B405F Advanced Management Accounting
Revision
Lecture 11
Five-Step Decision Process
1
2
3
4
5
Gathering information
Making predictions
Choosing an alternative
Implementing the decision
Evaluating performance
2
The Meaning of Relevance
Relevant costs and relevant revenues are
expected future costs and revenues that differ
among alternative courses of action.
 Sunk costs are irrelevant because they are past
costs.
 Common fixed costs are irrelevant because
they are non-differential costs.

3
Quantitative and Qualitative
Relevant Information

Quantitative factors are outcomes that are
measured in numerical terms:
–
–

Financial
Nonfinancial
Qualitative factors are outcomes that cannot
be measured in numerical terms:
–
Nonfinancial
4
One-Time-Only Special Order

Decision criteria:
Accept the order if the revenue differential
is greater than the cost differential.
5
Make or Buy Decision
Opportunity costs are not recorded in formal
accounting records since they do not generate
cash outlays.
 These costs also are not ordinarily
incorporated into formal reports.

6
Product-Mix Decisions Under
Capacity Constraints
Decision criteria:
Aim for the highest contribution margin per
unit of the constraining factor.
 When multiple constraints exist, optimization
techniques such as linear programming can be
used in making decisions.

7
Equipment Replacement

The book value of existing equipment is
irrelevant since it is neither a future cost nor
does it differ among any alternatives (sunk
costs never differ).
8
Decisions and Performance
Evaluation



Managers often behave consistent with their short-run
interests and favor the alternative that yields best
performance measures in the short run.
When conflicting decisions are generated, managers
tend to favor the performance evaluation model.
Top management faces a challenge – that is, making
sure that the performance-evaluation model of
subordinate managers is consistent with the decision
model.
9
Time Horizon of
Pricing Decisions

1
2
Two key differences when pricing for the
long run relative to the short run:
Costs that are often irrelevant for short-run
pricing decisions (fixed costs) are often
relevant in the long run.
Profit margins in long-run pricing decisions
are often set to earn a reasonable return on
investment.
10
Alternative Long-Run
Pricing Approaches
–
–
Market-based
Cost-based (also called cost-plus)
11
Target Price is...
the estimated price for a product (or service)
that potential customers will be willing to pay.
 The target price, calculated using customer
and competitors inputs, forms the basis for
calculating target costs.
–
12
Target Costs
Target sales price per unit
– Target operating income per unit
= Target cost per unit

13
Implementing Target Pricing and
Target Costing

1
2
3
4
Steps in developing target prices and target
costs:
Develop a product that satisfies the needs of
potential customers.
Choose a target price.
Derive a target cost per unit.
Perform value engineering to achieve target
costs.
14
Value-Added Costs

–
–
–
–
A value-added cost is a cost that customers
perceive as adding value, or utility, to a
product or service:
Adequate memory
Pre-loaded software
Reliability
Easy-to-use keyboards
15
Nonvalue-Added Costs

–
–
–
A nonvalue-added cost is a cost that customers
do not perceive as adding value, or utility, to a
product or service.
Cost of expediting
Rework
Repair
16
Cost Incurrence and
Locked-in Costs
Cumulative
Costs per unit
Locked-in
Cost Curve
Cost
Incurrence
Curve
R&D and
Design
Manufacturing
Value Chain
Functions
Mktg., Dist.,
& Cust. Svc.
17
Cost-Plus Pricing
The general formula for setting a cost-based
price is to add a markup component to the
cost base.
 Cost base
$X
Markup component
Y
Prospective selling price $X + Y

18
Life-Cycle Budgeting
The product life-cycle spans the time from
original research and development, through
sales, to when customer support is no longer
offered for that product.
 A life-cycle budget estimates revenues and
costs of a product over its entire life.

19
Predicted Costs
Many of the production, marketing,
distribution and customer service costs
are locked in the R&D and design stage.
 Life-cycle budgeting facilitates value
engineering at the design stage before
costs are locked in.

20
Strategy
Strategy specifies how an organization
matches its own capabilities with the
opportunities in the marketplace to accomplish
its objectives
 A thorough understanding of the industry is
critical to implementing a successful strategy

21
The Balanced Scorecard
The balanced scorecard translates an
organization’s mission and strategy into a
comprehensive set of performance measures.
 The balanced scorecard does not focus solely
on achieving financial objectives.
 It highlights the nonfinancial objectives that
an organization must achieve in order to meet
its financial objectives.

22
The Balanced Scorecard Flowchart
Financial
Customer
Internal
Business
Process
Learning
&
Growth
23
Aligning the Balanced
Scorecard to Strategy
Different strategies call for different
scorecards.
 What are some of the financial perspective
measures?
– Operating income
– Revenue growth
– Cost reduction is some areas
– Return on investment

24
Aligning the Balanced
Scorecard to Strategy

–
–
–
–
What are some of the customer perspective
measures?
Market share
Customer satisfaction
Customer retention percentage
Time taken to fulfill customers requests
25
Aligning the Balanced
Scorecard to Strategy

–




What are some of the internal business
process perspective measures?
Innovation Process
Manufacturing capabilities
Number of new products or services
New product development time
Number of new patents
26
Aligning the Balanced
Scorecard to Strategy
–






Operations Process
Yield
Defect rates
Time taken to deliver product to customers
Percentage of on-time delivery
Setup time
Manufacturing downtime
27
Aligning the Balanced
Scorecard to Strategy
–


Post-sales service
Time taken to replace or repair defective
products
Hours of customer training for using the
product
28
Aligning the Balanced
Scorecard to Strategy

–
–
–
–
–
What are some of the learning and growth
perspective measures?
Employee education and skill level
Employee satisfaction scores
Employee turnover rates
Information system availability
Percentage of processes with advanced
controls
29
Features of a Good
Balanced Scorecard
Tells the story of a firm’s strategy, articulating
a sequence of cause-and-effect relationships:
the links among the various perspectives that
describe how strategy will be implemented
 Helps communicate the strategy to all
members of the organization by translating the
strategy into a coherent and linked set of
understandable and measurable operational
targets
30

Features of a Good
Balanced Scorecard
Must motivate managers to take actions that
eventually result in improvements in financial
performance
 Limits the number of measures, identifying
only the most critical ones
 Highlights less-than-optimal tradeoffs that
managers may make when they fail to consider
operational and financial measures together

31
Balanced Scorecard
Implementation Pitfalls
Managers should not assume the cause-andeffect linkages are precise: they are merely
hypotheses
 Managers should not seek improvements
across all of the measures all of the time
 Managers should not use only objective
measures: subjective measures are important
as well

32
Balanced Scorecard
Implementation Pitfalls
Managers must include both costs and
benefits of initiatives placed in the balanced
scorecard: costs are often overlooked
 Managers should not ignore nonfinancial
measures when evaluating employees
 Managers should not use too many measures

33
Evaluating Strategy

Strategic Analysis of Operating Income – 3
parts:
1.
2.
3.
Growth Component – measures the change in operating
income attributable solely to the change in the quantity
of output sold between the current and prior periods
Price-Recovery Component – measures the change in
operating income attributable solely to changes in prices
of inputs and outputs between the current and prior
periods
Productivity Component – measures the change in
costs attributable to a change in the quantity of inputs
between the current and prior periods
34
Revenue Effect Analysis
Price
Recovery
Component
P2
P1
Q2
Growth
Component
Q1
35
Cost Effect Analysis
Price
Recovery
Component
P2
P1
Q2
Productivity
Component
Q
Q1
Growth
Component
36
The Management of Capacity
Managers can reduce capacity-based fixed
costs by measuring and managing unused
capacity
 Unused Capacity is the amount of productive
capacity available over and above the
productive capacity employed to meet
consumer demand in the current period

37
Analysis of Unused Capacity

Two Important Features:
1. Engineered Costs result from a cause-andeffect relationship between output and the
resources used to produce that output
2. Discretionary Costs have two parts:
1. They arise from periodic (annual) decisions
regarding the maximum amount to be incurred
2. They have no measurable cause-and-effect
relationship between output and resources used
38
Managing Unused Capacity
Downsizing (Rightsizing) is an integrated
approach of configuring processes, products,
and people to match costs to the activities that
need to be performed to operate effectively and
efficiently in the present and future
 Because identifying unused capacity for
discretionary costs is difficult, downsizing,
or otherwise managing this unused capacity,
is also difficult.

39
Customer-Profitability Profiles
Customer profitability reports often
highlight that a small percentage of
customers contribute a large percentage
of operating income.
 It is important that companies devote
sufficient resources to maintaining and
expanding relationships with these key
contributors to profitability.

40
Other Factors in Evaluating
Customer Profitability
Likelihood of customer retention
 Potential for sales growth
 Long-run customer profitability
 Increases in overall demand from having wellknown customers
 Ability to learn from customers

41
Sales Volume Variance
Sales
Mix
aMi
aQ
bMi
bQ
Sales
Quantity
BCMi
aX
Market
Share
aZ
Market
Size BCM
bX
bZ
42
Purposes of Cost Allocation

1
2
3
4
There are four essential purposes of cost
allocation:
To provide information for economic decisions
To motivate managers and other employees
To justify costs or compute reimbursement
To measure income and assets for reporting to
external parties
43
Cost Allocation Criteria
Cost
Allocation
by Cause
and Effect
Cost
Allocation
by Ability
to Bear
How many resources
are consumed by the
cost object?
Cost Object
Cost
Allocation
by Benefit
Received
How many benefits
are received by the user
from using the cost object?
The ability for the
cost object to absorb
additional cost given
reasonable profit
margin
User
44
Allocating Costs of a Supporting
Department to Operating Departments
Supporting (Service) Department – provides
the services that assist other internal
departments in the company
 Operating (Production) Department – directly
adds value to a product or service

45
Allocation Method Tradeoffs
Single-rate method is simple to implement,
but treats fixed costs in a manner similar to
variable costs
 Dual-rate method treats fixed and variable
costs more realistically, but is more complex to
implement

46
Allocation Bases


Under either method, allocation of support costs can
be based on one of the three following scenarios:
1. Budgeted overhead rate and budgeted hours
2. Budgeted overhead rate and actual hours
3. Actual overhead rate and actual hours
Choosing between actual and budgeted rates:
budgeted is known at the beginning of the period,
while actual will not be known with certainty until
the end of the period
47
Budgeted versus Actual Rates
Budgeted rates let the user department know
in advance the cost rates they will be charged.
 Users are better equipped to determine the
amount of the service to request.
 Budgeted rates also help motivate the
manager of the supplier department to
improve efficiency.

48
Budgeted versus Actual Usage
Allocation Bases
When budgeted usage is the allocation base,
user divisions will know in advance their
allocated costs.
 This information helps the user divisions with
both short-run and long-run planning.
 The main justification given for the use of
budgeted usage to allocate fixed costs relates
to long-run planning.

49
Allocating Support
Departments Costs

1
2
3
Three methods are widely used to allocate the
costs of support departments to operating
departments:
Direct allocation method
Step-down method
Reciprocal method
50
Direct Method
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
51
Step-Down Method
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
52
Reciprocal Method
Support Departments
Production Departments
Information Systems
Manufacturing
Packaging
Accounting
53
Allocating Common Costs
Common Cost – the cost of operating a
facility, activity, or like cost object that is
shared by two or more users at a lower cost
than the individual cost of the activity to each
user
 Two methods for allocating common cost are:
1 Stand-alone cost-allocation method
2 Incremental cost-allocation method

54
Joint-Cost Basics
Joint costs are the costs of a single production
process that yields multiple products
simultaneously.
 Industries abound in which a single production
process simultaneously yields two or more
products.

55
Joint Products and Byproducts
Main Products
Byproducts
Joint Products
High
Low
Sales Value
56
Approaches to Allocating
Joint Costs
The two basic approaches to allocating joint
costs are:
 Approach 1: Allocate costs using marketbased data such as revenues.
 Approach 2: Allocate costs in some physical
measure-based data such as weight or volume.

57
Allocating Joint Costs
Approach 1:
 The sales value at splitoff method
 The estimated net realizable value (NRV)
method
 The constant gross-margin percentage NRV
method

58
Constant Gross-Margin
Percentage NRV Method
Step 1: Compute the overall gross-margin
percentage.
 Step 2: Use the overall gross-margin
percentage and deduct the gross
margin from the final sales values to
obtain the total costs that each product
should bear.
 Step 3: Deduct the expected separable costs
from the total costs to obtain the joint59
cost allocation.

Comparison of Methods

–
–
–
–
Why is the sales value at splitoff method
widely used?
It is objective.
It does not anticipate subsequent management
decisions on further processing.
It uses a meaningful common denominator.
It is simple.
60
Irrelevance of Joint Costs
for Decision Making

No techniques for allocating joint-product
costs should guide decisions about whether a
product should be sold at the splitoff point or
processed beyond splitoff.
61
Accounting for Byproducts
Although byproducts have much lower sales
value than do joint or main products, the
presence of byproducts can affect the
allocation of joint costs.
 Byproduct accounting methods differ on
whether byproducts are recognized in the
financial statements at the time of production
or the time of sale.

62
Production
Method
Revenue
Sales
Method
MP Only
MP + BP
COGS
Total Cost – BP NRV
EI (MP)
COGS
Total Cost
EI
COGS
Total EI = EI (MP) + EI (BP)
63
Operation Costing
Job-costing
Systems


Operation Costing Process-costing
System
Systems
A hybrid costing system of customized
manufacturing (job-order) and mass
production (process) systems
Produce batches of similar products with
each batch being a variation of one
design.
64
Operation Costing
Materials
Batch B
Batch C
Operation 3
Batch A
Operation 2

The production system is a sequence of
operations or processes that a product
must go through.
All products may not go through all of the
processes
Operation 1

Finished
Goods
Inventory
65
Accounting for Operation Costing
Separate WIP for each operation (or process).
 As the product moves between operations,
debit receiving operation's WIP, credit sending
operation's WIP.
 Direct materials are traced directly to each
batch (or order).
 Conversion costs are accumulated by
operation. A single average conversion cost is
then applied to units that go through the
operation, regardless of which batch they
belong to.

66
Spoilage, Rework and Scrap
Terminology
There are three types of costs that arise as a
result of defects:
1 Spoilage (損壞品)
2 Rework (重製品)
3 Scrap (剩餘物資)
 Some amount of spoilage, rework, or scrap
appears to be an inherent part of many
production processes.

67
Abnormal Spoilage
Abnormal spoilage costs are written off as
losses of the accounting period in which
detection of the spoiled units occurs.
 Companies record the units of abnormal
spoilage and keep a separate Loss from
Abnormal Spoilage account.

68
FIFO: Spoilage

The FIFO method of process costing keeps
costs in the beginning inventory separate
from the costs in the current period when
determining the costs of good units (which
includes a normal spoilage amount) and the
costs of abnormal spoilage.
69
Job Costing: Spoilage or Rework
Normal spoilage or rework can be assigned to
a specific job or, if common to all jobs, as part
of manufacturing overhead.
 Abnormal spoilage or rework is written off as
a cost of the period.

70
Recognizing Scrap
Scrap, if material in dollar amount, is
recognized in the accounting records either at
the time of its sale or at the time of its
production.
 Scrap, if immaterial, is often recognized as
other revenues at time of sale.

71
Recognizing Material Scrap
at Time of Sale
Recognizing sale of scrap specific to Job #10:
 Cash or Accounts Receivable
300
Work-in-Process (Job #10)
300
Recognizing sale of scrap common to all jobs:
 Cash or Accounts Receivable
300
Manufacturing Overhead Control
300
72
Recognizing Material Scrap
at Time of Production
Recognizing scrap specific to Job #10 is
returned to the storeroom:
 Materials Control
300
Work-in-Process (Job #10)
300
Recognizing scrap common to all jobs is
returned to the storeroom:
 Materials Control
300
Manufacturing Overhead Control 300
73
Quality and Failure
Actual
Performance
Design
Specifications
Conformance
Quality
Failure
Customer
Satisfaction
Design
Quality
Failure
74
The Financial Perspective:
Costs of Quality
The costs of quality (COQ) refer to costs
incurred to prevent, or costs arising as a result
of, the production of a low-quality product.
 These costs focus on conformance quality and
are incurred in all business functions of the
value chain.

75
The Financial Perspective:
Costs of Quality
1
2
Prevention costs--costs incurred in precluding
the production of products that do not
conform to specifications.
Appraisal costs--costs incurred in detecting
which of the individual units of products do
not conform to specifications.
76
The Financial Perspective:
Costs of Quality
3
4
Internal failure costs--costs incurred by a
nonconforming product detected before it is
shipped to customers.
External failure costs--costs incurred by a
nonconforming product detected after it is
shipped to customers.
77
Cost of Quality Exclusions


Opportunity Costs resulting from poor
quality:
1. Contribution Margin and Income forgone
from lost sales
2. Lower Prices
Excluded due to estimation difficulties and
being unrecorded as to the financial
accounting records
78
Nonfinancial Measures
Nonfinancial measures of customer-satisfaction
 Nonfinancial measures of internal performance
 Measures of learning and growth

79
Evaluating Quality Performance
 Advantages
–
–
–
of Financial COQ measures:
Financial measures are helpful to evaluate
tradeoffs among prevention costs, appraisal costs,
and failure costs.
Financial COQ measures assist in problem solving
by comparing different quality-improvement
programs and setting priorities for achieving
maximum cost reduction.
COQ provides a single, summary measure of
quality performance.
80
Evaluating Quality Performance

Advantages of nonfinancial measures of
quality:
–
–
Nonfinancial measures of quality are often easy to
quantify and understand.
Nonfinancial measures direct attention to physical
processes and hence focus attention on the precise
problem areas that need improvement.
81
Control Charts
Defect Rate
Production Line B
m + 2s
m+s
m
m-s
m - 2s
1 2 3 4 5 6 7 8 9 10
Days
82
Number of Times
Defect Observed
Pareto Diagram
700
500
200 Copies are Copies are
fuzzy and
too
unclear
light/dark
Paper gets
jammed
83
Cause-and-Effect Diagrams
Methods and
Design Factors
Human Factors
Inadequate
supervision
Poor training
New operator
Flawed part design
Incorrect
manufacturing
sequence
Inadequate tools
Incorrect speed
Poor
maintenance
Multiple suppliers
Incorrect specification
Variation in purchased
components
Machine-related
Factors
Materials and
Components Factors
84
Time as a Competitive Weapon
Companies need to measure time in order to
manage it properly.
 Two common operational measures of time
are:
1 Customer-response time
2 On-time performance

85
Customer-Response Time
Order is
placed
Order is
received
Order is
set up
Waiting
Time
Receipt
Time
Order is
manufactured
Order is
delivered
Mfg.
Time
Manufacturing
Lead Time
Delivery
Time
Customer-Response Time
86
Theory of Constraints
The objective of TOC is to increase
throughput contribution while decreasing
investments and operating costs.
 TOC considers a short-run time horizon and
assumes operating costs to be fixed costs.

87
Theory of Constraints

The theory of constraints emphasizes the
management of bottlenecks as the key to
improving the performance of the production
system as a whole.
88
Methods to Relieve Bottlenecks
Eliminate idle time at the bottleneck operation
 Process only those parts or products that
increase throughput contribution, not parts or
products that will remain in finished goods or
spare parts inventories
 Shift products that do not have to be made on
the bottleneck operation to nonbottleneck
processes, or to outside processing facilities

89
Methods to Relieve Bottlenecks
Reduce setup time and processing time at
bottleneck operations
 Improve the quality of parts or products
manufactured at the bottleneck operation

90
Costs Associated with
Goods for Sale

1
2
3
4
5
Five categories of costs associated with goods
for sale are:
Purchasing costs
Ordering costs
Carrying costs
Stockout costs
Quality costs
91
Economic-Order-Quantity
Decision Model
The formula for the EOQ model is:
EOQ =
2 DP
C
D = Demand in units for a specified time period
P = Relevant ordering costs per purchase order
C = Relevant carrying costs of one unit in
stock for the time period used for D
92
Considerations in Obtaining
Estimates of Relevant Costs
Obtaining accurate estimates of the cost
parameters used in the EOQ decision model
is a challenging task.
 What are the relevant incremental costs of
carrying inventory?
– Only those costs of the purchasing company
that change with the quantity of inventory
held

93
Considerations in Obtaining
Estimates of Relevant Costs

–
–
What is the relevant opportunity cost of
capital?
It is the return forgone by investing capital in
inventory rather than elsewhere.
It is calculated as the required rate of return
multiplied by those costs per unit that vary
with the number of units purchased and that
are incurred at the time the units are received.
94
Economic-Order-Quantity
Decision Model
What are the relevant total costs?
 The formula for relevant total costs (RTC) is:
RTC = Annual relevant ordering costs +
Annual relevant carrying costs

RTC =

( )×P+( )
D
Q
Q
2
DP
QC
×C=
+
Q
2
Q can be any order quantity, not just EOQ.
95
Relevant Total Costs (Dollars)
10,000
Economic-Order-Quantity
Decision Model
8,000
Annual relevant
total costs
6,000
5,434
Annual relevant
ordering costs
4,000
2,000
Annual relevant
carrying costs
Order Quantity (Units)
600
988 1,200
EOQ
1,800
96
2,400
Reorder Point
988
Reorder
Point
Reorder
Point
494
Weeks
1
2
3
4
5
6
7
8
Lead Time
2 weeks
97
Safety Stock
Safety stock is inventory held at all times
regardless of the quantity of inventory ordered
using the EOQ model.
 Safety stock is used as a buffer against
unexpected increases in demand or lead time
and unavailability of stock from suppliers.

98
Evaluating Managers and
Goal-Congruence Issues

Goal-congruence issues can arise when there
is an inconsistency between the EOQ decision
model and the model used to evaluate the
performance of the manager implementing
the inventory management decisions.
99
Materials Requirement
Planning (MRP)
Materials requirements planning (MRP)
systems take a “push-through” approach that
manufactures finished goods for inventory on
the basis of demand forecasts.
 MRP predetermines the necessary outputs at
each stage of production.
 Inventory management is a key challenge in
an MRP system.

100
Just-In-Time Production Systems
Just-in-time (JIT) production systems take a
“demand pull” approach in which goods are
only manufactured to satisfy customer orders.
 Demand triggers each step of the production
process, starting with customer demand for a
finished product at the end of the process, to
the demand for direct materials at the
beginning of the process.

101
Major Features of a JIT System

1
2
3
4
5
The five major features of a JIT system are:
Organizing production in manufacturing cells
Hiring and retaining multi-skilled workers
Emphasizing total quality management
Reducing manufacturing lead time and setup
time
Building strong supplier relationships
102
Benefits of JIT Systems

–
–
Benefits of JIT production:
Lower carrying costs of inventory
Eliminating the root causes of rework, scrap,
waste, and manufacturing lead time.
103
Performance Measures and
Control in JIT Production
To manage and reduce inventories, the
management accountant must design performance
measures to control and evaluate JIT production.
 What information may management accountants
use?

–
–
Personal observation by production line workers and
managers
Financial performance measures, such as inventory
turnover ratios
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Performance Measures and
Control in JIT Production

What are nonfinancial performance
measures of time, inventory, and quality?
–
–
–
–
–
Manufacturing lead time
Units produced per hour
Days’ inventory on hand
Total setup time for machines/Total manufacturing
time
Number of units requiring rework or scrap/Total
number of units started and completed
105
Backflush Costing
A unique production system such as JIT often
leads to its own unique costing system.
 Organizing manufacturing in cells, reducing
defects and manufacturing lead time, and
ensuring timely delivery of materials enables
purchasing, production, and sales to occur in
quick succession with minimal inventories.

106
Backflush Costing

Where journal entries for one or more stages
in the cycle are omitted, the journal entries for
a subsequent stage use normal or standard
costs to work backward to flush out the costs
in the cycle for which journal entries were not
made.
107
Trigger Points
Stage A: Purchase of direct materials
 Stage B: Production resulting in work in
process
 Stage C: Completion of a good finished unit
or product
 Stage D: Sale of finished goods

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Trigger Points



Assume trigger points A, C, and D.
This company would have two inventory accounts:
Type
Combined materials
and materials in work-inprocess inventory
Account Title
1.
Inventory: Material
and In-Process
Control
2. Finished goods
Finished Goods
Control
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Trigger Points
Assume trigger points A and D.
 This company would have one inventory
account:

Type
Account Title
Combines direct materials
Inventory
inventory and any direct
Control
materials in work-in-process
and finished goods inventories

110
Special Considerations in Backflush
Costing
Backflush costing does not necessarily
comply with GAAP
– However, inventory levels may be
immaterial, negating the necessity for
compliance
 Backflush costing does not leave a good audit
trail – the ability of the accounting system to
pinpoint the uses of resources at each step of
the production process

111