To gain a complete understanding of the integration between ABC and the TOC, Huang first defines ABC and TOC from various cost accounting analysts/theorists’ perspectives such as Robin Cooper, H. Thomas Johnson, Robert S. Kaplan, Horngren, Sundem, and Simpson. ABC was first developed in 1971 and became popular in the 1980’s. In 1971 an ABC framework was provided that included five fundamental ideas (Exhibit 1).

ABC is defined as a system that accumulates the costs of each activity of an organization and then applies the costs of activities to cost objects related to products, services, and other objects using drivers. Activities (cost drivers) are classified into four types (p. 22): 1) Unit – costs driven by individual units, 2) Batch – costs driven by batches regardless of the units in a batch, 3) Product – costs driven by production and not the production of individual batches or units of the product. 4) Facility-sustaining – costs associated with the overall facility, not individual products. Huang describes The Consortium for Advanced Manufacturing-International’s (CAM-I) definition for ABC as a method of reorganizing causal relationships of cost drivers to cost activities by the measurement of cost and performance of process-related activities and cost objects. Thus, the influence and contributions from all the above individuals and agencies provided the seven underlying assumptions of ABC and the six-step process (Exhibit 2 & Exhibit 3 respectively).

In 1994, Huang states that a set of processes was introduced that improved the integration of ABC into a firm. First and foremost before any processes were implemented though, a firm needed to undergo an organizational change. To prepare a firm for the change, three interdependent phases are described (p. 22): 1) education, 2) sponsorship, and 3) alignment of incentives. Also, ABC has been described as a two-step process that breaks down into a snapshot model and a dynamic model for cost analysis. A snapshot model provides costs of products and clients at a given time. A dynamic model is a system that combines perspectives from other operational systems and provides cost data. The main goal was to evaluate customer profitability and improvement of decision quality.

Huang furthermore describes how Lindahl used an extension of ABC to cost management to develop activity-based management (ABM). ABM is the management and control of a firm’s performance using ABC information as the focus for decision-making. ABM is broken into several steps: planning, education and awareness, process/activity definition, data collection, performance improvement techniques, planning the ongoing system, and implementation. The key relationship between ABC and ABM is that ABC provides important information about cost drivers, activities, resources, and performance measures while ABM is a discipline that improves the value of its products and services.

Three benefits from the ABC implementation are: 1) Increased cost pools used for overhead costs, 2) The changing of the base to allocate overhead costs, and 3) Allowing a manager to recognize more traceable overhead costs than merely classifying them as indirect. The improved traceability of overhead cost is the greatest benefit to implementing ABC as discussed by Huang. With all of ABC’s advantages, a major disadvantage is the inability to inform management about spending changes and profitability because ABC is set up to measure the rate of demand and not the rate of supply.

Following the ABC discussion, the article defined the theory of constraints (TOC) as a method that deals with scheduling production through a pre-existing application that maximizes profitability by maximizing output. The TOC’s foundation comes from just-in-time inventory management and the pull manufacturing methodologies. This leads to the underlying assumptions of TOC (Exhibit 4). Constraints in TOC are defined as anything that impedes a system from reaching a higher level of performance toward its goal. Also, there are two types of constraints: 1) physical constraints – easy to identify and manage (i.e., capacity of machine) and 
2) nonphysical constraints – hard to identify and manage unless approached through varies methods. (i.e., market demand).

The TOC enables a firm to continuously improve through a five step process: 1) Identification of a system’s constraints. 2) The exploitation of a system’s constraints. 3) Subordinate everything else to decisions made in Step 2. 4) Elevate the system’s constraints by reducing the effects of the constraint, off-loading its demand, and change how a constraint is managed. 5) If a constraint is broken in Step 4, go back to Step 1.

The TOC’s foundation uses a pull-through production management system that is defined by moving products into production only as capacity becomes available for their completion. Production capacity within a pull-through system is governed by the capacity of that portion of the manufacturing process that acts as the constraint on throughput. Also, in the TOC costs are assumed to be fixed to maximize throughput and profit due to contribution margins equal to unit revenue. The main purpose of the TOC is its emphasis of a shift in management of an organization. A shift in perception from one that minimizes costs as top priority to a realization that the overall success of an endeavor is more important. The shift requires management to emphasize throughput, which focuses on constraints, productive capacity, and buffer management to continuously improve instead of an emphasis on cost.

Within the article, Huang discusses three kinds of integration situations to combine ABC and TOC principles:

1) Short-term decision back (TOC) and long-term decision foundation (ABC). The TOC is considered a useful short-term tool because costs are fixed, meaning improving profitability is only accomplished by increasing throughput. Thus, performance is measured by effectiveness as opposed to efficiency, which is the traditional focus of standard costing. Short-run decisions require management to accurately measure the effects produced by alternative changes in inputs. While ABC is used primarily as a technique to improve long-run decisions by improving product selection and mix, facility size, and location in which all costs are considered variable. The economic concept of short-run versus long-run depends on the expansion or contraction of capacity within a production facility. The TOC and ABC is best applied in their respective ranges (short-run & long-run) and not suited to the middle range of decision types that involve a mix of fixed and variable elements. Huang comments that a possible solution to middle range decisions is to use direct costing for continuous product costing and for financial reporting along with ABC. This then does not violate ABC’s proportionality assumptions.

2) Mixed-Integer Programming Model. This optimizes an objective function subject to constraints with continuous and integer variables. An objective function is used to describe an organizational goal while a second set of equations are used to model constraints that limit of the objective. Once formulated, an algorithm is used to solve the resulting set of equations. An algorithm provides variables that maximize objective functions, maximize slack variables that measure excess resources of non-constrained activities, and maximize the value of the objective function (p. 25). 

3) TOC and ABC and Cycle-Time Management. Managing cycle times blend ABC and the TOC and categorize six activities for cycle times: 1) Setup, 2) Wait, 3) Processing, 4) Inspection, 5) Unloading, and 6) Moving. Once cycle times are broken into short intervals they become manageable for processes associated with products, customer orders, or batch goods. Managing cycle times by the TOC and ABC can be done through various processes. One such process is to increase productivity and then perform cost-benefit analysis. The TOC helps to increase productivity by reducing cycle time without adding capacity and enables timely delivery, increasing throughput in firms that have internal manufacturing, and lowering average fixed costs per unit in the short-run. ABC facilitates the cost-benefit analysis in making quality decisions concerning cycle-time activities by answering five questions: 1) Will overall cycle-time reduction result in increased throughput? 2) What activities consume the most resources within each process? 3) What activities can be changed or reduced without compromising throughput? 4) What will it cost to change or reduce activities that contribute to cycle time? 5) What are the realizable cost savings from reduced cycle time for specific activities? The mingling of the TOC and ABC answer the above questions and provide an insightful way for managing cycle-time situations.

Huang provides an example that integrates the TOC and activity-based costing management (ABCM) for a silk-screen printing firm. The firm first traced costs to activities and then applied ABCM that identified the output measure for each activity. ABCM used practical capacity of activities to calculate a charging rate to be applied in determining the cost of products produced. In the example, the TOC is used to: 1) Identify constraints, nonconstraints, and unused capacity of an activity, 2) Exploit the constraints, 3) Subordinate activities, 4) Elevate additional capacity acquired, and 5) Inertia is overcome by the repetition of steps.

In conclusion, Huang makes a point that by taking advantage of integrating the TOC and ABC a firm will attain quality decision-making.