THEORY OF CONSTRAINT TOC is an approach to production management which aims to maximise throughput contribution (sales revenue - material cost)

while keeping conversion cost (all operating except material costs) & investment cots (inventory & equipment) to minimum. A strategy to throughput contribution is accepted if in conversion & investment costs is in contribution. It focuses on bottlenecks which act as constraints to this maximisation. Bottleneck is an activity within the organisation where demand for that resources outstrips its capacity to supply (limiting factor).
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THEORY OF CONSTRAINT (cont) One process will act as a bottleneck or limiting factor & constrain throughput. This is known as the binding constraints in TOC. Output through the binding constraint should never be delayed as this leads to lost sales. To avoid this happening a buffer inventory should be built up immediately prior to bottleneck. Operations prior to bottleneck should operate at same speed as bottleneck, otherwise WIP (other than than the buffer inventory) will be built up. Inventory is not desirable as it costs money in terms of storage & interest costs.
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THROUGHPUT ACCOUNTING
TA is an approach to accounting which is in sympathy with JIT. Product costs relates to key resources used by the products. Purchased materials & components must be processed to generate sales. Maximum amount of throughput is required with the financial definition: Sales Direct Materials Costs

TewYouHoo/Throughput accounting

TA For JIT Is Based On 3 Concepts 1. In short run it is more useful & simpler to consider entire costs excluding materials, as fixed & these costs are grouped together & called total factory costs. 2. In a JIT environment, zero inventory is ideal Profit is a function of time taken for manufacturing to respond to needs of market. Products should not be made if there is no demand. Unavoidable idle capacity is acceptable, except if in the operation concerned a bottleneck exists
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TA For JIT Is Based On 3 Concepts (cont) 3. Profitability is determined by the rate at which products contributes money In a JIT system, this depends on the speed at which goods can be produced & delivered to customers.

TewYouHoo/Throughput accounting

CONVENTIONAL COST ACCOUNTING Inventory is an asset

THROUGHPUT ACCOUNTING Inventory is a result of unsynchronised manufacturing & is a barrier to making profit Such classifications are no longer useful Profitability is determined by rate at which money is earned

Costs can be classified as direct or indirect Product profitability can be determined by deducting a product cost from SP Profit can be increased by reducing cost elements

Profit is a function of material cost, total factory cost & throughput

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TewYouHoo/Throughput accounting

TRADITIONAL PRODUCT COSTING Labour costs & traditional V OH are treated as VC Inventory is valued in income statement & B/S at total production cost Variance analysis is employed to determine whether standards were achieved Efficiency is based on labour & machines working to full capacity Value is added when an item is produced

THROUGHPUT ACCOUNTING They are not normally treated as VC

It is valued at material cost only

It is used to determine why planned product mix was not produced Efficiency requires schedule adherence & meeting delivery dates It is added when an item is sold
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TewYouHoo/Throughput accounting

THROUGHPUT ACCOUNTING
Principle behind it is that all costs other than material are effectively fixed. Throughput is dependent on 4 elements: Unit SP Sales volume Purchase price of material Speed of usage of direct material

TewYouHoo/Throughput accounting

BOTTLENECK RESOURCES Match production resources with demand for them. This implies there are no constraints in TA. TA is dedicated to identification & elimination of bottle-neck resources by OT, product specification changes & process improvements to reduce set-up & waiting times. Where constraint cannot be eliminated & to avoid build-up of WIP, production must be limited to capacity of the bottleneck resource but this capacity must be fully utilised.
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BOTTLENECK RESOURCES (cont)

When 1 bottleneck is remove, another one will emerge & the process has to be repeated again OTHER FACTORS WHICH LIMIT THROUGHPUT 1. Existence of an uncompetitive SP. 2. Need to deliver on time to particular customers. 3. Lack of product quality & reliability. 4. Lack of reliable material supplies. 5. Shortage of production resources.
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IS TA GOOD OR BAD TA is too ST as all costs other than direct materials are regarded fixed. Concentrates on direct material costs & does nothing to control other costs such as OH. These characteristic make TA a good complement for ABC since ABC focuses on labour & OH. Throughput maximising could lead to profitmaximising output. TA helps to direct attention to bottlenecks & focus management on key elements in making profits, inventory reduction & reducing response time to customer demand.
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THROUGHPUT ACCOUNTING
Labour Sales Direct Material = Throughput Other Production OH Administration Selling Operating Profit

Only material costs are considered variable Conversion costs are classified as fixed & grouped as total factory costs
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PERFORMANCE MEASURES IN TA Efficiency with which a particular product make use of the bottleneck resource is calculated as RETURN PER FACTORY HOUR

= Sales Material Costs__________ Usage (in hrs) of the Bottleneck Resource

TA RATIO is the relationship between RPFH & cost of each factory hr TA ratio = RPFH_______ Cost Per Factory Hr Total Factory Costs_____ Bottleneck Resource Available
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Cost Per Factory Hr =

TewYouHoo/Throughput accounting

THROUGHPUT & DECISION MAKING TA approach is very similar to contribution per unit of scarce resource. Difference is that throughput is defined as sales less materials whereas contribution is sales less all VC. Production priority is given to products that maximise throughput per unit of bottleneck resource. Rank products according to TA ratio.

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HOW TO IMPROVE TA RATIO 1. Improve throughput per unit by SP or material cost per unit. 2. Improve throughput return per hr by time spent on the bottleneck resource. 3. conversion costs.

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LIMITATIONS OF TA RATIO
1. Many organisations cannot produce & market products based on ST profit considerations alone. 2. Need to consider strategic-level issues such as market developments, product developments & stage reached in product life cycle.

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