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Theory of Constraints Accounting: Definition & Examples

Instructor: Ryan Morales
In this lesson, you will learn more about the theory of constraints in accounting. What is a constraint? How should it be managed? How does the theory of constraint relate to throughput accounting? These will all be explained in the lesson.

Illustration of Personal and Business Constraint

As a young university student, you probably have both the desire and energy to pursue a lot of things- your education, several interesting hobbies, sports, activities in your local community, even a part-time job perhaps. However, you very well know that as much as you want to pursue these many endeavors, you are confronted with limitations. For one, there is time constraint. Your schedule will only allow you to engage in some, but not in all activities you like to do. You may also be constrained by your budget.

Businesses share the same experience. Let me take you to the shop floor of your favorite home furniture. Production process goes through several steps. First, there is the receiving and inspection of timber- the raw materials. Then, the timber goes through the process of cutting and molding into required shapes and sizes. The next step is component fabrication in which the molded timber is processed by different machines to acquire the desired features. The components are then assembled to form part of the intended furniture. Often, the assembling process is more difficult and takes quite a longer time compared to other steps in the process. The last step includes finishing and packing the furniture for delivery. In this case, the assembling process is considered to be the production constraint. This is the identified choke point of the entire production process.

Theory of Constraints

The theory of constraints (TOC) proposes that improvement efforts of the company should always be focused on the limiting factor because all other efforts elsewhere in the business will be rendered useless unless such constraint is managed well. The goal therefore of management is to properly identify and manage the constraint.

Constraint Defined

A constraint is also known as bottleneck or choke point. It is anything that prevents the organization from achieving its goals. A constraint can take on many forms. It can be a tangible or an intangible constraint. A tangible constraint takes on a physical form. For instance, slow equipment, raw material shortages, lack of factory space and lack of people are examples of tangible constraints. It can also be an intangible constraint. Examples of intangible constraints are policies which have impact on the speed as well as the cost of production like overtime policies, government mandated employee break time, etc.

Managing the Constraint

Managing the company constraint involves several steps. The first step is to actually identify the constraint. Management has to identify the part of the process that slows down the rate at which the goals are achieved. In our illustration earlier, the identified constraint is the assembly department. That is where production bottleneck exists. The next step is to identify the cause or causes of the choke point. Is it because of the longer process time by the assembling department equipment? Is it due to equipment breakdowns? Is it due to the limited number of equipment in this department? Or is it because of the lack of training of the personnel in the department? Once the cause or causes have been properly identified, the next step then is to make quick improvements to improve throughput using available resources. If the constraint still exists, the company may consider further actions to manage the constraint. This step may somehow involve capital investment. For instance, the company may need to invest in additional equipment for the assembly department or the company may need to spend more on employee training and development. Once the constraint has been resolved, management then proceeds on identifying the next constraint. The steps above are repeated until the next constraint is improved. Hence, the entire constraint management process actually promotes continuous improvement.

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