Accounting Best Practices, Fifth Edition

9–10. Implement Throughput Accounting

The preceding best practice recommended the use of activity-based costing (ABC) as a central costing technique. However, ABC suffers from a key assumption that can result in incorrect decision making in the short term—it assumes that all costs are variable. Over the long term, this assumption is correct, since even the largest assets, such as a building, can be eliminated. However, these costs are fixed in the short term, and so should not be allocated for short-term order acceptance or manufacturing prioritization purposes. Thus, ABC can result in the allocation of an excessive amount of “fixed” costs to a product, resulting in decisions not to accept customer orders that could have yielded short-term profits.

An alternative system to use for these short-term decisions is throughput accounting. Under this approach, only the cost of direct materials is considered to be variable, with all other costs assumed to be fixed in the short term. This assumption results in significantly larger product gross margins than would be the case if ABC were used, so that lower price points will now be considered to yield acceptable gross margins. Throughput accounting is especially valid for manufacturing facilities that use large amounts of machinery, since these assets are substantially less variable in the short term than would be the cost of manufacturing ...