Review

Questions/Notes for Discussion

Job costing Lesson 5 Practice Quiz: Questions 9, 10 and 11

Management Accounting 2A
COMAA2-22 ABC Costing Lesson 6 Practice Quiz: Questions 9 and 10

Question 1: How to calculate the cost of a job.

Self-assessment 3
Question 2: How to apply ABC

Duration = 2 hours, Scope: The context of costing;

Online Test 1 Cost behaviour; Cost elements; Overheads
Eduvos (Pty) Ltd (formerly Pearson Institute of Higher Education) is registered with the Department of Higher Education and Training as a private higher education institution under the (including activity-based costing); and Job costing.
Higher Education Act, 101, of 1997. Registration Certificate number: 2001/HE07/008

Week 3: Lesson 8. Throughput accounting & Digital products

What will be covered
Learning outcomes
in today’s lesson?
Week 3 7.1 Discuss and apply the theory of constraints.

Throughput Introduction, concepts and

formulae
7.2 Calculate and interpret throughput accounting ratio.

accounting and 7.3 Suggest how a TPAR could be improved.

Digital products Example 7.4 Define digital product.

7.5 Evaluate reasons why digital products are more difficult to cost than traditional
Class activities products.
7.6 Assess the costs that may be different to the costs incurred in traditional
products.
Digital products
7.7 Examine the features and benefits of digital costing systems.

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Throughput accounting Throughput Accounting introduction
Throughput • Throughput Accounting (TA) is a modern management accounting technique that
Marginal costing
accounting offers an alternative view to traditional cost accounting. It is a principle-based and
simplified management accounting approach that provides managers with
Highlights contribution = Throughput contribution = information which supports decision-making for profitability improvement.
Sales value less variable Sales value less material
costs cost • TA is similar to marginal costing, but:
Fixed costs charged in full Factory cost = § it can be used to make longer term decisions about capacity/production
against revenue for the Labour + overheads equipment;
period § it focuses on constraints as the factors limiting the performance of organisations,
rather than on the cost-cutting exercises that typify cost accounting.
Inventories valued at variable Inventories (should be
production cost none!) valued at material • TA is used as the performance measure in the “Theory of Constraints.”
cost
Impact on pricing: Theory of constraints & • NB: Throughput Accounting is neither cost accounting nor costing. It is cash
Marginal cost+ Ratios focused and does not allocate all costs to products and services.

The aim of throughput accounting Concept 1: Throughput

The aim of throughput accounting (TA) is to maximise throughput contribution whilst • Throughput contribution = sales revenue – direct material cost.
keeping conversion (operational) and investment costs to a minimum. § Only material cost is seen as a variable cost as
§ most costs are fixed over the short term,
If a strategy for increasing throughput is being considered, it will only be accepted if § including labour costs.
the conversion and investment costs increase by a lower amount than contribution. o Different to marginal costing, where labour costs are seen as variable.

• In TA, the only cost that is deemed to relate to volume of output is the direct • Throughput accounting (including the Theory of Constraints – see later slides) tries to
material cost. All other costs (including all labour costs) are deemed to be fixed. change the manufacturing strategy to achieve evenness of production flow.
These fixed costs may be called Total Factory Costs (TFC). o Different to marginal costing, where the emphasis is on the short-term.
• Throughput contribution = Revenue – Totally variable costs.
§ Since totally variable costs are normally just raw materials and bought-in- • The aim of throughput accounting is to provide information to managers that will
components, it is often convenient to re-define throughput contribution as: allow them to maximise throughput (whilst minimising investment and operating
§ Throughput contribution = Revenue – direct material costs. expenses).

TA is based on three concepts (see next slides).

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Concept 2: Minimise investment Concept 2: Minimum investment continued
TA strives to minimise investment costs. The lower the investment, the higher the • Inventory valuation
return on investment will be. The investment for TA consists of non-current assets § Inventory is valued at the purchase price of raw materials and specific parts (until
and inventory. sold).
§ No other costs are included in the value of inventory, not even direct labour cost.
Inventory
• TA attempts to ensure that little or no inventory is held as inventory adds no value
Other investments
of profit until it is ultimately sold.
• The investment for throughput accounting purposes also includes the equipment,
• In a JIT environment, the ideal inventory level is zero. However, in a JIT system, buildings, etc., used to produce inventory (finished goods).
idle capacity is acceptable as it is unavoidable (production only starts when an
order is placed). • TA assumes that a manager has a given set of resources (the investment) available.
§ Using these resources, purchased materials and parts must be processed to
• Idle capacity (i.e. machines standing still) is not acceptable for TA. TA, together with generate sales revenue.
the theory of constraints (TOC), wants evenness of production flow, § The manager should therefore, within the given constraints, attempt to maximise
§ so that the organisation’s bottleneck resource may be used optimally. throughput.
§ Consequently, buffer stock is kept just before the constraint (i.e. bottleneck) to
ensure that no stoppages occur.

Concept 3: Minimise operating expenses (cost control) Conventional cost accounting vs Throughput accounting
Operating expenses are defined as all the money a business spends to produce Conventional cost accounting Throughput accounting
throughput (i.e. to turn the inventory into throughput). Operating expenses should be
Inventory is an asset. Inventory is NOT an asset. It is a result of
minimised. unsynchronised manufacturing and is a
barrier to making profit.
• Profit is generated by sales that are made.
§ The faster goods can be made to satisfy customer orders, the faster money can be
Costs can be classified as direct or In-/direct classifications are no longer
earned. indirect. useful.
§ Producing inventory that does not get sold immediately (either WIP or finished Product profitability can be determined Profitability is determined by the rate at
goods) adds cost (e.g. storage) and NOT profit, and should therefore be by deducting a product cost from selling which money is earned.
discouraged. price.
Profit is a function of costs. Profit is a function of throughput as well as
• Conversion costs = all operating expenses except direct material cost (i.e. all costs costs.
except the totally variable costs).

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Throughput accounting terminology Throughput accounting profit calculation
Throughput contribution = Revenue – direct material costs. R

Operating expenses = All expenses, excluding direct material costs. Revenue 750 000
Raw material cost (total variable cost) (200 000)
Net profit = Throughput contribution – operating expenses.
Throughput contribution 550 000
Investment = All the money the business invests to buy the things Operating expenses (400 000)
that it intends to sell, and all the money tied up in Net profit 150 000
assets so that the business can make the
throughput.

Return on investment = Net profit / Investment.

Formulas and ratio calculations for Throughput Accounting Theory of constraints

Only actions that strengthen the weakest link in the chain, improve the process.
1. Throughput profit = Sales – Direct materials costs
2. Identify process
2. Throughput Accounting ratio (TPAR) = Return per factory hour constraints
Cost per factory hour
The higher the TPAR, the more profitable the company. 1. Measure 3. Effectively manage
process bottlenecks
3. Return per factory hour = Throughput profit per unit . capacity (maximise their use)
Time per unit on bottleneck resource

4. Cost per factory hour = Total factory cost . 4. Co-ordinate the processes
Total time available on bottleneck resource (sub-ordinate all other facilities)

A measurement of the ability of a process to convert resources into valuable

products/services.

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Throughput accounting (TA) and the theory of constraints (TOC) Throughput accounting (TA) and the theory of constraints (TOC)
• TA attempts to maximise throughput. To do so, the company must identify any TOC is therefore a continuous process of identifying and eliminating constraints
bottlenecks that prevent it from achieving its (production, sales or service) goals, (bottlenecks) in a system. TA and TOC strives for evenness of production flow so that
i.e. that stops it from maximising its throughput. the company works as effectively as possible. To achieve this goal, the company will
§ A bottleneck resource (also called a ’constraint’ or a ‘hurdle’) is “an activity, prioritise production on the basis of throughput per usage of the scarce resource.
resource or policy that limits the ability to achieve an objective”. (CIMA)
To achieve the aim of earning the highest throughput for each unit of the bottleneck
To work as effectively as possible, the company will have to identify the bottleneck resources consumed, a five-step approach is taken:
(the most constraining item), then schedule all production in such a way that the
bottleneck is used optimally, and then attempt to break the bottleneck. For instance, if Step 1 Identify the bottleneck constraint (e.g. hours required / hours available).
the bottleneck is machine production capacity, the company can investigate acquiring Step 2 Calculate the throughput contribution per unit for each product.
or renting another machine, or increasing the production capacity of the current Step 3 Calculate the throughput contribution per unit of the bottleneck resource
machine. Once the bottleneck is broken, the company identifies the next most for each product.
constraining item. This process of identifying and removing bottlenecks, is referred to Step 4 Calculate the TPAR and rank the products accordingly.
as ‘the theory of constraints’. Step 5 Allocate resources using this ranking.

Example 1 Example 2
Two products together require 30 000 labour hours and 20 000 machine hours. The Win Ltd produces two products, called Alpha and Beta. Win Ltd is only able to employ
company has available 25 000 labour hours and 15 000 machine hours. seven skilled labourers at its factory for an average 40 hours per week per person (on
the assumption that labourers each clock 8 hours per day for 5 days a week). One
Required hour of each shift is allowed as a lunch break.
Determine whether any constraints exist, and, if both resources are limited, consider
which bottleneck should be removed first. Labourers are capable of producing 500 Alphas (selling price R200 per unit, material
cost R100 per unit) or 400 Betas (selling price R240 per unit, material cost R120 per
Solution unit) in an hour. Conversion costs amount to R9 800 000 per week. Market demand is
75 000 product Alphas and 60 000 product Betas in a week.

Required
Advise Win Ltd on the optimal usage of its labour during each four-week period and
the resultant profit that it may expect to generate based on your proposed production
schedule.

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 Solution One of the eight hours that the Calculate the throughput contribution per unit for each product
Does a bottleneck exist? labourers clock, is used to have
lunch (idle time). Alpha = R200 – R100 = R100 per unit
Hours available: Beta = R240 – R120 = R120 per unit
7 employees x 5 days per week x 7 hours per day = 245 hours per week
Calculate the throughput contribution per unit of the bottleneck resource for
Product Minutes p.u. Minutes required Total minutes each product
Alpha 60/500 = 0.12 75 000 x 0.12 = 9 000
Beta 60/400 = 0.15 60 000 x 0.15 = 9 000
Alpha = R100 per unit x 500 produced in an hour = R50 000
18 000
Beta = R120 per unit x 400 produced in an hour = R48 000
Or alternatively: Hours
Alpha 75 000/500 = 150 hrs Calculate the TPAR and rank the products accordingly
Beta 60 000/400 = 150 hrs
300 hrs TPAR = Throughput contribution per labour hour
Conversion costs per labour hour
300 hours required / 245 hours available = 122.45%
" bottleneck exists! Conversion (factory) cost per labour hour = R9 800 000 / 245 = R40 000

Calculate the TPAR and rank the products accordingly (continued) Compile production schedule and determine profit

Alpha = R50 000 / R40 000 = 1.25 Production schedule: R

Beta = R48 000 / 40 000 = 1.20 Alpha (75 000 / 500) = 150 hours
150 x R50 000 = 7 500 000
The ranking is therefore 1st Alpha and then Beta. Remaining for Beta = 95 hours
95 x R48 000 = 4 560 000
75 000 Alphas should be produced. 500 units can be produced per hour, thus Throughput contribution 12 060 000
production of the Alphas will require 75 000 / 500 = 150 hours. Conversion costs 9 800 000
Profit per week 2 260 000
Available for Betas = 245 hours – 150 hours = 95 hours

Number of Betas that can be manufactured = 95 hours x 400 Betas

= 38 000 Betas

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 Class activity 1 Solution
The following data relates to two products manufactured by Taflean Ltd:
Product X Product Y
Selling price per unit R15 R20
Direct material cost per unit R10 R11
Maximum demand (units) 25 000 30 000
Time required on the
bottleneck (hours per unit) 2 6
Taflean Ltd has 80 000 bottleneck hours available each
period.

Total factory costs amount to R128 000 in the period.

Required: Calculate the optimal product mix and the

maximum profit.

Solution continued Solution continued

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Class activity 2 Solution
Below is a Statement compiled by the Accounting Assistant regarding LexisPeris
Manufacturers:

Required:
Calculate (according to the TOC) the production schedule required to ensure maximum
profit. Also calculate the profit achieved based on your proposed production schedule.

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Other aspects of throughput accounting Digital costing
Can throughput accounting be applied in a service organisation? • A digital costing system is a computerised system used to track and manage costs by
Absolutely! gathering data in real-time by connecting to the internet. It involves the use of
• Sales departments work on selling price less bought-in-cost, anyway. software and digital tools to collect, analyse, and report on various cost-related
• Can highlight bottlenecks, e.g.: information.
§ Credit rating checks taking too long
§ Queues too long • A digital costing system can connect the entity's digital systems (such as production,
§ Mechanics using a vehicle lift inefficiently inventory management, and purchasing systems) with the digital systems of its
§ Waiting at a photocopier suppliers, customers, and the market, to enhance cost management and
procurement processes.
Disadvantages of throughput accounting
• It concentrates on the short-term, when a business has a fixed supply of resources • Digital costing provides access to a greater number of suppliers, and also provides
and operating expenses are largely fixed. more details on overheads (and therefore can acommodate more overhead drivers).
• It is difficult to apply throughput accounting concepts to the longer term when all Even though it processes large volumes of data, it can provide products costs very
costs are variable and vary with the volume of production and sales or another cost quickly.
driver.

Features of digital costing systems Digital products

• Prices are obtained electronically from suppliers/the market, thus the information is Introduction
provided in real-time and is up-to-date. Digital products are items that are created, distributed and consumed in electronic (or
• Large numbers of suppliers can be integrated into the system. digital) format, such as software applications, mobile apps, e-books, online courses,
• The product cost may constantly change – this can both make the product more digital music, streaming services, and video games. These products are intangible.
competitive in the market (advantage), and lead to confusion with consumers
(disadvantage). Features
• Intelligence capabilities (machine learning and AI) are built in – this could provide the • Unlike physical products that require manufacturing, inventory management, and
company with quick, accurate and reliable insights so that it can make more shipping, digital products are typically created once and then reproduced and
informed decisions. distributed at low cost (or even for free).
• Digital costing systems are expensive to implement but the operation costs are low • Digital products can easily be updated with new features which can be released
(it costs less to run than to employ cost accountants to perform the same function). online.
• Digital products are easily scalable, i.e. there are few physical constraints, that limit
production (i.e. fewer bottlenecks than with physical production).
• Longer life spans than physical products – does not suffer the same wear & tear as
physical products, and can, as stated above, be updated more quickly and easily.

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Cost elements:
Traditional accounting methods cannot easily be used to cost digital products. What Happens Next?
To be completed before the next Lecture-led session (self-directed learning
For instance, marginal costing is inappropriate as a costing technique, as: and assessments):
• Digital products have high indirect labour (i.e. fixed) costs because of the provision • Online test 1
of ongoing updates and support.
• Lesson 8 (Throughput accounting, Digital costing systems and Digital
• Infrastructure costs, such as payments to have the product on a particular platform,
products) Practice Quiz
are high.
• Self-assessment 4
• No inventory is held.
• Lesson 9 (Contract costing) Notes
• Variable costs are close to zero (digital products can be replicated at a minimal cost
per unit).
What will be covered in the following Lecturer-led sessions:
Absorption costing can’t be used effectively, as: • Contract costing
• It may be challenging to allocate overhead costs appropriately, as digital products
may not have direct labour hours or machine usage (drivers are difficult to
determine).

The best techniques to use for costing digital products are ABC or target costing.

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