Throughput Accounting (TA)

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

Throughput is a measure of profitability and is defined by the following equation:

Throughput = sales revenue – direct material cost

The aim of throughput accounting is to maximise this measure of profitability, whilst simultaneously reducing
operating expenses and inventory (money is tied up in inventory).

The goal is achieved by determining what factors prevent the throughput from being higher. This constraint is called
for example there may be a limited number of machine hours or labour hours.

Main assumptions

The only totally variable cost in the short-term is the purchase cost of raw materials that are bought from external su

Direct labour costs are not variable in the short-term. Many employees are salaried and even if paid at a rate per unit
are usually guaranteed a minimum weekly wage.

Given these assumptions, throughput is effectively the same as contribution.

l, and then focuses on

simultaneously reducing

igher. This constraint is called a bottleneck

at are bought from external suppliers.

d even if paid at a rate per unit,

Theory of Constraints [ TOC ]

Goldratt and Cox describe the process of identifying and taking steps to remove the constraints that restrict output
as the Theory Of Constraints (TOC).

Step 1 Identify the system's bottleneck

Step 2 Decide how to exploit the bottlenecks
Step 3 Subordinate everything else to the decision in step 2
Step 4 Elevate the system's bottlenecks
Step 5 If, in the previous step, a bottleneck is broken, go back to step 1

What is a Bottleneck ?

As an example, assume that a furniture manufacturer moves wood, metal, and other raw materials into production
and then incurs labor and machine costs to produce and assemble furniture. When production is complete, the finishe
goods are stored in inventory. The inventory cost is transferred to cost of goods sold (COGS) when the furniture is s

Example I

Picture a fully-booked restaurant. Suddenly, both servers call in sick last minute.

This halts the process since there’s nobody to take orders or deliver the food to tables.

You can send your line cooks out to do the job but their lack of training makes them slower and increases mistakes.
Plus, since the line cooks are now taking orders, they’re slower to cook the food.

Cost is another issue. Bottlenecks are expensive as you end up shelling out extra cash to deal with delays or remedy

In the restaurant scenario, you might end up giving customers money back to compensate for bad service and incorre
onstraints that restrict output

aw materials into production

duction is complete, the finished
COGS) when the furniture is sold to a customer.

lower and increases mistakes.

to deal with delays or remedy issues.

sate for bad service and incorrect orders.

Question

Demand for a product made by P Ltd is 500 units per week. The product is made in three consecutive
processes – A, B, and C. Process capacities are:

Process A B C
Capacity per week 400 300 250

The long-run benefit to P Ltd of increasing sales of its product is a present value of $25,000
per additional unit sold per week.

Investigations have revealed the following possibilities:

Option 1
Invest in a new machine for process A, which will increase its capacity to 550 units per week. This will cost $1 m.

Option 2
Replace the machine in process B with an upgraded machine, costing $1.5m. This will double the capacity of proces

Option 3
Buy an additional machine for process C, costing $2m. This will increase capacity in C by 300 units per week.

Required
What is P Ltd's best course of action?

The above options are not mutually exclusive, so your answer should consider combinations
as well as looking at them individually.

Solution

There are three processes in the making of final product

Output of process A becomes input for Process B For example

Output for process B becomes input for Process C Process A could be priniting
Process C is the final process and its output is my final product Process B could be binding
Process C could be wrapping for f

Demand 500 units ** While process A gives me 400 units as output, proces
Production (max possible) 250 units So, even if output of process A is 400, you only move ah
And while process B gives you 300 units per week, proc
It can handle and give you only 250 units per week

Here, process C is my bottleneck

Because although A gives me 400 as output, my final pr
lower output capacity of process C

" The chain is not stronger than its weakest link"

Process A can give me 400 but due to limited processing capacity of process C, I get restricted

Stage I Analysis

If we go ahead with option 1, output of process A will be 550

However, my total weekly output of final product will still be 250 only
This is because of the limited processing capacity of process C
So, option 1 is ruled out as it does not remove the bottleneck

If we choose option 2, process B gets an upgrade and its output is now 300* 2 = 600
Had all machines been at this level, I would have gotten 600 units of final product
But, Process C is a spoilsport. It ruins my plans and gives me only 250 units
Even if B gives me 600, C will be able to handle and process only 250
So, option 2 is also ruled out

If we go for option 3, then there will be an additional machine in process C

Output of C will now be 250 + 300 = 550

What does my updated schedule look like

Process A B C
Output (in units) 400 300 550

Now, machine B is my pain point as it is restricting my output

Machine B is my bottleneck now

Stage II Analysis

If we go ahead with option 1, output of process A will be 550

However, my total weekly output of final product will still be 300 only
This is because of the limited processing capacity of process B
So, option 1 is ruled out as it does not remove the bottleneck

If we choose option 2, process B gets an upgrade and its output is now 300* 2 = 600
Had all machines been at this level, I would have gotten 600 units of final product
But even after doing so, my final output per week will still be 400 at max
Why ? Because of the limited processing capacity of machine A

** When I do an upgrade for process B, I have to spend 1.5 mn

What does my updated schedule look like

Process A B C
Output (in units) 400 600 550

Process A is my bottleneck

Stage III Analysis

Process A is my bottleneck

If we use option 1, output of process A is now 550

What does my updated schedule look like

Process A B C
Output (in units) 550 600 550

Demand however is 500 per week

So, now demand is my bottleneck

I have production capacity of 550 per week

But demand is only 500, that means I can sell just 500units
Demand is my bottleneck
in three consecutive

its per week. This will cost $1 m.

s will double the capacity of process B.

y in C by 300 units per week.

For example
Process A could be priniting 400 100
Process B could be binding 300 50
Process C could be wrapping for final dispatch 250

gives me 400 units as output, process B can handle only 300

process A is 400, you only move ahead with 300 due to process B
gives you 300 units per week, process C is not equipped to handle that
e you only 250 units per week

y bottleneck
gives me 400 as output, my final product gets restricted at 250 because of
y of process C
get restricted

** When I use additional machine in process C, I have a cash outflow of 2 mn

After I remove the bottleneck in process C -

Maximum output possible 300 [ Because of process B which is the new bottleneck ]
Current output under bottleneck conditions 250
What is additional output 50 [ 300 - 250 ]
So, total benefit will be 1,250,000 [ 50 * 25000 per additional unit '
But, when I use additional machine,
Cost of that machine is 2,000,000
I am in a net loss position -750,000

Stopping here is not good!!!

After I remove the bottleneck in process B (and earlier in process C )-

Maximum output possible 400
Current output under bottleneck conditions 250
What is additional output 150
So, total benefit will be 3,750,000 [ 150 additional units * 25000 ]
But, when I use additional machine / upgrade 150 because after removing 2 bottlenecks, output jumped
Purchase Cost of machine for process B -1,500,000 up from 250 to 400
Purchase Cost of machine for process C -2,000,000

I will have a net benefit of 250,000

After I remove bottlenecks in C first, then B and finally in Process A

Maximum output possible 500

Current output under bottleneck conditions 250
What is additional output 250
So, total benefit will be 6,250,000 [ 250* 25000]
But, when I use additional machine / upgrade
Cost of machine for process C -2,000,000
Cost of machine for process B -1,500,000
Cost of machine for process A -1,000,000

Net Benefit / (cost) 1,750,000

which is the new bottleneck ]
ing 2 bottlenecks, output jumped
Question

Hard Tiles recorded a profit of $120,000 in the accounting period just ended, using marginal costing.
The contribution/sales ratio was 75%.

Material costs were 10% of sales value and there were no other variable production overhead costs.
Fixed costs in the period were $300,000.

What was the value of throughput in the period?

Solution

Profit = Contribution - Fixed cost

120000 = Contribution - 300000

Contribution = 120000 + 300000 = 420000

Contribution / Sales = 420000 / Sales = 75%

Sales = 420000 / 75% = 560000

Material cost = 10% of sales = 10% of 560000 = 56000

Throughput = Sales - Material cost = 560000 - 56000 = 504000

arginal costing.

verhead costs.