THE ROLE OF MANAGEMENT ACCOUNTING

   The financial professional, playing a pivotal role in TOC

implementation, uses management accounting to focus on

identifying, analyzing, and reporting key events and opportunities affecting the organization. Emphasizing the development and maintenance of core management information sources within an organization, management accounting serves as the basis for integrating the diverse sources of data available to decision makers.

Within TOC, the role of management accounting includes the following activities:

• provide economic estimates of throughput, operational expense, and inventory;

• accumulate and integrate data from TOC, total quality

management, and related management models to ensure

consistency in the reporting system;

• verify constraint identification;

• provide capacity cost estimates and support for investment

analysis of potential additions to capacity;

• explain the various assumptions underlying differences from other strategic or tactical analyses;

• work with operating managers to identify solutions for easing constraints and their impact;

• develop and sustain the activity-based cost management system to complement the information provided and required by TOC;

• work to develop a comprehensive knowledge of incremental cost patterns and underlying cost structures to ensure that ongoing TOC decisions incorporate the impact on step-fixed and semivariable costs throughout the organization;

• provide throughput contribution data and identification of the relevant constraint for all decisions;

• identify direct linkages between throughput and operational expenses;

• report on the impact of constraints; and

• ensure that the finance function does not become the constraint.

TOC THINKER alternative begins with the idea that each organization has a goal and that better decisions increase its value. The goal for a profit maximizing firm is easily stated, to increase profit, now and in the future. Throughput accounting applies to not-for-profit organizations too, but they have to develop a goal that makes sense in their individual cases. Throughput Accounting also pays particular attention to the concept of bottlenecks in the manufacturing or servicing processes.

 Throughput accounting uses three measures of income and expense: Throughput (T) is the rate at which the system produces "goal units." When the goal units are money (in for-profit businesses), throughput is sales revenues less the cost of the raw materials (T = S - RM). Note that T only exists when there is a sale of the product or service. Producing materials that sit in a warehouse does not count. ("Throughput" is sometimes referred to as "Throughput Contribution" and has similarities to the concept of "Contribution" in Marginal Costing which is sales revenues less "variable" costs - "variable" being defined according to the Marginal Costing philosophy.)

• Investment (I) is the money tied up in the system. This is money associated with inventory, machinery, buildings, and other assets and liabilities. In earlier TOC documentation, the "I" was interchanged between "Inventory" and "Investment." The preferred term is now only "investment." Note that TOC recommends inventory be valued strictly on totally variable cost associated with creating the inventory, not with additional cost allocations from overhead.
• Operating expense (OE) is the money the system spends in generating "goal units." For physical products, OE is all expenses except the cost of the raw materials. OE includes maintenance, utilities, rent, taxes, payroll, etc.

Organizations that wish to increase their attainment of The Goal should therefore require managers to test proposed decisions against three questions. Will the proposed change:

1. Increase Throughput? How?
2. Reduce Investment (Inventory) (money that cannot be used)? How?
3. Reduce Operating expense? How?

The answers to these questions determine the effect of proposed changes on system wide measurements:

1. Net profit (NP) = Throughput - Operating Expense = T-OE
2. Return on investment (ROI) = Net profit / Investment = NP/I
3. Productivity (P) = Throughput / Operating expense = T/OE
4. Investment turns (IT) = Throughput / Investment = T/I

These relationships between financial ratios as illustrated by Goldratt are very similar to a set of relationships defined by DuPont and General Motors financial executive Donaldson Brown about 1920. Brown did not advocate changes in management accounting methods, but instead used the ratios to evaluate traditional financial accounting data.

Throughput Accounting is an important development in modern accounting that allows managers to understand the contribution of constrained resources to the overall profitability of the enterprise.

When cost accounting was developed in the 1890's, labor was the largest fraction of product cost and workers might not know how many hours they would work in a week when they reported on Monday morning. Cost accountants, therefore, concentrated on how efficiently managers used labor since it was their most important variable resource. Now, however, workers who come to work on Monday morning almost always work 40 hours or more; their cost is fixed rather than variable. Many managers are still evaluated on their labor efficiencies, though, and many "downsizing," "rightsizing," and other labor reduction campaigns are based on them.

Goldratt argues that, under current conditions, labor efficiencies lead to decisions that harm rather than help organizations. Throughput accounting, therefore, removes standard cost accounting's reliance on efficiencies in general and labor efficiency in particular from management practice. Many cost and financial accountants agree with Goldratt's critique, but they have not agreed on a replacement of their own and there is enormous inertia in the installed base of people trained to work with existing practices.

The recent development of TA is constraints accounting, which focuses more strongly on the in decision making.

Throughput accounting (TA) is an alternative to cost accounting proposed byTOC. It is not based on Standard Costing or Activity Based Costing (ABC). Throughput Accounting is not costing and it does not allocate costs to products and services. It can be viewed as business intelligence for profit maximization. Conceptually throughput accounting seeks to increase the velocity at which products move through an organization by eliminiating bottlenecks within the organization.

Cost (or Management) accounting is an organization's internal method used to measure efficiency. Since no one outside the organization uses such internal accounts for investment or other decisions, any methods that an organization finds helpful can be used. Outside parties to a business depend on accounting reports prepared by financial (public) accountants who apply Generally Accepted Accounting Practices (GAAP) issued by the Financial Accounting Standards Board (FASB) and enforced by the U.S. Securities and Exchange Commission (SEC) and other regulatory agencies.

Throughput accounting improves profit performance with better management decisions by using measurements that more closely reflect the effect of decisions on three critical monetary variables (throughput, inventory, and operating expense — defined below).

Throughput account and process management

It has always been one of our major con­cerns that ABC is applied at too low a level of detail. As a result ABC in itself may be a significant administrative overhead cost driver. Improvements at the activity level are also more than likely to result in increases in surplus capacity rather that the sought after cost savings.

 the process level where a number of activities are logically linked together. The concepts of throughput accounting applied to process management would ap­pear to hold promise. The focal-point process would be the only process that is analysed and monitored at the activity level unless prob­lems are identified, in which case the analysis would drop down to the activity level for the problem process. Changing the focus from production efficiency to throughput will also support a more customer-oriented environ­ment.

Throughput accounting

Because the plant is viewed as one process and added value is not recognised until sale, cost accounting is vastly simplified. Work-in-process and finished goods are costed at ma­terial cost only. Manufacturing costs are treated as period costs. Variances are not needed for each cost centre, but only for the manufacturing process as a whole.

Waldron and Galloway (1988-1) suggest the fol­lowing perform­ance measures:

The rate at which a product contributes money determines relative prod­uct profitability; the rate at which a product contributes money compared to the rate at which the factory spends it, determines abso­lute profitability.

 Uses a simplified exam­ple to demonstrate these measures. As you will readily identify, these measures turn the old management accounting concept of CULF (Contribution per Unit of Limiting Factor) into a powerful management tool.

The use of the above rates require a time basis — the key question is which time meas­ure is appropriate? Goldratt and Cox (1984) suggest the use of the productive time avail­able in the bottle-neck resource. They argue that this approach focuses the factory to spend its productivity improvement efforts and capi­tal investment to increase the productive time in the bottle-neck resource. To improve any other resource merely increases the surplus capacity on that resource. They recognise that this may result in a floating bottle-neck which Continued on future.