Management Accounting Performance Evaluation: Traditional Accounting Methods Still Have Their Place in a Modern Manufacturing Environment. Grahame Steven Examines the Limitations of Backflush Accounting
Steven, Grahame, Financial Management (UK)
The traditional approach to manufacturing, which originated in the Victorian era, emphasises long production runs to maximise the use of resources. While this increases efficiency and reduces manufacturing costs, it creates stock, since production is not triggered by customer orders. The method produces goods irrespective of whether anyone wants them or not. But stock costs money, since it has to be stored and insured. Stock also has a sell-by date. And large stock holdings may also conceal other problems--poor planning and inefficient production processes--for example.
This approach was challenged by methods developed in the fifties and sixties by Japanese companies and later adopted by western firms--particularly total quality management and just in time (JIT). The modern approach can be encapsulated in two words: customer focus. Although this sounds like common sense, it has significant operational implications and requires a complete culture change in many instances, which can be hard to achieve.
JIT is based on the principle of giving customers what they want when they want it. Goods are produced only when they have been ordered. This approach also recognises that value is added only during manufacturing, so it's dedicated to the elimination of non-value-adding activities such as storing raw materials. As a result, stock is considered to be a bad thing.
Although stock may be held for good business reasons, the JIT philosophy states that it must not be held to meet the deficiencies of the organisation's production and planning systems. But it is important to remember that it's impossible for most organisations to hold no stock all of the time.
Do these new approaches to manufacturing have significant implications for conventional accounting systems? Based on standard costing, such systems are sequential tracking methods. When raw material is delivered to the factory, a "goods received" note is raised to debit raw materials and credit purchase accruals--the supplier's invoice is matched against the accrual at a later date. Raw materials are then released to the factory and an accounting entry is made to record this movement to work in progress. The factory eventually produces finished goods and once again an accounting entry records this transfer. At a later date the final accounting entry is made after the finished goods are sold. The system will also account for substandard production, reworked materials, stock returns and so on.
Conventional accounting systems give complete visibility over stocks held in the factory, provide comprehensive control information and enable the calculation of manufacturing variances. But these systems are expensive to operate and are inappropriate for a JIT manufacturing environment, according to some commentators.
The main reason why they are deemed unsuitable is that JIT implies that little or no stock will be held by a company, so why would it be necessary to have a detailed view of minimal stock holdings? The factory also must "get it right first time" to allow the company to provide goods to its customers within an acceptable period. Assuming that any previous problems in the manufacturing process have been addressed, advocates of a new accounting system believe there is consequently less need for control information in a modern production facility.
An approach called backflush accounting (BA) has been developed to meet the requirements of J IT manufacturing. The most important point to appreciate about BA is that it isn't a sequential tracking system. Block entries are made at the end of each month based on the standard costing system to record the dispatch of goods, the manufacture of goods and the use of raw materials. BA does not account for individual transactions. It also assumes that there is no requirement to calculate manufacturing variances, because a modern manufacturing environment will produce goods to predetermined specifications. …