Variable Costing and Theory of Constraints (TOC):
The
Theory of Constraints (TOC) focuses on managing
constraints in a company
as the key to improving profits. Companies involved in
Theory of Constraints (TOC) use a form of
variable costing. One
difference is that in
Theory of Constraints (TOC) approach, direct labor is generally
considered to be a fixed cost.
In many companies
direct labor is not really
a
variable cost. Even though direct labor may not be paid on an hourly
basis, many companies have a commitment--sometimes enforced in labor
contracts or by law--to guarantee workers a minimum number of paid hours. In
TOC companies, there are two additional reasons to consider direct labor
to be a fixed cost.
First,
direct labor is not usually a
constraint. In simplest case
constraint is a machine. In more complex cases, the
constraint is a policy (such as a poorly designed compensation scheme
for sales persons) that prevents the company from using its resources more
effectively. If
direct labor is not the
constraint, there is no reason to increase it. Hiring more
direct labor would increase costs without increasing the output of
salable products and services.
Second, TOC emphasizes continuous improvement to
maintain competitiveness. Without committed and enthusiastic employees,
sustained continuous improvement virtually impossible. Since layoffs often
have devastating effects on employee morale, managers involved in TOC are
extremely reluctant to lay off employees.
For these reasons, most managers in TOC
companies regard
direct labor as a
committed fixed cost rather than as a
variable cost. Hence, in the modified form of
variable costing used in TOC companies,
direct labor is not usually included as a part of
product costs.
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