Methods Throughput Accounting - Research Paper Example

Throughput Accounting Table of Contents Introduction ............................................................................................................1 Throughput Accounting..........................................................................................1 Steps involved in throughput accounting…………………………………………2 Limitations of Throughput Accounting…………………………………………..5 Analysis…………………………………………………………………………..6 Summary………………………………………………………………………….7 References………………………………………………………………………..8 Introduction Management Accounting has incorporated a number of cost accounting techniques. The purpose of these techniques is to develop a framework through which efficiency and performance of organizations should touch their peak level. In addition, such techniques must not only increase sales revenues, but also should be able diminish cost of doing business. Throughout the history of management accounting, a number of cost accounting techniques also have been developed to focus on the productivity and performance through fixed overhead costing methods, Absorption costing methods, Activity Based Costing (ABC), however a little amount of concentration has been provided towards the constraints and problems being faced by organizations. History has witnessed that the performance of organizations is largely challenged by the constraints and these are the factors that have really potential to influence the performance of the organizations. Thanks to the theory of throughput accounting that has largely focused to constraints being faced by organizations. Constraints could be a policy, a material constraint, time constraint and so on. By focusing on the different aspects of cost and performance of organizations, throughput accounting has become successful in attracting the attention of number of multinational organizations. In the subsequent parts of this paper, first theory of throughput accounting is defined and its basic foundations have also been discussed. Subsequent to that, steps involved in throughput accounting have also been elaborated and it is followed by the part comprising of the inherent limitations being faced by this concept. Before the summary part, analysis portion has been included. Throughput Accounting Hutchinson (2007) defines throughput as the rate at which the system generates money through sales (48). And throughput accounting has been defined as the sales price minus all variable costs (Noreen et al. 1995). And others define throughput as sale prices minus material cost. And, the concept of throughput accounting based on two components: First, every system must have at least one constraint (Rahman, 1998, p. 337). If it were not accurate, then a real system as a profit making organization would make uncountable profits. As a result, a constraint is anything limiting a system from achieving higher level of performance versus its objectives (Glodratt, 1988, p.453). Second, the presence of constraints provides opportunities for improvement (Rahman, 1988, p.337). Contrary to the conventional thinking, the concept of throughput accounting considers constraints as positive, not negative because they highlight and determine the performance of a system. And, the understanding and subsequent elevation of the system’s constraints will enhance the performance of the system. Within the above mentioned context, throughput accounting has become an important development in the modern conventions of accounting allowing management accountants to comprehend the significance and contribution of the constrained resources to aggregate profitability. The concept of throughput accounting does not largely focus on the efficiencies and performance based on the efficiencies instead it takes into account the different types of constraints which can be in the shape of time constraints and policy constraints. Steps involved in throughput accounting Goldratt (1990) contends that the working principles of throughput accounting or theory of constraints extend a focus to a continuous improvement process and this principle is comprised of five focusing steps as elaborated below: (1) Identify the system’s constraint(s): Constraints may be relating to physical (e.g. machines, people, materials, demand level) or managerial (Rahman, 1998, p. 338). Generally, organizations have limited physical constraints but face numerous managerial constraints in the form of procedures, policies, methods and rules. In this regard, Goldratt (1993) devised a technique called a Current Reality Tree for identifying policy constraints. It remains utterly important to identify the nature and type of constraints and necessary to prioritize them by keeping in view their impacts over the objectives and aims of the organization. (2) Decide how to exploit constraints pertaining to the system: If the constraint is of physical nature, in that case, efforts must be taken to make the constraint as effective as possible. On the other hand, the managerial constraint should not be exploited but efforts must be taken to eliminate and replace them with a policy supporting increased throughput. (3) Subordinate every step to the above decision: This means that every component of the system (non-constraints) must be adjusted in order to support the maximum efficiency and effectiveness of the constraint because constraints dictate a firm’s throughput; and resource synchronization along with the constraint facilitates the most effective method of utilization of resource. Moreover, non-constraint resources comprise of productive capacity (capacity supporting the constraint throughput) and the idle capacity (capacity to safeguard against system disruptions and capacity not currently required) (Lockamy and Cox, 1994). Also, if non-constraints resources are utilized more than the normal productive capacity to support the constraint, they do not enhance throughput but supplement unnecessary inventory. (4) Elevate the system’s constraint (s): If the existing constraints still remain the most critical in the system, rigorous improvement efforts on these constraints will increase their performance substantially. As the constraints begin to improve, the potential of non-constraints resources can be better obtained leading to improvements in the aggregate system performance. Subsequently, the system will face a new type of constraint. (5) If in any of the above steps a constraint is broken, initiate from the step 1. Do not allow inertia to become the next constraint: The first portion of this step makes theory of constraints (Throughput accounting) an uninterrupted process and the second part is a strong reminder that no policy or solution is appropriate or correct for all time or in every sort of situation (Rahman, 1998, p. 338). It is highly critical for the organizations to comprehend and recognize that as the business environment does not remain the same but changes constantly business policy must not remain the same but should be refined so that changes must be taken into account. Limitations of Throughput Accounting There are a number of authors who have highlighted a number of shortcomings in the throughput accounting. In this regard, Freeman (2007) argues that throughput accounting is a short term decision tool which is considerably unable to provide any assistance for the long term decisions. For a considerable number of organizations, strategic decisions, which are normally long term decisions, are not addressed by the concept of throughput accounting and as a result, it proves to be a stark shortcoming inherent in the throughput accounting. Moreover, Freeman (2007) pointed that the creditability of theory of constraints was severely compromised when Galloway and Waldron discovered numerous difficulties with their throughput accounting formulation. Subsequent to that, they amended their throughput accounting performance measures and withdrew the concept of throughput accounting product costing in favor of Activity Based Costing (ABC) approach. Also, it is still unclear where the commercial advantage lies. Over the last two decades, a number of papers have been published denoting the significance and contributions of throughput accounting. Despite providing complex examples, the assessment results of throughput accounting based approach in providing optimal work flows remain incongruent. There is a dearth of clarity as to whether throughput accounting is sufficiently capable of providing competitive advantage in an era filled with complexities and rapidly changing business conditions and business environment. Furthermore, the traditional accounting has become sufficiently capable of satisfying the needs of regulatory and external financial reporting requirements. Even if throughput accounting is implemented in the organizations, it would become a challenging to satisfy the requirements of international financial regulatory framework and requirements. In addition to that, selling price, which remains to be most significant element in the concept of throughput accounting, may not be competitive. Consequently, the uncompetitive selling price would not be able to generate more sales volume. The suppliers of material may not be reliable as well. In this case, the potential of throughput accounting would not be achieved. Moreover, throughput accounting pays very little attention to overhead costs. Analysis A number of significant findings can be obtained from the above provided literature review. First, throughput has been defined as the rate at which the system generates money through sales. This highlights that the concept of throughput is based on producing money instead of highlighting profit which is a traditional accounting motive behind any accounting activity. Second, the literature review also highlights that the concept of throughput accounting contrary to conventional thinking, takes into account the bottlenecks or constraints as positive. It represents constraints as an opportunity that could be further used to increase efficiency and performance of the organization and system as well. Throughput accounting differently elaborates bottlenecks or constraints in totally contrast with the approach maintained as a negative approach by the traditional cost accounting concepts toward constraints. In addition, the theory of throughput accounting does not focus on efficiencies which are normally highlighted by other accounting methods. The focus of throughput accounting suggests that throughput accounting is a new way to address organizational issues being faced by organizations. It enables them to contemplate on the constraints instead of focusing on the efficiencies. However, despite so many positive findings, the concept of throughput accounting cannot be termed as an error free accounting mechanism. First, throughput accounting is a short term decision tool totally disregarding the significance of long term decisions. Organizations, in this complex era, are more concerned for better long term decisions instead of developing their policies for the short term decisions. Summary Management Accounting consists of numerous cost accounting techniques. Many of them elaborate and focus on performance and efficiency of organizations. However, concept of throughput accounting largely focuses on the constraints being faced by organizations. As a concept, throughput has been defined as the rate at which the system generates money through sales. However, throughput accounting has not been as successful as it should be. First, it has been criticized for supporting organizations taking short term decisions. There are a number of organizations remain more concerned about their long term decisions and expecting that they should bear fruit as required by the long term objectives. Moreover, the current era has become dynamic and complex. For any organization, surviving in the current climate has become a challenging reality. And, they are largely required to introduce and maintain competitive selling prices. However, the theory of throughput accounting does not offer any solution addressing the main concerns of today’s organizations. In addition, the theory of constraint has not offered any solution toward avoiding the issues of material supplies, which is the second component in the mathematical calculation of the theory of throughput accounting. Consequently, the Activity Based Accounting can be termed as having numerous advantages than the ones offered by the concept of throughput accounting. References Freeman, J. (2007). Theory of Constraints and Throughput Accounting. London: Chartered Institute of Management Accountants. Goldratt, E.M. (1988). Computerized shop floor scheduling. International Journal of Production Research, Vol. 26 No. 3, pp. 443-55. Goldratt, E.M. (1990), The Haystack Syndrome: Sifting Information out of the Data Ocean. New York, NY: North River Press. Goldratt, E.M. (1993), “What is the theory of constraints?” APICS – the Performance Advantage, June, pp. 18-20. Hutchinson, R. (2007). The impact of time-based accounting on manufacturing performance. Michigan MI: Proquest Information and Learning Company. Lockamy, A. and Cox, J.F. (1994). Reengineering Performance Measurement, New York, NY: Irwin Publishing. Noreen, E., Smith, D. and Mackey, J. (1995), the Theory of Constraints and Its Implications for Management Accounting, Massachusetts, MA: North River Press. Rahman, S. (1998). Theory of constraints: A review of philosophy and its applications. International Journal of Operations & Production Management, Vol. 18. No. 4. Pp.336-355. Read More