Throughput accounting emphasis over cost control and to minimise inventory level.

What is Throughput Accounting (TA)?

TA is based on theory of constraints which means that throughput of the factory will be determined by the speed of bottleneck process. TA is very similar to marginal costing but here throughput is relevant rather than contribution analysis. TA assumes that only variable cost is material cost and all other factory cost is fixed in the short run along with labour cost. It is more appropriate to use Just-in-time (JIT) environment because of emphasis on minimising inventory and cost control.

Throughput = Sales - Material Costs.

In a JIT environment, production only for building inventory is a bad thing. Products should not be made unless there is a customer for them. This mean that accepting some idle time in non-bottleneck operations. Work In Progress (WIP) should be valued at material cost only so that no value is added to profit until sale in made.

Profit is determined by the rate at which throughput can be generated i.e. how quickly raw material can be turned into sales to generate cash. Producing for the sole purpose of increasing inventory creates no profit and so should not be encouraged.

Traditional costing	Throughput accounting
Labour costs and variable overheads are treated as variable costs.	All costs other than material are seen as fixed in the short run.
Inventory is valued at total production cost.	Inventory is valued at material cost only.
Value is added when an item is produced.	Value is added when an item is sold.
Product profitability can be determined by deducting a product cost from selling price.	Profitability is determined by the rate at which money is earned.

TPAR = Return per factory hour / Cost per factory hour. Return per  factory hour = (Sales revenue – material purchases) / Time on bottleneck resources. Cost per factory hour = Total factory costs / Time on bottleneck resource. Total factory costs = Fixed production costs including labour.

How to interpret TPAR?

Total throughput should exceed total factory costs otherwise organisation will make a loss. This means that TPAR should exceed 1.0

How can business improve TPAR?

• Increase throughput per bottleneck hour or decrease cost per factory hour.
• Increase selling price of the product. This will increase throughput per unit and so will increase throughput per unit of bottleneck resource.
• Reduce material cost per unit. This will increase throughput per unit and so will increase throughput per unit of bottleneck resource.
• Reduce expenditure on factory costs (operating costs). This will reduce operating cost per unit of bottleneck resource.
• Improve efficiency and increase no. of units or products that are made in each bottleneck hour. This would increase total throughput per hour. The operating costs per hour would be unaffected therefore TPAR would increase.
• Elevate bottleneck so that there are more hours available of the bottleneck resource. Throughput per unit of bottleneck resource would be unaffected but operating costs are fixed costs and there are more bottleneck hours available, the operating cost per bottleneck hour would fall and the TPAR would increase.

However there may be adverse consequences from some of these measures.

Measures	Consequences
Increase sales price per unit	Demand for the product may fall
Reduce material cost per unit, eg change materials or suppliers	Quality may fall and bulk discounts may be lost
Reduce operating expenses	Quality may fall or errors may increase