Throughput accounting
Throughput accounting is a principle-based and simplified management accounting approach that provides managers with decision support information for enterprise profitability improvement. TA is relatively new in management accounting. It is an approach that identifies factors that limit an organization from reaching its goal, and then focuses on simple measures that drive behavior in key areas towards reaching organizational goals. TA was proposed by Eliyahu M. Goldratt as an alternative to traditional cost accounting. As such, Throughput Accounting is neither cost accounting nor costing because it is cash focused and does not allocate all costs to products and services sold or provided by an enterprise. Considering the laws of variation, only costs that vary totally with units of output e.g. raw materials, are allocated to products and services which are deducted from sales to determine Throughput. Throughput Accounting is a management accounting technique used as the performance measure in the Theory of Constraints. It is the business intelligence used for maximizing profits, however, unlike cost accounting that primarily focuses on 'cutting costs' and reducing expenses to make a profit, Throughput Accounting primarily focuses on generating more throughput. Conceptually, Throughput Accounting seeks to increase the speed or rate at which throughput is generated by products and services with respect to an organization's constraint, whether the constraint is internal or external to the organization. Throughput Accounting is the only management accounting methodology that considers constraints as factors limiting the performance of organizations.
Management accounting is an organization's internal set of techniques and methods used to maximize shareholder wealth. Throughput Accounting is thus part of the management accountants' toolkit, ensuring efficiency where it matters as well as the overall effectiveness of the organization. It is an internal reporting tool. Outside or external parties to a business depend on accounting reports prepared by financial accountants who apply Generally Accepted Accounting Principles issued by the Financial Accounting Standards Board and enforced by the U.S. Securities and Exchange Commission and other local and international regulatory agencies and bodies such as International Financial Reporting Standards.
Throughput Accounting improves profit performance with better management decisions by using measurements that more closely reflect the effect of decisions on three critical monetary variables.
History
When cost accounting was developed in the 1890s, labor was the largest fraction of product cost and could be considered a variable cost. Workers often did not know how many hours they would work in a week when they reported on Monday morning because time-keeping systems were rudimentary. Cost accountants, therefore, concentrated on how efficiently managers used labor since it was their most important variable resource. Now however, workers who come to work on Monday morning almost always work 40 hours or more; their cost is fixed rather than variable. However, today, many managers are still evaluated on their labor efficiencies, and many "downsizing," "rightsizing," and other labor reduction campaigns are based on them.Goldratt argues that, under current conditions, labor efficiencies lead to decisions that harm rather than help organizations. Throughput Accounting, therefore, removes standard cost accounting's reliance on efficiencies in general, and labor efficiency in particular, from management practice. Many cost and financial accountants agree with Goldratt's critique, but they have not agreed on a replacement of their own and there is enormous inertia in the installed base of people trained to work with existing practices.
Constraints accounting, which is a development in the Throughput Accounting field, emphasizes the role of the constraint, in decision making.
The concepts of Throughput Accounting
Goldratt's alternative begins with the idea that each organization has a goal and that better decisions increase its value. The goal for a profit maximizing firm is stated as, increasing net profit now and in the future. Profit maximization seen from a Throughput Accounting viewpoint, is about maximizing a system's profit mix without Cost Accounting's traditional allocation of total costs. Throughput Accounting actions include obtaining the maximum net profit in the minimum time period, given limited resource capacities and capabilities. These resources include machines, capital, people, processes, technology, time, materials, markets, etc. Throughput Accounting applies to not-for-profit organizations too, where they develop their goal that makes sense in their individual cases, and these goals are commonly measured in goal units.Throughput Accounting also pays particular attention to the concept of 'bottleneck' in the manufacturing or servicing processes.
Throughput Accounting uses three measures of income and expense:
- Throughput is the rate at which the system produces "goal units." When the goal units are money , throughput is net sales less totally variable cost, generally the cost of the raw materials. Note that T only exists when there is a sale of the product or service. Producing materials that sit in a warehouse does not form part of throughput but rather investment.
- Investment is the money tied up in the system. This is money associated with inventory, machinery, buildings, and other assets and liabilities. In earlier Theory of Constraints documentation, the "I" was interchanged between "inventory" and "investment." The preferred term is now only "investment." Note that TOC recommends inventory be valued strictly on totally variable cost associated with creating the inventory, not with additional cost allocations from overhead.
- Operating expense is the money the system spends in generating "goal units." For physical products, OE is all expenses except the cost of the raw materials. OE includes maintenance, utilities, rent, taxes and payroll.
- Increase throughput? How?
- Reduce investment ? How?
- Reduce operating expense? How?
- Net profit = throughput – operating expense = T – OE
- Return on investment = net profit / investment = NP/I
- TA Productivity = throughput / operating expense = T/OE
- Investment turns = throughput / investment = T/I
Explanation
For example: The railway coach company was offered a contract to make 15 open-topped streetcars each month, using a design that included ornate brass foundry work, but very little of the metalwork needed to produce a covered rail coach. The buyer offered to pay $280 per streetcar. The company had a firm order for 40 rail coaches each month for $350 per unit.| Overhead Cost by Department | Total Cost | Hours Available per month | Cost per hour |
| Foundry | 7,300.00 | 160 | 45.63 |
| Metal shop | 3,300.00 | 160 | 20.63 |
| Total | 10,600.00 | 320 | 33.13 |
| Standard Cost Accounting Analysis | Streetcars | Rail coach |
| Monthly Demand | 15 | 40 |
| Price | $280 | $350 |
| Foundry Time | 3.0 | 2.0 |
| Metalwork Time | 1.5 | 4.0 |
| Total Time | 4.5 | 6.0 |
| Foundry Cost | $136.88 | $91.25 |
| Metalwork Cost | $30.94 | $82.50 |
| Raw Material Cost | $120.00 | $60.00 |
| Total Cost | $287.81 | $233.75 |
| Profit per Unit | $ | $116.25 |
| Throughput Cost Accounting Analysis | Decline Contract | Take Contract |
| Coaches Produced | 40 | 34 |
| Streetcars Produced | 0 | 15 |
| Foundry Hours | 80 | 113 |
| Metal shop Hours | 160 | 159 |
| Coach Revenue | $14,000 | $11,900 |
| Streetcar Revenue | $0 | $4,200 |
| Coach Raw Material Cost | $ | $ |
| Streetcar Raw Material Cost | $0 | $ |
| Throughput Value | $11,600 | $12,260 |
| Overhead Expense | $ | $ |
| Profit | $1,000 | $1,660 |