Throughput Accounting: A new approach to Management Accounting

ICAI CA final Management Accounting module makes a slight reference to the concept of ‘Throughput Accounting’. On reading various literatures on this concept, it changed my perception towards management accounting. Throughput Accounting is based on the Theory of Constraints (TOC) founded by Dr.Eliyahu Goldratt an Israeli physicist who became a business management guru.

Throughput Accounting (TA) changes the way the business owners take decisions about revenue recognition, costs and profitability by using the figures of Management Accounting. However, the basic accounting rules remain the same. Throughput accounting is different from traditional management accounting in the sense that traditional management accounting tries to apply the same measures that are used to judge a whole system/organisation (profit and return on investment) to day to day decisions by dividing the system into sub-systems and then into activities. Whereas TA acts as a decision making tool for every sub-system and activity.

According to Goldratt’s Theory of Constraints, there are only three measures used for decision making  in the order of –

i. Throughput (T)

ii. Investment (I)

iii. Operating Expense (OE)

“Throughput” is the money that is generated from sales – which means the value of Sales less the TVC – Truly Variable Cost – only the cost of making and selling additional units. Thus labour cost is not considered as variable cost.

“Investment” is the name given to the money tied up in the system.

“Operating Expense” is the name given to all the money (other than TVC) incurred to turn investment into sales – this includes wages etc.

Any decision can be undertaken on the basis of effects on T, I and OE. If the Throughput i.e. Sales less Truly variable costs is positive, then the activity can be undertaken since throughput of every activity  has impact on the overall profitability of an organization.

In other words, TA as a measurement and decision making tool focuses on sales efforts on those products that truly make more money. It helps make better judgment for optimum utilization of constraints by diverting available resources to activities that truly generate revenue. Decisions in TA are based on the real effect on the bottom line and helps in clear understanding of systems.