Contemporary developments in MA in Pharma plc

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This report will investigate the contemporary developments in MA (Management Accounting) which will be implemented in Pharma plc, an international pharmaceutical manufacturing company. Company's CEO has been tempted towards contemporary developments in MA and its positive effects on efficiency that the company has witnessed as lacking due to practicing traditional accounting methods. Thus, Pharma plc needs to change its current processes for higher performance, productivity and profitability. Therefore, I, as a Management Accountant of the company, have been asked to suggest introducing Throughput Accounting technique as one of the contemporary development and its subsequent benefits for the company.


"Throughput accounting is a relatively new approach to production management, and uses a variant of contribution per limiting factor" (Jones, 2006 pp.136). Nevertheless, this approach focuses on production system from the view point of bottlenecks. Thus, for the effective implementation of the TA (Throughput Accounting) system and to improve the organizational economic performance, it is mandatory to remove the identified bottlenecks. However, a bottleneck is an activity within the organization where the demand for that resource outstrips its capacity to supply (Darlington et al 1992). Goldratt and Cox (1984) also promulgate that significant financial objective of a company is the achievement of maximized throughput by optimal usage of limiting factors. This is further convoluted in the equation as under:

Sales Price - Material Cost

Throughput Accounting = -----------------------------------

Time on Key Resources

In essence, the objective of TA system is to maximize Throughput Contribution by keeping the conversion and investment costs at their minimum. According to Balderstone and Keef (1999), TA is a decision making tool aimed at improving profit performance through better management decisions. In addition, these decisions are based on three critical monetary variables; throughput, inventory, and operating expense. TA system is based on Just in Time (JIT) philosophy. Thus, the products with a TA ratio of less than 1 should not be produced as they are not profitable. Whereas, products with TA ratio more than 1 should produce on preferential basis for the maximization of the company's overall throughput.

Pharma plc is practicing traditional costing method. Traditional costing method consists Marginal Costing which is based on Sale minus variable cost; direct material, direct labour and variable overheads to production or service department. Besides, fixed cost is treated separately as a period cost (BBP, 2007). According to Jones (2006), opening and closing inventories are calculated on the basis of all variable production cost in traditional costing method. In traditional manufacturing process, there are several stages of production process and the management seeks to protect each stage in the process from disruption of one another by means of increased production and holding inventories (BBP, 2007). "Goldratt argues that traditional cost accounting is public enemy number one of productivity for two reasons. First, by using by efficiency rates as local performance measures, and measuring the volume variances, traditional cost accounting encourages the accumulation of inventories. Second, the cost accounting approach emphasises local cost reduction- a flawed strategy for continuous improvement, as a cost can only be reduced to a certain minimum level"(Cited by Graves and Gurd, 1998 pp. 36).

According to TA system, prospective organisations focus on maximising the throughput-sale not production to minimise operating expenses and inventories. However, Graves and Gurd, (1998) accentuates that Goldratt defines throughput as the rate at which the system generate money through sales; sales minus direct material cost. Moreover, under this system inventory is the stock held for the resale purpose to generate profit. Hence, inventories are evaluated at direct material cost only. Moreover, all operating expenses other than material cost are spent to convert inventory into throughput.

Table A highlights the main differences of both Traditional and Throughput accounting systems as under:


Fundamental concepts of Traditional Cost Accounting

New Principles of Throughput


There are direct and indirect costs: direct costs are variable and indirect costs are fixed.

Summing component costs to derive a product cost and subtracting the result from the sales price is a good way to determine relative product profitability.

Inventory is an assets and working on material increases its value.

Reducing component cost directly increases profit.

Distinguishing between indirect and direct costs is no longer useful.

It is the rate at which the factory earns money that determines profitability, not the contribution of each product.

Inventory is not an asset. It is the product of unsynchronised manufacturing and stands between you and profit.

Profit is a function of material cost, total factory cost and throughput.

Source: (Adapted from Waldron, 1988 pp.13)


In the light of above mentioned differences and other influencing factors it is observed that GAL (Garrett Automotive Ltd) achieved the improved performance by adopting the modern costing techniques. In this particular regard, GAL re-organised its operation by enhancing its product portfolio and extending the small number batches. However, standard costing system was the significant element of their operational practices generating periodic sets of detailed variances reports, which were hard to understand and interpret. Moreover, GAL encountered a problem, when one of its major customers demanded 3.5% reduction in the sale price per annum. On these basis, GAL benchmarked 3.5% as potential profit shrinkage to test various aspects of their operations. The effect of these potential changes of 3.5% in various elements of GAL's P&L account is illustrated in figure 1.

Source: (Darlington et. al., 1992 pp.32)

However, sales and materials were the integral factors of the existing costing methods to ascertain profit. Therefore, it was mandatory to introduce a new costing system at GAL, on the basis of these two elements. Furthermore, the production lines at the company are re-designed with a view to optimise its throughput.

The TA (Throughput Accounting) approach is very similar to contribution per unit of scarce resource. Whereas, in Traditional Accounting, the identification of bottleneck is a substantial element to stimulates managerial actions and alleviate the problem encountered as shown in figure 2. In addition, figure 2, underlines the bottlenecks by introducing machine D and E which raised the weekly output of GAL from 2,025 to 2,700 units.

Source: (Darlington et al., 1992 pp.32)

Due to the simplification of information and throughput costing system the employees of GAL realized the importance of adhering to the production schedule. The introduction of TA and the new machinery in the contemporary production line enabled the company to increase its profits from the same volume of sales. It was done without spending a large amount of capital and reducing the number of employees at GAL.


According to BBP (2007 b p.7), Ride Co. was practicing Traditional Costing method (Marginal costing) and producing 180,000 units in total- Roadster 150,000 units and Everest 30,000 units with the total profit of $14,550m. Whereas, after adopting the throughput accounting method the total units reduced to 170,000- Roadster 100,000 units and Everest 70,000 units respectively while the profit increased to $15750m. Furthermore, it reduced the cost in terms of producing less number of units and increased profit by introducing contemporary throughput accounting method. Additionally, the comprehensive significance of throughput accounting over traditional costing method is shown in Appendix A with practical example of Ride Co.


Despite significant benefits of throughput accounting method, over traditional accounting system, it has some limitation as well which are as follows:

Kaplan highlights that TA ignores fixed costs and emphasizes on short-term optimisation through assuming the variables; prices, product mix, customer order, technology and production as fixed (cited by Darlington, 1992).

"TA does not help with long-term strategic decisions as it does not identify the profit implications of decisions taken on this time-scale" (Darlington, 1992 p. 35).

TA facilitates the production decisions. However, the huge majority of organisations cannot produce and sale goods on the basis of short-term profit considerations. "Strategic-level issues such as market developments, product developments and stage reached in the product life cycle must also be taken into account" (BBP, 2007 p.105).

It is difficult to identify the constraints and bottlenecks correctly because Throughput Accounting System is based on the Theory of Constraint.

"The reduction in stocks and work-in-progress stemming from the use of TA means a short-term profit problem" (Darlington et al, 1992 p. 35).


Management accounting measures and reports financial information just like other types of information are to help managers to achieve the goals of the organization. Additionally, a management accounting system is an important facet of management accountants. Management accounting identifies, generates, presents, illustrates and utilizes information to formulate business strategy, planning and controlling business activities, making decision, efficient use of resources, improving performance, value increase, protecting tangible and intangibles assets and corporate governance and internal control (Bhimani et al 2008).


Strategic management accounting mainly plays three roles which are competitor analysis, performance measurement and the strategic management in the different stages of product life cycle (Bromwich, 1990). The shift is from a traditional monitoring and control perspective to a more business and support oriented focus. A key role of accounting is for the management accountant to link financial considerations with both operating concerns and the strategic priorities of the enterprise (Bhimani et al 2008).

The Throughput approach may be very helpful as a production management system for managers who accept the concept of throughout maximization and inventory minimization. The Throughput accounting approach can also help the manager looking at resource usage (Graves and Gurd, 1998). For successful implementation of this system it is important for the management accountant to identify the bottlenecks and constraints precisely and initiate positive steps to remove the identified bottleneck and enhance performance of the organization.


It has been evident from the discussion so far that contemporary development (Throughput Accounting) has significant result in terms of profit and cost over Traditional Accounting methods. However, the outcome of this system is situational specific - it differs from firm to firm and from situation to situation.


Although Throughput Accounting is fundamentally a technique, the managers and accountants of Pharma plc must realise how to perceive the running of the business and should see it is a part of an approach to management rather than simply a technique.