a.

Machine utilisation rate:

Machine type 1 = 675/600 = 112.5%

Machine type 2 = 415/500 = 83.0%

Machine type 1 has the highest utilisation rate and the rate is above 100. Therefore, machine type 1 is the bottleneck/limiting factor.

b.

Allocation of machine type 1 hours according to this ranking:

Product A 120 units using 180 hours

Product C 60 units using 180 hours

360 hours used

Product B (240/4.5) 53 units using 238.5 hours

598.5 hours used

c. A major concept underlying throughput accounting is that the majority of costs, with exception of material and component costs, are fixed.

In ABC’s case it is clear that the labour cost, which is treated as a variable cost in traditional marginal costing, is indeed a fixed cost. The employees are paid for a guaranteed 800 hours (160 × 5) each month, whereas the number of labour hours required to meet the maximum demand can be calculated as 780 hours as follows.

Therefore, labour is a fixed cost that will not alter within the relevant range of activity. Throughput accounting recognises this in the calculation of throughput.

Furthermore, given the perishable nature of ABC’s products, the throughput accounting approach to inventory minimisation and maximisation of throughput would be more appropriate.

d.

Allocation of machine type 1 hours according to this ranking:

Product C 60 units using 180 hours

Product B 70 units using 315 hours

495 hours used

Product A (105/1.5) 70 units using 105 hours

600 hours used

e. Throughput accounting approach

The conventional cost accounting approach used by ABC views inventory as an asset.

In the throughput accounting approach inventory is not viewed as an asset, but rather as a result of unsynchronised manufacturing. The existence of inventory is thus viewed as a breakdown in synchronisation and a barrier to generating profits.

In throughput accounting the ideal inventory level is zero, with the exception that a buffer inventory should be held prior to the bottleneck machine.

As regards the valuation of inventory, the throughput philosophy is that no value is added to inventory items and no profit is earned until the items are actually sold. Thus inventory is valued at its material cost only until it is sold.

Contrast the approach

The marginal costing approach currently used in TK differs from throughput accounting in the following areas:

This approach to inventory valuation is in contrast to the full absorption costing system used by ABC. The latter approach encourages managers to produce output just to add to work in progress or finished goods inventory, since this helps with the absorption of overheads and boosts reported profits. This behaviour will be avoided, and managers will be more likely to be willing to minimise inventory if it is valued at material cost only.

Variable and fixed costs: Marginal costing divides costs into variable costs (which vary with production volume and include materials, labour, and variable overheads) and fixed costs (which remain constant regardless of production volume).

Throughput accounting considers materials cost as the only variable cost. All other costs, including labour are considered as factory cost of operating expenses and are treated as costs for the period.

Contribution margin: The key metric in marginal costing is the contribution margin, which is sales revenue minus variable costs. This margin contributes to covering fixed costs and generating profit.

The key metric in throughput accounting is throughput contribution, which is sales revenue minus material cost only. This margin contributes to covering the operating expenses and generating a profit.

Inventory valuation: Inventory is valued based on variable costs only (as defined above). Fixed costs are treated as period costs and are expensed in the period they are incurred.

In throughput, inventory is valued based on variable costs only, specifically direct material costs, avoiding complex overhead allocations.

f. The importance of identifying scarce resources when preparing budgets

i. If an organisation produces just one product, the budget for the scarce resources is usually the starting point in the budget preparation process.

ii. If an organisation produces two or more products and there is only one scarce resource, limiting factor analysis must be used to determine the most profitable use of the scarce resource.

iii. When there is more than one scarce resource, linear programming must be used to identify the most profitable use of resources.

iv. To optimise resource allocation to competing products

Prioritisation: By identifying scarce resources, companies can prioritise their allocation to the most impactful activities, ensuring that these constraints do not hinder overall production or service delivery.

v. To Enhance decision-making

Informed Planning: Knowing which resources are scarce allows for more informed and strategic decision-making, enabling better planning and utilisation of available resources to meet production targets and customer demand.

vi. For cost efficiency

Minimised Waste: Effective management of scarce resources reduces waste and inefficiencies, leading to cost savings and improved profitability.

vii. To improve bottleneck management

Focus on constraints: Identifying scarce resources helps in focusing efforts on managing and alleviating bottlenecks, which can significantly enhance throughput and overall system performance.

viii. Risk mitigation

Contingency Planning: Understanding resource limitations allows for better risk management and the development of contingency plans to mitigate potential disruptions.

ii. The use of linear programming to determine the optimum use of resources

 Linear programming is applicable when the scare resource is more than one resource.

 Decisions about what mix of product should be manufactured and sold in order to maximise profit or minimise costs are formulated and solved as linear programming problem.

 It allows optimal solution that satisfy several constraints at once.

 It is used in many industries e.g. agriculture where farmers can generate more revenue from their limited land; transportation (for cost and time efficiency) etc.

 It is used to determine the price of a scarce resources.

 It is used to determine shadow prices.

 Linear programming is a technique which determines the most profitable production mix, taking into account resources constraints and limitations faced by an organisation. All costs are assumed to be either fixed or variable in a relation to a single measure of activity (usually units of output).

The problem is formulated in terms of an objective function and constraints are then graphed. This process highlights all possible output combinations given the resources constraints and limitations and allows for the identification of the output combination which would maximise contribution (the optimal solution). If there are more than two types of output, the graphical approach is not possible and the simplex method must be used instead.