Throughput accounting looks at the theory of constraints, the throughput accounting ratio (TPAR), ways to improve the TPAR and how to apply throughput accounting to a multi-product decision-making problem.
Throughput Accounting is a management accounting technique that is based on the theory of constraints. The primary tenet in throughput accounting is that “an organization should seek to maximize throughput by identifying and eliminating bottlenecks.” Just-in-time features heavily in throughput accounting.
a) Discuss and apply the theory of constraints.
The theory of constraints (TOC) is an “approach to production management and optimizing production performance.” Its aim is to turn materials into sales as fast as possible in order to maximize the net cash generated from sales.Note: Throughput is the money generated by a system via the sales that it makes
Formula: Throughput = Sales – Material Costs
Goldratt and Cox, who developed the TOC in 1986, devised a five step approach that summarises the stages of the TOC:
- Step 1: Identify the constraint (bottleneck resource) – The bottleneck affects both output and throughput
- Step 2: Devise a way to exploit the constraint and thus maximize throughput –
- Step 3: Link everything else to the decisions made in Step 2
- Step 4: Elevate the performance of the constraint – Increase the capacity of the bottleneck resource until it ceases to be a bottleneck resource
- Step 5: If the constraint has changed, go back to step one and go again
b) Calculate and interpret a throughput accounting ratio (TPAR).
The throughput accounting ratio (TPAR) is the ratio of the throughput unit of bottleneck resource to the factory cost per unit of bottleneck resource.Note: The TPAR ratio should be more than 1.0.
Formula: Throughput = Sales revenue – Material cost
Formula: Total factory costs = All production costs except materials
Formula: Return per factory hour = Throughput ÷ Time of key resource
Formula: TPAR = Throughput unit of bottleneck resource ÷ factory cost per unit of bottleneck resource
Formula: Factory cost per unit of bottleneck resource = Total factory costs ÷ Total units of bottleneck resource
Example: Widgets Inc. manufactures widgets. Each widget takes 3 hours to make on Machine A and the output capacity is 500 hours per week. The product has a material cost of $25 per unit and sells for $265 per unit. The total operating costs are $35,000 per week. Calculate the TPAR ratio.
Throughput per Machine A hour = (265-25) ÷ 3 hours = $80
Factory cost per Machine A hour = $35,000 ÷ 500 = $70
Therefore TPAR = $80 ÷ $70 = 1.14
This means that the product will barely be profitable.
c) Suggest how a TPAR could be improved.
The TPAR ratio should be as high as possible. If it is too low or falls below one, it can be improved by:
- Increasing the throughput per bottleneck hour
- Reducing the operating cost per bottleneck hour
- Increase the selling price of the product
- Reducing the material cost per unit
- Reducing expenditure on operating and factory costs
- Improving efficiency and increasing the number of units or product made in each bottleneck hour
- Elevating the bottleneck
d) Apply throughput accounting to a multi-product decision-making problem.
Please refer to the Throughput Accounting examples in BPP’s ACCA F5 Performance Management study text.
- BPP’s ACCA F5 Performance Management Study Text
- ACCA F5 Syllabus and Study Guide
- Open Tuition’s ACCA F5 Performance Management Study Materials
- Acowtancy Free ACCA F5 Course
- My ACCA Exams Journey
- Preparing for ACCA F5 Performance Management
- A1: Specialist Cost and Management Accounting Techniques | Activity Based Costing (ACCA F5)
- A2: Specialist Cost and Management Accounting Techniques | Target Costing (ACCA F5)
- A3: Specialist Cost and Management Accounting Techniques | Life Cycle Costing (ACCA F5)