Manufacturing Breakthrough Blog

Cost Accounting vs Throughput Accounting

Tuesday January 6, 2015

Review

In my last posting I presented a new set of guidelines for making decisions on proposed improvement actions.  This new set of guidelines is something referred to as Throughput Accounting (TA) or Throughput Decision Making. TA is not intended to replace traditional Cost Accounting, but is very beneficial for managers evaluating proposed improvement actions in real time.  In today’s posting I want to present an example that some of you may have run into at your companies.  As a refresher, in my last posting I introduced three Throughput Accounting (TA) measurements that we will use in our example.

  1. Throughput (T) – The rate at which a system generates money through sales.  Throughput corresponds to what CA refers to as contribution margin.
  2. Inventory/Investment ( I ) – Some cash is needed to acquire the resources necessary to produce products.  These expenses include the cost of inventory (raw material, work-in-process and finished goods), but also includes property, plant, and equipment and other things referred to as assets.  Inventory/investment includes the capabilities of the system as well as raw materials and purchased parts, but, unlike CA, it does not include direct labor or manufacturing overhead.
  3. Operating Expense (OE) – Cash is also needed to provide the on-going capability to complete the organization’s business model.  These expenditures relate to the time period, rather than to specific sales, and CA refers to them as period costs.  Included in this category are things like taxes, energy expenses, etc., but also includes all labor expenses which is a major difference between CA and TA.

Net Profit = Sales – Variable Costs – Period Expenses

So let’s look at an example.

An example using CA, then TA

This very simple example will demonstrate the extent of the difference between CA and TA for decision-making as well as how dramatically different our conclusions will be when using both methods.  I will present this example by first analyzing the decision on an improvement suggestion using CA and then do so using TA. This company is currently producing and selling 2,000 parts that they sell for $500 each.  The following is a table that summarizes the processing times for the four work stations used to produce each part:

Workstation

Original Processing Times

Proposed Processing Times

1

10 minutes

6 minutes

2

20 minutes

22 minutes

3

10 minutes

10 minutes

4

6 minutes

  6 minutes

Total Time

46 minutes

44 minutes

 

So as can be seen in the above table, the CI team’s improvement idea would reduce the time required to complete the work at workstation 1 from 10 minutes to 6 minutes, but would increase the processing time at workstation 2 by 2 minutes.  The CI team points out that the total processing time to produce a part would decrease by 2 minutes (i.e. 46 minutes is reduced to 44 minutes).

Let’s first look at this proposal by using Cost Accounting (CA) and then we will look at it using Throughput Accounting (TA).  The CI Team knows that according to CA methods, it is desirable to reduce the total processing time to produce parts, so by implementing this improvement idea, the team knows they have accomplished this.  Their conclusion is that by reducing the unit cost of each part, at lease according to CA rules as follows, the new unit cost would be:

Cost Element

Cost

Raw Materials

$ 60.00

Direct Labor (44 minutes @ $0.2500

   11.00

Overhead (44 minutes @ $1.875)

   82.50

Standard Unit Cost

$153.50

 

A question

This translates to a per part savings of $4.25, so the expected annual cost savings, using traditional Cost Accounting is $8,500 in the first year.  But since the proposed change is a capital expenditure we must subtract the $4,000 to achieve an adjusted first year savings of $4,500.  So based upon this, here’s a question for you: 

Next time

In my next posting we’ll take a look at this same scenario using the Throughput Accounting decision making strategy.

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