Backorder is defined as order received for good or service but cannot be fulfilled and can be due to various reasons such as the non-availability of the ordered product or the stock is still in the production phase or the order is placed with manufacturer and delivery is still pending, etc. It is an indication of the company’s backlog i.e. it needs to increase its supply & produce more.
It shows how well the company is managing the inventory and customers & how effectively it communicates to retain its customers. The examples of backorder are as follows:
- Mr. A purchases 10 buses from the dealer, but the dealer only has 4 buses in inventory, which he can deliver, and for the remaining 6 buses, Mr. A has to wait for 7 to 8 months as it takes the dealer 7 to 8 months to get it from the supplier.
- So Mr. A has two options either he can purchase 4 buses on the spot and for remaining he can wait for 7 to 8 months, or if Mr. A needs all 10 on the urgent basis, he can take 4 from that dealer and ask the dealer to deliver within two months if possible and if it is not possible then cancel the order for remaining 6 buses which he will buy from another dealer. So, because of competition, it is important to fulfill backorders within the stipulated time to retain the customer.
Accounting for Backorders
- The backorder needs special accounting as the order received. Still, the product is not sold, and it is the duty of the company to inform the customers about the status of the product ordered and the expected time of delivery. It is upon customer after receiving information on whether to wait or cancel the order. The backorders can be treated as a sale on a return basis as it involves the chances of cancellation of the order. The accounting treatment is as follows:
- Record the sale as backorder sale and if the company has ordered to supplier for backorder products, record it as backorder purchases. If the manufacturing is in the process, then it comes under inventory as work in progress. If the order is canceled, then also the company’s sales wouldn’t be affected as it doesn’t record backordered sales as complete sales. Once the order gets fulfilled, transfer the backorder sale to a sales account, and if the order canceled and goods arrived, then transfer the backorder sales in the inventory account.
- Reduces the Inventory Storage Cost – The backorders, if effectively fulfilled within a short span of time, the customers can wait and its benefits as a cost advantage to the company. It reduces inventory storage costs.
- Enhances Customer Relationship – The backorders enhance the customer relationship if they are properly communicated to the customers. Wait by the customer for products shows the faith of the customer towards the product and the company as a whole.
- Determines the Demand for Product – Backorders helps to determine the demand for the product in the market. It is an indication of high demand and also an indication that the company needs to increase the manufacturing or purchase to fulfill the demand.
- Helps to Stay in Competition – If backorders are fulfilled by the company within a reasonable time, then it can stay in the market for longer and can able to face competition.
- Determines the Capabilities of the Company and Enhances Efficiency – Backorder is the indication that the company has underestimated the demand for its products, and also by fulfilling it within a reasonable time enhances the efficiency of staff as the process gets faster to fulfill the order at the earliest.
- Backorders, if treated efficiently, then it makes business run faster and satisfy the customers.
- Cancellation of Orders – Due to backorders, the customer might cancel the order as he might not be able to wait due to urgent need of the product, and hence the business of the company can be transferred to the competitor.
- Adverse Impression on Customers and Reduces Goodwill – If the product continuously remains in the backorder, then it creates the wrong impression in the minds of customers and eventually reduces the faith and goodwill of the company.
- Indication of Improper Management by Company – If backorders take a long time to complete, it is an indication of improper management by the company, and it needs to improve to sustain in the market.
- Can Enhance the Cost – As in the hurry of fulfilling the backorder demands, it can increase the cost as the supplier may sell the material at a higher rate due to high and urgent demand.
- Backorders are the orders which are placed by customers, but that cannot be fulfilled due to the non-availability of product in the stock, and it indicates that the company needs to hurry up its operations to remain in the competition.
- Backorders, if managed well, then it can benefit the company at large as it reduces the inventory carrying cost and enhances the efficiency of operational staff. If the customers are ready to wait for the product, then it is signed to the company that customers have faith in the product, and the company needs to keep the faith.
- Every company needs to properly communicate to the customers that order for product is received and the time limit for delivery of the product. It is upon the customer to wait or cancel the order depending upon the type and goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price. of the product and need of a customer.
This article has been a guide to what is Backorder & its meaning. Here we discuss examples of the backorder, its accounting along with its advantages and disadvantages. You can learn more about from the following articles –