Management Strategies

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LEAN ACCOUNTING: Novel Number Crunching
A few brave finance and accounting managers are changing how they track costs to support lean manufacturing and improve decision making.
> BY DAVID DRICKHAMER

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S WARY AS EXECUTIVES ARE THESE

days of anything that smacks of “creative” accounting, there’s a quiet revolution unfolding among lean manufacturers. The idea creeping into the heads of a few radical thinkers is that the financial numbers reported should actually reflect the underlying reality of the business. Armed with more relevant information, business unit managers could then make better decisions when it came to product pricing, make-versusbuy questions, and product and customer rationalization. Falling under the general heading of “lean accounting,” the approach does not require any new math or tricky algorithms. But it does demand a fundamental change in perspective. Wayne Thompson, global finance manager for value stream analysis at Southco, a Concordville, Pa., company that makes latches, fasteners and hinges, offers an example of this approach to decision making. A unit of his company had an opportunity to bid on a component with a market price of $3.75. The standard accounting showed it would cost $4.61 for the unit to make and sell the product. “We took a look at it and recognized that from a traditional cost accounting standpoint, this would be a loser,” says Thompson. “When in fact, if you go through lean processes and
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we actually come away with a very profitable application. Brian Maskell and Bruce Baggaley. And the difference between the price and material cost would drop to the bottom line. and that’s just not true. Essentially. which can stretch over a number of years. and reaped a six-figure contribution to quarterly profits. there are an increasing number of workshops and printed resources. using the information generated by traditional methods can lead to decisions that are not only wrongheaded. Jerrold M. If sales remain flat.” Material accounted for $1 with standard cost calculations. don’t immediately realize the results on the bottom line. and the remainder was for labor and overhead. Traditional accounting methods encourage high-volume production runs that fully absorb overhead and build work-in-process and finished-goods inventory. They reflect the era in which they were developed. In fact. A manager at an IW 500 company tells the story of a plant in one division hit by a market downturn and subseADDITIONAL READING Although lean accounting techniques have not yet crept into the accounting textbooks or college classrooms. during the transition. WCM Associates (2003). Fiume. T HE LEAN ACCOUNTING MOVEMENT WAS born of frustration. Southco did successfully bid for the order. depending upon available capacity and the real investments in people and equipment required. written down. What’s more. Who’s Counting. Managing Times Press (2003). and because the additional labor required to run the machine was negligible.> Management Strategies look at out-of-pocket expenses. Many manufacturers that have used the techniques championed by Toyota to reduce set-up times and convert from batch production methods to workcells and one-piece flow. But because the company had the capacity to make the product on existing equipment.” stresses Thompson. Jean E. you’re going to have an incremental amount of labor and spending. the lean-accounting approach treats many of the costs typically regarded as variable as fixed. Solomon. the new product would essentially cost Southco only the price of the raw material. Productivity Press (2004). net earnings take a hit as obsolete inventory is . “Standard cost tells you that for every dollar of material you bring on. but tragic. lower production volumes caused by the reduction of excess inventory also increase the overhead burden on the remaining output. Cunningham and Orest J. Here are some of the best: Practical Lean Accounting. Lean accounting proponents argue that lean production operations simply cannot be measured in the same way that traditional batch manufacturing is. Real Numbers. which was characterized by less product variety and economy-of-scale thinking.

thereby decreasing the overall volume of transactions. slightly modified. expensing material as soon as it’s pulled into production. Many manufacturing plants today rely on such activities to monitor product costs and track the value of inventory. the lean accounting approach takes a simpler look at what goes on between the inputs and outputs of a production process. a customer-centric structure that pulls together all of the fulfillment functions from order receipt to delivery. If the products had been priced to accurately reflect the incremental cost of production. rather than source products from this plant. the internal customers would have paid less in-house than they did outside. tracking costs in less-minute detail. there are unnecessary transactions. lean-accounting advocates say that such procedures are inherently wasteful. proponents argue. and eliminating work orders. Traditional financial statements are still needed to satisfy audi- Everything Is A Process extends the push to eliminate waste within companies that have embraced lean manufacturing. The application of lean tools to administrative functions mirrors the transition on the plant floor where batch-processing methods are replaced by multi-functional workcells that speed the flow of paper and information and reduce the amount of queue time between value-adding activities. But. This may begin with cutting the number of vendors and identifying key suppliers that can reliably deliver material and components under blanket purchase orders. profit-and-loss statement. company executives chose to shut down the under-utilized plant. Just as there can be excessive transactions on the plant floor. LEAN ACCOUNTING . the same techniques need to be applied to administrative functions to free people to work on process-improvement activities. however. which increased the overhead and led to an increase in prices that reduced sales even further. Under a lean accounting system each value stream has its own. reports and sign-offs within accounting processes. Hastening this death spiral. other business units within the division purchased parts from outside suppliers because of non-competitive transfer prices based upon standard cost plus 15%. In fact. the tracking of transactions and the reporting of variances altogether. At heart. Eventually. This reduced overhead absorption. as part of the transformation to a lean enterprise. which had plenty of available capacity. Before a manufacturer can drop such activities. the production operation has to be far enough into lean manufacturing to be organized by value streams.quent lower sales volumes. A S THE NAME IMPLIES.

....... Getting all of these people on board is difficult....... “Who’s Counting..com 52 IW I DECEMBER 2004 I www...... Solomon even wrote a business novel....0% stand what they’re spending—i....5% what the input is to get a certain level of output..8% ating income statement next to a Distribution $ 337... and I have a value stream map hanging on the wall. The ultimate result: Accountants give up their roles as traffic cops and start providing the type of analysis and reports that make decision-making more straightforward...... If the company is trying to rein in procurement costs.... The story shows...33.861. IT and customer service......358 . people at all levels Total Sales Expense $ 139......... But when the numbers make intuitive sense.519 ..710 .5% modified one to prove the point that a product that might not meet a Support $ 762...5% trollers can explain what drives all Total Adjustments $ 270. ddrickhamer@industryweek.. company that builds complex machinery for making corrugated paperboard...5% side and look at it incrementally and see where standard cost Comparison of a traditional profit and loss statement (P&L) and a lean-accounting P&L...................21..2% says....000 ..industryweek.9.” Such constraints are invisible in a standard printout from accounting that lists how many minutes or hours are required at each operation.. When Sales $ 9. If asked directly...23.” says Jerry Solomon..66.....19.741 .398.570.7% performance isn’t cloaked in acNet Operating Margin $ 2......” Solomon says.......5% says they often put a standard operConversion $ 6..259 ..5% can make better—and more profitable—decisions......741 ...” Thompson Change in Inventory $ 690.. Md.......164 ...... but these statements aren’t used to run the business.. “From a financial perspective..... unless I improve this particular operation first...... for example.8..” same in both examples.19........388.e......2% “People know and breathe and die by standard cost.. making the transition reLEAN quires some convincing.....8% very beneficial to the bottom line.364..235 .....100.. Then they can focus on how to do it better..7....100.....205.... purchasing. First.242 .7.481 ..... even though the concepts pique a lot of people’s interest.. without a mandate from the top... One advantage of the lean accounting P&L is that the type of costs are bro- Plain English P&L ken down into recognizable categories.... Net Earnings $ 1.... Still.......30....66.......... In addition to adoption by the accounting and finance departments.2. why it’s so difficult to do and why so few companies have actually made the change..184 . The top and bottom line are the make a better decision.0% gross margin test can actually be Total Costs $ 8..... but it will do me no good in getting product through the system to the customer. it requires buy-in from managers in engineering..973 . and business Other Operating Costs $ 738..000 ....... a Hunt Valley..935..758 ........5% “It allows the workforce to underSG&A Expense $ 195....... “I’m sitting here in my office right now. high conversion costs reflect a capital-intensive business.1..072 .116 .> Management Strategies tors and reporting requirements.12.... the impact of such efforts would be readily apparent on the P&L. it’s hard for managers to give up methods taught in business school and abandon the metrics that they’ve always used to track performance.. In this exbreaks down and where we can ample... if not impossible.0% looking at whether Southco can Costs make an adequate profit at a certain market price.861.2..... vice president of manufacturing..87... “I know I can improve certain operations in those data boxes I have up there...509 .com ..057.3......5% it’s worth the effort. few CEOs and even conGross Margin $ 3...713 ... when you create a true value stream—cells with all of the workcenters connected to each other—the investment decision when you’re looking at equipment is so much easier to make.0% counting jargon...007 .7% calculated. Marquip Ward United..570...171.... rather than a battle over the accuracy of the numbers... “They want to see it side-byNet Earnings $ 1.. Margin $ 1..” that describes the transition to a lean accounting approach within a manufacturing company.. Net Operating Margin $ 2... TRADITIONAL Those who have begun to change Sales $ 9.0% the way they track financials say Cost of Sales $ 6...8% of their variances or how they are Net Manufacturing Margin $ 2..197.. Lean accounting also has a broad impact on the organization...... Wayne Thompson Procurement $ 910.” Solomon says.

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