Throughput accounting is a managerial accounting tool designed to optimize production plans so that profit is maximized. Profit is maximized by planning product mix so that it generates maximum output by least utilizing limited/scarce resources, which is based on the theory of constraint.

Throughput accounting works when we have the the following 2 factors in decision-making.

• We have a scarce resource.
• There is a product mix (more than one product in the business portfolio).

If any of the above factors are missing, throughput accounting and the constraint theory will not be applicable.

Let’s go through a systemized approach to understand how throughput accounting works.

1-Identify bottleneck/scare resources

Bottleneck or scarce resource is the one that limits the business’s ability to continue production and earn profit.

Different businesses may have different scarce resources. For instance, handicraft businesses may be expected to have skilled labor as a scarce resource. Production businesses may have machine hours as a bottleneck/scarce resource, and so on.

The first step is to identify the scarce resource.

2-Calculate throughput per unit and bottleneck/ scarce resources

The second step is to calculate throughput per unit of scarce resource. For instance, consider the following table.

Description	Product-A	Product-B	Product-C
Sales price (A)	$20	$30	$40
Direct material cost (B)	$10	$12	$20
Throughput per unit =(A-B) = C	$10	$18	$20
Scarce resource (Machine hours) (D)	2	1	5
Throughput/scarce hour (C/D)	$5/scarce resource	$18/scarce resource	$4/scarce resource
Maximum demand	10,000	15,000	25,000

Maximum machine capacity = 50,000 hours

In rows 4 and 6, respectively, we have calculated throughput per unit and per bottleneck resource.

3- Rank the products in line with the greatest throughput per scarce resource

First rank = Product-B ($18 throughput/scarce resource)

Second rank = Product- Product-A ($5 throughput/ scarce resource)

Third rank = Product-C ($4 throughput/ scarce resource)

It’s important to note that our ranking is not based on maximum throughput per unit but on maximum throughput per scarce resource. The logic behind this idea is that our decision has to be based on optimized use of scarce resources.

If we consider throughput per unit while planning production, we will ultimately make less profit as we will not be doing justice to the scare resource by NOT making smart use of it.  

4-Allocate resources in line with ranking and demand

Please note that product B is generating the highest throughput per scarce resource. This means that this product must be given priority in the production mix. So, we will meet the maximum demand for this product and produce 15,000 units. It will consume 15,000 hours (15,000 units x 1 hour/unit)

Similarly, product A should be given second priority, and we can meet the maximum demand of 10,000 units by allocating 20,000 machine hours 20,000 (10,000×2).

We have consumed 35,000 (15,000+20,000) hours in producing products B and A, and the remaining hours amount to 15,000 (50,000-35,000) hours, which can be used for product C. The total production for this product can be 3,000 (15,000 hours/5 hours/unit) units, which is less than the maximum demand of 25,000 units.

Hence, we will not be able to satisfy 100% of the demand for product-C because machine hours are scarce.

Why are we selecting the product with the highest throughput per scarce resource and not the product with the highest throughput/unit?

The reason is that the product with the highest throughput per unit utilizes a higher proportion of scarce resources. So, if we give priority to this product, it will result in rapid consumption of scarce resources, and there will be less or no scarce resources available to make a product that consumes comparatively less scarce resources and provides optimized return.

We always need to make decisions based on scarce resources as they are limited and must be utilized in the best possible way. Hence, we should plan a product mix which uses the lowest quantity of scarce resources.

The assumptions in throughput accounting.

Following are the assumptions used in throughput accounting.

1. The business operates in a just-in-time inventory.
2. The business will be able to sell all the production.
3. The product demand is reasonably forecasted.
4. The fixed cost does not change while choosing a product mix.
5. The scarce resource is expected to remain limited in the future.

You may want to read, Throughput accounting ratio.

Conclusion

Throughput accounting helps in planning product mix. The product generating the highest throughput per scarce resource is given priority in the production plan.

According to the theory of constraint, there is always a bottleneck or limiting resource that limits the business’s capacity to make products and maximize profit. Hence, scarce resources should be identified and optimized in terms of usage.

Throughput accounting assumes a just-in-time inventory system and that all units produced will be sold. Additionally, fixed costs do not change when choosing a product mix.