MANAGEMENT SERVICES “Innovating

STRATEGIC MANAGEMENT ACCOUNTING Educational

Services”
Throughput Costing

REVIEW NOTES
1.0 The Theory of Constraints (TOC) and Throughput Accounting

1.1 Bottlenecks and Limiting Factor

1.1.1 The theory focuses on constraints or bottlenecks which
hinder speedy production. This binding constraint in the
production process dictates the pace of the manufacturing
throughput rate. The idea is to remove or unclog the
bottleneck to accelerate the production process from the
point of procuring materials up to the point of delivering the
goods to the customers.
1.1.2 There could be as many bottlenecks that could be found in
the production processes. The bottlenecks could be in terms
of machine hours, direct labor hours, materials availability,
market capacity, financial constraints and priorities, talents
and technology.
1.1.3 These bottlenecks impede the capacity of the enterprise to
produce more goods and services. In case the market could
still accommodate, the constraints or the bottlenecks should
be managed with an aim of allowing the production process
to produce goods up to the point where they could meet
customer demands. This means that if the present
bottleneck is machine hours, then efforts should be made to
speed up the production process in the use of machine
either by re-lay-outing the production process, training men
to be more skilled, acquiring more durable materials, or
acquisition of more machines. In the process, creativity,
innovations, and systems improvements would come into
play. The process of eliminating or unclogging the
bottleneck should be made using the overriding criterion of
benefit-cost analysis as the guiding principle.

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MS STRATEGIC MANAGEMENT ACCOUNTING. Throughput Costing
1.1.4 Once the most constraining bottleneck is remedied, then
another most constraining bottleneck that principally hinders
the potential of the production process would be identified.
This would then be remedied, and the cycle goes on until the
maximum capacity of the plant is attained. In such case, the
overall plant becomes the bottleneck in responding to
customer demands.
1.2 TOC costs
1.2.1 In the process of analyzing the cost of production, TOC
identifies three types of costs, namely:
 Throughput contribution. It is the difference between the
revenues and direct materials. Direct materials costs
include purchased components and materials handling
costs. Take note, direct labor is not considered as a
variable cost but rather as a fixed cost. Direct labor cost
tends to more fixed than variable in the present
manufacturing set-up.
 Conversion costs. It includes all manufacturing costs
except direct materials that are needed in manufacturing
a product.
 Investments. It includes all stock, raw material, work-in-
process, finished goods, research and development
costs, equipment, building, etc.
1.3 The aim of the TOC is increase throughput contribution while
decreasing conversion costs and investment.

2.0 THROUGHPUT COSTING

2.1 The cost of direct materials is considered as the only product cost.
All the other costs such as direct labor, factory overhead, variable
expenses, and fixed expenses are considered as period costs.

Throughput = Sales – Direct Materials

Profit = Throughput - Expenses

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 STRATEGIC MANAGEMENT ACCOUNTING. Throughput Costing MS
2.2 Throughput costing also emphasizes the importance of the theory
of constraints.
2.3 The limiting resource should be prioritized in producing the activity
(ie, product, division, process, etc.) that gives the highest return per
limiting factor.
2.4 The highest return is based on the throughput ratio (TR) computed
as follows:

TR = Throughput per bottleneck / Expense per TR = TPB / EPB

bottleneck
Throughput per bottleneck = Throughput / TPB = T / BTPU
Bottleneck time per unit
Expense per bottleneck = Total expenses / EPB = Exp / BTPU
Bottleneck time per unit

2.5 If the TR is greater than one, the product or other business

alternative is profitable. The product that gives the highest TR
would be prioritized.

2.6 Illustrative problem. Efem Manufacturing uses throughput

accounting and provides the following information in January 2014:

Product 1 Product 2
Sales P 200 P175
Direct materials 120 75
Throughput 80 100
Expenses 60 40
Profit 20 60
Bottleneck minutes 8 2
TPB 10 50
EPB 7.5 20
TR 1.33 2.5
Rank 2 1

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MS STRATEGIC MANAGEMENT ACCOUNTING. Throughput Costing
ILLUSTRATIVE PROBLEM
1. THROUGHPUT COSTING

Direct Materials Lang Corporation provides you the following business

data for 20CY:

Product 1 Product 2
Unit sales price P 400 P140
Unit direct materials cost 80 10
Unit direct labor cost 30 8
Unit variable overhead cost 20 10
Unit variable expenses 10 5
Unit fixed overhead cost 50 20
Unit fixed expenses 12 10
Production 12,000 units 14,000 units
Sales 14,000 units 15,000 units
Minutes per unit 30 minutes 10 minutes

The total available time is 25,000 hours.

Required: Determine the following for each product:

1. Throughput = USP - UDMC
2. Return per bottleneck = Throughput / Time per bottleneck
3. Cost per bottleneck =Expenses / Time perbottleneck
4. Throughput accounting ratio = Return per bottleneck /
Expense per bottleneck

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 STRATEGIC MANAGEMENT ACCOUNTING. Throughput Costing MS
Solution Guide

Product Product
1 2
USP P 400 P 140
- UDMC 80 10
Throughput 320 130
- Expenses 202 53
Profit 118 77
Return per bottleneck P320 / 30 10.67 13.00 P130 / 10
Expense per bottleneck P202 / 30 6.73 5.30 P53 / 10
TA Ratio RPB/EPB 1.58 2.45
Rank 2 1

MULTIPLE CHOICE QUESTIONS

1. A company operates a throughput accounting system. The details of
product A per unit are:

Selling price 24.99

Material cost P8.87
Conversion costs P12.27
Time on bottleneck resources 6.5 minutes

The return per hour for product A is:

A. P81.88
B. P113.26
C. P117.42
D. P123.80
E. P148.80

2. A company produces two products, A and B, which pass through two

production processes, J and K. the time taken to make each product in
each process is:

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MS STRATEGIC MANAGEMENT ACCOUNTING. Throughput Costing
Product A Product B
Process J 6.5 minutes 9 minutes
Process K 22 minutes 15 minutes

The company operates a 16-hour day and the processes have an

average downtime each day of:

Process J 2.5 hours

Process K 2 hours

The cost and revenue for each unit of each product are:

Product Product
A B
Direct materials P 15.00 P 15.0
Direct labor 17.00 12.00
Variable overhead 8.00 6.00
Fixed costs 8.00 6.00
Total cost 48.00 39.00
Selling price P 87.50 P 72.50

Sales demand restricts the output of A and B to 40 and 60 units a day,

respectively. The daily production plan that would maximize the
throughput contribution is
A. 40 units of A
B. 38 units of A
C. 36 units of A and 4 units of B
D. 34 units of A and 5 units of B
E. 56 units of B

3. A company manufactures four products – J, K, L and M. The products

use a series of different machines but there is a common machine, X,
which causes a bottleneck. The standard selling price and standard
cost per unit for each product for the forth-coming year are as follows:

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 STRATEGIC MANAGEMENT ACCOUNTING. Throughput Costing MS

J K L M
Selling price 2,000 1,500 1,500 1,750
Cost:
Direct materials 410 200 300 400
Labor 300 200 360 275
Variable overheads 250 200 300 175
Fixed overheads 360 300 210 330
Profit 680 600 330 570
Machine X – Minutes 120 100 70 110
per unit

Direct material is the only-level manufacturing costs. Using a

throughput accounting approach, the ranking of the products would be:
J K L M
st nd rd
A. 1 2 3 4th
B. 1st 2nd 4rt 3rd
C. 2nd 1st 4rt 3rd
nd rd st
D. 2 3 1 4th
E. 3rd 2nd 1st 4th

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