MODULE CAE08: COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANAGEMENT

CHAPTER 5 JUST IN TIME AND BACKFLUSH ACCOUNTING

What I Need to Know?

1. Understand the JIT philosophy
2. Differentiate the JIT system from the traditional costing system

Just-in-time means that raw materials are received just in time to go into production,
manufactured parts are completed just in time to be assembled into products, and
products are completed just in time to be shipped to customers. The JIT requires raw
materials to be delivered at exactly the points they are needed, and just when they are
needed to initiate production, thus eliminating the need for the warehouse space that
has been considered an expensive part of any manufacturing operation. It also reduces
the cost of handling, from the point of delivery of raw materials to the point where the
finished product is shipped to the customer.

The distinguishing characteristic of JIT costing is that production costs are accumulated
with inventory at later stages of the production process. The rationale for this difference
is that JIT assumes that small quantities of direct materials, work-in-process, and
finished goods inventories will be maintained.

JIT costing differs from traditional costing with regards to the accounts used and the
timing of cost recording. There are basically three major differences:

1. Instead of using separate accounts for Material and Work In Process as in

traditional costing JIT costing combines these into a Raw and in Process
account.

2. Direct labor is usually considered a minor cost time in a JIT setting so no

separate account for direct labor is created. Direct labor and factory overhead
 MODULE CAE08: COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANAGEMENT

are usually charged to a Conversion Cost account or sometimes direct to COGS

account.

3. In traditional costing overhead is applied to products as they are being produced

and is recorded into WIP account. In JIT costing, overhead is not applied to
production until they are completed. When products are completed under JIT
costing, labor and overhead is added to COGS, since the goods are sold soon
after production is completed.

KEY TAKEAWAYS

The just-in-time (JIT) inventory system is a management strategy that minimizes

inventory and increases efficiency.

Just-in-time (JIT) manufacturing is also known as the Toyota Production System (TPS)
because the car manufacturer Toyota adopted the system in the 1970s.

Kanban is a scheduling system often used in conjunction with JIT to avoid overcapacity
of work in process.

The success of the JIT production process relies on steady production, high-quality
workmanship, no machine breakdowns, and reliable suppliers.
 MODULE CAE08: COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANAGEMENT

Backflushing

Backflushing is also known as backflush costing/accounting. It is shortened version of

the traditional method o accounting for cost. Under job order costing and process
costing numerous subsidiary records of the cost of the work in process are maintained
and these records are updated by many accounting entries. Under JIT system, where
the time from the receipt of the materials to the completion of the product is reduced to
a few hours, the usefulness of tracking the cost of the WIP becomes impractical.
 MODULE COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANANGEMENT

Sample problem:
1. Cost Savings From Smaller Inventory. Automated Assembly Company maintains a
WIP inventory at each of 15 work stations, and the average size of the inventory is 200
units per station. The physical flow of units into and out of each WIP location is first-in,
first-out. The total number of instances in which some work station goes out of its
control limits is expected to be 100 during the coming year. In 80% of these instances,
the out-of-control condition is expected to be discovered immediately by the operator at
that station; in the other 20% of these instances, a defect will enter 10% of the units
produced. These defective units enter WIP between stations, where they will be
discovered by the next station's operator. Every out-of-control condition is corrected as
soon as it is discovered. The average cost of a unit in WIP is $40, and the average loss
from an out-of-control condition is $20 per defective unit produced. The annual cost of
carrying WIP is 33% of the cost of the inventory.

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 MODULE COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANANGEMENT

Management plans to reduce the number of units held at every work station by
50%. The rate of final output will be unchanged, and no other changes will be made in
the system.

Required:

(1) Calculate the expected carrying cost savings from the change planned by the
management.
(2) Calculate the expected savings in cost of defects if the changes are implemented.

SOLUTION
(1) Carrying cost savings = 33% x reduction in average cost of WIP
= 33% x 50% x past average cost of WIP
= .33 x .5 x (15 x 200 x $40)
= $19,800
(2) Savings in cost of defects = $20 x reduction in the number of defective units
= $20 x (50% x 200 x 10%) x (.20 x 100)
= $20 x 10 x 20
= $4,000

2. Inventory Size, Velocity, and Lead Time. Probtype Incorporated requires an average
lead time of 45 days on customer orders that require parts not kept in stock. When
such a customer order is received, the parts order is placed with a vendor immediately
by telephone, and the parts are received in an average of 21 days. The parts are
inspected and put into production an average of three days after receipt. The average
time spent in production is 16 days. After production is completed, the order goes
through final inspection in two days and arrives at the customer's site after an additional
three days, on average.

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 MODULE COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANANGEMENT

Management plans to leave the rate of final output unchanged, induce vendors to
reduce their total lead time by one-third, and reduce the average size of WIP to one-
fourth of its present level.

Required: Assuming management's plans are implemented successfully, calculate the

average lead time on customer orders that require parts not kept in stock.

SOLUTION

The average lead time will be 26 days, calculated as follows:

Reduction of vendor lead time = 1/3 x 21 days = 7 days

Reduction of time in WIP = 3/4 of present time in WIP

= 3/4 x 16 days
= 12 days

New lead time = present lead time - reductions

= 45 days - (7 days + 12 days)
= 26 days

3. Comparison of Process Costing and Backflushing; Unit Cost Calculations. BF

Company had 35 units in process, 50% converted, at the beginning of a recent, typical
month; the conversion cost component of this beginning inventory was $525. There
were 40 units in process, 50% converted, at the end of the month. During the month,
5,000 units were completed and transferred to finished goods, and conversion costs of
$250,000 were incurred.

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 MODULE COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANANGEMENT

Required:

(1) Carrying calculations to three decimal places, find the conversion cost per unit for
the month:

(a) by the average cost method as used in process costing.

(b) by dividing the total conversion cost incurred during the month by the number
of units completed during the month (do not calculate equivalent units).

(c) by dividing the total conversion cost incurred during the month by the number
of units started during the month.

(2) Using the three unit costs from Requirement (1), calculate three amounts for the
total conversion cost of the ending inventory of work in process to the nearest
dollar.

(3) In light of the results of Requirement (2), which of the three methods of calculating
unit conversion cost would you recommend for the purpose of inventory costing,
1(a), 1(b), or 1(c)? Why?

SOLUTION

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 MODULE COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANANGEMENT

(1) (a) Equivalent production = 5,000 + (.50 x 40) = 5,020 units

$250,525
= $49.905 per unit
5,020

$250,000
(b) = $50 per unit
5,000

(c) Units started = 5,000 + 40 - 35 = 5,005

$250,000
= $49.950 per unit
5,005

(2) 40 x .50 x 49.905 = 998

40 x .50 x 50.000 = 1,000
40 x .50 x 49.950 = 999

(3) Considering that the results of Requirement (2) were within two dollars of each
other, then method 1(b) would be recommended because of its ease and
simplicity.

4. Backflush Costing With a Finished Goods Account. The LanFat Manufacturing

Company uses a Raw and In Process (RIP) inventory account and expenses all
conversion costs to the cost of goods sold account. At the end of each month, all
inventories are counted, their conversion cost components are estimated, and inventory
account balances are adjusted accordingly. Raw material cost is backflushed from RIP
to Finished Goods. The following information is for the month of August:

Beginning balance for RIP account, including $4,800 of conversion cost ...... $ 43,500
Raw materials received on credit ................................................................... 680,000
Ending RIP inventory per physical count, including $5,300 conversion
cost estimate ............................................................................................. 47,200

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 MODULE COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANANGEMENT

Required: Prepare all journal entries involving the RIP account.

SOLUTION

Journal entries involving the RIP account are:

Raw and In Process ................................................................... 680,000

Accounts Payable ................................................................. 680,000

This is a summary entry for all receipts of raw materials during the period. As direct
materials are used, no entry is needed, because they remain a part of RIP.

Finished Goods .......................................................................... 676,800

Raw and In Process .............................................................. 676,800

This entry backflushes material cost from RIP to Finished Goods. This is a
postdeduction. The calculation is:

Material in August 1 RIP balance ............................................... $ 38,700

Material received during August ................................................. 680,000
$718,700
Material in August 31 RIP, per physical count ............................ 41,900
Amount to be backflushed .......................................................... $676,800

Raw and In Process ................................................................... 500

Cost of Goods Sold ............................................................... 500

Conversion cost in RIP is adjusted from the $4,800 of August 1 to the $5,300 estimate
at August 31. The offsetting entry is made to Cost of Goods Sold, where all conversion
costs were charged during August.

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 MODULE COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANANGEMENT

5. Backflush Costing With No Finished Goods Account. The ATM Manufacturing

Company produces only for customer order, and most work is shipped within twenty-
four hours of the receipt of an order. ATM uses a Raw and In Process (RIP) inventory
account and expenses all conversion costs to the cost of goods sold account. At the
end of each month, inventory is counted, its conversion cost component is estimated,
and the RIP account balance is adjusted accordingly. Raw material cost is backflushed
from RIP to Cost of Goods Sold. The following information is for the month of June:

Beginning balance of RIP account, including $900 of conversion cost........... $ 8,500

Raw materials received on credit ................................................................... 187,000
Ending RIP inventory per physical count, including $1,100 conversion
cost estimate ............................................................................................. 7,900

Required: Prepare all journal entries involving the RIP account.

SOLUTION

Journal entries involving the RIP account are:

Raw and In Process ................................................................... 187,000

Accounts Payable ................................................................. 187,000

This is a summary entry for all receipts of raw materials during the period. As direct
materials are used, no entry is needed because they remain a part of RIP.

Cost of Goods Sold .................................................................... 187,800

Raw and In Process .............................................................. 187,800

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 MODULE COST ACCOUNTING AND CONTROL WITH STRATEGIC COST MANANGEMENT

This entry backflushes material cost from RIP to Cost of Goods Sold. This is a
postdeduction. The calculation is:

Material in June 1 RIP balance .................................................. $ 7,600

Material received during June .................................................... 187,000
$194,600
Material in June 30 RIP, per physical count ............................... 6,800
Amount to be backflushed .......................................................... $187,800

Raw and In Process ................................................................... 200

Cost of Goods Sold ............................................................... 200

Conversion cost in RIP is adjusted from the $900 of June 1 to the $1,100 estimate at
June 30. The offsetting entry is made to Cost of Goods Sold, where all conversion
costs were charged during June.

Reference:
Compilation of Lecture Notes of Guia Mae B. Abaja, CPA, Part-time Professor

For further discussion please refer to the link provided:

CHAPTER 5-Just In time and Backflush Accounting- https://www.youtube.com/watch?v=gh2Y3UhSIB4
CHAPTER 5-Just in time Inventory Method- https://www.youtube.com/watch?v=oIGbbtN14qI
CHAPTER 5-Traditional Costing System- https://www.youtube.com/watch?v=M-uGibLcQ-g

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