XXIV Encontro Nac. de Eng.

de Produção - Florianópolis, SC, Brasil, 03 a 05 de nov de 2004

Confrontation between the Activity-Based Costing and the

Throughput Accounting of the Theory of Constraints: the decision on
the production mix.

Evandro Sylvio Lima Sinisgalli (ITA) sinisgal@terra.com.br

Ligia Maria Soto Urbina (ITA) ligia@mec.ita.br

Abstract
The main objective of this paper is to collate Activity-Based Costing methodology (ABC) with
the Throughput Accounting methodology of the Theory of Constraints. This comparison is
performed analyzing the impact on profits of producing the product mix recommended by
each methodology. It is utilized a didactic example to show the case where the best mix
selected by the ABC methodology, which chooses the best mix based on the calculated
product costs, generates loss, while the best mix proposed by the Throughput Accounting,
through the identification of the capacity-constrained resource and of the calculation of the
product unit throughput, determines one mix that maximizes the company’s profitability.
Thus, it is discussed the relation and the alignment between the performance operational
measurements (throughput, investment and operating expenses) and the measures that
traditionally are used to evaluate the company’s profitability and performance, as net profit
and return on investment.
Key words: ABC costing; Throughput accounting; Production mix.

1. Introduction
In the last years the traditional management accounting has received strong critiques. Many
researchers affirm that it is obsolete, because it was not able to accompany the technological
advances that have transformed production systems. In fact, it is argued that the introduction
of automation technologies at the industrial plants has changed the composition of the
production costs, elevating the relative contribution of the manufacture overhead costs, which
are supposed to be grown from approximately 10% to around 65%. Meanwhile, the traditional
accounting has continued to distribute overhead costs using direct labor as allocation base
(CORBETT, 1997, p. 33).
As a consequence, information supplied by product costs is distorted and may generate wrong
management decisions when looking for the more profitable price and production mix. Under
these circumstances, Corbett (1999, p. 33) makes two questions: "1. Can the costing methods
change so that they can supply good information? 2. Is it necessary to allocate the costs to the
products? ".
Researchers that answer yes to those questions defend the activity based costing (ABC)
methodology as the best solution for the problem. This method uses some cost drivers for
allocating manufacture overhead costs, with the intention to turn the cost verification more
precise and trustworthy. On the other hand, the followers of Eliyahu Goldratt, creator of the
Theory of Constraints, affirm that no cost must be allocated to the products. They are the
defenders of the Throughput Accounting methodology, who have negative answers for
Corbett’s two questions.

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Thus, the objective of this article is to make a confrontation between the ABC costing system
and the throughput accounting method as support of management decisions, specifically when
looking for the most profitable mix of production.
2. Activity-Based Costing
Hansen and Mowen (2001, p. 392) explain this type of costing method: "The activity-based
costing system (ABC), first allocates the costs to the activities and, after that, to the products
and other objects of cost. The underlying assumption is that activities consume resources and
products and other objects of costs consume activities ".
Since the ABC has its focus on activities and not on products, it helps to prevent information
distortions about product costs that appear when managers utilize traditional costing.
Moreover, it provides more precise information about product costs. Thus, the basic principle
of ABC methodology is to identify the organization’s activities in order to obtain each activity
cost, and, afterwards, to calculate the product cost based on its consumption of activities.
Therefore, the logic of the method is to visualize activities as resource users, and products as
consumers of activities.
Resources are expenses corresponding to the physical entrance of items required to perform
an activity. For example: people and machines are resources that have costs, wages and
depreciation respectively.
Nakagawa (2001, p. 42) gives the following definition: "Activity can be defined as a process
that combines, in the adequate form, people, technologies, materials, methods and its
environment, having as objective the production of products".
Hansen and Mowen (2001, p. 396) present the resource drivers as being: "Factors that
measure the consumption of resources by the activities". For example: the time spent by the
supply department on input purchases.
For Gunasekaran (1999, p. 415) the activity driver is described as follows: "It is the measure
of the frequency and intensity of the demand placed on each activity by the product. It is the
connector link between cost object and the activities that represent chances for product
improvements". For example: the number of orders of material purchases of the supply
department.
3. Throughput Accounting
Throughput Accounting is the management accounting created by the Theory of the
Constraints that utilizes three operational performance measurements, to evaluate the impact
on company’s profit of local actions/decisions made by managers. This theory sees the
company as a system, that is, a set of interdependent parts, whose global performance depends
on the behavior of each one of the parts. The company, as a system, exists to reach a global
goal.
Not always the company’s goal is immediately reached, because there are constraints in the
system. Goldratt (1990, p. 4), about of this, states: "A constraint of a system is nothing more
than we feel to be expressed in the words: anything that hinders a system to reach a bigger
performance in relation to its goal ".
It is important, then, to find measures that allow managers to judge the impact of a local
action/decision on the company’s goal. Traditionally, measures as net profit and return on
investment have been used to analyze global company’s performance; however, these
measures do not allow judging the impact of a local action/decision. In order to create a

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bridge between local decisions and company profitability, Goldratt, created three operational
measures of performance that are defined as follow:
Throughput (G)
It is the index that monitors how the system generates money through sales. Unit throughput
is the sales price minus totally variable cost (UT = SP – TVC).
Corbett (1997, p. 33) explains the meaning of this cost:
The fundamental issue here, to abolish any doubt, is the word total. Totally variable
in relation to the units sold, that is, a TVC is that amount expended when an
additional product is sold. The more evident example of TVC is the raw material
cost; for each additional unit sold it is incurred the value of its raw material.
Investment (I)
It is defined as all money that the system invests on the purchase of things that it intends to
sale. Investment as conceived here has an ample meaning including the concept of inventory
(raw material, products in process, and finished goods inventory), as well as the concept of
assets (machines, equipments, properties, vehicles, etc).
Operating Expense (OE)
Goldratt (1991, p. 26) considers that this measure of performance can be "... defined as all
money that the system spends transforming inventory into profit ".
This item incorporates all necessary expenses for the company’s functioning: the directors’
wages, direct labor costs, light, water, taxes, depreciation, insurance, etc.
These three measures are seen in formulas of the net profit (NP) and of the return on
investment (ROI), presented as follow:
NP = T - OE; ROI = (T – OE) / I.
A fundamental advantage of using these performance measures is that it is not necessary to
allocate costs to the products, as happens in the cost accounting methodology.
4. Confrontation between the ABC Costing and the Throughput Accounting
An example transcribed below and supplied by Corbett will be used (1997, p. 98-107) to
make a comparison between the ABC costing methodology and the throughput accounting.
In this example, the possible variations of the prices and the demands of the products had
been disconsidered, as well as the absenteeism, and the broken machines and material scrap.
The company has four different machines A, B, C and D, and manufactures only two
products. Product R is sold at the price of R$ 95,00 per unit, and it has a demand of 130 units
per week. Product S has a sale price of R$ 105,00 per unit, and its weekly demand it is also
130 units.
Product R is constituted of three parts, raw material 1, raw material 2, and raw material 3.
Raw material 1 is first processed in machine B, for 4 minutes, later it is mounted in the
machine A, with raw material 2 during 10 minutes; afterwards, it goes to machine B, where it
is processed during 5 minutes, and then it is mounted with raw material 3, in machine D
during 10 minutes.
Product R has a material cost of R$ 45,00. Product S uses only two types of raw materials, the
3 and the 4, and its material cost is of R$ 42,00. Figure 1 brings all these information of the
process flow. There, it can be seen that the two products use raw material 3 sharing the middle
flow, which has the biggest volume in this company.

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ProductR R S S
Product

R$ 95,00 R$ 105,00
130 / weekly 130 / weekly

D A
10 min. 5 min.

B D
5 min. 5 min.

A
10 min. C B
8 min. 3 min.

B B C
4 min. 3 min. 6 min.

RM 1 RM 2 RM 3 RM 4
R$ 20,00 R$ 3,00 R$ 22,00 R$ 20,00

Figure 1 – Process Flow of the Company RS

Each machine has an operator that works 8 hours per day, 5 days per week, providing a total
of 2.400 minutes per machine weekly. Also, the weekly operational expenses are equivalent
to R$ 12.000,00.
Utilizing the data supplied by the example presented above, both methodologies, the ABC
costing and the throughput accounting were used to determine the production mix that
maximizes profits at the company RS.
It must be pointed out that it is not possible to calculate the weekly profit of the company for
the sales mix of 130 units of R and 130 units of S, because the machine C does not have
enough weekly capacity to manufacture these amounts. Table 1 discloses the time consumed
by the machines.
Minutes Minutes Total of minutes
Machines required required required
4 = 3/2400
for R for S
1 2 3 = 1+2
A 1.300 650 1.950 81,2%
B 1.560 780 2.340 97,5%
C 1.040 1.820 2.8601 119,2%
D 1.300 650 1.950 81,2%
Table 1 - Calculation of the Time Consumed by the Machines
To know maximum profit possible for the RS company, it is necessary to determine which
product presents the biggest profit, so that managers place the higher production priority to
the higher profit product, looking for satisfying its demand in the first place, and afterwards

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producing the other product, which has a lower position in the profit ranking, until, either
there is no available time for machine C, or its demand is satisfied.
4.1 ABC Costing Solution
Initially, it is performed an expenditures survey for each one of the activities that will be
necessary to confection and to commercialize the products. In this example of the ABC
costing methodology, there are three activities: purchases, production and sales.
Table 2 relates the operational expenses per week.
Expenses Activity R$
Reception Purchases 884,00
Inspection Purchases 580,00
Storeroom Purchases 1.560,00
Direct Labor Production 1.500,00
Supervision Production 1.155,00
Depreciation Production 425,00
Production Engineering Production 800,00
Quality Production 850,00
Dispatch Sales 1.100,00
Attendance Sales 3.146,00
Total 12.000,00
Table 2 – Operational Expenses
Table 3 supplies the total activity costs for the two products.
Activity R$
Purchases 3.024,00
Production 4.730,00
Sales 4.246,00
Total 12.000,00
Table 3 – Total Activity Costs
Once it is obtained the cost of each activity, it is necessary to allocate it between product R
and product S. In order to do that, it is used a different cost driver for each one of these
activities.
a) The purchase activity will have as cost driver the number of receptions per week. This
indicator reveals the product demands placed in this activity.
Table 4 shows the cost allocation of the purchases activity for each one of the products.
Number of
Products Percentage Activity cost
receptions
R 1,5 42,86% 1.296,00
S 2,0 57,14% 1.728,00
Total 3,5 100,0% 3.024,00
Table 4 – Cost Allocation for Purchases Activity
b) The production activity will have as cost driver the product consumption time of each
machine. Thus, Table 5 presents the value consumed by each machine in the production
activity. After that, costs will be distributed in agreement with the machine time consumed by
each product.

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A B C D
Direct labor 375,00 375,00 375,00 375,00
Production supervision 250,00 305,00 250,00 350,00
Engineering 175,00 210,00 175,00 240,00
Depreciation 95,00 110,00 80,00 140,00
Quality 190,00 220,00 190,00 250,00
Total 1.085,00 1.220,00 1.070,00 1.355,00
Table 5 - Production Activity Costs allocated to each Machine
Table 6 shows the total production activity cost for each product.
Costs Time R Time S Total Costs R Costs S
Machines time
1 2 3 4 = 2+3 5 = 1/4x2 6 = 1/4x3
A 1.085,00 10 5 15 723,00 362,00
B 1.220,00 12 6 18 813,00 407,00
C 1.070,00 8 14 22 389,00 681,00
D 1.355,00 10 5 15 903,00 452,00
Total 4.730,00 40 30 70 2.828,00 1.902,00
Table 6 - Cost Allocation for the Production Activity
c) The sales activity will have as a cost driver the number of orders made per week. It
discloses the demand placed in this activity by the products.
Table 7 discloses the sales activity costs allocation for each product.
Products Number of orders Percentage Cost
R 5 83,33% 3.538,00
S 1 16,77% 708,00
Total 6 100,00% 4.246,00
Table 7 – Cost Allocation for the Sales activity
Table 8 shows that product R receives the largest proportion of the costs, since the cost
drivers reveal that R consumes more activities than S.
Activity Product R Product S
Purchases 1.296,00 1.728,00
Production 2.828,00 1.902,00
Sales 3.538,00 708,00
Total 7.662,00 4.338,00
Table 8 – Total Cost of Products
Since product R possess the lesser price, the greater raw material cost, and allocated costs, it
is possible to conclude that this product is the less interesting for the company. Therefore, to
reach the maximum profit it is convenient to give production preference to product S and,
after satisfying its demand, using the machine C’s remaining time to manufacture product R.
Thus, the plant will attend all the demand of product S (130 units). Afterwards, there are still
left 5802 minutes that allow manufacturing 72 units3 of product R. Therefore, the mix that
maximizes the company’s profit is composed of 130 S + 72 R.
Table 9 brings the weekly maximum profit obtained by the ABC costing methodology, and it
can be observed that the company RS does not obtain profit.

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Product R Product S Total

Sales Revenue 6.840,00 13.650,00 20.490,00
Raw Material Cost 3.240,00 5.460,00 8.700,00
Gross Margin 3.600,00 8.190,00 11.790,00
Operational Expense 12.000,00
Maximum Profit -210,00
Table 9 – Maximum Profit Calculations
4.2 Throughput Accounting Solution
The Throughput Accounting methodology requires information concerning the unit
throughput per minute of Capacity-Constrained Resource (Unit/minCCR), in order to classify
products according to its potential contribution to improve company’s profits. Table 10
presents these values.
Unit CCR
Products Price TVC throughput time Unit/minCCR Classification
(min/un)
1 2 3 = 1-2 4 5 = 3/4
R 95,00 45,00 50,00 8 6,25 1º
S 105,00 42,00 63,00 14 4,50 2º
Table 10 - Determination of the Strategic Classification
The indicator that measures throughput per minute in the constraint shows that R is the most
interesting product for the company. It is important to point out that the classification
presented in table 10, based on the Throughput Accounting methodology, is opposite to
that one supplied by the ABC costing system.
Table 11 reveals that the company does not possess enough available capacity to satisfy all
market demand, which would require the company to operate 19,17% above its full capacity.

Occupation Accumulated
Products Demand CCR time (minutes) CCR utilization utilization of
CCR
1 2 3 = 1x2 4 = 3/2400 5
R 130 8 1.040 43,33% 43,33%
S 130 14 1.820 75,83% 119,17%
Table 11 – Constraint Utilization according to the Product Priority
Table 12 discloses that the company will manufacture all 130 units of product R that are
demanded by the market, and that the 1.360 remaining minutes will be expended
manufacturing 97 units4 of Product S.
Confronting both methodologies, utilizing Table 12 and Table 9, it is observed that the
product mix recommended by the Throughput Accounting system allows the company to
obtain a maximum profit of R$ 611,00 per week. On the contrary, the product mix
recommended by ABC costing methodology, for this same plant, only assured a lower loss of
R$ 210,00 per week.

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Products Maximum profit Unit throughput Thoughput/product

mix
R 130 50,00 6.500,00
S 97 63,00 6.111,00
Total thoughput 12.611,00
(-) OE 12.000,00
Net profit 611,00
Table 12 – Calculation of performance measures
5. Conclusions
The main objective of this paper was to confront the different optimal operational decisions,
specifically the product mix, suggested by both the ABC costing system and the Throughput
Accounting system. The comparison intended to evaluate the optimal decision provided by
both systems, utilizing as main criterion the coherence showed between the suggested
optimized local operational decision and the global company’s performance achieved.
Utilizing the same example, this work allowed perceiving important differences between
these two accounting approaches. Based on the calculated value of product costs, obtained
using different drivers for allocating costs to activities, the ABC costing system provided an
optimal production mix, which in this case generated the lower possible loss. On the other
hand, the Throughput Accounting system, based on the identification of the constrained
resource and on the unit profit of the product, found one mix that maximized the company’s
profitability. Therefore, this comparison allowed reaching the conclusion that the local
operational decision suggested by Throughput Accounting is coherent with a global
performance optimum for the company’s, whereas, the ABC accounting solution did not
allowed the company to reach its maximum profit. Thus, this paper supports the premise that
Throughput Accounting is the best methodology, because it supplies the adequate information
so that manager’s local decisions related to the production mix are capable to lead the
company toward its highest profit positioning.
References
CORBETT NETO, Thomas (1997): “Contabilidade de Ganhos”, São Paulo: Editora Nobel, 189 páginas.
CORBETT NETO, Thomas (November 1999): “Making Better Decisions”, CMA Management, p. 33- 37.
GOLDRATT, Elyahu (1991): “A Síndrome do Palheiro, garimpando informações num oceano de dados”, São
Paulo: IMAM, 243 páginas.
GOLDRATT, Elyahu (1990): “What is this thing called Theory of Constraints, and how should it be
implemented”, Croton-on-Hudson, North River Press, 160 pages.
GUNASEKARAN, A. e SINGH, D. (1999): “Design of Activity-Based Costing in a small company: a case
study”, Computers & Industrial Engineering 37, p. 413-416, Proceedings of the 24th International Conference on
Computers and Industrial Engineering.
HANSEN, D. e MOWEN, M. (2001):“Gestão de Custos”, São Paulo: Pioneira Thomson Learning, 783 páginas.
JOHNSON, H. Thomas e KAPLAN, Robert (1991): “Relevance Lost, the Rise and Fall of Management
Accounting”, Boston: Harvard Business School Press, 269 pages.
NAKAGAWA, Masayuki (2001):“ABC – Custeio Baseado em Atividade”, São Paulo: Editora Atlas, 96 páginas.

1
[(130 un R x 8 min) + 130 un S x (8 min + 6 min)] = 1.040 + 1.820 = 2.860 min
2
2.400 min – (130 un x 14 min) = 580 min
3
580 min / 8 min = 72,5 un
4
2.400 min – (130 un x 8 min) = 1.360
1.360 min / 14 min = 97,1 un

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