THROUGHPUT

ACCOUNTING
Definition
It is the rate of conversion of raw materials and purchased components into products sold to
customers.
Constraints and Bottle necks in the
system

Throughput accounting originated from the theory of constraints (TOC) which is based on the
view that every system has a constrain (anything that limits our ability to achieve what you want
to achieve)
If a system had no constraints, its output would be either zero or the system would continue to
produce more and more without any limits.
Therefore for any system whose output is not zero, there must be a constraint that stops it from
producing more output than it does.
Reasons for Constraints
External factors such as limits to customer demand on products produced by the organisation.
Weaknesses in the system s controls that is weak management.
Weaknesses in the system such as shortages on key resources (materials) or capacity.
In-a manufacturing system, constraints are referred to as bottlenecks. A bottle neck is simply a
constraint that limits the output of an organisation(material ,labour and capacity)
Dealing with constraints

Management of the business operations should focus on dealing with key constraints by
identifying what they are.
Action by management to improve operational efficiency is a waste of time and efforts if it is
applied to any area of operations which is not a constraint.
The key constraints limits through put since this could be a limitation in sales demand,
inefficiency production, unreliable suppliers or shortage of key resources of production.
Cont…
Godraft developed the theory of constraints .He argued that :
1. Management should identify the key constraints and consider way of removing or easing the
constraint so the system is able to produce more output.
2. When one constraint is moved, another key constraint will take place so management must
be aware of that.
3. The new key constraint must be identified and management should now turn its attention to
way of reducing / removing its key constraint.
4. By removing constraints one by one, the output of the org will improve.
RELEVANCE OF TOC IN
THROUGHPUT A/C
Godratt argued that if the aim of the business is to make money and profit ,then the appropriate
method to do so are :
1. Increase the throughput
2. Reduce operating expenses
3. Reduce investment [money invested in inventory-can be reduced by reducing the level of
inventory] .
4.Godratt argued also that the most effective way of increasing profit is to increase throughput
and it can be increased by identifying bottlenecks and ease them .
Assumptions
1. In traditional marginal costing it is assumed that direct labour cost are variable costs where as
in throughput it is termed a fixed cost since employees are paid on a continuous basis.
2. The only variable cost is the purchase of raw materials which comes from external suppliers.
3. A business makes real profit by value addition.
4. Value added should be measured as the value of sales minus the variable cost of sales.
THROUGHPUT INVENTORY AND
OPERATING EXPENSES
Throughput accounting is based on these three (3) major items, that is, the throughput itself,
inventory and operating expenses.
Therefore throughput is the rate at which the entity achieve its goal measured in goal units :
Thus throughput =sales –total variable cost (The variable cost is the sum of materials and any
other components.
NB. Throughput is only created when all inventories are sold
The Operating expenses
These are the expenditures incurred to produce output and it consists of labour and any other
fixed cost incurred by the organisation.
Measurement
$
Sales xxx
Variable cost (material) ( xx)
Through put xxx
Less operating expenses (x)
Profit x
VALUE OF INVENTORY IN
THROUGHPUT
Inventories do not have value except the variable cost of the materials and components.
Work in progress and finished goods is only money invested that cost of purchase of the raw
materials is the value and nu value addition occurs until they are sold.
Thus, in throughput accounting, all inventories are valued at the cost of raw materials and
components.
The variable cost should not include the cost of labour as no value addition takes place by
producing but only when items are sold.
Example
A company produces 1000units of a product during the month of June and sells 800units for $32000. There was no opening inventory .Cost of
production were as follows:
$
Direct labour 8000
Raw materials 6000
Fixed production overheads 10 000
Other Non-production overheads 5000

Required
To calculate the profit of the period using:
a)absorption costing
b) Marginal costing
c) Throughput accounting
NB. Assume for the absorption that the budgeted and actual overheads were the same and there are no under/over absorption of overheads.
Criticisms of throughput
It concentrates on the short –term when a business has fixed supply of resources and operating
expenses that are largely fixed.
It is more difficult to apply throughput accounting concepts to longer term when all costs are
variable and vary with the volume of production and sales or any other cost driver.
In the longer term ABC might be more appropriate for measuring and controlling performance.
How to improve throughput
accounting
Increase sales price for each unit sold so as to increase throughput per unit.
Reduce total operating expenses to reduce cost per assembly.
Reduce material cost per unit by changing material or switching suppliers.
Improve the productivity of the assembly workforce and reduce the time required to make each
unit of the product.
Throughput per assembly hour would increase but the expenses per assembly hour would be
unchanged therefore the throughput would increase.
THROUGHPUT PRODUCTIVITY
Is measured as: throughput * 100%
Operating expenses
THROUGHPUT PER UNIT OF
CONSTRAINT
The advantage is that labour is treated as a fixed cost. Thus in line in that where production
process has been automated, directed labour costs becomes less important to total production
costs. Unlike traditional approaches
THROUGHPUT ACCOUNTING
RATIO
Is the ratio of (throughput in a period per unit of bottleneck resources to [operating expenses
per unit of bottleneck resource)

Thus throughput accounting ratio = throughput per hour of bottleneck resources

Operating expenses per hour of bottleneck resources
EXAMPLES
Makore investments manufacture window seals, each seal selling for $20. The materials costs
are $8 per unit. Total operating expenses each month are $12 000.
Machine capacity is the key constraint on production. There are only 600 machine hours
available each month and it takes three minutes of machine time to produce each unit.

Required
Calculate the throughput accounting ratio
How might the ratio be increased
End