THROUGHPUT ACCOUNTING

Throughput can be defined as the rate at which an entity achieves its

goals, measured in ‘goal units’. In not-for-profit entities, the goal of the
entity could be measured in terms of a non-financial goal. For profit-
making entities, the goal is profit. Throughput differs from contribution in
traditional marginal costing because variable costs consist only of real
variable costs, which are (mainly or entirely) materials costs.

Throughput accounting is not really a costing system at all, because with

costing no costs are allocated to units of production, with the exception
of materials costs.

Assumptions In Throughput Accounting

Throughput accounting is based on a number of assumptions.

1. In traditional marginal costing, it is assumed that direct labour costs

are a variable cost, but in practice this is not usually correct. Employees
are paid a fixed weekly or monthly wage or salary, and labour costs are a
fixed cost.

2. The only variable cost is the purchase cost of materials and

components purchased from external suppliers.

3. A business makes real profit by adding value. Value is added by selling

goods or services to customers whose market value is more than the cost
of the materials that go into making them. However, value is not added
until the sale is actually made.

4. Value added should be measured as the value of the sale minus the
variable cost of sales, which is the cost of the materials.
Concepts Of Throughput Accounting

1. Throughput With Theory Of Constraints

2. Throughput With Inventory Or Investment

3. Throughput With Operating Expenses.

1. Throughput With Theory Of Constraints

Throughput accounting is derived from the Theory of Constraints, which

is based on the view that every system has a constraint. A constraint is
anything that limits the output from the system.

Constraints for a manufacturing company might be caused by any of the

following:

* External factors, such as a limit to customer demand for the products

that the company makes.

* Weaknesses in the system itself, such as shortages of key resources

and capacity limitations

* Weaknesses in the system’s controls, such as weak management.

In a manufacturing system, constraints can be described as bottlenecks

in the system. A bottleneck is simply a constraint that limits throughput.

Dealing With Constraints

* Management should identify the key constraint and consider ways of

removing or easing the constraint, so that the system is able to produce
more output.

* However, when one constraint is removed, another key constraint will

take its place.

* The new key constraint must be identified, and management should now
turn its attention to ways of removing or easing the new key constraint.
* By removing constraints one after another, the output capacity of the
system will increase.

Relevance Of Constraints To Throughput Accounting

The relevance of constraints to throughput accounting is to increase

throughput. Throughput can be increased by identifying the bottlenecks in
the system, and taking action to remove them or ease them.

2. Throughput With Inventory Or Investment

Inventory or investment is all the money that is tied up in a business, in

inventories of raw materials, WIP and finished goods. The term
‘investment’ is normally preferred to ‘inventory’ because it includes the
amount of capital tied up in making the product and selling it to
customers. Investment therefore includes not only the amount invested in
inventories but also investment in non-current assets.

Inventory is eventually converted into throughput, but until it is sold it is

capital tied up earning nothing. When inventory is sold, throughput is
created.

Throughput is not created until finished goods are sold. Creating finished
goods for inventory is therefore damaging to the entity’s goals, because it
ties up finance in investment and investment finance has a cost.

Inventories do not have value, except the variable cost of the materials
and components. Even for work-in-progress and inventories of finished
goods, the only money invested is the purchase cost of the raw materials.

No value is added until the inventory is sold.

* In throughput accounting, all inventories are therefore valued at the cost
of raw materials and components, and nothing more.

* It should not include any other costs, not even labour costs. No value is
added by the production process, not even by labour, until the item is sold.

* It is impossible to make extra profit simply by producing more output,

unless the extra output is sold

3. Throughput With Operating Expenses

Operating expenses are all the expenditures incurred to produce the

throughput. They consist of all costs that are not variable costs, and so
include labour costs. Profit in throughput accounting is measured as
throughput minus operating expenses.

Performance Measurement Ratios In Throughput Accounting

There are several methods of measuring performance in throughput

accounting, they include:

1. Net Profit Basis: This is total Throughput minus Operating expenses.

An objective is to increase net profit of the entity.

2. Return On Investment: The objective is to increase the return on

investment, either by increasing net profit or reducing the size of the
investment.

3. Throughput Productivity: The objective is to increase throughput

productivity, either by increasing throughput or reducing operating
expenses.
4. Throughput Accounting Ratio (T.A.R): The throughput accounting ratio
is the ratio of [throughput in a period per unit of bottleneck resource] to
[operating expenses per unit of bottleneck resource].

Units of a bottleneck resource are measured in hours (labour hours or

machine hours).

How Can The T.A.R Be Increased

T.A.R can be increased by taking the following measures:

1. Raising Selling Prices.

2. Improving Machine Efficiencies

3. Reducing Total Operating Expenses

4. Training Of Workers

5. Increasing The Working Hours.

SAMPLE QUESTION 1

NOVEMBER 2016 DIET- QUESTION 1 (HICENTA LIMITED)

SAMPLE QUESTION 2

NOVEMBER 2020 DIET - QUESTION 2 (IDEAL NIGERIA LIMITED)

SAMPLE QUESTION 3

NOVEMBER 2021 - QUESTION 3 (KAHKIRI LIMITED)

SAMPLE QUESTION 4