Backflush Accounting

Backflush accounting is best suited to companies that maintain low or no inventory.

Traditional costing systems use sequential tracking to track costs as units pass from raw
materials throughout the production process to their eventual sale.

Traditional Cost Accounting System

Raw materials
Direct labour Work in process Finished Goods Cost of goods sold
Overhead

Backflush accounting is a simplified standard costing system which focuses on the output
of an organisations manufacturing process and then using standard costs works backwards
to attribute costs to inventory and sales
Backflush Accounting System

Material
Cost of goods
sold
Conversion

Cost accounts are simplified to reduce the amount of data handling.

In backflush, there are no process accounts.
Labour is traced as an indirect cost. Production is dependent on demand and so labour is
paid regardless of activity.

Ex.1 A Company operates a backflush costing system. The standard cost of product X is:
Materials $ 8.00
Conversion $ 13.00
Details of transactions in the month were:
$
Raw material b/f 100
Purchases 8,000
Conversion 13,000
Cost of goods sold 18,500
(at standard cost)
Required:
What is the closing balance on raw materials account?
(Ans: $1,052)

Advantages
1 Simpler than traditional costing systems
2 Fewer entries therefore saving in the time and cost of operating cost system
3 Discourages managers from producing for invnentory as inventory does not add
value until it is sold.
Disadvantages
1 Backflush will not suit all companies. It cannot successfully operae in situations
where inventory levels are significant and tend to fluctuate.

1
 2 The production process needs to be relatively short with accurate standard
production costs
3 The absence of detailed financial information may make the task of management
control more difficult. Adequate production controls are therefore vital.
4 Reconciliation of cost accounts to financial accounts could be more difficult.

Throughput Accounting and Theory of Constraints

Throughput
Sales - Material Cost

Theory of Consraints (TOC)

The theory of consrainsts is a production system where the key financial concept is
the maximisation of throughput while keeping conversion and investment costs to
a minimum. TOC focuses on bottlenecks in the production process which act as a
barrier to throghput maximisation.

Bottleneck

Raw Material Component Final

Materials Sales
Preparation Preparation Assembly

90 units 50 units 100 units

per hour per hour per hour

One process acts as a bottlneck, known as binding constraint. In above example

Component Preparation is a bootleneck.

Goldratt's five steps for dealing with a bottleneck activity :

Step # 1 Identify the binding constraint
Step # 2 Exploit. The highest possible output must be achieved from the binding
constrain. This output must never be delayed.
Step # 3 Subordinate. Operations prior to the binding constraint should operate
at the same speed as it so that WIP does not build up.
Step # 4 Elevate the system bottleneck. Steps should be taken to increase
resources or improve its efficiency.
Step # 5 Return to step 1. The removal of one bottlenec will create another
elsewhere in the system.

Throughput Accounting (TA)

TA is an accounting system based on the theory of constraints. It is very similar to
marginal costing but can be used for longer-term decision making about production
capacity. It is an alternative system of cost and management accounting in JIT
environment.
TA emphasis throughput, inventory minimisation and cost control.

2
 Three concepts
1 All factory costs are fixed in the short run except material.
2 In a JIT environment, producing for inventory is bad. Ideally inventory would be
zero. Products should not be made unless there is a customer for them. This means
accepting some idle time in non-bottleneck operations. WIP should be valued at
material cost only, so that no value is added to profit until a sale is made.
3 Profit is determined by the rate at which throughput can be generated, ie how
quickly raw materials can be turned into sales to generate cash. Producing just to
increase inventory creates no profit so should not be encouraged.

Traditional Costing Throughput Costing

Labour costs and variable overheads All costs other than materials are
are treated as variable costs. seen as fixed in the short term.

Inventor is valued at total Inventory is valued at material

production cost. cost only.

Product profitability can be Profitability is determined by the

determined by deducting a product rate at which money is earned.
cost from selling price
Ratios
Total Factory Cost (TFC) = Fixed production costs, including labour

Return per factory hour = Sales revenue - material purchases

Time on key resources

Cost per factory hour = Total factory costs

Time on key resources

Throughput Accounting Return per factory hour

Ratio Cost per factory hour

The TPA ratio should be greater then one if a product is to be viable.

Priority must be given to products generating the best ratios.

Q. 1 MN Limited manufactures automated industrial trolleys, known as TRLs. Each TRL

sells for $2,000 and the material cost per unit is $600. Labour and variable overhead
are $5,500 and $8,000 per week respectively. Fixed production costs are $450,000
per annum and marketing and administrative costs are $265,000 per annum.
The trolleys are made on three different machines. Machine X makes the four
frame panels required for each TRL. Its maximum output is 180 panels per week.
Machine X is old and unreliable and it breaks down from time to time. It is estimated
that, on average, between 15 and 20 hours of production are lost per month. Machine
Y can manufacture parts for 52 TRLs per week and machine Z which is old but
resonable reliable, can process and assemble 30 TRLs per week.
The company has recently introduced a JIT system and it is company policy to hold
little WIP and no finished goods inventory from week to week. The company
operates a 40-hour week, 48 weeks a year.
Required:
a) Calculate the throughput accounting ratio for the key resources for an average hour.
b) What action could you take to improve a throughput accounting ratio?
3
Q2 A company can produce many types of product but is currently restricted by the number
of labour hours available on a particular machine. At present this limitation is set at 12,000
hours per annum. One type of product requires materials costing $5 which are then
converted to a final product which sells for $12. Each unit of this product takes 45 minutes
to produce on the machine. The conversion costs for the factory are estimated to be
$144,000 per annum.
Calculate the throughput accounting ratio for this product and state the significance
of the result.

Q3 S Ltd manufactures three products, A, B and C. The products use a series of different
machines but there is a common machine, P, that is a bottleneck.
The selling price and standard cost for each product for the forthcoming year is as follows:
A B C
$ $ $
Selling price 200 150 150
Direct materials 41 20 30
Conversion costs 55 40 66
Machine P - minutes 12 10 7
Calculate the return per hour for each of the products

Q4 JJ Ltd manufactures three products: W, X and Y. The products use a series of different
machines but there is a common machine that is a bottleneck.
The standard selling price and standard cost per unit for each product for the forthcoming
period are as follows:
W X Y
£ £ £
Selling price 200 150 150
Cost
Direct materials 41 20 30
Labour 30 20 36
Overheads 60 40 50
Profit 69 70 34
Bottleneck machine
– minutes per unit 9 10 7

40% of the overhead cost is classified as variable

Using a throughput accounting approach, what would be the ranking of the products for
best use of the bottleneck?

Q5 SM makes two products, Z1 and Z2. Its machines can only work on one product at a time.
The two products are worked on in two departments by differing grades of labour. The
labour requirements for the two products are as follow:

Minutes per unit of product

Z1 Z2
Department 1 12 16
Department 2 20 15

There is currently a shortage of labour and the maximum times available each day in
Departments 1 and 2 are 480 minutes and 840 minutes, respectively.
The current selling prices and costs for the two products are shown below:

4
 Z1 Z2
£ per unit £ per unit
Selling price 50.00 65.00
Direct materials 10.00 15.00
Direct labour 10.40 6.20
Variable overheads 6.40 9.20
Fixed overheads 12.80 18.40
Profit per unit 10.40 16.20
As part of the budget-setting process, SM needs to know the optimum output levels.
All output is sold.
Required:
a) Calculate the maximum number of each product that could be produced each day, and
identify the limiting factor/bottleneck. (3 marks)
b) Using traditional contribution analysis, calculate the ‘profit-maximising’ output each day,
and the contribution at this level of output. (3 marks)
c) Using a throughput approach, calculate the ‘throughput-maximising’ output each day, and
the ‘throughput contribution’ at this level of output. (3 marks)

Q6 A company produces three products using three different machines. No other products
are made on these particular machines. The following data is available for December 03

Product A B C
Contribution per unit £36 £28 £18
Machine hours required per unit
Machine 1 5 2 1.5
Machine 2 5 5.5 1.5
Machine 3 2.5 1 0.5

Estimated sales demand (units) 50 50 50

Maximum machine capacity in December will be 400 hours per machine.
Required:
(a) Calculate the machine utilisation rates for each machine for December 2003
(b) Identify which of the machines is the bottleneck machine.
(c) State the recommended procedure given by Goldratt in his “Theory of
Constraints” for dealing with a bottleneck activity. (10 marks)
(d) Calculate the optimum allocation of the bottleneck machine hours to the three products.

Q. 7 Ride Limited
Ride Ltd. is engaged in the manufacturing and marketing of bicycles. Two bicycles are
produced. These are the 'Roadster; which is designed for use on roads and the Éverest
which is a bicycle designed for use in mountanous areas. The following information relates
to the year ending 31-12-2005.

1 Unit selling price and cost date is as follows

Roadster Éverest
Selling price Rs. 4,000 5,600
Material cost 1,600 2,000
Variable conversion cost 400 1,200

5
 2 Fixed production overheads attributable to the manufacture of the bicycles
will amount to Rs. 81 million.
3 Expected demand is as folllows:
Roadster 150,000 units
Éverest 70,000 units
4 Each bicycle is completed in the finishing department. The number of each
type of bicylce that can be completed in one hour in the finishing department
is as follows:
Roadster 6.25
Éverest 5
There are a total of 30,000 hours availabale within the finishing department.
5 Ride Ltd. operates a just in time manufacturing system with regard to the
manufacture of bicycles and aim to hold very WIP inventories and no finished
goods stocks whatsoever.
Required:
a) Using marginal costing principles, calculate the mix(units) of each type of
bicycle which wil maximise net profit and state the value of net profit.
b) Calculate the througput accounting ratio for each type of bicycle and briefly
discus when it is worth producing a product where throughput accounting
principles are in operation. Your answer should assume that the variable
conversion cost amounting to Rs. 96 million incurred as a result of the
chosen product mix in part (a) is fixed in the short-term.
c) Using throughput accounting principles, advise management of the quantities
of each type of bicycle that should be manufactured which will maximise
net profit and prepare a projection of net profit that would be earned by Ride
Ltd.
d) Explain how the concept of contribution in throughput accounting differs from
its use in marginal costing.

Q8 Multiple Choice Question

The following scenario is to be used for questions 1 and 2
A company manufactures three products: W, X and Y. The products use a series of
different machines, but there is a common machine that is a bottleneck.
The standard selling price and standard cost per unit for each product for the next period
are as follows: W X Y
£ £ £
Selling price 180 150 150
Cost:
Direct material 41 20 30
Direct labour 24 16 20
Variable production overheads 30 20 50
Fixed production overheads 36 24 30
Profit 49 70 20
Time (minutes) on bottleneck machine 7 10 7
The company is trying to plan the best use of its resources.

1 Using a traditional limiting factor approach, the rank order (best first) of the products would be
A W, X, Y
B W, Y, X
C X, W, Y
D Y, X, W
6
2 Using a throughput accounting approach, the rank order (best first) of the products would be
A W, X, Y
B W, Y, X
C X, W, Y
D Y, X, W

3 A company operates a just-in-time purchasing and production system and uses a

backflush accounting system with a single trigger point at the point of sale. A summary of
the transactions that took place in June (valued at cost) is:
£
Conversion costs incurred 890,000
Finished goods produced 1,795,000
Finished goods sold 1,700,000
Conversion costs allocated 840,000
The two items debited to the cost of goods sold account in June would be
£ £
A 890,000 and 95,000
B 1,700,000 and 50,000
C 1,700,000 and 95,000
D 1,795,000 and 50,000

4 MN plc uses a Just-in-Time (JIT) system and backflush accounting. It does not
use a raw material stock control account. During April, 1,000 units were produced
and sold. The standard cost per unit is £100: this includes materials of £45.
During April, conversion costs of £60,000 were incurred.

What was the debit balance on the cost of goods sold account for April?
A £90,000
B £95,000
C £105,000
D £110,000

The following data are given for sub-questions 5 and 6 below

A manufacturing company recorded the following costs in October for Product X:
$
Direct materials 20,000
Direct labour 6,300
Variable production overhead 4,700
Fixed production overhead 19,750
Variable selling costs 4,500
Fixed distribution costs 16,800
Total costs incurred for Product X 72,050

During October 4,000 units of Product X were produced but only 3,600 units were sold.
At the beginning of October there was no inventory.

5 The value of the inventory of Product X at the end of October using marginal costing was:
A $3,080
B $3,100
C $3,550
D $5,075
7
 6 The value of the inventory of Product X at the end of October using throughput accounting was
A $630
B $1,080
C $1,100
D $2,000

Q9 M/s. Hi Sky Ltd., produces three products, ‘A’, ‘B’ and ‘C’. The capacity of Hi Sky’s plant
Aug is restricted and all products pass through a single process. This process is expected to
2014 be operational for 7 hours per day and can produce 1,600 units of ‘A’ per hour, 1,800 units
of ‘B’ per hour, and 800 units of ‘C’ per hour. Conversion costs are Rs. 600, 000 per day
Selling prices and material costs for each product are as follows: Rupees
Selling Price Material Cost Throughput Contribution
Product per Unit per Unit per Unit
A 160 80 80
B 140 50 90
C 280 110 170
Required:
(i) Calculate the profit per day if daily output achieved is 4,000 units of ‘A’, 3,500 units
of ‘B’ and 1,000 units of ‘C’. 02
(ii) Determine the efficiency of the bottleneck process given the output in (i) above. 04
(iii) Calculate the Throughput Accounting ratio for each product. 04
(iv) How the concept of ‘Throughput Accounting’ is a direct contrast to the fundamental
principles of conventional costing? 03

Q 10 Vision International manufactures two products, the LED and the LCD. They pass
Nov through three processes; Proces-1 Proces-2 Proces-3. There are 24 hours of time
2013 available per day for all processes. Information relating to these products is as follows:
Rs./ Unit
LED LCD
Selling price 50,000 40,000
Direct materials 35,000 30,000
Direct labour 2,500 5,000
Maximum demand per day (units) 15 20
Time required per unit (hours):
Proces-1 0.60 0.70
Proces-2 1.00 0.50
Proces-3 0.50 0.80
Additional Data: Rs./ Day
Labour cost 135,000
Variable overhead 60,000
Fixed cost 45,000
Required:
(i) Identify bottleneck process. 02
(ii) Calculate unit contribution per scarce source under throughput accounting. 02
(iii) Rank these products. 01
(iv) Calculate optimum production plan. 02
(v) Calculate throughput accounting (TA) ratio for each product. 03

8
Q 11 Yam Co is involved in the processing of sheet metal into products A, B and C using
three processes, pressing, stretching and rolling. Like many businesses Yam faces
tough price competition in what is a mature world market.

The factory has 50 production lines each of which contain the three processes:
Raw material for the sheet metal is first pressed then stretched and finally rolled.
The processing capacity varies for each process and the factory manager has
provided the following data:

Processing time per metre in hours

Product A Product B Product C
Pressing 0.50 0.50 0.40
Stretching 0.25 0.40 0.25
Rolling 0.40 0.25 0.25

The factory operates for 18 hours each day for five days per week. It is closed for
only two weeks of the year for holidays when maintenance is carried out. On
average one hour of labour is needed for each of the 225,000 hours of factory time.
Labour is paid Rs 10 per hour. The raw materials cost per metre is Rs 3.00 for
product A, Rs 2.50 for product B and Rs 1·80 for product C. Other factory costs
(excluding labour and raw materials) are Rs 18,000,000 per year. Selling prices
per metre are Rs 70 for product A, Rs 60 for product B and Rs 27 for product C.
Yam carries very little inventory.

Required:
(a) Identify the bottleneck process and briefly explain why this process is described
as a ‘bottleneck’. (3 marks)
(b) Calculate the throughput accounting ratio (TPAR) for each product assuming
that the bottleneck process is fully utilised. (8 marks)
(c) Assuming that the TPAR of product C is less than 1:
(i) Explain how Yam could improve the TPAR of product C. (4 marks)
(ii) Briefly discuss whether this supports the suggestion to cease the production
of product C and briefly outline three other factors that Yam should consider
before a cessation decision is taken. (5 marks)