Throughput costing is a system based on the fact that most production costs will not vary at the level of the individual unit produced.
Throughput costing, also known as super-variable costing, is a relatively recent concept. All expenditures except direct materials are treated as period expenses under throughput pricing.
Unlike traditional costing methods that allocate overhead costs based on predetermined rates, Throughput Costing takes into account only the costs that are considered truly variable and essential to the production. This includes direct materials and direct labour costs that are directly incurred in the manufacturing process.
Throughput Costing aims to provide a clearer picture of the cost of production, allowing businesses to make informed decisions about pricing, product mix, and resource allocation. By identifying and focusing on the key factors that drive costs, businesses can work towards improving efficiency and maximizing profitability.
When to Use Throughput Costing?
Before selecting throughput costing, a corporation should likely satisfy two conditions. The first criterion refers to the manufacturing process itself. Throughput costing only makes sense for manufacturing organisations when most labour and administrative expenses are fixed. Highly automated assembly lines and continuous operations are more likely to fit this requirement.
For instance, thirty manufacturing employees may be obliged to complete a shift regardless of whether or not the machinery is operating at maximum capacity. The second requirement is that management likes cost accounting information that is useful for short-term, incremental analysis, such as determining if the firm should accept a one-time special sales order at a discounted price. In this regard, a company’s selection of throughput costing follows logically from its preference for variable costing over absorption costing.
Treatment of Costs in Throughput Costing
Under the method of throughput costing, inventory costs are derived from direct materials only whereas the other costs are regarded as expenses incurred in the period of manufacture thus, period costs. The administrative and selling costs are considered and accounted for period costs. The method hereby is of great significance as it is used in making short-term capacity decisions.
The approach of throughput costing facilitates in building to inappropriate levels by reducing incentives. The method is, therefore, appropriate for use in instances of internal financial reporting for the fiscal year.
When to Choose Throughput Costing
A company should probably meet 2 criteria before it chooses throughput costing:
- The first criterion relates to the nature of the manufacturing process. Throughput costing is suitable only for companies engaged in a manufacturing process in which conversion costs such as direct labour and manufacturing overhead are fixed costs and do not vary proportionately with the production units. Assembly line and continuous processes that are highly automated are most likely to meet this criterion
- The second criterion is that management favours cost accounting information beneficial for short-term, incremental analysis, such as whether the company should accept or reject a special offer at a reduced sales price. In this respect, a company’s choice of throughput costing is a logical extension of the company’s choice of variable costing over absorption costing
Throughput costing is a variant of variable costing in which direct labour and variable manufacturing overhead are treated as period expenses. Product costs are only direct material costs in throughput costing. All other manufacturing costs are treated as expenses in the accounting period in which they occur, and inventory is valued using only direct material costs.
There is one major conceptual distinction between throughput costing and variable costing: in throughput costing, direct labour and variable manufacturing overhead are charged as expenses in the current period.
As a result, they are not deferred to a future period via the ending inventory. As a result, when there are more units produced than sold, variable costing will show a higher nett income than throughput costing.