Difference between Cost accounting and Throughput accounting
Before jumping into the parlance of cost accounting and throughput accounting, let’s first understand the difference between financial accounting and management accounting:
Financial Accounting is the process of compiling and presenting activities carried out by an organization in a defined accounting period.
Financial accounting deals with the preparation and presentation of financial statements such as balance sheets, Profit and Loss statements, and cash flow statements.
Management Accounting deals with both quantitative and qualitative aspects of the business.. It provides the management with the information and insights required to facilitate decisions that can bring the organization closer to its goal (profits, ROI for a for-profit entity).
MA is also extensively used to measure and control the impact of everyday decisions on the overall performance of the organization (profits, ROI, ROCE, Profitability % for a for-profit entity).
Cost Accounting is one of the many tools used to arrive at Management Accounting decisions. In cost accounting, product cost acts as the main driver for most of the decision-making. Here, product cost is assumed to be the sum of direct and indirect costs.
Direct cost: Cost directly attributed to the product. Example: material cost, packaging cost
Indirect cost: Cost that cannot be directly attributed to the product. Example: Cost of labour
Why organizations use cost accounting:
For-profit organizations are assessed by investors/board/senior management based on parameters such as profits, return on capital invested, and return on equity infused in the company. Middle-lower management do not find these parameters handy for day-to-day local decision-making about aspects such as pricing, order rates and so on.
Product cost measure acts as a bridge between these local decisions and the overall goal of the company. Here, the profitability of the individual product (based upon the cost) is considered. The core assumption is that if the product is profitable, then at the end of the period company would also be profitable.
Further, cost accounting tries to be fair, making products pay for the resources used — allocation of cost based upon resource activation (indirect cost). The implicit assumption is products that use more of the company’s resources should bring in more revenue.
This assumption is only valid if we accept that the significance of all assets in an organization is directly proportional to how much they cost in money terms.
Most of the time it is true. But, what if the expensive machines are non-bottlenecks, and cheaper machines are constraints? Or maybe, there are no constraints in the manufacturing line?
In such conditions, decisions based on product cost will not lead to the most optimal situation for the company to achieve its goal. And herein lies the limitation of cost accounting methods.
Erroneous assumption in cost accounting: It is possible to measure the impact of an area (or decision) on the organisation’s ROI/profits by measuring how much money an area (or decision) absorbs or frees up.
Throughput Accounting is an alternative tool that managements can rely on to help them make the right decisions. Throughput accounting takes a systems approach to govern the organization’s decision making.
The fundamental assumption in Throughput Accounting is this — It’s not the product that makes a profit but the organization.
Basics of Throughput accounting:
Sales/revenues bring in money to the company
Truly Variable costs (TVC) are costs directly associated with the production of products.
Throughput (T) = Sales-TVE
Investment (I) is the money that is inside the system and is utilized to convert the input to the goal units (Working capital).
Operating Expense (OE) is the money that the system spends to convert Investment into Throughput. It is a period cost.
A company makes profits when the overall throughput crosses the Operating Expenses.
Simply put, for every decision the management makes, it needs to check if Throughput exceeds the increase in Operating Expense or not.
