Achievers ACCA Devinda Weerasekara

The Theory of Constraints (TOC)

• A constraint is anything that will restrict a company from achieving its objective.
• A constraint is also known as a bottleneck resource.
• The theory of constraints looks at how to eliminate a bottleneck process in the long term.
• Constraint /Bottleneck / Limiting Factor means anything that will stop the company from achieving
its objectives

Example : Process of manufacturing a shirt

Cutting Sewing Buttoning Packing

600 Shirts 550 shirts 650 shirts 675 Shirts

per Hr per Hr per Hr per Hr

In a manufacturing environment, the bottleneck process is your slowest process or the one with the
lowest capacity. In this example, the bottleneck is the sewing process since it is the slowest and
will slow the entire production process down. Even though the buttoning process can do up to
650 shirts per hour, they are forced to do only 550 shirts per hour since that is all that sewing
process can deliver. Also, packing process can pack up to 675 shirts per hour but are forced to
do only 550 per hour due to the low speed and capacity of the sewing process. Companies
should deal with bottlenecks in the short terms as well as in the long term.

Short Term Strategy

In the short term, the company needs to ensure that the entire capacity of the bottleneck is
utilized. In the above example, where the sewing process is the bottleneck, the company
should ensure that the entire 550 shirts per hour capacity is utilized and nothing less than that.
To do this, the company should ensure that the sewing process is operating at an efficiency
level of 100%. Anything less than 100% would mean that the full 550 shirts per hour capacity
will not be utilized. They should put the best employees into the bottleneck process and ensure
that 100% efficiency levels are achieved.

Long Term Strategy

In the long term, the company should eliminate the bottleneck process. Eliminating the
bottleneck process by definition means that the particular process should no longer be the
slowest process or the process with the lowest capacity level. This could be achieved by taking
actions such as increasing the number of machines in the bottleneck process, investing in the
latest technology to improve efficiency, automation and training employees to be more
efficient.

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Achievers ACCA Devinda Weerasekara

However, with a bottleneck being defined as the slowest manufacturing process, when one
bottleneck is eliminated, another bottleneck gets automatically formed. For example, let’s say
that we have now increased the capacity of the sewing process to 750 shirts per hour which
means that sewing process will no longer be the bottleneck. However, now the slowest process
is the cutting process which has automatically become the bottleneck process.

Throughput Accounting

• Throughput accounting aims to make the best use of a scare resource (bottleneck) in a JIT
environment.
• The aim of throughput accounting is to maximize this measure of profitability, whilst
simultaneously reducing operating expenses and inventory (money is tied up in inventory).
• Throughput is a measure of profitability and is defined as throughput contribution:

Throughput Contribution = Selling Price – Direct Material Cost

• Throughput accounting theory states that direct material cost is the only variable cost and
other costs (Direct Labour, Direct Other Expenses and Variable OH) are not completely
variable.
• For example, employees are paid a minimum wage or a fixed salary which makes the labour
cost a Fixed cost or a semi variable cost.

The Throughput Accounting Ratio

When there is a bottleneck resource, performance can be measured interms of throughput for
each unit of bottleneck resource consumed.

There are three inter-related ratios:

Note: The total factory cost is the fixed production cost, including labour. The total factory cost
may be referred to as 'operating expenses'.

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Achievers ACCA Devinda Weerasekara

Interpretation of TPAR

• TPAR>1 would suggest that throughput exceeds operating costs so the product should make
a profit. Priority should be given to the products generating the best ratios.
• TPAR<1 would suggest that throughput is insufficient to cover operating costs, resulting in a
loss.

Example

X Limited manufactures a product that requires 1.5 hours of machining. Machine time is a
bottleneck resource, due to the limited number of machines available. There are 10 machines
available, and each machine can be used for up to 40 hours per week.

The product is sold for $85 per unit and the direct material cost per unit is $42.50. Total factory
costs are $8,000 each week.

Calculate

(a)the return per factory hour

(b)the TPAR.

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Achievers ACCA Devinda Weerasekara

Question 1

A business manufactures a single product that it sells for $10 per unit. The materials cost for
each unit of product sold is $3. Total operating expenses are $50,000 each month. Labour hours
are limited to 20,000 hours each month. Each unit of product takes 2 hours to assemble.

Required:

Calculate the throughput accounting ratio (TPAR)

Improving the TPAR

Options to increase the TPAR include the following:

• increase the sales price for each unit sold, to increase the throughput per unit
• reduce material costs per unit (e.g. by changing materials or switching suppliers), to
increase the throughput per unit
• reduce total operating expenses, to reduce the cost per factory hour
• improve the productivity of the bottleneck, e.g. the assembly workforce or the bottleneck
machine, thus reducing the time required to make each unit of product. Throughput per
factory hour would increase and therefore the TPAR would increase.

Question 2

Huron Ltd manufactures a product called the GL1. The GL1 requires five hours of machine time. Machine
time is a bottleneck resource, as there are only four machines which are available eight hours a day, five
days a week. Each GL1 sells for $210 and has direct material costs of $26 per unit, labour costs of $19
per unit and factory overhead costs of $15 per unit. These costs are based on weekly production and
sales of 150 units.

What is the throughput accounting ratio (to 2 decimal places)?

A 0.87
B 1.15
C 1.31
D 2.62

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Achievers ACCA Devinda Weerasekara

Question 3

Skye Limited has a two process and details of these processes are as follows:

Process P: Each machine produces 6 units an hour and Skye has 8 machines working at 90% capacity.
Process Q: Each machine produces 9 units per hour and Skye has 6 machines working at 85% capacity.
One of Skye products is Cloud. Cloud is not particularly popular but does sell at a selling price of $20
although discounts of 15% are usual. Material costs are $5 and direct labour costs are double the
material cost. Cloud spends 2 hours in process P but 3 hours in process Q.

What is Cloud’s TP per hour in its bottleneck process?

A $5.50
B $6.00
C $12.00
D $17.00

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