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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Related summaries:
Baxendale, S. J. and P. S. Raju. 2004. Using ABC to enhance throughput accounting: A strategic perspective. Cost Management (January/February): 31-38. (Summary).
Campbell, R. J. 1995. Steeling time with ABC or TOC. Management Accounting (January): 31-36. (Summary).
Campbell, R., P. Brewer and T. Mills. 1997. Designing an information system using activity-based costing and the theory of constraints. Journal of Cost Management (January/February): 16-25. (Summary).
Coate, C. J. and K. J. Frey. 1999. Integrating ABC, TOC, and financial reporting. Journal of Cost Management (July/August): 22-27. (Summary).
Corbett, T. 2000. Throughput accounting and activity-based costing: The driving factors behind each methodology. Journal of Cost Management (January/February): 37-45. (Summary). (According to Corbett, the underlying assumptions of ABC and TOC are the exact opposites and accountants cannot agree with both).
Demmy, S. and J. Talbott. 1998. Improve internal reporting with ABC and TOC. Management Accounting (November): 18-20, 22 and 24. (Summary).
Goldratt, E. M. 1990. What is this thing called Theory of Constraints. New York: North River Press. (Summary). (In Chapter 4 Goldratt says that the word "cost" is a dangerous and confusing multi-meaning word and that the word "product cost" is "an artificial, mathematical phantom" p. 49).
Goldratt, E. M. 1990. The Haystack Syndrome: Sifting Information Out of the Data Ocean. New York: North River Press. (Summary). (In Chapter 7 Goldratt tells us that the business world today has changed and cost accounting has been slow to react. They have not reexamined the fundamentals, the financial statement logic, to create new solutions. Instead, they have formulated ineffective answers like “cost drivers” and “activity-based costing.” We can no longer allocate based on direct labor. So allocating expenses at the unit level, batch level, group level, and company level is meaningless. These cannot be aggregated at their respective levels nor at the top. So why do it?).
Goldratt, E. M. and J. Cox. 1986. The Goal: A Process of Ongoing Improvement. New York: North River Press. (Summary).
Holmen, J. S. 1995. ABC vs. TOC: Its a matter of time. Management Accounting (January): 37-40. (Summary).
Huang, L. 1999. The integration of activity-based costing and the theory of constraints. Journal of Cost Management (November/December): 21-27. (Summary).
MacArthur, J. B. 1996. From activity-based costing to throughput accounting. Management Accounting (April): 30, 34, 36-38. (Summary).
Martin, J. R. Not dated. Chapter 7: Activity Based Product Costing. Management Accounting: Concepts, Techniques & Controversial Issues. Management And Accounting Web. Chapter7.htm
Martin, J. R. Not dated. Chapter 8: Just-In-Time, Theory of Constraints, and Activity Based Management Concepts and Techniques. Management Accounting: Concepts, Techniques & Controversial Issues. Management And Accounting Web. Chapter8.htm
Martin, J. R. Not dated. Comparing Dupont's ROI with Goldratt's ROI. Management And Accounting Web. ComparingDupontGoldrattROI.htm
Martin, J. R. Not dated. Comparing Traditional Costing, ABC, JIT, and TOC. Management And Accounting Web. TradABCJITTOC.htm
Martin, J. R. Not dated. Drum-Buffer-Rope System. Management And Accounting Web. DrumBufferRope.htm
Martin, J. R. Not dated. Global measurements of the theory of constraints. Management And Accounting Web. TOCMeasurements.htm
Martin, J. R. Not dated. Goldratt's dice game or match bowl experiment. Management And Accounting Web. MatchBowlExperiment.htm
Martin, J. R. Not dated. TOC problems and introduction to linear programming. Management And Accounting Web. TOCProblemsIntroToLP.htm
Rezaee, Z. and R. C. Elmore. 1997. Synchronous manufacturing: Putting the goal to work. Journal of Cost Management (March/April): 6-15. (Summary).
Ruhl, J. M. 1996. An introduction to the theory of constraints. Journal of Cost Management (Summer): 43-48. (Summary).
Ruhl, J. M. 1997. The Theory of Constraints within a cost management framework. Journal of Cost Management (November/December): 16-24. (TOC Illustration).
Westra, D., M. L. Srikanth and M. Kane. 1996. Measuring operational performance in a throughput world. Management Accounting (April): 41-47. (Summary).
Yahya-Zadeh, M. 1999. Integrating long-run strategic decisions into the theory of constraints. Journal of Cost Management (January/February): 11-19. (Summary).