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Throughput Accounting: Today's Topics: Homework
Throughput Accounting: Today's Topics: Homework
Lecture Topic:
During the lecture, take notes here. Insert a sub-page for each lecture topic.
Introduction
Throughput is the money generated from sales minus the cost of the materials used in making the
items sold. i.e.
Throughput = Sales - Material cost
In throughput accounting all other direct costs except direct material are recognised as conversion
costs. For instance, direct labour is added with indirect materials and other overheads to form
conversion costs.
Throughput accounting recognise direct material only as variable cost. Direct labour and direct
expenses are recognised as fixed costs. So a total of direct labour, direct expenses and overheads
is called total factory cost.
Bottleneck resource
A bottleneck resource is a limiting factor or a constraint that prevent output and throughput from
getting higher. So a bottleneck resource can be a production factor such as machine time or labour
time or it can be lack of product quality etc.. So when they is a bottleneck resource, the objective
of an organisation should be to maximise throughput. Bottleneck resource is also called binding
constraint.
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cost. It concentrates on bottlenecks which are constraints or limiting factors that prevent
maximisation of throughput. TOC says that they is no need to hold inventory as inventory costs
money in terms of storage space etc..
The theory of constraints states that the aim of management should be to maximise total
throughput and the only way to increase throughput is by increasing the capacity of the bottleneck
constraint. Management should focus on increasing the capacity of the bottleneck resource.
For example, time on Machine Type X may be a bottleneck resource. The only way to increase
throughput is to increase the output capacity of Machine Type X.
Ways in which this might be done, without buying a new Type X machine, could include:
○ Moving from working 5 days a week to working 6 or 7 days a week
○ Moving from working a 12-hour production day to an 18-hour or 24-hour production day
○ Carrying out routine maintenance work on the machine outside normal working hours, so
that maintenance does not disrupt production.
If the capacity of a bottleneck resource is elevated (increased) sufficiently it will eventually cease
to be a bottleneck resource. Another resource in the system will become the new bottleneck
resource. The same approach is now going to be used for the new bottleneck resource.
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Throughput accounting is based on following concepts:
a. Cost behavior
In the short-term all manufacturing cost with the exception of material cost are fixed costs.
These fixed costs include direct labour. It is useful to group all these costs together and
call them Total Factory Costs (TFC).
b. Inventory
Throughput is only created when a finished output has been sold. So by keeping produced
items as stock, this prevent throughput from being made. Therefore, managers should
always think of increasing throughput while at the same time tries to reduce inventory and
operational expenses. Managers should look for best ways to reduce stock as soon as
possible. Just in Time (JIT) technique may be used which require products to be made only
when customers has ordered them to have inventory level at zero.
In order to maximise throughput, managers should try their best to find bottlenecks and remove
them. When its impossible to remove the bottlenecks, the managers should ensure that those
bottlenecks are fully utilised.
The throughput accounting ratio (TA ratio) is a useful ratio and below is the formula for
calculating it:
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Factory cost per unit of bottleneck resource
(Note: Instead of ‘per unit of bottleneck resource’, you may come across the term ‘per factory
hour’. This means the same thing in this context.)
The factory cost per unit of bottleneck resource (factory hour) is calculated using the following
formula:
Total throughput should exceed total factory costs; otherwise the organisation will make a loss.
This means that the TA ratio should exceed 1.0. A TA ratio that is below 1.0 is likely not
profitable.
Products can be ranked in order of priority. Higher TA ratios should be given priority over lower
TA ratios.
Note:
Note that ranking products in order of priority according to their TA ratio will always give the
same ranking as putting them in order of throughput per unit of bottleneck resource.
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throughput.
3. Scale down or rank the throughput of non-bottleneck activities to match what can be dealt
with by the bottleneck.
4. Remove the bottleneck if possible
5. Since throughput accounting is a continues improvement process, return to step 1 and re-
evaluate the system now that bottlenecks have been removed.
Summary
After the lecture, use this space to summarize the main points of this Lecture
Topic.
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