Throughput Accounting & Theory of Constraints - Literature review Example

ABSTRACT: This Literature Review tries to put light on the theory of Throughput Accounting along with its significance and correlation with the Theory of Constraints. This is done by placing arguments by various prominent authors on the subject. Table of Contents ABSTRACT: This Literature Review tries to put light on the theory of Throughput Accounting along with its significance and correlation with the Theory of Constraints. This is done by placing arguments by various prominent authors on the subject. 1 Table of Contents 1 Introduction 3 An Introduction to Management Accountancy 3 Throughput accounting and Management Accounting 4 Throughput Accounting And Theory of Constraints 6 Throughput Accounting in a Historic Prospective 6 A Different Concept 7 Criticism for the Throughput Process 9 How much can be made vs. “How Much you can Make” 10 Throughput Accountancy and the Theory of Constraints: A Mutual Prospective 10 Activity Based Accounting vs. Throughput Accounting 11 Why is Management Accountancy Irrelevant to the general public 12 An Evaluation of the Aforesaid 13 Criticizing the Above 13 Why is Throughput Accounting Better? 14 JIT (Just – in – Time) 14 JIT Philosophy 15 Total Quality Management (TQM) 15 Theory of Constraints and Strong Criticism against the “Guru” Eliyahu M. Goldratt 17 Goldratt’s Denial of these Allegations 18 Conclusion 19 Works Cited 20 Introduction An Introduction to Management Accountancy Management Accountancy is a belatedly revealed Accountancy theory that unlike other accountancy theories does not primarily deal with costing, taxation, corporate fundamentals / technicalities, etc. According to Peter Atrill, Eddie McLaney, and the Open Learning Foundation, Management Accounting is primarily focused on accumulating, amassing, analyzing, and exposing mostly economical / fiscal information to the concerned authorities so as to facilitate the decision making process, which principally helps in making managerial decisions and predicting the success ratio. (Atrill, et al., 1994 pp. 6-7) (Scarlett, 2006 p. 351) Furthermore the authors discuss the contrast - ability amongst Financial and Management accountancy; such as: Results / figures of Management accounts are not publically reported, unlike financial accountancy. (Seed, Allen; National Association of Accountants; National Association of Accountants, 1988) Forecasting abilities, unlike financial accountancy which focuses on historic data. (Seed, Allen; National Association of Accountants; National Association of Accountants, 1988) Under certain circumstances, this does not comply with the General accounting principles. (Seed, Allen; National Association of Accountants; National Association of Accountants, 1988) Throughput accounting and Management Accounting According to Mr. David James Anderson, Throughput Accounting is a Management Accountancy principle, of which the prime motive is to help in the decision making process for managers in terms of marketing decisions, promotional decisions, hiring decisions, etc. (Anderson, 2004 pp. 15-17) Although author Mr. David J. Anderson primarily focuses on the use of Throughput accounting in Software engineering industry as the author himself is a software engineer. But based on the titles of some of his books, his knowledge about Management accounts is eminently displayed. The author focuses on how the Throughput Accountancy principle of Management accounts can be incorporated in a forecasting software so as to enable automated forecasting, and to facilitate the managers to make better decisions and business plans. The author has presented a superb figure in his book to further clear the throughput accountancy fundamental: Figure 1: (Anderson, 2004 pp. 15-17) Many other prominent authors such as Steven M. Bragg, Mike Bendrey, Michael Bendrey, Roger Hussey, Colston West, and Terence Lucey have also discussed this same fundamental (Bragg, 2007) (Bendrey, et al., 2003) (Lucey, 2003) (Garrison, et al., 1997), which we have elaborated in detail in the next section of our Literature review: Throughput Accounting And Theory of Constraints Within this segment of our Literature review the author has discussed some very prominent views and arguments regarding the concept of Throughput accountancy, its use, principle, and criticism by various dominant authors in the field. Throughput Accounting in a Historic Prospective Authors Victoria J. Mabin and Steven J. Balderstone shed light on the formation of the concept of Throughput Accounting and Theory of Constraints (TOC) in their book “The world of the Theory of Constraints” (2000). The theory of constraints and the Throughput accounting concept which was initially created by Eliyahu M. Goldratt in around 1984, is said to fulfil the gaps in the Cost Accountancy, some authors even consider the concept of Throughput Accountancy as a dominant alternative the some cost accounting principles. (Mabin, et al., 2000 p. 66) (Ean, 2005 pp. 75-89) Author Steven M. Bragg who wrote his famous book “Throughput Accounting: A Guide to Constraint Management” (2007) also agrees to the works of Mabin & Balderstone which talk about the initiation of the use of Throughput Accounting (TA) and Theory of Constraints. Although Bragg’s book was published much after Mabin & Balderston’s work, the book has focused more on the Theory of Constraints and little focus on the theory of Throughput Accountancy. (Bragg, 2007 pp. 39-45) But Mr. Bragg strongly believes that Throughput Accountancy is now being used at a much more enormous level then 20 years ago when this fundamental was created by Eliyaho M. Goldratt. Companies that use modern management techniques compulsorily use the theory of Throughput Accountancy to forecast some chief management moves. (Bragg, 2007 pp. 39-45) Further in his book Mr. Bragg discusses the importance of Throughput Accountancy and contrasts both the concepts Throughput vs. Cost, and provides his view, which as the title says is eminently Throughput Accountancy. This was primarily due to the fact that according to Mr. Bragg, Cost Accountancy focuses on product costs, whereas Throughput Accounting focuses on increasing the profit. (Bragg, 2007 pp. 39-45) A Different Concept Authors Mike Bendrey, Michael Bendrey, Roger Hussey, and Colston West (2003) discuss a completely new concept where the deny that Throughput Accountancy is an alternative to the Cost Accountancy principles, and state that Throughput Accounting is not possible without using some segments of the costing principles (Bendrey, et al., 2003 pp. 14-20). They have also mentioned a ratio the “Throughput Accounts Ratio (TAR)” in their book “Essentials of Management Accounting in a Business”: Figure 2: (Bendrey, et al., 2003) Based on this ratio and some other prominent facts the authors believes that Cost and Management Accounts are interrelated and one cannot be possible without the other. Criticism for the Throughput Process Authors Nitza Geri and Boaz Ronen (2005) disagree with the afore mentioned relation to cost v throughput and provide a much clearer view to the subjects. Dr. Nitza Geri states that since the 19th Century, numerous companies were partially indecisive about using Cost Accounting as a means to make future decisions and forecasts, as cost accounting refers to individual product costing and identifies raw stock as variables, whereas, at that time many companies used to consider the total costs of a product as the means to make any final decisions, which many companies now use to determine average total cost, but the fundamental is unacceptable in present general accounting Principles (Geri, et al., 2005 pp. 133-144), as it leads to improper costing, and under fewer cases, ‘where the raw cost is tremendously variable it may also be considered as sort of gambling’1. Although, Geri and Ronen (2005) do agree on the fact that “The decision making direction of The Theory of Constraints (TOC) is based on contribution of costing principles” (Geri, et al., 2005 pp. 133-144). Other authors such as Stenzel, Northrup, Scarlett, McMullen, and a firm Elseiver Science (corporate author), also strongly support the afore mentioned concept amongst the correlation of Cost and Management systems. (Stenzel, et al., 2003) (Northrup, 2004) (Scarlett, 2006) (Elsevier Science , 2002) (McMullen, 2003) How much can be made vs. “How Much you can Make” This was a very strong philosophy Tony Watson stated the statement “How much you can make” in his book published in 2001, where he discussed the principle of How much can be made analysis through cost accounts vs. “how much ‘you’ can make” from a throughput accounting prospect. Thereby establishing a superior distinction amongst the policies and determining his personal favourite. (Watson, 2001 pp. 2-3) Throughput Accountancy and the Theory of Constraints: A Mutual Prospective Authors Monte Swain and Jan Bell discuss the concept of Throughput Accountancy as a evaluator of operations / functioning of Theory of Constraints. (Swain, et al., 1999) The authors also sheds light on the fact that the Throughput accounting methodology can be used against Cost accountancy and is bound to replace the possibly ‘old’ principles. Other authors with similar views include Debra Smith (2000) and Victoria J. Mabin (2003) also agree to this and provide views on how to help sustain cost accountancy by supplementing further old principles so as to bring some more forecasting and decisive abilities (Smith, 2000) (Mabin, et al., 2000). But then again, once management is involved in such a philosophy, it will no longer remain ‘Cost’ Accountancy. Activity Based Accounting vs. Throughput Accounting David Dugdale in his report (2006a) states arguments in favour of Mr. Goldratt’s theories, and also states one very peculiar quotation from Mr. Goldratt’s book (Dugdale, et al., 1996a): “Three simple questions: How much money is generated by our company? How much money is captured by our company? And how much money do we have to spend to operate it?” (Goldratt, 1990) This clearly states the importance of the application of throughput accounting system + operations + Costing principles. The answer for all the 3 questions may only be attained through a mixture of all of the above mentioned factors. The author David Dugdale clearly suggests that Throughput accountancy is a much more superior principle and even other additions to this concept by other authors such as those by Galloway and Waldron were “insufficient” and “not required” (Dugdale, et al., 1996b). Why is Management Accountancy Irrelevant to the general public Primarily, because it is not a compulsion to display the results of all Management accountancy audits on public display. Therefore anything concerning to the Management Accountancy principles is irrelevant to the general shareholder. Although, major shareholder do demand to see such results, but is solely up to the company’s discretion as to whether such an activity should be allowed or the company’s professionals can talk their way out of this without causing any loss of goodwill. (Hirsch, 2000) Secondly, under most cases the Management accountancy philosophies fail to follow the accountancy guidelines set up as the Generally Accepted Accountancy Principles. So neither the government or taxation houses have anything to do with how a company handles Management accounts. (Horngren, et al., 1994) (Mowen, et al., 2005) Thirdly, it is not related to costs or costing or history, but is just a predictability test, somewhat like a probability analysis which is done purely to generate ‘assumptions’ based on ‘assumptions’; therefore making it as irrelevant for the general public as the question “Which side of the coin will emerge on top?” An Evaluation of the Aforesaid Although Management Accountancy has nothing to do with cost, but is eminent that Throughput Accountancy encompasses essential components that helps analyze the future prospects of the business, there by, helping the shareholders gain a clearer view of the present market scenario. Therefore some authors believe that it should be posted and the public should be made aware of such probabilities and figures. (Weetman, 2002) It is possible that proper application of the Throughput Accountancy principles at this stage could also help predict a company create its own bail out package and sustain these horrific times. Criticizing the Above If probability figures are lower than expected, the overall standing of a company could go down the drains, and the company might lose a lot of money for a matter that does not concern costing and pricing, and especially does not provide 100 % accurate results as many results are based on assumptions. Therefore such news should not be revealed to the markets. Why is Throughput Accounting Better? Mr. Goldratt discusses in his book (1990) that throughput accounting is not the way to go because of 2 major principles that he either adopted from other authors or discovered by himself (Goldratt argues that he has modified some old principles and invented these new principles, whereas some authors argue that Goldratt has adopted these principles from some other sources). These were the Just in time (JIT) and the Total Quality Management (TQM) (Goldratt, 2006) (Goldratt, 1998), which are discussed in the following sections… JIT (Just – in – Time) Goldratt (2006) discussed the concepts of Total Quality Management and Just – in – time, the latter will be discussed within this segment of this literature review. Just in Time is a throughput accountancy principle which focuses on reducing the cost of the product through the means of reducing process of inventory management; this concept particularly affects the carrying costs of material, thereby reducing the material costs and increasing profits. (Goldratt, 2006) JIT Philosophy ‘Inventory is distinguished as rubbish’, is a general philosophy of the JIT system. Total Quality Management (TQM) Figure 3: Created using High Graphic Interface capabilities of MS WOrd 2007 The TQM concept is focused on 3 main elements: Total: Encompasses the totality of the organization. Quality: Quality + complexities involved Management: Management elements, for e.g.: plan, promote, etc. These three elements combined give throughput accounts a new power in whole the TQM system which is dominantly implied in many large organizations such as Sony, etc. Theory of Constraints and Strong Criticism against the “Guru” Eliyahu M. Goldratt Many prominent philosophers of accountancy refuse to accept that Mr. Eliyahu M. Goldratt had created this theory of constraints; the main argument provided here is that Mr. Goldratt had adopted many concepts such as the afore mentioned Just in time and Total Quality management from previous authors. Authors such as Maurice L. Hirsch, Allen H. Seed, Nitza Geri and Boaz Ronen strongly believe that Eliyahu M. Goldratt had got his concepts from other writers. The primary base of this controversy lies in the fact that The Theory of Constraints is a mixture of several management accounting principles which had originated about 3 decades before Mr. Goldratt brought up the TOC or the Theory of Constraints philosophy. Some of the principles from which this theory has supposedly emerged are the: CPM PERT JIT Dan Trietsch also suggests that the DBR principles are mediocre against other rival methodologies (From Management by Constraints (MBC) to Management By Criticalities (MBC II)). This led to many controversies and brawls amongst both the professors. These afore mentioned authors strongly believe that Eliyahu M. Goldratt and his sub ordinates has established a strong position of him as some sort of a ‘Guru’ which was unacceptable to many academic professionals of Management studies and Operational management philosophies and groups. But still many argue and believe that Goldratt is in fact the father of the ‘Theory of Constraints’. Goldratt’s Denial of these Allegations Mr. Goldratt did not sit quite and watch while his theories were being accredited to someone else. In his latter works such as "What is the Theory of Constraints and How Should it be Implemented?” Mr. Goldratt discusses the foundation principles and history of his own concepts thereby certifying his position as the ‘father’ of Theory of Constraints’. Within his works Goldratt deliberately examines the history, founding stones / theories which led to his discovery, marking out his specifications, and providing the proper use of his theories by the means of various examples. Although, Goldratt has also established his own clear view about the competing theories, and states through indirect means that his principles will not out date the current accountancy procedures, but will work together with them in order to create even more finer results. Conclusion While concluding the above the author would again bring light up on a line: ‘How much can be made & “How Much you can Make”’ to clearly present his personal views on the subject. It is eminent that Goldratt has been able to successfully defend his position and strong hold as the ‘father’ of the theory of constraints which was a major supportive element for throughput accountancy. Although, answering whether throughput will ultimately replace cost accountancy is a huge NO as many principles in Throughput Accountancy rely on Costing basics. Besides, the general public as well as the government still trusts cost principles based on their non responsiveness towards assumptions and display of more accurate results. This has ultimately led to the disruption of the theory of “replacement” or an “alternative philosophy”. Importance of Throughput Accountancy cannot be neglected and undoubtedly it is a more useful technique. But still, each of these accounting principles have their own importance, such as costing for generating accurate product costs and throughput in generating decisive results and assumption based costs. Thereby, we conclude this Literature Review by stating the importance of both Cost and Throughput principle, but putting more emphasis on the importance of Throughput Accountancy. Works Cited Anderson, David James. 2004. Agile Management for Software Engineering: Applying the Theory of Constraints for Business Results. Chicago : Prentice Hall PTR, 2004. Atrill, Peter and McLaney, Eddie. 1994. Management Accounting: An Active Learning Approach. Boston : Blackwell Publishing, 1994. pp. 6-7. Bendrey, Mike, et al. 2003. Essentials of Management Accounting in Business. s.l. : Cengage Learning EMEA, 2003. Bragg, Steven M. 2007. Throughput Accounting: A Guide to Constraint Management. New York : Wiley-Interscience, 2007. Dugdale, D. and Jones, T. C. 1996a. Accounting for throughput. s.l. : Management Accounting, 1996a. —. 1996b. Accounting for throughput. s.l. : Management Accounting, 1996b. Ean, Khaw Choon. 2005. Thinking Smart: Applying the Theory of Constraints in Development Thinking Skills. s.l. : Coronet Books Inc, 2005. ISBN 9679789187, 9789679789188. Elsevier Science . 2002. International Journal of Production Economics . s.l. : Elsevier, 2002. From Management by Constraints (MBC) to Management By Criticalities (MBC II). Trietsch, Dan. Number 1/2005, Amsterdam : IOS Press, IOS Online Journal Press, Vol. Volume 24, pp. 105-115. ISSN: 0167-2533 (Print) 1875-8703 (Online). Garrison, Ray H. and Noreen, Eric W. 1997. Managerial Accounting. s.l. : Irwin, 1997. ISBN 0256169179, 9780256169171. Geri, N. and Ronen, B. 2005. Relevance Lost; The rise and fall of activity based costing. s.l. : Human Systems Management, 2005. Goldratt, E.H. 2006. The Haystack Syndrome: Sifting Information out of the Data Ocean. s.l. : North River Press, 2006. ISBN 0-88427-184-6. Goldratt, Eliyabu M. 1998. Essays on the Theory of Constraints. s.l. : North River Pr, 1998. ISBN 0884271595, 9780884271598. Goldratt, Eliyahu M. 1990. What is this Thing Called Theory of Constraints and how Should it be Implemented? s.l. : North River Press, 1990. Hirsch, Maurice L. 2000. Advanced Management Accounting. s.l. : Cengage Learning EMEA, 2000. ISBN 1861526768, 9781861526762. Horngren, Charles T., Foster, George and Datar, Srikant. 1994. Cost Accounting: A Managerial Emphasis. Chicago : Prentice Hall, 1994. ISBN 0131810669, 9780131810662. Lucey, Terence. 2003. Management Accounting. s.l. : Cengage Learning EMEA, 2003. ISBN 0826463606, 9780826463609. Mabin, Victoria J. and Balderstone, Steven J. 2000. The World of the Theory of Constraints: A Review of the International Literature. s.l. : CRC Press, 2000. p. 66. McMullen, Thomas B. 2003. Introduction to the Theory of Constraints (TOC) Management System. Chicago : CRC Press, 2003. Mowen, Maryanne M. and Hansen, Don R. 2005. Management Accounting: The Cornerstone for Business Decisions. s.l. : Thomson/South-Western, 2005. ISBN 0324187548, 9780324187540. Northrup, C. Lynn. 2004. Dynamics of Profit-focused Accounting: Attaining Sustained Value and Bottom-Line Improvement. s.l. : J. Ross Publishing, 2004. Scarlett, Robert. 2006. Performance Evaluation: Performance Evaluation. s.l. : Butterworth-Heinemann, 2006. Seed, Allen; National Association of Accountants; National Association of Accountants. 1988. Adapting Management Accounting Practice to an Advanced Manufacturing Environment. Washington : National Association of Accountants, 1988. ISBN 086641164X, 9780866411646. Smith, Debra. 2000. The Measurement Nightmare: How the Theory of Constraints Can Resolve Conflicting Strategies, Policies, and Measures. Chicago : CRC Press, 2000. ISBN 1574442465, 9781574442465. Stenzel, Catherine and Stenzel, Joe. 2003. From Cost to Performance Management: A Blueprint for Organizational Development. New York : John Wiley and Sons, 2003. Swain, Monte and Bell, Jan. 1999. The theory of constraints and throughput accounting. New York : McGraw Hill, 1999. Watson, Tony J. 2001. In Search of Management: Culture, Chaos and Control in Managerial Work. s.l. : Cengage Learning EMEA, 2001. Weetman, Pauline. 2002. Management Accounting: An Introduction. London : Pearson Education Limited, 2002. ISBN 027365778X, 9780273657781. Read More