## **Learning Outcomes**

After reading this article, you will understand the principles of throughput accounting as an alternative costing technique. You will be able to explain the focus on bottleneck resources, calculate throughput contribution and the throughput accounting ratio, and apply these principles to short-term decision-making. You will also recognise the advantages and limitations of throughput accounting compared to traditional costing methods.

## **ACCA Management Accounting (MA) Syllabus**

For ACCA Management Accounting (MA), you are required to understand alternative costing techniques beyond absorption and marginal costing. This includes the principles and practical application of throughput accounting. In particular, be prepared to:

- Explain throughput accounting and its focus on bottleneck resources
- Calculate throughput contribution per unit and per bottleneck hour
- Compute and interpret the throughput accounting ratio (TAR)
- Apply throughput accounting to assist in short-term production and pricing decisions
- Compare throughput accounting with traditional costing approaches
- Discuss the practical limitations or assumptions involved in throughput accounting

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What is the main resource constraint analysed in throughput accounting?
   a) Fixed overheads
   b) Bottleneck process
   c) Total variable costs
   d) Direct labour

2. How is throughput contribution per unit calculated?
   a) Sales price – all production costs
   b) Sales price – total variable costs
   c) Sales price – direct material cost only
   d) Sales price – total fixed costs

3. What does a throughput accounting ratio (TAR) below 1.0 indicate about a product?
   a) It is the most profitable use of the bottleneck
   b) The bottleneck is underutilised
   c) The product is not a good use of the bottleneck resource
   d) The product uses no bottleneck time

4. List two advantages and one disadvantage of throughput accounting compared to absorption costing.

## **Introduction**

Traditional costing methods typically divide costs into variable and fixed and seek to assign or absorb overheads based on labour or machine hours. However, in modern manufacturing and service environments, bottlenecks (or constraints) often limit throughput, and many overheads are fixed in the short term. Throughput accounting offers an alternative approach by focusing on maximising the cash generated from sales relative to scarce resources, mainly the bottleneck process.

Throughput accounting helps managers make better short-term decisions by highlighting which products or services deliver the most profit per unit of bottleneck time. This method is especially valuable in environments where one process or resource restricts the overall output.

> **Key Term: throughput accounting**
> A short-term management accounting method that focuses on maximising the rate at which a business generates cash from sales, relative to the constraints imposed by the most limited (bottleneck) resource.

## **THROUGHPUT ACCOUNTING PRINCIPLES**

Throughput accounting is grounded in the theory of constraints, which recognises that in the short run, most costs are fixed except for direct materials, and that throughput is limited by the slowest or most overloaded resource—the bottleneck.

### Throughput Accounting and the Theory of Constraints

Throughput accounting centres on three key concepts:

- **Throughput**: The rate at which a business earns money through sales, after paying direct material costs
- **Inventory**: Money tied up in goods intended for sale
- **Operating expense**: All other expenses, including labour and overheads, assumed to be fixed in the short-term

Throughput accounting seeks to maximise throughput (cash generated from sales, less material cost) using the resource, department, or process that limits total output (the bottleneck).

> **Key Term: bottleneck (constraint)**
> The process, machine, or resource whose capacity limits the total output for a period.

### Throughput Contribution

In throughput accounting, only direct materials are treated as truly variable in the short term. All other costs (including direct labour and overheads) are considered fixed.

> **Key Term: throughput contribution**
> Sales revenue less direct material cost. Represents the cash generated per unit by a product or service.

Throughput contribution per unit:

`Throughput contribution per unit = Sales price – Direct material cost per unit`

All other costs (operating expenses and inventory investments) are not deducted at this stage.

### Identifying and Managing the Bottleneck

The bottleneck determines the maximum potential throughput. To maximise profitability, resources must be scheduled so the bottleneck is kept busy, and no time is wasted on products or activities that use the bottleneck inefficiently.

### Throughput Contribution per Bottleneck Hour

To use time at the bottleneck efficiently, throughput accounting compares the throughput contribution generated by each product per unit of bottleneck time.

`Throughput per bottleneck hour = Throughput contribution per unit / Bottleneck time per unit`

This figure allows management to prioritise production of products that generate the most throughput from every hour of bottleneck resource.

### The Throughput Accounting Ratio (TAR)

The throughput accounting ratio helps judge if production is making the most effective use of the bottleneck. It compares the return generated by a product per hour of the bottleneck to the operating expense incurred in that same hour.

`Throughput accounting ratio (TAR) = Contribution per bottleneck hour / Operating cost per bottleneck hour`

- A TAR above 1.0 means the product generates more profit per hour of bottleneck time than it consumes in operating expenses for that hour.
- A TAR below 1.0 means the product does not cover its share of operating expenses for each bottleneck hour used. Such products reduce total profit if produced in preference to others.

> **Key Term: throughput accounting ratio (TAR)**
> The ratio of a product’s throughput contribution per hour of bottleneck resource to the operating cost per hour of that bottleneck. Indicates whether production is adding sufficient profit relative to the bottleneck capacity consumed.

## **Compared with Traditional Costing**

Throughput accounting differs from absorption and marginal costing in several ways:

| Aspect              | Traditional Costing                                 | Throughput Accounting                           |
| ------------------- | --------------------------------------------------- | ----------------------------------------------- |
| Variable costs      | Direct materials, direct labour, variable overheads | Direct materials only                           |
| Fixed costs         | Allocated/absorbed by unit or hours                 | Not attributed to products; fixed in short term |
| Focus               | Cost per unit, profit per unit                      | Bottleneck utilisation, cash flow per hour      |
| Inventory valuation | Includes production costs                           | Excludes all costs except direct materials      |
| Key concern         | Cost allocation, under/over absorption              | Maximising throughput per bottleneck hour       |

> **Exam Warning**
> In throughput accounting, direct labour is treated as a fixed cost—not as a variable or marginal cost. Only direct material is considered variable.

## **APPLICATION OF THROUGHPUT ACCOUNTING**

In practice, throughput accounting provides a simple, clear decision rule: always use the bottleneck resource on the products or services that generate the highest throughput contribution per bottleneck hour.

The process typically involves:

1. Identifying the bottleneck resource.
2. Calculating throughput contribution per unit for each product.
3. Calculating throughput contribution per bottleneck hour.
4. Ranking products in order of throughput per bottleneck hour.
5. Determining the product mix that maximises throughput, given bottleneck capacity.

### **Worked Example 1.1**

A factory produces two products, X and Y. Both use the same bottleneck machine that can run 600 machine hours per week.

- Product X: Sales price \$30, direct materials \$10, takes 0.5 machine hours per unit.
- Product Y: Sales price \$45, direct materials \$22, takes 1.2 machine hours per unit.

Calculate throughput contribution per bottleneck hour for each product, and identify which to prioritise.

> **Answer:**  
> Product X: Throughput per unit = \$30 – \$10 = \$20; per hour = \$20/0.5 = \$40  
> Product Y: Throughput per unit = \$45 – \$22 = \$23; per hour = \$23/1.2 ≈ \$19.17  
> Product X generates more throughput per bottleneck hour. The factory should prioritise X.

### Production Planning with Bottleneck Constraints

After ranking products, production plans should ensure the bottleneck is used solely for the highest ranked products, up to sales demand or bottleneck capacity.

Any remaining capacity may then be allocated to lower-ranked products.

### **Worked Example 1.2**

In the previous example, weekly demand is 800 units of X and 200 units of Y. The bottleneck allows 600 machine hours per week.

Calculate how many units of each product should be produced to maximise throughput.

> **Answer:**  
> Units of X required: 0.5 hours × 800 = 400 hours  
> Units of Y required: 1.2 hours × 200 = 240 hours  
> Total required: 640 hours (exceeds capacity).  
> Allocate: Produce all of X (800 units, 400 hours), capacity remaining: 200 hours.  
> Y production = 200 hours / 1.2 = 166 units (rounded down).  
> Produce 800 units of X and 166 units of Y.

## **ADVANTAGES AND LIMITATIONS OF THROUGHPUT ACCOUNTING**

**Advantages:**

- Clear focus on maximising returns from scarce resources
- Supports rapid, practical short-term decisions
- Simple calculations, easy to communicate
- Discourages overproduction and excess inventory

**Limitations:**

- Assumes only direct materials are variable in the short term
- Ignores possible changes to fixed costs in medium-term scenarios
- Does not consider qualitative or long-term strategic factors
- May not fit all types of service or custom production

### **Revision Tip**

When asked about throughput accounting in the exam, always state that direct material is the only variable cost in the short term, and all other costs are fixed.

## **Summary**

Throughput accounting redirects management’s attention from traditional cost allocation to generating cash from sales, given constraints such as bottleneck processes. By focusing on throughput per bottleneck hour, this method ensures production plans are aligned with short-term profitability and effective use of scarce resources. However, it is not a replacement for long-term strategic analysis or for allocating overheads over extended periods.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain the focus of throughput accounting on maximising cash flow from sales through scarce (bottleneck) resources
- Calculate throughput contribution per unit and per bottleneck hour
- Compute and interpret the throughput accounting ratio (TAR)
- Apply throughput accounting principles to short-term production decision-making
- Compare throughput accounting with absorption and marginal costing
- Identify advantages and limitations of throughput accounting

## **Key Terms and Concepts**

- throughput accounting
- bottleneck (constraint)
- throughput contribution
- throughput accounting ratio (TAR)

Alternative costing principles - Throughput accounting principles