aim to simultaneously (1) meet customer demand in a
timely way, (2) with high-quality products, and (3) at the lowest possible total cost.

FEATURES OF JIT MANUFACTURING

JIT manufacturing systems to be effective should have the following features:
 The company must have dependable suppliers who are willing to deliver on short notice
exact quantities of raw materials according to precise quality specifications (even
including multiple deliveries within the same day). Suppliers must also be willing to
deliver the raw materials at specified department rather than at a central receiving
department.
 A grouping of all the different types of equipment used to make a given product should
be made. Materials move from one machine to another, and various operations are
performed in sequence. Materials handling costs are minimized.
 A multi-skilled work force must be developed. Under JIT system, one worker may have
the responsibility to operate and maintain several different types of machines.
 A total quality control system must be applied throughout the manufacturing operations.
Total quality control means no defect. Since only required quantities are produced under
the pull-through approach, any defects at any department will shut down operations at
subsequent departments.
 The time required to get equipment, tools, and materials ready to start the production of
a product (set-up time) should be reduced. The time from when an order is received
until it becomes a finished product (manufacturing lead time) should likewise be
reduced. Reducing setup time makes production in smaller batches economical, which
in turn reduces the inventory levels. Reducing manufacturing lead time enables a
company to respond faster to changes in customer demand.

BENEFITS OF JIT MANUFACTURING SYSTEMS

The major benefit of implementing JIT manufacturing system is the lowering of the costs of
inventory. Other benefits are:
 Manufacturing activities are significantly reduced or eliminated.
 Product quality and faster delivery are enhanced.
 Inventory storage costs are reduced or eliminated.
 Production cost savings are realized because of the improved flow of processing goods.
 Specific causes of rework, scrap, and waste are reduced if not totally eliminated.
 Materials and work in process inventory accounts are eliminated. In place of these
accounts only one account is used, Materials and In Process (MIP) also called Raw and
in Process (RIP) account.

BACKFLUSH COSTING
To compliment JIT manufacturing system, a simplified procedure is used to allocate costs
between the cost of sales and inventories. This simplified procedure is known as back-flush
costing.

Usually costs are tracked sequentially as products pass through these four stages in a cycle from
purchase of direct materials to sale of finished goods:

Stage 1 Purchase of Raw Materials

Stage 2 Production resulting in Work in Process
Stage 3 Completion of Units of Product
Stage 4 Sale of Finished Goods

The above sequential tracking costing system has four trigger points, corresponding to stages 1,
2, 3, and 4. Trigger points refers to a stage in the cycle from purchase of raw materials (stage 1)
to sale of finished goods (stage 4) at which journal entries are made in the accounting system.

An alternative approach to sequential tracking is backflush costing. Backflush costing is a

costing procedure that omits recording some or all of the journal entries relating to the cycle
from purchase of raw materials to the sale of finished goods. When journal entries for one or
more stages in the cycle are omitted, the journal entries for subsequent stage used normal or
standard costs to work backward in order to flush out the costs in the cycle where journal
entries were omitted. No separate accounting for work in process is made.

Actual conversion costs are recorded as incurred, similarly as that under the conventional
recording system. Conversion costs are then applied to products at various trigger points. It is
assumed that any conversion costs not applied to products are carried forward and disposed of
at year-end.

The following cases will illustrate backflush costing. They differ in the number and placement
of trigger points.
Case 1 Case 2 Case 3
Trigger Points Stage 1. Purchase of Stage 1. Purchase of
Raw Materials Raw Materials
Stage 3. Completion Stage 3. Completion
of Finished Goods of Finished Goods
Stage 4. Sale of Stage 4. Sale of Stage 4. Sale of
Finished Goods Finished Goods Finished Goods
Inventory Accounts Materials and In Materials Inventory
Process Inventory
Finished Goods Finished Goods
Inventory Inventory
Main Features Three trigger points Two trigger points Two trigger points
Use of combined No Finished Goods No Materials
Materials and In Inventory Account Inventory Account
process inventory
account (MIP)
NOTE: In all three cases, there are no journal entries to record work in process (stage 2)
because JIT manufacturing leads to large reduction in work in process.

ILLUSTRATION
The following data for Cookie Manufacturing Company will be used to illustrate the backflush
costing:
Materials purchased on credit ₱ 195,000
Actual conversion costs incurred ₱ 126,000
Number of units manufactured 10,000 units
Number of finished units sold 9,900 units
Standard costs per unit
Materials ₱ 19
Conversion Costs ₱ 12

Case 1: Trigger points at purchase of direct materials (Stage 1), completion of goods (stage 3),
and sale of finished goods (Stage 4).

Trigger point 1 occurs when materials are purchased. These costs are charged to Materials and
In Process Inventory account (MIP). Actual conversion costs (labor and overhead) are recorded
as incurred and charged to Conversion Costs Control account. Conversion costs are applied to
products at trigger point 2 — transfer of units to Finished Goods Inventory account. Trigger
point 3 occurs at the time finished goods are sold.

The following are the accounting procedures to allocate costs to units sold and to inventories:
1: Record materials purchased during the period.
Entry (a) Materials and In Process Inventory 195,000
Accounts Payable 195,000

2: Record conversion costs incurred during the period.

Entry (b) Conversion Cost Control 126,000
Various Accounts 126,000

3: Determine the number of units manufactured during the period.

 10,000 good units were manufactured during the period.

4: Compute the normal or standard costs per finished unit.

 The standard cost per unit is ₱31. (₱19 direct materials + ₱12 conversion costs)

5: Record the cost of goods finished during the period.

Entry (c) Finished Goods Inventory 310,000
Materials and In Process Inventory 190,000
Applied Conversion Costs 120,000
 Finished goods (10,000 units x ₱31)
 Applied Conversion Costs (10,000 units x ₱12)
This fifth procedure gives backflush costing its name. Note that costs have not been recorded
sequentially with the flow of product along its production route through work in process and
finished goods. Instead, the output trigger point reaches back and pulls the standard direct
materials costs from Materials and In Process Inventory and the standard conversion costs for
manufacturing the finished goods.

6: Record the standard cost of goods sold during the period.

Entry (d) Cost of Goods Sold 306,900
Finished Goods Inventory 306,900
 9,900 units x ₱31.

7: Record underapplied or overapplied conversion costs.

Companies that use backflush costing usually have low inventories, so that underapplied or
overapplied conversion costs is written off to cost of goods sold only. The journal entry to
dispose of the difference between the actual conversion costs incurred and standard conversion
costs applied is:
Entry (e) Applied Conversion Costs 120,000
Cost of Goods Sold 6,000
Conversion Cost Control 126,000

At the end of the period, the ending inventory balances are:

Materials and In Process Inventory (₱195,000 - 190,000) ₱5,000
Finished Goods Inventory (₱310,000 - 306,900) 3,100
Total ₱8,100

Case 2: Trigger points are purchase of raw materials (stage 1) and sale of finished goods (stage
4)
This case is much more different from a sequential tracking costing system than the backflush
costing system in Case 1. This case and Case 1 have the same trigger point, purchase of raw
materials but the second trigger point in Case 2 is the sale, not the completion of finished units.

1: Record materials purchased during the period.

Materials and In Process Inventory 195,000
Accounts Payable 195,000

2: Record conversion costs incurred during the period.

Conversion Cost Control 126,000
Various Accounts 126,000

3. Completion of Finished Goods - no entry

4. Sale of Finished Goods

Cost of Goods Sold 306,900
Materials Inventory 188,100
Applied Conversion Costs 118,800

5. Record underapplied or overapplied conversion costs.

Applied Conversion Costs 118,800
Cost of Goods Sold 7,200
Conversion Cost Control 126,000

The two trigger points are represented by transactions (1) and (4). Entry (1) has the same
trigger point as in Case 1, the purchase of materials. Entry (2) for the conversion costs incurred
is recorded in the same way as in Case 1. Trigger point 2 is the sale of finished goods (not the
completion of finished units, as in Case 1), so there is no entry corresponding to entry (3) of
Case 1. The cost of finished units is computed only when finished goods are sold, which
corresponds to entry (4) of Case 1: 9,900 units sold x ₱31 per unit = ₱306,900, which is
composed of direct materials costs (9,900 units x ₱19 per unit = ₱188, 100) and applied
conversion costs (9,900 units x ₱12 per unit = ₱118,800).
No conversion costs are inventoried. As compared in Case 1, Case 2 does not assign ₱1,200
(₱12 per unit x 100 units) of conversion costs to finished goods inventory. Hence, Case 2
allocates P 1,200 less in conversion costs to inventory relative to the conversion costs allocated
to inventory in Case 1. Of the ₱126,000 in conversion cost, ₱118,800 is allocated at standard
cost to the units sold. The remaining ₱7,200 (126,000 — ₱118,800) of conversion costs is
underapplied. Entry (5) presents the journal entry to write off these underapplied costs to cost
of goods sold.
The ending inventory of materials is ₱6,900 (₱5,000 direct materials still on hand + ₱1,900
direct materials in the 100 units manufactured but unsold).

Case 3: Trigger points are completion of finished good units of product (Stage 3) and sale of
finished goods (Stage 4)
1: Purchase of direct materials - no entry

2: Record conversion costs incurred during the period.

Conversion Cost Control 126,000
Various Accounts 126,000

3: Record the cost of goods finished during the period.

Finished Goods Inventory 310,000
Accounts Payable 190,000
Applied Conversion Costs 120,000

4: Sale of Finished Goods

Cost of Goods Sold 306,900
Finished Goods Inventory 306,900

5: Record underapplied or overapplied conversion costs.

Applied Conversion Costs 120,000
Cost of Goods Sold 6,000
Conversion Cost Control 126,000

This case has two trigger points. In contrast to Case 2, the first trigger point in Case 3 is
delayed until the completion of units. It is represented by transaction (3). Since the purchase of
raw materials is not a trigger point, there is no entry corresponding to transaction (1) purchases
of raw materials.

Adjusting Entries in Backflush Costing

The accounting procedures illustrated in Cases 1, 2 and 3 do not strictly adhere to generally
accepted accounting principles. For example, work in process, which is an asset, exists but is
not recognized in the financial statements. Users of backflush costing, however, cite the
generally accepted accounting principle of materiality in support of these versions of backflush
costing. As illustrated in the three cases, backflush costing can approximate the costs that
would be reported under sequential costing methods by changing the number of trigger points
and where they are located. If material amounts of direct materials inventory or finished goods
inventory exist, adjusting entries can be included into backflush closing procedures.

Assume there are material differences in operating income and inventories based on a backflush
costing system and the usual standard costing system. An adjusting entry can be recorded to
make the backflush costing satisfy external reporting requirements. For example, the backflush
entries in Case 2 results in expensing all conversion costs to Cost of goods sold (₱118,800 at
standard costs + ₱7,200 write off of underapplied conversion costs = ₱126,000). But suppose
conversion costs were regarded as sufficiently material in amount to be included in Material
Inventory. Then entry (5), closing the Conversion Costs accounts, would be revise as follows:

Applied Conversion Costs 118,800

Materials Inventory ( 100 units × 12) 1,200
Cost of Goods Sold 6,000
Conversion Cost Control 126,000

Another illustration:

Action Corporation manufactures electrical meters. For May, there were no beginning
inventories of raw materials and no beginning and ending work in process. Action uses JIT
manufacturing system and backflush costing with three trigger points: Purchase of raw
materials – debited to Raw and In Process account, Completion of finished goods – debited to
Finished Goods account, and Sale of finished goods.

Action’s standard costs per meter are direct materials, ₱25 and conversion costs, ₱20. The
following data apply to May manufacturing:

Raw materials purchased ₱550,000

Conversion costs incurred ₱440,000
Number of units manufactured 21,000
Number of units sold 20,000

The balances of Raw and in Process and Finished Goods inventory accounts at the end of May
are:

Raw and In Process

21,000 x ₱25 = ₱525,000
₱550,000 – ₱525,000 = ₱25,000

Finished Goods, end

21,000 – 20,000 = 1,000 units
1,000 x ₱45 = ₱45,000

References:
Guerrero, P. (2018). Cost Accounting Principles and Procedural Application, GIC Enterprise &
Co., Inc., Manila, Philippines.

Guerrero, P. (2016). CPA Examination Review Advanced Financial Accounting. Manila,

Philippines