Accounting Best Practices, Fifth Edition

16–3. Modify the Bills of Material Based on Actual Scrap Levels

The typical company relies heavily on its bills of material to determine the cost of its products. They can be used not only as a reference tool to quickly look up a cost, but also as the primary means of calculating the remaining on-hand inventory balance if back-flushing is used. Under the back-flushing concept, a company simply enters the amount of its production for the day, and the computer will automatically clear this inventory from stock, based on the amount of materials that should have been used, as noted in the bills of material. Though this approach is remarkably easy to use, given the reduced volume of paperwork, it can quickly lead to very inaccurate inventory balances if the underlying bills of material are incorrect. This is a particularly difficult problem if the true scrap level is not reflected in the bills of material. If this is the case, the amount of materials listed in each bill will be too small, resulting in an inadequate amount being back-flushed out of inventory, which leaves inventory balances too high.

The soultion is to ensure that the correct scrap levels are included in each bill of material. By doing so, the amount of material back-flushed out of the inventory will be much more accurate, resulting in a more accurate inventory, cost of goods sold, and fewer (if any) material stock-outs to interfere with production.

To add accurate scrap rates to the bills of material, there must be ...