Management And Accounting Web

MacArthur, J. B. 1993. Theory of constraints and activity-based costing: Friends or foes? Journal of Cost Management (Summer): 50-56.

Summary by Linda Perez
Master of Accountancy Program
University of South Florida, Fall 2000

ABC Main Page | TOC Main Page

The main idea in this paper is that ABC and the theory of constraints (TOC) can be considered complementary rather than conflicting or contradictory. The value of ABC comes in accurately estimating the long-term cost of products and product lines, whereas the accounting approach that supporters of TOC recommend is more appropriate as a short-term measure.

TOC ABC
Definition "Manufacturing philosophy" that seeks to maximize profit through proper management of bottlenecks or constraints. It has a short-run emphasis with long-run implications "Accounting model" that measures by the long-run cost of the resources consumed to perform activities
Goal To improve profit and system optimization To provide the main source of information for activity-based management
Continuous Improvement objectives I.D. the system’s constraints, Decide how to exploit the system’s constraints, Subordinate everything else to the exploitation, Elevate the system’s constraints, and If in the previous steps a constraint has been broken, go back to Step 1, but do not allow inertia to cause a system constraint Measure organizational costs more accurately and finely than traditional costing systems
Accounting approach Utilizes three global operational measurements: Throughput – the rate at which the system generates money through sales, Inventory – all the money the system invests in purchasing things the system tends to sell, Operating Expense – all the money the system spends in turning inventory into throughput Deals with the problem of arbitrary allocations of overhead costs by classifying activities and tracing costs to the appropriate activity level with cost drivers: Unit-level activities, Batch-level activities, Product-level activities, Facility-level activities
Limitations Short-run focus that restricts its usefulness for decision making, form of variable costing accounting approach, assumes all costs (including operating costs) other than raw material costs are fixed It’s not a stand-alone approach. It should consider other factors such as cash flow information, product mix and customer mix
Capacity Balance the flow of work, but do not try to balance the plant capacity Measure unused capacity costs to manage capacity
Waste reduction perspectives Operating expenses that do not help in turning inventory into throughput should be reclassified as waste. Waste activities (i.e., setup time) at constraint resources (which determine throughput) should be targeted for waste reduction efforts to elevate the system’s constraints. Buffer inventory before the bottleneck is not waste ABC uses the term "non-value-added activities" (NVAA). ABC estimates of various types of NVAA give management an idea of potential long-run operating cost savings from the elimination of each NVAA

Concluding Thoughts

Both TOC and ABC provide information that can be useful to decision makers if they interpret and use the information properly. Managers must understand the strengths and weaknesses of both methodologies before they use TOC or ABC information to make decisions. TOC is useful for decisions requiring short-run accounting information. ABC information provides estimates of the long-run cost of organizational activities and cost objects, which can be useful for long-term decisions. The TOC and ABC models, therefore, are complementary rather than conflicting.

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