An example on throughput accounting

An example on throughput accounting

 

Throughput accounting (TA) makes product-mix decisions by identifying the constraint (the bottleneck) and using each scarce bottleneck hour where it earns the greatest throughput—not necessarily where a product earns the greatest profit or contribution per unit. In its common short-run form, throughput is sales revenue less direct material cost, while labour and production overhead are treated as operating expenses for the period.

Worked example

Assume Harbour Homewares Ltd makes three products. Every unit must pass through a specialist packing machine, which has only 100 hours (6,000 minutes) available per month. That machine is therefore the system constraint.

The company has identified the following maximum monthly demand:

Product	Selling price per unit	Direct material per unit	Throughput per unit	Packing-machine minutes per unit	Maximum demand
A	$120	$45	$75	15	200 units
B	$95	$25	$70	10	240 units
C	$160	$70	$90	30	100 units

For simplicity, assume all units produced are sold in the month. Direct labour, machine depreciation, rent, supervisors’ salaries, utilities and similar costs are included in monthly operating expense rather than deducted product by product.

Step 1: Calculate throughput

The basic calculation is:

Throughput per unit=Selling price−Direct material cost

Therefore:

TA=120−45=$75

TB=95−25=$70

TC=160−70=$90

At first glance, Product C seems best because it produces the largest throughput per unit ($90). That conclusion is wrong because it consumes much more of the scarce packing-machine time.

Step 2: Calculate throughput per constraint hour

The relevant decision measure is:

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

Product	Throughput per unit	Constraint time	Throughput per constraint minute	Throughput per constraint hour	Priority
B	$70	10 mins	$7.00	$420	1
A	$75	15 mins	$5.00	$300	2
C	$90	30 mins	$3.00	$180	3

The production priority is therefore:

1.    Product B — earns $420 of throughput for each bottleneck hour.

2.    Product A — earns $300 per bottleneck hour.

3.    Product C — earns $180 per bottleneck hour.

This illustrates the central TA point: although C has the highest unit throughput, B is economically preferable because it generates the most throughput from the resource that limits total output. ACCA expresses this measure as return per factory hour: throughput per unit divided by time on the bottleneck resource.

Step 3: Build the optimum mix

Allocate the 6,000 available constraint minutes in priority order, while respecting market demand.

Production sequence	Units produced	Constraint time used	Constraint time remaining	Total throughput
Product B first	240	240×10=2,400 mins	3,600 mins	240×70=$16,800
Product A second	200	200×15=3,000 mins	600 mins	200×75=$15,000
Product C last	20	20×30=600 20 mins	0 mins	20×90=$1,800
Total	460	6,000 mins	0 mins	$33,600

Thus, the optimum short-run production and sales plan is:

B: 240 units; A: 200 units; C: 20 units

Monthly throughput is:

$16,800+$15,000+$1,800=$33,600

Step 4: Deduct operating expense

Assume monthly operating expense is $18,000, including direct labour, factory payroll, rent, utilities, maintenance, depreciation and other conversion costs.

Net profit=Total throughput−Operating expense

= $33,600 − $18,000

=  $15,600​

Under TA, these operating costs are not arbitrarily allocated to individual products for the short-run production-mix decision. Instead, management focuses on increasing total throughput generated by the constraint, while controlling operating expense and inventory. TA and the Theory of Constraints define the three core measures as throughput, inventory/investment, and operating expense.

Optional: Throughput accounting ratio

The firm may also calculate the throughput accounting ratio (TPAR):

TPAR = Throughput return per bottleneck hour / Operating expense per bottleneck hour

First, calculate operating expense per bottleneck hour:

$18,000/100 hours=$180 per constraint hour

 

Product	Throughput per constraint hour	Operating expense per constraint hour	TPAR
B	$420	$180	2.33
A	$300	$180	1.67
C	$180	$180	1.00

A TPAR above 1 indicates that throughput generated per bottleneck hour exceeds the operating cost incurred per bottleneck hour; the higher the ratio, the more attractive the product is from a constraint-management perspective.

Management interpretation

The worked example leads to four practical conclusions:

• Do not rank products by selling price, gross margin, or throughput per unit alone.
• Use the constrained resource—for example, a specialist machine, skilled employee, delivery capacity, scarce retail shelf space, or customer-service agent time—as the denominator.
• Produce in descending order of throughput per bottleneck hour, subject to demand.
• Do not deliberately make excess stock simply to keep non-bottleneck staff or machines busy. If output cannot pass through the constraint and be sold, it increases inventory rather than throughput.

For an assignment, a concise conclusion could be:

Throughput accounting recommends that Harbour Homewares prioritise Product B, then A, then C because B generates the highest throughput per hour of the scarce packing-machine capacity. The optimal plan yields monthly throughput of $33,600 and profit of $15,600 after operating expenses.