Theory of Constraints Decision Support Metrics highlight the absurdity of using Cost Accounting data for making Operational or Strategic Decisions
Now, it doesn’t take much exposure to Throughput Accounting to recognize that it makes sense. These days it’s even included in modern Management Accounting text books. But to understand its implications I’m going to ask you to take a giant leap out of your comfort zone.
It is the very size of that leap that ensures that our client’s competitors, regardless of what improvement technology they use, will probably never out-perform them.
In a ground-breaking presentation in 1981, Eli Goldratt (the originator of the Theory of Constraints, and not known for his diplomacy) declared Cost Accounting to be “Enemy #1 Of Productivity.”
It would have been just as accurate to have called it Enemy #1 of Profitability … especially for a manufacturing business.
Throughput Accounting, also known sometimes as Throughput-based decision making, is the replacement.
Now, five crucial points I need to make before I continue.
First, be aware that I can prove Eli’s claim, to a level of overkill, in just 60 minutes. It’s the first thing we do in our workshops and seminars. The point Eli made almost 30 years ago is not only just as valid today, it’s become MORE valid!
Next, be aware that this single issue is at the core of ALL the massive improvements that our clients routinely achieve with our help.
Third, it’s natural to have a lot of skepticism on this … but it’s important to recognize that we’re not on our own in making these claims.
Management Accounting textbooks and courses have for years stated that standard fully-allocated cost accounting data should not be used as a basis for operational decision making.
In fact, anyone qualifying as a management accountant today will have at some point during their education covered the sheer absurdity of cost accounting data for decision-making, and also been introduced to Throughput Accounting.
That’s because after 20 years of slaughtering some of cost accounting’s most sacred cows, our replacement suite of measurements finally became officially recognized.
The problems with cost accounting were so well known inside the Accounting profession almost 20 years ago that “mainstream” accountants developed an alternative. Called Activity Based Costing, this was probably the only thing more worthless for decision-support than conventional standard cost accounting. We don’t encounter it these days, thank heaven. But we used to be able to completely destroy it’s legitimacy as a tool for decision support in less than an hour.
Fourth, please recognize that we’re not beating-up on cost accountants or cost accounting. Cost Accounting has a useful role in business; even, an essential one. But that role is NOT operational decision support. Unfortunately, that is exactly the role most managers expect it to play.
Instead, that’s the key role of Throughput Accounting.
And finally, be aware that this is a MEASUREMENTS issue … that leads to BEHAVIOR issues.
We don’t have an axe to grind with cost accounting per se. Our problem is when managers use the data in ways that lead to behaviors that act counter to the company’s profitability.
Which they do, all the time, especially if they’re smart and conscientious. Which is why Throughput Accounting was a necessary development.
The problem is that in industry, almost no-one has heard any of this.
99% of managers simply consider Cost Accounting data to be an established fact, a reality, … something akin to the Theory of Gravity. They are as likely to challenge the concept of Cost Accounting as they are to challenge the Theory of Gravity. That is … not at all.
The advent of Lean Manufacturing led to several attempts to replace the Cost Accounting data. sadly, most of them missed the goal. More happily, what’s emerged is now much more closely aligned to Throughput Accounting; just, not as far-reaching in terms of decision support.
Even today, in 2020, a Cost Accounting mind-set dominates decision making in almost every function of every manufacturing business we encounter …
- Even those who claim otherwise,
- Even those too small to even have a cost accounting function,
- And even those who claim to have almost no cost data (“We’ve just got to get a handle on costs in this plant” … is their refrain.)
And to be honest … as management consultants with a profit motive, we are thankful because as long as manufacturers use cost accounting data in support of decision making we are guaranteed an income because there will be performance problems we can fix, quickly and easily … almost as if by magic.
Management’s belief in the concept of Cost Accounting enables us to make the fast, massive improvements that make us look like heroes and help our clients bank the added profit that makes our fee negligible in comparison..
When we encounter a plant where we can see the language and behaviors in management and on the shop floor that confirm that the cost accounting mind-set is in place, we can immediately start homing-in on opportunities for serious improvements.
It is already established at that point that performance problems are inevitable. All we are doing from that point on is, validating their existence in detail and in scale,. and looking for customer-specific issues that will factor in the detailed solution.
Cost Accounting data is treated as entirely legitimate by most managers – and if you don’t believe me, ask yourself just one question: does anyone in senior management in your company pay any attention to the margins on different products (or the margins on different orders, if you don’t have standard products)?
If the answer is “yes” then my point is made, because the margin on a product or on an order – meaning, selling price less material, labor and overhead costs – is 100% a cost accounting concept. No, “margin” wasn’t handed down by Moses on a tablet – it’s a man-made concept, and it’s mathematically absurd.
Corbett’s book called “Throughput Accounting,” is one of several useful publications that provides detailed numerical examples to accompany an explanation.
Another book, The Theory of Constraints and its Implications for Management Accounting by Noreen, Smith & Mackey was sponsored by the Institute of Management Accountants in the US, and also by Price Waterhouse (Paris). It rigorously examined manufacturing businesses in US and Europe who had been using Theory of Constraints for some time to demonstrate the effectiveness of the Throughput Accounting approach.
A Book “The Management Nightmare” by Debra Smith provides probably the best picture of the whole topic because she devotes a whole chapter to the type of profit-killing behaviors that the Cost Accounting mind-set creates in companies. And Debra is one of the best qualified Accountants you’ll ever encounter– with a history as an auditor, Controller of a division of a Fortune 500 company, and Visiting Professor at Washington State University.
So, just for the moment giving us the benefit of the doubt, assuming we and many others are right … what replaces the flawed traditional measurements?
That’s why Throughput Accounting was developed – to provide managers with a basis for accurately predicting the bottom-line impact of their decisions and actions.
Throughput Accounting usually makes intuitive sense to everyone at all levels and in all functions of a manufacturing organization – it is simple, and logical. It demands less data than conventional Management Accounting, and it is far more tolerant of inaccurate or incomplete data.
Its principal value, though, is simply that it supports better (and faster) decision-making.
Also, the data needed for effective Throughput Accounting is mostly available within organizations anyway. It usually requires no additional effort to collect or maintain the inputs for Throughput Accounting.
Now, managers should be prepared for some surprises when they view their products and their operation from a Throughput Accounting perspective.
Not least, understanding for the first time which products really make the most money for the company, and which don’t. This issue alone is usually a stunner but in just an hour or so of one of our workshops or presentations it becomes painfully clear to managers just what the impact of this change in measurements can be on sales and marketing, production, purchasing, finance and accounting, engineering, quality management, new product development, even HR.
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