01 technical

throughput
and backflush RELEVANT to ACCA QUAlification paper F5

Throughput accounting and backflush accounting Example 1

focuses on what an organisation’s purpose is – its goal

have been developed in response to relatively Throughput accounting has a very direct relationship Take a not-for-profit organisation which
modern advances in manufacturing: performs a medical screening service in three

– and helps attain it by increasing their ‘goal units’.

1 The increased reliance by manufacturing with decision making and performance management. It sequential stages:
businesses on sophisticated and expensive 1 Take an X-ray.
facilities and machinery. This greatly increases 2 Interpret the result.
the proportion of costs which are fixed. (This 3 Recall patients who need further investigation/tell
was one reason why activity-based costing others that all is fine.
has become more important: if fixed costs
are more significant they should be dealt with The ‘goal unit’ of this organisation will be to
more accurately.) progress a person through all three stages. The
2 A recognition that holding inventory is likely to be number of people who complete all the stages is
a waste of resource. the organisation’s throughput, and the organisation
3 The increased use of just-in-time manufacturing, should seek to maximise its throughput. However,
so that inventory (particularly work-in-progress) there will always be a limit to throughput, and
is much reduced and its valuation is therefore the resource which sets that limit is called
less important. the ‘bottleneck resource’.Adding more detail to the
medical screening process above:
Throughput accounting
Throughput accounting has a very direct Process Time/patient Total hours
relationship with decision making and performance (hours) available/week
management. It begins by focusing on what an Take an X-ray 0.25 40
organisation’s purpose is – its goal – and seeks
to help organisations attain their purpose by Interpret the
increasing their ‘goal units’. The approach can be result 0.10 20
applied to both profit-seeking and not-for-profit
organisations, provided meaningful goal units can Recall patients
be identified. who need further
investigation/
tell others that
all is fine 0.20 30

You can easily see from this table that the

maximum number of patients (goal units) who can
be dealt with in each process is:

X-rays: 40/0.25 = 160

Interpret results: 20/0.10 = 200
Recall etc: 30/0.20 = 150
 student accountant issue 03/2010
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Studying Paper F5?
Performance objectives 12, 13 and 14 are linked

accounting
accounting

contribution per unit is the difference between the selling price of a

profit-seeking organisation is to use contribution analysis. The
So, the recall procedure is the bottleneck resource. $ $
Throughput, and thereby the organisation’s Selling price 140
performance, cannot be improved until that part of Material 20
the process can deal with more people. Therefore, Labour 30
to improve throughput: Variable overhead 10

The traditional approach to decision making in a

1 Ensure there is no idle time in the bottleneck Fixed overhead 25
resource, as that will be detrimental Total absorption cost 85
to overall performance (idle time in a ­Profit per unit 55
non‑bottleneck resource is not detrimental to
overall performance). The cost card is based on a budgeted output of
2 See if less time could be spent on the 10,000 units.
bottleneck activity. In this example, the marginal cost (the additional
3 Finally, increase the bottleneck resource available. cost caused when one more unit is made) is $60
per unit ($20 + $30 + $10). The contribution per

unit and the marginal cost of a unit.

In Example 1, increasing the bottleneck resource, unit is:
or the efficiency with which it is used, might be
relatively cheap and easy to do because this is $140 - $60 = $80
a simple piece of administration while the other
stages employ expensive machinery or highly skilled The contribution is the amount by which you ‘win
personnel. There is certainly no point in improving the race’: each extra unit sold brings in $140, but
the first two stages if things grind to a halt in each extra unit made causes costs of $60, so after
the final stage; patients are helped only when the making and selling one more unit the business is
whole process is completed and they are recalled better off by $80, the contribution.
if  necessary. The fixed cost element is independent of the
The traditional approach to decision making in number of units actually made. It is based on
a profit-seeking organisation is to use contribution budgeted output and budgeted fixed costs and,
analysis. The contribution per unit is the difference working backwards, the total budgeted fixed costs
between the selling price of a unit and the marginal must have been:
cost of a unit, where marginal cost consists of the
material, variable labour and variable overhead per $25 x 10,000 = $250,000
unit. Example 2 will remind you of this approach.
A typical cost card for a product is as follows: A typical calculation then made using this
information is to find the break even point, which is
this example is 250,000/80 = 3,250 units.
03 technical
reflect the reality of a modern manufacturing business. the notion that
the assumptions it makes about cost behaviour often do not accurately
in example 2, The contribution approach is not wrong in principle, but

there are significant variable labour and overhead costs is suspect.

In Example 2, contribution is the goal unit. If that Throughput = selling price – material
is maximised, so is profit, which is the goal of a per unit per unit per unit
profit-seeking organisation.
The contribution approach is not wrong in Throughput = sales revenue – cost of materials
principle, but the assumptions it makes about
cost behaviour often do not accurately reflect the Throughput is generated only when a sale is made.
reality of a modern manufacturing business. In Increasing inventory does not increase throughput.
particular, the notion that there are significant See Table 1 in Example 3 below. Available hours:
variable labour and overhead costs is suspect. 5,000 machine hours, 6,000 labour hours, 2,500
Many of these businesses rely on sophisticated quality control hours.
automated systems that run continuously with The factory is modern and highly automated.
relatively little manual involvement. Even when Despite the presentation of the information, it
production is slack, provided the downturn is is considered that all costs, except material, are
expected to be short lived, most employees will effectively fixed. The first step in managing the
still be paid because it is expensive to dismiss performance of an organisation is to discover the
workers and then to rehire and retrain them. For limits to its performance. What is the bottleneck
short-term fluctuations in production it would be resource here?
more accurate to consider labour costs and all From the data we can identify the bottleneck
overheads to be fixed, leaving material as the only resource as seen in Table 2 opposite. So the
truly variable cost. bottleneck resource, the one which limits output,
If all costs except material are fixed, businesses is machine hours. There is more than enough of the
will become richer provided the sales revenue per other two resources.
unit exceeds material price per unit. In effect, sales If the company can’t make everything it wants
price less material price is the new contribution to, it has to decide on an optimum production plan.
per unit, but to make clear what we are talking Because the factory is highly automated and material
about this is not called ‘contribution’: it is called is the only truly variable cost, throughput will be the
‘throughput’. appropriate measure to use when calculating how
In fact, ‘throughput’ is sometimes usefully known much the manufacture and sale of each unit increases
as ‘throughput contribution’: the company’s wealth (see Table 3 opposite).

table 1, example 3

Product A Product B Product C

Expected demand/budgeted output (units) 8,000 10,000 6,000
Selling price per unit ($) 130 100 135
Material cost per unit 33 20 40
Labour cost per unit 30 24 36
Variable overhead cost per unit 25 20 30
Fixed overhead cost per unit 15 12 18

Machine hours/unit 0.25 0.2 0.3
Labour hours per unit 0.25 0.2 0.3
Quality control time per unit 0.1 0.1 0.1
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bottleneck resource. These are uniquely precious and must be

table 2, example 3

Needed for full production Available

Machine hours 0.25 x 8,000 + 0.2 x 10,000 + 0.3 x 6,000 = 5,800 5,000
Labour hours 0.25 x 8,000 + 0.2 x 10,000 + 0.3 x 6,000 = 5,800 6,000
Quality control hours 0.10 x 8,000 + 0.1 x 10,000 + 0.1 x 6,000 = 2,400 2,500

in example 3, machine hours have been identified as the

table 3, example 3

Product Selling price Material Throughput/unit
($) ($) ($)
A 130 33 97
B 100 20 80
C 135 40 95

table 4, example 3

Product Throughput/unit Machine hours/unit Throughput/machine hour = Rank
($) return/factory hour ($/hour)

used up in the best possible way.

A 97 0.25 388 2
B 80 0.20 400 1
C 95 0.30 317 3

We can’t simply conclude from this that Product This shows that priority should be given to making
A must be best because it earns more per unit Product B, the highest earner per machine
than the other products. It is essential to take into hour, then to Product A, and finally to Product C.
account the use that each product makes of the The production plan would therefore be as seen in
bottleneck resource. Here, machine hours have been Table 5 on page 5.
identified as the bottleneck resource. These are
uniquely precious and must be used up in the best
possible way.
This can be done by calculating for each unit:

Throughput
Time in bottleneck resource

and then using the answers to rank the products as

shown in Table 4 above.
05 technical

hour in example 3, it is common to express these amounts as ratios, known

Instead of directly comparing return/factory hour to costs/factory
table 5, example 3

Units Machine Machine (bottleneck) Throughput ($)

as throughput accounting ratios (TAR), as shown in Table 6 .

hours/unit hours used
Product B 10,000 0.20 2,000 10,000 x 80 = 800,000
Product A 8,000 0.25 2,000 8,000 x 97 = 776,000
Product C
(balance) 3,333 0.30 1,000 (balance) 3,333 x 95 = 316,635

Maximum machine hours available 5,000 1,892,635

Total expected non-material costs (from the original budget) =

Product A: 8,000 x (30 + 25 + 15) = 560,000

Product B: 10,000 x (24 + 20 + 12) = 560,000
Product C: 6,000 x (36 + 30 + 18) = 504,000
(1,624,000)
Profit 268,635

The throughput/machine hour (or return/factory Products A and B are clearly worth making and
hour) shows the rate at which throughput can be selling because their earning rates (return/factory
earned when making and selling each product. hour) exceed the factory spending rate on fixed
Similarly, if the total expected non-material costs costs (cost/factory hour). Product C is more difficult
are divided by the available machine hours then the to deal with. If the factory costs are truly fixed
cost per factory hour is obtained: then Product C is still worth making as it earns a
throughput amount of $317/factory hour – which
$1,624,000/5,000 = $324.80 is a lot better than earning nothing. However, if the
fixed costs identified with Product C ( $504,000)
So, for every hour the machine operates (which could actually be avoided, then Product C should
really means for every hour the factory operates be abandoned as it costs more to run the factory to
as nothing else matters if the machine is the make the product than the product can earn.
bottleneck resource), running costs accrue at the Instead of directly comparing return/factory hour
rate of $324.80/hour. The products the factory to costs/factory hour, it is common to express these
makes earn a net $388 for Product A, $400 for amounts as ratios, known as throughput accounting
Product B and £317 for Product C. ratios (TAR), as shown in Table 6 opposite.
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In back-flush accounting, costs are not associated with units

table 6, example 3

also called delayed costing, as costs are not allocated to

Throughput accounting ratios

until they are completed or sold. Back‑flush accounting is

Product A Product B Product C
Return/factory hour 388.00 400.00 317.00
Costs/factory hour 324.80 324.80 324.80
Throughput accounting ratio 1.17 1.21 0.93

The TAR tells us nothing that we have not worked In backflush accounting, costs are not associated
out already. Its interpretation is: with units until they are completed or sold.
1 The higher the better (but we already knew Backflush accounting is sometimes called delayed

production until after events have occurred.

the ranking of the products from the return/ costing, which is a helpful name, as costs are not
factory hour) allocated to production until after events have
2 The TAR should be greater than 1 if a product occurred. Standard costs are then used to work
is worthwhile (earning rate greater than backwards to flush out manufacturing costs into
spending rate). production, splitting them between stocks of
finished goods (if any) and cost of sales. No costs,
Organisations should focus on how they can whether material or conversion costs, are allocated
increase their TAR. Obvious routes are to increase to work-in-progress.
selling prices, decrease material costs, or decrease The traditional and backflush approaches can be
factory costs. Provided a TAR is greater than 1 it illustrated by Figures 1 and 2 on page 8.
will be worth trying to increase throughput, and
this must be done by eliminating idle time in the Variants of backflush accounting
bottleneck resource, increasing the bottleneck There are two variants of backflush accounting and
resource (until another resource becomes the they differ according to what are called ‘trigger
bottleneck), or decreasing the use the product points’. Trigger points are the events which cause
makes of the bottleneck resource. costs to be moved into inventories.

Backflush accounting
Backflush accounting is a costing short cut. It
relies on a business having immaterial amounts
of work‑in-progress and is therefore particularly
suitable for businesses operating just-in-time
inventory management. If the amount of
work‑in‑progress is negligible, what is the point in
meticulously valuing it? Fretting that some products
might be 25% complete and others 60% complete,
and then adding carefully calculated labour
and overheads to these (immaterial) items, is a
complete waste of time and effort.
07 technical

stocks of both raw materials and work-in-progress must be negligible. It has

variant 2 of backflush accounting is more radical because no records are
kept of work-in-progress or raw materials, so if this method is to be used,
Variant 1 Note that at some point the creditors account will
This is the less radical variant. There are two have to record correctly what is owing to them so,
inventory accounts, raw materials and finished from time to time, this will be adjusted by a cost
goods, and there are two trigger points: variance. Thus, if the standard cost of raw materials
used was $50,000, but the actual cost of materials
1 Purchase of raw materials was $52,000, an adverse variance of $2,000 has to
be recognised and the creditors account would have
Dr Materials account two entries Cr $50,000 (and Dr $50,000 to finished
Cr Creditors goods), then Cr $2,000 and (Dr $2,000 to profit
and loss account).
The cost of labour and other manufacturing So, are there any benefits in adopting backflush
expenses are debited to a conversion cost account accounting other than avoiding complex recording
and credited to cash or creditors. The conversion and calculations to value immaterial amounts of
cost account can be thought of as a suspense inventory? Let’s consider the trigger point found in
account where amounts are placed temporarily. both variants: costs are transferred when goods are
completed. What would happen if that trigger point
2 On completion of units were changed to permit cost transfer only when
goods were sold?
Dr Finished goods account with the standard cost That would mean conversion costs would remain
of goods produced as costs until goods were sold, rather then being
Cr Materials account with the standard cost transformed into finished stock when goods
of  materials were completed. Managers would then have no
Cr Conversion cost account with the standard incentive to make goods unless they were going to
cost of conversion. be sold imminently, otherwise they would simply
be incurring more expense, and that would make
Variant 2 their performance look bad. The purpose of a
This is more radical because no records are kept of manufacturing business is not to make goods; its
work-in-progress raw materials, so if this method purpose is to make and sell goods. Only then is
is to be used, stocks of both raw materials and there throughput, and backflush accounting can be
only one trigger point.

work-in-progress must be negligible. It has only one set up so that costing records encourage managers
trigger point. to adopt this goal-orientated behaviour.
As before, the cost of labour and other
manufacturing expenses are initially debited to Ken Garrett is a freelance writer and lecturer
a conversion cost account and credited to cash
or creditors.
Entries into the finished goods inventory account
are made only when goods are completed, and the
journal entries will be:

Dr Finished goods account with the standard cost

of goods produced
Cr Creditors with the standard cost of material
used in goods produced
Cr Conversion cost account with the standard
cost of conversion.
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figure 1: traditional costing

Material

Materials account

Costs in Costs out

WIP stage 1 WIP stage 2 Finished goods
to WIP

Conversion costs
To cost
of  sales
Costs in Costs out
to WIP

figure 2: backflush accounting

Material

Materials account

Costs in Costs out to

Finished goods
finished goods

Conversion costs
To cost
of  sales
Costs in Costs out to
finished goods