The incompatibility of standard costing

Executive Summary

This project reviews and compares the concepts of throughput accounting (TA) and cost-based approaches. The primary objective is to investigate of both approaches so as to provide management with the capability of making better operations decisions in the presence of diverse activities and committed costs. First, we look at the prelude to change in cost-based approaches. Second, Throughput Accounting (TA) and Theory of Constraints (TOC) are discussed such as the five steps for improvements in TOC. Next, the impact of the company of shifting to throughput accounting is really great? Then, Goldratt and Galloway and Waldron criticize of TA. Finally, TA versus Cost-Based approaches are compared based on numerical examples and arguments. Numerical results show that both TA and cost-based approaches can provide management with better performance measurement of reducing the costs and help to improve the company's profitability. Accordingly, suggestions for integrating the two approaches are in conclude.

I am a plant manager reporting to the Division Vice President in one of the UK's corporation which produces investment casting for jet engines in the aerospace industry. My corporation has felt the need for a more responsive, more holistic approaches and thus the Division Vice President studies about the throughput accounting (TA) and theory of constraints (TOC), introduced in McGuinn's 2009 article, "Got Lean? Six Sigma? Here's Another Theory".

Hence, he asked me to conduct thorough research and educate him on the throughput accounting versus cost-based accounting approaches. Explore a few case studies as illustrations of the required shift and the impact it has on companies. Further, He expected me to answer questions such as:

  • What are Throughput Accounting (TA) and Theory of Constraints (TOC)?
  • Is the impact of the company of shifting to throughput accounting really great?
  • Criticism of Throughput Accounting (TA)
  • Throughput Accounting (TA) Versus Cost-Based Accounting

My Division Vice President believes that this research will benefit the strategic direction of the company and help him in effective decision making.


Not to talk about non-profit organization, the ultimate goal of any company is simply to make more money. In order to gain more, there must be greater swiftness of system in producing the money. "TA is the first approach that factors in the most important element missing in all of the cost-based accounting approaches - Throughput (TOC Center, 1999)." TA is not a costing systems and which is a fundamental shift away from the focus on costs and the allocation of them to products. Throughput can be defined as the rate at which the company generates more revenues through sales (TOC Center, 1999). From this statement, it can be concluded that what a company can do in order to grasp its goal is by maximising its throughput.

A Prelude to Change in Cost-Based Accounting Approaches

It is believed that cost-based approaches do not flow with the development in manufacturing environment such as traditional accounting, which is proved by the fact that traditional accounting today still places same emphasis on direct labour cost as what it did during its early period of development. True enough that today's manufacturing life in which more automation is required, has led direct labour to lose influence and caused the cost-based accounting to become obsolete technique.

Moreover, cost-control is important but cost-based approaches are not achieving corporate sales and earnings growth (TOC Center, 1999). No company aims to downsize as its long-term corporate strategy. However, cost-based approaches are hindering a company from making profits. Cost-based approaches focus on controlling costs, putting expense at the centre of the decision-making and performance measurement process. Consequently, the end result is data that does not match reality and thus, there is a growing realisation that the need of different alternatives to reduce the unintended and inaccurate result of cost-based approaches.

A study conducted by TOC Center (1999) added that managers in hundreds of companies have only used cost accounting approach only when it is able to grant the figure which is closest to their expectation. Called to make a difference, the application of Theory of Constraints (TOC) ideas as 'Throughput Accounting' is a systems management philosophy developed by Ellyahu. M. Goldratt in the early 1980s (Dugdale and Jones, 1998). Conversely, "cost-based accountings fail to recognize the critical role of constraints and treat all areas as equally important (TOC Center, 1999)."

The TOC Center uses the TOC concepts to accelerate process improvement in manufacturing and project operations which has a 15 year track record of helping companies. It has worked with more than 100 companies using TOC to make large leaps in operational performance. TOC Center has been on the leading edge of the facilitating change since the publishing of The Goal more than 20 years ago. The publication date of this article showed the year 1999. In other words, it was published a decade ago. Thus, the relevance of the article could be questioned.

However, in this article, it is relevant to the topic of my article because the purpose of my research is to give a wide range of examples and arguments in order to compare the TA and cost-based approaches. The TOC Center philosophy is "you get the results or you don't pay" and thud it uses a few case studies as illustrations of the required shift and the impact it has on companies, proven focusing techniques of TA and totally criticizes the cost-based approaches as an obsolete technique which should not be used. The examples provided is proved enough to illustrate how effective of the TA is because which are giving in the different industries. It has increased the perceived reliability towards the contents of my project.

David Dugdale is currently Professor Emeritus of Management Accounting at the University of Bristol. All of his works consistently discussed management accounting topics including costing systems, performance measurement and investment decision-making. He is also a vice-chair of the Research Board of the Chartered Institute of Management Accountants and an Associate Editor of the British Accounting Review. Hence, his experiences allowed him to conduct a very reliable study on the theme of management accounting. Another author, T. Colwyn Jones is Emeritus Professor of Sociology of Accounting at the University of the West of England, Bristol. He is also an Editorial Board member: Accountancy, Business and the Public Interest; PhD Supervisor, University of Canterbury, NZ and thus, there will be no question of the reliability of both authors.

In this article, David Dugdale and Colwyn Jones gratefully acknowledge the financial support of CIMA Research Foundation for their research into accounting for throughput. They indicate how products could be ranked according TA ratio and also conclude by describing the way in which product costs can be compiled on TA principles. The inclusion of formulas has increased the perceived reliability towards the contents of article as a whole. Thus, their work is relevant to my project. However, the publication date for this article showed the year 1998 and thus the relevance of the article could be questioned. Nevertheless, a new publication in 2008 by Fry, Philipoom and Leitch indicated a sense of similarity to the work of David Dugdale and Colwyn Jones. For example, in talking about TA or the use of TOC, both authors quoted Goldratt approach. Besides, for some of the parts of their publications, although they structured their words and works differently, it can be found out that their points were actually matched to each other. To talk the same messages with a 2008 publication regardless the fact that it was published in 1998, means the concepts adopted for the paper by Dugdale and Colwyn Jones are still relevant today.

Throughput Accounting (TA) and Theory of Constraints (TOC)

"TA is advocated by the Theory of Constraints (TOC) which was developed and popularized by Goldratt (1990), Goldratt and Cox (1992), Fredendall and Lea (1997), Hall et al. (1997), and Ruhl (1996, 1997). Boyd and Cox (2002) also included this cost system in their optimal decision making study in a constrained environment" (Fry et al., 2008, p.1671).The problem arises when it is found out that there is always a factor which limits the throughput. This factor is known as constraint. Goldratt stressed the importance of constraint to company's performance and proposed Theory of Constraints (TOC) as a process of constant improvement to the company. There are five steps for improvements in the TOC.

Timothy D. Fry is Professor of Management Science, University of South Carolina; Columbia, South Carolina. He has been conducting a lot of studies in the areas of Management Accounting and Operations Management. On the other hand, the time period was from 1979 until 2005 in his paper. He used statistics to support his points, and thus his research is reliable. However, my standing is that the source is not wholly relevant to my article.

Identify the Constraints

There are no perfect approaches in this world and all approaches are subject to defect. Thus, critical evaluation of weakness is necessary for development. Constraints could be related to time, space and many other things. A research in the Hi-Tech industry which is conducted by Pass and Ronen (2003) discovered that "the Hi-Tech firm always has two Permanent Bottlenecks: marketing and sales (M&S) and R&D".

Decide How to Make the Best Use of Constraints

At this step, there is no additional investment yet. Pass and Ronen (2003) identified three actions to be taken which are "efficiency improvements, effectiveness improvements, and elimination of policy and dummy constraints". In the case of the Hi-Tech firm where M&S and R&D are the problems, for efficiency to be improved, critical evaluation should be carried out for the work of salespersons and R&D people. Pass and Ronen (2003) noticed that "salespersons waste over 50% of their time on irrelevant and non-value added jobs" and they also monitored "a senior system engineer wasting hours of his precious time on upgrading the Windows software at workstations". In order to improve the effectiveness of the Hi-Tech firm, they argued that "strategic screening and prioritizing of products, services, projects, clients and markets on which the firm wishes to focus" should be done. Finally, it is necessary to eliminate both policy and dummy constraints. In this case, Pass and Ronen (2003) pointed out that the use of traditional cost accounting as company's policy can hinder the company in achieving its goal and thus, there is a need to remove it.

Pass and Ronen's paper is published in 2003 which is time lapse of 7 years to current business environment. Time is money in business and thus the ideas of the article may not fully reflect the current conditions of the business world. However, the paper addresses the issue of managing a market-constrained Hi-Tech firm, from the vantage point of the Theory of Constraints (TOC). The table and figure which indicated in the paper is clearly explained or quoted sources. And, to look at qualification, Ronen is a Professor of Business Administration at Tel Aviv University's Leon Recanati Graduate School of Business Administration. He has published over 100 papers in leading academic and professional journals and co-authored several books on Theory of Constraints and advanced managerial methods. Besides, prior to his academic career he worked for 10 years in the high-tech electronics industry and thus, based on his experience, my standing is that the study done by Ronen is relevant and reliable.

Submit Non-constraints to Constraints

Ricketts (2007) highlighted the importance of harmony between non-constraints and constraints. He mentioned that when non-constraints generate more than what constraints can handle, it will result in work in progress. However, when non-constraints generate less than constraints' capacity, it means as an output lost to the plant. The case study in Hi-Tech firm where market is a constraint shows that submission of non-constraints to constraints can be done by providing explanation of the importance of meeting market need and demand to the company or applying a system which is responsive to customer's needs (Pass and Ronen, 2003).

Ricketts's work is partly relevant to the topic of my article. However, in his paper, he incorporated a lot of charts and diagrams that have no quoted sources. While by providing charts and diagrams can actually do better in convincing the users, Ricketts's decision for not putting the sources of information attracted the opposite reaction. By doing so, for the worst case scenario, there is possibility that the author is not being objective in his analysis. Supposedly, Ricketts should give the information on how he derived at any chart which he had included in his paper. Moreover, he should provide bibliography/references of all sources of information that he have accessed. Besides, some of the points in the paper Ricketts based on his opinions and not facts. Hence, the inclusion of statistics has decreased the perceived reliability towards the contents of paper as a whole. Moreover, the publication date showed the year 2007 and thus the relevance of the article could be questioned.

Elevate the Constraints

After all of the three steps above are done, it is necessary that proper evaluation is carried. If the company deems that the constraint still limits its performance, it can decide to invest in project which will erase the current limitation. Therefore, the solutions which are to be taken for the Hi-Tech firm will be to hire more salespersons, to spend more for research and development and to launch advertising campaign (Pass and Ronen, 2003).

Following Removal of Current Constraint, Redo All Steps

TOC is an unending process. In other words, the process does not just stop when the current problem is solved. When the previous steps a constraint has been broken, other things can emerge as a new constraint. Therefore, TOC requires repetition of all steps which have been done previously. However, the most important thing is that not to allow same constraint which is already solved to arise again in the future.

Is the Impact of the Company of Shifting to Throughput Accounting really Great?

Evaluates the Practicality

Throughput accounting (TA) has caused the shift in accounting practitioners' mindset, especially for those who embrace conventional cost accounting. Now, everything must be throughput oriented with measures of efficiency and overhead allocations are no longer useful. A study which is done by Boyd and Cox III (2002) has compared the uses of traditional cost accounting, direct costing, activity-based costing and theory of constraints in making decisions such as pricing, making or buying. In the study, Theory of Constraints which based its decisions on concept of throughput beats the other three accounting systems and comes out as the winner. This is supported by CIMA (2008) who points out that "the TOC concept avoids cost allocation semantics and restructures the financial control system from one based on reporting entities, such as departments, to a company wide overview of value streams." Therefore, the use of TA has helped to bring throughput P&L into the surface. Accounting practitioners like this concept as it is unbelievably easy to understand.

Cox III holds TOCICO certifications in all disciplines. He is a Jonah's Jonah, Professor Emeritus, and was the Robert O. Arnold Professor of Business in the Terry College of Business at the University of Georgia. Besides, he has written three books on TOC. On the other hand, Boyd is an Associate Professor in Department of Management at University of Louisville. Beyond his current job in the academic line, there were also seasons when Boyd worked as Positions through Senior Manager, Audit, Deloitte & Touche. Thus, with more than 30 years of experiences in the management accounting sector, Boyd's paper is a reliable source of information. On the other hand, the publisher of the journal which is International Journal of Production Research, is a well-established and highly successful journal reporting production and manufacturing research. It has published quite a number of journals includes papers on manufacturing technology and the fundamental behaviour of production resources and so on. Therefore, the publisher is reliable in this case and the content is reliable to certain extent.

Sufficient of researches is done, but the issue of up-to-date is questionable because the publication date shows year 2002. However, Boyd and Cox (2002, cited by Fry et al. 2008, p.1669) for example, generally find that consideration of the constraints, as would be the case using TOC, yielded better decisions than using traditional accounting, e.g. full costs. To talk the same messages with a 2008 publication regardless the fact that it was published in 2002, means the concepts adopted for the paper by Boyd and Cox are still relevant today.

The other article is published by CIMA and which is leading professional body of management accountants. The article is said to be reliable as it was published in a professional body website whereby a lot of professionals will be reading at it. However, have a possibility of being bias towards their own professions regard the ethical issues. Besides, the paper is relevant as year of publication is 2008 which is up to date. Finally, the article is wholly relevant to the purpose of my project as it reviews academic research and to highlight the need of the users.

According to Dugdale and Jones (1996b), throughput P&L is not suitable for financial reporting. Furthermore, TA is similar to conventional variable costing. The only difference is that labour is now treated as fixed cost. Variable costing has gained more support compared to absorption costing because it does not encourage stock building, its decision is more relevant and it might symbolise flow of cash (Dugdale and Jones, 1997). However, Dugdale and Jones (1997) pointed out that resistance to variable costing might come from financial reporting standards which require "inclusion of production overhead in the value of work in progress and finished goods". As the result of using marginal costing to derive the product cost, throughput accounting provides incentive for business to quote a very aggressive price. This will help the product to become more competitive in the market (Dugdale and Jones, 1996a).

On the other hand, TA has impacted the conventional production scheduling by pointing out the weaknesses of Material Requirements Planning (MRP) system. The most basic concept adopted by the system is that it assumes production capacity to be unlimited. MRP system believes that there is always capacity to produce or even there is not any, it will not take to have the capacity. However, there is no such thing in the real life. As TOC has argued, there is always constraint for every system. Therefore, two main flaws of MRP system occur because it will always plan production regardless of shortage. Besides, it will always wait until all criteria are met in order to continue with the production. So, let's say that customers order 50 units. The materials in house can only produce up to 48 units. In this case, MRP system will wait until there is enough materials while already can produce most of it. If this thing is seen through window of throughput, it will be considered as a waste of time and eventually, there will be loss of throughput (Dugdale and Jones, 1997). In order to solve the existing problems, computer software OPT (Optimised Production Technology) is introduced. 'The Goal' highlighted the basis of this OPT software (Dugdale and Jones, 1996a).

Dugdale and Jones (1996a) explore the ideas of throughput accounting, "contrast and evaluate the issues and conclude by identifying the potential of these ideas to transform manufacturing and accounting practice". Then, Dugdale and Jones (1996b), they "explore the issues through a detailed study of one company where TOC had a significant impact on the thinking of accountants and led them to make a number of changes to their accounting systems". However, evidence only from few companies where it is not proved enough to make any conclusion. Furthermore, Dugdale and Jones (1997), they "look at recent developments in the field of accounting for throughput, and specifically those techniques that have been generated by practitioners interested in throughput ideas". Hence, Dugdale and Jones's paper is relevant to my project but the issue of up-to-date is questionable.

Impact on the Companies

There are many companies around the world who apply Goldratt's theory of constraints and come out with a lot of good testimonies. A company like Motorola has increased "throughput by 150% and reduced cycle times by 20%" and "Monster Cable who used to spend 10 days for processing order receipt, does it today for only few hours (Goldratt's marketing group, 2008)."

Eli Goldrat is the author of "THE GOAL", an underground best seller that utilizes a non-traditional approach to convey important business information. The ideas illustrated in "THE GOAL" underscore Dr. Goldratt's Theory of Constraints, an overall framework for helping businesses determine: (Sources: Goldratt's marketing group, 2008)

  • What to change---what is the leverage point
  • What to change to---what are the simple, practical solutions
  • How to cause the change---overcoming the inherent resistance to change.

"In the year 2000, Dr. Goldratt established Goldratt's Marketing Group to make TOC knowledge available to different market needs. Since then Goldratt's Marketing Group has produced and distributed TOC learning resources for individuals, such as books, videos and CDs, self learning programs, simulators, and the latest GOLDRATT WEBCAST SERIES. In 2002 Dr. Eli Goldratt founded the Goldratt Group by also establishing Goldratt Consulting and Goldratt Schools, with the purpose of Making TOC the main way of managing organizations. The Goldratt Group aims to place any system, large or small, for profit and not for profit, on a process of ongoing improvement (Goldratt's marketing group, 2008)." Therefore, it is partly relevant to the topic of my article and there will be no question of the reliability of the author. However, there is possibility that the Goldratt's Marketing Group might favour certain thing and thus it is not being objective or showing bias.

Criticism of Throughput Accounting (TA)

Galloway and Waldron have been working for ideas in TA. They work might seem to be in accordance with Goldratt's but over certain things they have different point of views with each other.

Goldratt saw Activity Based Costing (ABC) as an obsolete technique which should not be used. Therefore, Goldratt totally criticised the financial community as it does not want to move on and continually demands this rotten technique. Again, he repeated here that the thing matters most is not the product cost but profit generated (Dugdale and Jones, 1996a). However, Waldron did not agree with his views. Waldron said that instead of saying activity-based costing as a flaw, throughput accounting can actually be improved through the usage of it. He argued that throughput will never become a good basis for product costs. However, right selling price is still of great importance and thus, ABC will be needed as the product costing system (Dugdale and Jones, 1996a). Therefore, Waldron believed that it will not be enough to derive for decision if Goldratt only practices throughput accounting. In accordance with Waldron, Dugdale and Jones (1997) cite the works of Noreen et al about an experience of company who used throughput accounting as a basis for product price. The company has come out with a conclusion that "initial exposure to TOC was just enough to be dangerous. Armed with throughput accounting data that indicated fat margins, prices were cut 20% across the board on a number of standard products. This tactic worked great for about a month until competitors reacted and dropped their prices too. Prices did not recover after this skirmish and throughput declined." From this example, it can be seen that throughput accounting is not as perfect as what Goldratt thinks.

In relation to the application of theory of constraints, Goldratt introduced stock buffers to protect the bottlenecks. Nevertheless, Galloway and Waldron argue that no matter what purposes it might be, the decision to add more inventories is always a bad decision. The reason is because it may cause the production managers to be slack in their jobs. They may not care about the bottlenecks and will not bother to get rid of them. That is why Galloway and Waldron would prefer to use Just in Time (JIT) principles as it encourages zero stock (Dugdale and Jones, 1996a).

On the other hand, the biggest criticism of throughput accounting is that it is only relevant in the short term. The real challenges come when "the organization has a fixed supply of resources, when its expenses and spending for the next period - other than materials - have already been determined, when its products have already been designed, when its prices have been set, and when its customers orders have been received (Corbett, 2000)."

Throughput Accounting (TA) Versus Cost-Based Accounting

Today companies are well along in the implementation of cost-based approaches because cost control is important and the most important that managers use cost accounting to help make strategies decision to reduce the company's costs and in order to achieve the company sales. According to Goldratt, traditional cost accounting has placed extreme emphasis in pressing operating expense to the minimum. It might be relevant in the past because companies competed on the basis of price. Therefore, reduction of cost is very important as it provides competitive advantage (Bowhill and Lee, 2002). However, Goldratt argued that now this action has high tendency to mislead. In the attempt of reducing cost, the company might lose the opportunity for good investment. In the end, throughput will suffer. Because of this, Goldratt urges for radical change in managerial emphasis. If prior to the rise of Throughput Accounting (TA), operating expense comes first, followed by throughput and inventory, now throughput will be placed as number one, followed by inventory and operating expense (Goldratt, 1990, pp.47-51). On the other hand, cost-based accounting approaches focus on controlling costs at the exclusion of throughput, putting expense at the centre of the decision-making and performance measurement process. Thus, the end result is data that does not match reality (TOC Center, 1999).

As an addition, TA also identified baseless point of using direct labour as a base of allocation in traditional full costing. The reasoning will be because labour cost has lost relevance in today's world. In relation with this view, Lea and Min (2008) said that "direct labour might comprise less than 10% in highly automated manufacturing firms". In other words, direct labour has only small influence toward the company as a whole. Finally, TA also "does not allocate costs to products" (Corbett, 2000). Lea and Min (2008) cite the works of O'Guin (1991) and Horngren et al. (2000) to add to this point and conclude that "allocation of the overhead to products using traditional volume-based cost drivers caused product cost distortion when different types of products (e.g. simple high volume products and complex low-volume products) are manufactured".

As the result we can see that cost-based accounting approaches have lost some of its usefulness since it requires more effort but without providing better results. However, the most important is how the companies seek and implement or even make the best use of both approaches because there are still many possibilities that both approaches can be combined to achieve the companies' overall objectivities.

The publication date for TOC Center's paper showed the year 1999 and thus the relevance of the article could be questioned. However, a new publication in 2009 by McGuinn indicated a sense of similarity to the work of TOC Center. For example, in talking about Throughput Accounting vs. Cost Accounting, both authors argued both of the approaches. Hence, in relation to my article, some of the arguments from the TOC Center's paper are similar to the other up to date publications. However, some of the contents are merely based on TOC Center's point of views so there is possibility that it is not being objective in its analysis and showing bias. Hence, in overall, I perceive that the article is of little reliability.


There are various techniques and models in the real world which are adopted by each company to suit their own industry specific needs. Cost control is important but the most important that managers use cost accounting to help make strategies decision to reduce the company's costs and in order to achieve the company sales and earnings growth.

Nowadays, the use of throughput accounting increases because of the companies realise some potential danger that the conventional costing approaches might generate inaccurate information and therefore cause the managers make wrong decisions. However, given the central role of management accounting in all business functions, is the impact on the business of shifting to throughput accounting really great? Throughput accounting has caused the shift in accounting practitioners' mindset, but not all. Besides, it is not easy to change from one method to another. It would take time to get used to and to realise its benefits. Not all companies are flexible and can easily adapt with its changing environment.

Goldratt has totally criticised cost accounting for being not relevant and developed the ideas for throughput accounting based on his theory of constraints. In the development of throughput accounting, there are people who support, expand and criticise the theory. In the end, the usefulness of throughput accounting remains to be an open discussion and proper evaluation needs to be done for every decision making. This is supported by TOC Center (1999), "TA now offers a way to understand, analyze, and focus productivity improvement efforts based on their impact on cost and Throughput. Companies seeking to drive Throughput-based improvement should see the logic of using a similarly capable accounting/decision model to accomplish their aims."

Although cost-based accounting approaches have highlighted that clearly understanding of what it costs to provide products/services is at the same time a tool for better management. However, this may not be accurate enough to make business decision. Thus, companies have felt the need for a more responsive, more holistic system. Since the advent of TA, companies can have a better choice among all of these cost accounting models, seek to remedy the knowledge gap between the theory and practice to help make decisions to reduce the costs and the most important thing is to improve the company's profitability.

Last but not least, all of the journals and sources which I have gone through are really a brilliant works from the authors. Most of the authors are expert in management accounting with experience of more than 10 years in the academic line and thus their experiences allowed them to conduct a very reliable study. They help me to produce a high level dissertation because it will affect the logic or line of argument. However, some of the authors' works are partly relevant to the topic of my project. Moreover, there is possibility that the authors are not being objective in their analysis. Hence, it is important to recognize the need for information and determine the extent of information needed then access the information effectively and efficiently in order for information to become evidence. Besides, the date of publication was considered relevant as it showed from 2008 to 2009. In contrast, the relevance of the article could be questioned. However, some new publication in 2008 or 2009 indicated a sense of similarity to the work of author and thus for most of the parts of their publications, although they structured their words and works differently, it can be found out that their points were actually matched to each other. Therefore, it means the concepts adopted for the paper are still relevant today.


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