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Throughput Accounting(Cost is Cost, right?)

CEBI Spring SummitApril 24, 2008

Terry Weaver

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Accounting Methods

• Cost Accounting• Throughput Accounting

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Cost Accounting• Traditional manufacturing accounting,

designed to determine the “average” unit cost of producing a product (Standard Cost)

• A “4-walls” approach, absorbing all enterprise costs into product cost

• Direct Material• Direct Labor• Indirect Material (allocated)• Indirect Labor (allocated)• Machinery depreciation, maintenance, repair

(allocated)• Manufacturing Overhead (allocated)• Facility Costs (allocated)• Sales, General and Admin (SG&A)? (allocated)

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Limitations of Traditional Cost Accounting

• As production became more automated:– Direct Material was reduced– Direct Labor was reduced– Indirect costs ~wash– Machinery and equipment costs increased– Engineering and Mfg. O/H increased

• More and more costs became essentially “fixed” vs. “variable”

• And, since “burden” allocations were traditionally applied to direct labor only, burden rates spiraled towards “incredible”

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Cost Accounting Limitations

Using standard cost accounting to analyze management decisions can distort the unit

cost figures in ways that can lead managers to make decisions that do not reduce costs

or maximize profits

In fact, they can do just the reverse

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Throughput Accounting• Based on Theory of Constraints

– Every production process has a limiting factor– Focus on “maximizing the throughput dollars”

from each constrained resource

Thus, it follows:

– If a resource is not constrained, it can be eliminated from consideration as far as management decision-making is concerned

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Marginal CostThe actual cost of producing 1 more of

anything, considering only the actual variable costs involved

Question:

What are variable costs, really?

Revenue – Marginal Cost = Contribution Margin

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Variable Costs

???????

Standard Costs

$20Facility Costs Allocation$225

$20$10$10$25$40

$100

Standard Cost

Manufacturing O/H AllocationMaintenance & Repair AllocationMachinery Depreciation AllocationEngineering/Layout @ $25/hrLabor @$20/hrMaterial

Burden = 150%

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When to use which? • Standard Cost

– Budgeting– Resource Planning

• Throughput Cost– Constrained Resources

• Marginal Cost– Operational Decision-making