Application of the Theory of Constraints and Activity-based Costing for Product Costing

Abstract

Activity-Based Costing (ABC) is the accounting methodology most suitable for a strategic evaluation of costs and for taking into account the variety of products in production cost determination. ABC provides the analytical causal-functional determination of the product cost of multi-product or multi-service companies. In the case of short-term choices, in the presence of constraints, the Theory of Constraints (TOC) and the measurement system that derives from this, Throughput Accounting, is more effective in identifying bottlenecks and the best product mix. The proposed solutions can be grouped into three main categories: the complementary use of both methods, the integration of the two models in a single model and the exclusive use of the TOC. The combination of ABC and TOC is capable of supporting not only the decisions that relate to the production mix, which can be taken by comparing the measure of throughput generated by individual productions, but also those linked to make or buy production. The flexibility of the model structure allows the immediate identification of the proper activity-based cost configuration. The distinction between available capacity and used capacity highlights constraints that can be optimised through the analysis of the "contribution margin for used scarce resource" per unit of product. The different organizational units need, therefore, cost information structured using different combinations of fixed and variable costs in order to better support decisions.