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Throughput accounting (TA) is a principle-based and simplified
management accounting In management accounting or managerial accounting, managers use accounting information in decision-making and to assist in the management and performance of their control functions. Definition One simple definition of management accounting is the ...
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 Cost accounting is defined as "a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in detail. It includes methods for recognizing, classifying, allo ...
. As such, Throughput Accounting is neither
cost accounting Cost accounting is defined as "a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in detail. It includes methods for recognizing, classifying, allo ...
nor costing because it is cash focused and does not allocate all costs (variable and fixed expenses, including overheads) to products and services sold or provided by an enterprise. Considering the laws of variation, only costs that vary totally with units of output (see definition of T below for TVC) e.g. raw materials, are allocated to products and services which are deducted from sales to determine Throughput. Throughput Accounting is a
management accounting In management accounting or managerial accounting, managers use accounting information in decision-making and to assist in the management and performance of their control functions. Definition One simple definition of management accounting is the ...
technique used as the performance measure in the Theory of Constraints (TOC). 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 (see definition of T below) 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 (public) accountants who apply Generally Accepted Accounting Principles ( GAAP) issued by the
Financial Accounting Standards Board The Financial Accounting Standards Board (FASB) is a private standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles Publicly traded companies typically are subject to the most rigorous ...
(FASB) and enforced by the
U.S. Securities and Exchange Commission The U.S. Securities and Exchange Commission (SEC) is a large independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929 The Wall Street Crash of 1929, also known as the Great Crash ...
(SEC) and other local and international regulatory agencies and bodies such as
International Financial Reporting Standards International Financial Reporting Standards, commonly called IFRS, are accounting standard Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus ...
(IFRS). 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 (
throughput In general terms, throughput is the rate of production or the rate at which something is processed. When used in the context of communication networks, such as Ethernet Ethernet () is a family of wired ing technologies commonly used in s ...
,
investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance Finance is the study of financial institution ...

investment
(AKA
inventory Inventory () or stock () refers to the goods and materials that a holds for the ultimate goal of resale, production or utilisation. is a discipline primarily about specifying the shape and placement of stocked goods. It is required at differen ...
), and
operating expense An operating expense, operating expenditure, operational expense, operational expenditure or opex is an ongoing cost for running a product, business, or system . Its counterpart, a capital expenditure Capital expenditure or capital expense (cap ...
— defined below).


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, (referred to as the Archemedian 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 In economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plant l ...

Profit maximization
seen from a Throughput Accounting viewpoint, is about maximizing a system's profit mix without
Cost Accounting Cost accounting is defined as "a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in detail. It includes methods for recognizing, classifying, all ...
'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 (own or borrowed), people, processes, technology, time, materials, markets, etc. Throughput Accounting applies to
not-for-profit A nonprofit organization (NPO), also known as a non-business entity, not-for-profit organization, or nonprofit institution, is a legal entity organized and operated for a collective, public or social benefit, in contrast with an entity that o ...
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' (referred to as ''constraint'' in the Theory of Constraints) in the manufacturing or servicing processes. Throughput Accounting uses three measures of income and expense: *
Throughput In general terms, throughput is the rate of production or the rate at which something is processed. When used in the context of communication networks, such as Ethernet Ethernet () is a family of wired ing technologies commonly used in s ...
(T) is the rate at which the system produces "goal units." When the goal units are money (in for-profit businesses), throughput is net sales (S) less totally variable cost (TVC), generally the cost of the raw materials (T = S – TVC). 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. ("Throughput" is sometimes referred to as "throughput contribution" and has similarities to the concept of "contribution" in marginal costing which is sales revenues less "variable" costs – "variable" being defined according to the marginal costing philosophy.) *
Investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance Finance is the study of financial institution ...

Investment
(I) 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 (TOC) 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 An operating expense, operating expenditure, operational expense, operational expenditure or opex is an ongoing cost for running a product, business, or system . Its counterpart, a capital expenditure Capital expenditure or capital expense (ca ...
(OE) 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. Organizations that wish to increase their attainment of '' The Goal'' should therefore require managers to test proposed decisions against three questions. Will the proposed change: # Increase throughput? How? # Reduce investment (
inventory Inventory () or stock () refers to the goods and materials that a holds for the ultimate goal of resale, production or utilisation. is a discipline primarily about specifying the shape and placement of stocked goods. It is required at differen ...
) (money that cannot be used)? How? # Reduce
operating expense An operating expense, operating expenditure, operational expense, operational expenditure or opex is an ongoing cost for running a product, business, or system . Its counterpart, a capital expenditure Capital expenditure or capital expense (cap ...
? How? The answers to these questions determine the effect of proposed changes on system wide measurements: #
Net profit In business Business is the activity of making one's living or making money by producing or buying and selling products (such as goods and services). Simply put, it is "any activity or enterprise entered into for profit." Having a busin ...
(NP) = throughput – operating expense = T – OE #
Return on investment Return on investment (ROI) or return on costs (ROC) is a ratio between net income In business Business is the activity of making one's living or making money by producing or buying and selling products (such as goods and services). Sim ...
(ROI) = net profit / investment = NP/I # TA
Productivity Productivity is the efficiency Efficiency is the (often measurable) ability to avoid wasting materials, energy, efforts, money, and time in doing something or in producing a desired result. In a more general sense, it is the ability to do th ...
= throughput / operating expense = T/OE # Investment turns (IT) = throughput / investment = T/I These relationships between financial ratios as illustrated by Goldratt are very similar to a set of relationships defined by
DuPont DuPont de Nemours, Inc., commonly known as DuPont, is an American company formed by the merger of Dow Chemical The Dow Chemical Company (TDCC) is an American multinational chemical corporation headquartered in Midland, Michigan, United Sta ...

DuPont
and
General Motors General Motors Company (GM) is an American multinational Multinational may refer to: * Multinational corporation, a corporate organization operating in multiple countries * Multinational force, a military body from multiple countries * Multinat ...
financial executive
Donaldson BrownFrank Donaldson Brown (February 1, 1885 – October 2, 1965) was a financial executive and corporate director with both DuPont DuPont de Nemours, Inc., commonly known as DuPont, is an American company formed by the merger of Dow Chemical an ...
about 1920. Brown did not advocate changes in management accounting methods, but instead used the ratios to evaluate traditional financial accounting data.


Explanation

:\text = \text :\text = \text / \text 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. :The cost accountant determined that the cost of operating the foundry vs. the metalwork shop each month was as follows: :The company was at full capacity making 40 rail coaches each month. And since the foundry was expensive to operate, and purchasing brass as a raw material for the streetcars was expensive, the accountant determined that the company would lose money on any streetcars it built. He showed an analysis of the estimated product costs based on standard cost accounting and recommended that the company decline to build any streetcars. :However, the company's operations manager knew that recent investment in automated foundry equipment had created idle time for workers in that department. The constraint on production of the railcoaches was the metalwork shop. She made an analysis of profit and loss if the company took the contract using throughput accounting to determine the profitability of products by calculating "throughput" (revenue less variable cost) in the metal shop. :After the presentations from the company accountant and the operations manager, the president understood that the metal shop capacity was limiting the company's profitability. The company could make only 40 rail coaches per month. But by taking the contract for the streetcars, the company could make nearly all the railway coaches ordered, and also meet all the demand for streetcars. The result would increase throughput in the metal shop from $6.25 to $10.38 per hour of available time, and increase profitability by 66 percent.


Relevance

One of the most important aspects of Throughput Accounting is the relevance of the information it produces. Throughput Accounting reports what currently happens in business functions such as operations, distribution and marketing. It does not rely solely on GAAP's financial accounting reports (that still need to be verified by external auditors) and is thus relevant to current decisions made by management that affect the business now and in the future. Throughput Accounting is used in Critical Chain Project Management (CCPM), Drum Buffer Rope (DBR)—in businesses that are internally constrained, in Simplified Drum Buffer Rope (S-DBR) Eli Schragenheim and H William Dettmer - Manufacturing at Warp Speed - —in businesses that are externally constrained (particularly where the lack of customer orders denotes a market constraint), as well as in strategy, planning and tactics, etc.


References

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External links


Throughput Accounting DictionaryThroughput Accounting 101Throughput Accounting online Continuing Professional Education (CPE) for CPAs and CMAs
Management accounting Business terms Business process management