The Theory of Constraints & Throughput Accounting Flashcards
Who introduced the Theory of Constraints?
Goldratt & Cox (1984) in ‘The Goal’
What are the 5 steps that TOC suggests to maximise profit in the presence of a bottleneck constraint?
1 Identify the constraint
2 Decide how best exploit it
3 Subordinate all other operations to support step 2
4 Elevate the constraint, such as increase its capacity
5 Return to step 1 if a bottleneck has been broken in a previous step
What are the consequences arising from the steps to maximise profit?
1 A buffer of WIP should be kept in front of the bottleneck to ensure there is no shortage of material
2 Strict quality control is needed to ensure time is not wasted processing rejects
3 Attempts should be made to find alternative processes
4 Non-bottleneck resources should be run to support the bottleneck
5 The level of inventory elsewhere should therefore fall
How to identify bottleneck (from 2 machines)?
Identify units demand Multiply by Machine 1 time per unit Add up to give total time (convert to hours) Compare to operational time of machine Repeat for Machine 2
If Machine operational time is more than unit time, it is not a bottleneck. If unit time is more than machine operational time, it is a bottleneck.
What criticisms does TOC raise of traditional accounting performance measures?
Machine efficiency measures are misleading as they suggest all machines should be working at full capacity, but this will not help achieve overall goal.
It treats WIP as an asset and includes labour and overhead, therefore it encourages production and punishes managers who reduce inventory as it lowers profit.
Temptation to use too many performance measures
What three key performance measures are necessary?
Throughput: Sales revenue minus material purchases
Operational expense: All operating costs minus material
Inventory: Total of plant and equipment and other assets
What should managers prioritise of the key performance measures?
Increase throughput as scope to reduce expense and inventory is limited
What does Throughput Accounting suggest?
All costs are fixed in the short run except for material
It is the rate at which products generate throughput that determines profitabilityi
Inventory should be valued at material cost only as its production does not increase profitability
Per Galloway and Waldron (1988), how is Return per factory hour calculated?
(Sales - Material cost)/ Time on bottleneck resource
Per Galloway and Waldron (1988), how is Cost per factory hour calculated?
Total factory cost / Time available on the bottleneck resource
Total factory cost = all cost except for materials
Per Galloway and Waldron (1988), how is the TA ratio calculated?
Return per factory hour / Cost per factory hour
If TA ratio > 1 then a product is viable
How are variable costs treated in marginal and throughput accounting?
Marginal: Direct material, direct labour and some overhead
TA: Direct material only
How is profit maximisation achieved in marginal and TA?
Marginal: Maximising contribution (sales less variable costs), prioritising products that generate highest contribution per hour spent on bottleneck resource
TA: Maximising throughput (sales less material costs), prioritising products that generate highest throughput per hour spent on bottleneck resource
What are the criticisms of TOC and Throughput Accounting?
Organisations don’t have just one single goal
Assuming all costs other than material are fixed is simplistic
TA ratio is only useful as a short term decision tool
Developing accounting measures that apply TOC principles is difficult in practice
