OPERATING DECISIONS 129
Table 9.3 Beaufort accessories – product ranking based on throughput
Part F Part G Part H
Selling price per unit £150 £200 £225
Variable material cost per unit £50 £80 £40
Throughput contribution per unit £100 £120 £185
Machine hours per unit 2 4 5
Return per machine hour £50 £30 £37
Ranking (preference) 1 3 2Goldratt and Cox considered all other costsas fixed and independent of customers
and products, so operating expenses included all costs except materials. They
emphasized the importance of maximizing throughput while holding constant
or reducing operating expenses and inventory. Goldratt and Cox also recognized
that there is little point in maximizing non-bottleneck resources if this leads to an
inability to produce at the bottlenecks.
Applying the Theory of Constraints to the Beaufort Accessories example and
assuming that machine hours are the bottleneck resource, Table 9.3 shows the
throughput ranking. Under the Theory of Constraints, Part F retains the highest
ranking but Part H has a higher return per unit of the bottleneck resource than Part
G after deducting only the variable cost of materials. This is a different ranking
to the previous method, which used the contribution after deductingallvariable
costs. The difference is due to the treatment of variable costs other than materials.
Strategic management accounting (see Chapter 4) can assist a business by
applying these concepts to competitors in order to gain a better understanding
of how those competitors are utilizing their capacity. Understanding their irrel-
ative strengths and weaknesses can result in gaining competitive advantage in
the market.
Operating decisions: relevant costs
Operating decisions imply an understanding of costs, but not necessarily those
costs that are defined by accountants. We have already seen in Chapter 8 the
distinction between avoidable and unavoidable costs. This brings us to the notion
of relevant costs.Relevant costsare those costs that are relevant to a particular
decision. Relevant costs are thefuture, incremental cash flowsthat result from a
decision. Relevant costs specifically do not includesunk costs, i.e. costs that have
been incurred in the past, as nothing we can do can change those earlier decisions.
Relevant costs are avoidable costs because, by taking a particular decision, we
can avoid the cost. Unavoidable costs are not relevant because, irrespective of
what our decision is, we will still incur the cost. Relevant costs may, however, be
opportunity costs. Anopportunity costis not a cost that is paid out in cash. It is the
loss of a future cash flow that takes place as a result of making a particular decision.