Lean accounting, target costing

and balanced scorecard

 Learning objective
After studying this chapter, students should be
able to :
1. Describe the basic features of lean
manufacturing
2. Describe lean accounting
3. Explain the basics of life-cycle cost
management and target costing
4. Discuss the basic features of balanced
scorecard and its role in lean manufacturing
 Allen Autopart
Allen produces 4 major products lines : shock
absorbers, aluminum alloy and steel wheels, brake
system and aluminum radiators

Some future plans  the company was facing an

increasingly competitive business environment

Allen was positioning to enter the Chinese market for

auto parts

Other major players was also entering the Chinese

market such as Denso (Japanese), Bosch (German) and
Deplhi (U.S)
 How Allen being competitive in a new environment?
Allen Autopart operates in an Products and processes are
environment where change is constantly being redesigned
rapid and improved

The competitive environment demands that firms offer customized products and
services to diverse customer segment

The firms must fins cost-efficient ways of producing high-variety, low volume
product cost, paying attention to linkage between the firms and its customers and
suppliers

Firms operating in this kind environment are forced to

REEVALUATE HOW THEY DO THINGS
 Improving performance translates into constantly searching for :
• Ways to eliminate waste
• To undertake ONLY those actions that BRINGS values to the customer

This philosophy approach to manufacturing called LEAN MANUFACTURING

LEAN MANUFACTURING?

An approach designed to eliminate waste and maximize customer value

It characterized by :
1. Delivering the right product
2. In the right quantity
3. With the right quality (zero defect)
4. At the exact time the customer needs
5. At the lowest possible cost
 LEAN MANUFACTURING
SYSTEM

Eliminate waste Reduce cost More efficient

Redefining the activities

performed within an
organization

Cost leadership
 Celestica de
Monterrey, S.A.,
C.V

Apply lean manufacturing

results

Space utilization improve Reduction setup times by

34% 85%

Reduction scrap by 66%

Reduction customer lead

time by 71%
 Lean manufacturing was implemented by many
companies with similar results
• Takata Seatbelt, Inc
• Lockheed Martin
• The Boeing Company
• Boston Scientific
• Autoliv
• Deli Computer
• Littlefuse, Inc
• Steelcase, Inc
• Maytag
• Raytheon Missile Systems
• TI Group Automotive Systems
 World-class manufacturing
Lean manufacturing and JIT manufacturing and
Same in substance purchasing

• Employee empowerment
• Team structure
• Cellular manufacturing
• Reduced set up times
• Small batches
 Becoming lean require lean thinking

Lean manufacturing is distinguished by the

following 5 principles of lean thinking :

1. Precisely specific value by each of particular

product
2. Identify the “value stream” for each
3. Make value flow without interruption
4. Let the customer pull value from the
producer
5. Pursue perfection
 Value by product

It is an item or feature for

Value is determined by the
which the customer is willing
customer
to pay

Customer value is
the difference between
Realization Sacrifice

What is customer What is customer give up,

receive including what are willing to
pay for the basic and special
product features, quality,
brand name and reputation

Value  relates to a specific product and to a

specific feature of the product

Adding features and function that are not wanted

by customers is waste of time and resources
 Value stream

Is made up of all activities, both value added and nonvalue added

required to bring a product group or service from its starting point
(customer order) to finished product in hand

Order fulfillment value New product value

stream stream

Focuses on providing Focuses on

current products to developing new
current customers products for new
customers

Analyzing value stream allow management to

identify waste  non value added is source of
waste
 Value stream for one product of Allen

Sales Order entry Scheduling Purchasing

Packaging and Cellular Support Production

shipping manufacturing activities planning

Billing Collecting cash Post sales

customer and receivables services
 Value stream can be created for every product; but it is more
common to a group of products that use common processes
into the same value stream

To identify the value stream

Simple two-dimensional matrix :

• Activities and process
• Product
 Matrix approach to identify value stream

Production activities : order fulfillment value stream

Brake
model Order Producti Purchasi Aluminu Steel cell Stress Packagin Invoicing
entry on ng m cell testing g and
planning shipping
A X X X X X X
B X X X X X X
C X X X X X X X X
D X X X X X X X X
 Once value stream are identified  next step : assign people
and resources to the value stream

Rule of thumbs :
Each value stream should have between 25-150 people

As much as possible, the people, the machine, the

manufacturing process and the manufacturing process  need
to be dedicated to the value stream
 Value flow

Traditional manufacturing setup :

Department A Department B Department C Department D

This approach requires :

• A significant move time and wait time
• Lengthy changeovers are needed to prepare the equipment to produce to
next batch that may have some different characteristics
• It is not equipped to deal with product variety  move and wait time is
source of waste
 Lean manufacturing can help
to

• Reduce move and wait time

• Allow production of small batches (low
volume) of differing product (high variety)

Through

Reduce setup/changeover
Cellular manufacturing
time

Reducing time to configure Replace the traditional plant

the equipment to produce a layout with a pattern of
different type of products manufacturing cells
enables small batches in
greater variety to be
Cell structure is chosen over
produced
departmental structure because it
reduce lead time, decrease cost
 Manufacturing cells

• Contain all the operations in close proximity that are needed to produce a family
of products
• This machines uses are typically grouped in a semicircle
• The reasons for locating processes close each other  to minimize move time
and keep a continuous flow between operation while maintaining zero inventory
between any two-operation
 Allen Company – current departmental layout

50 minutes 30 minutes
Wait time = Wait time =
7 minutes 8 minutes
Machining Casting

Move and pre wait time = 15 minutes

Move and pre

40 minutes wait time = 10 30 minutes
minutes
Painting Finishing

Color code
Blue Value added process time
Red Non-value-added move and pre-process wait time
 Process time
Machining 50 minutes
Casting 30 minutes
Painting 40 minutes
Finishing 30 minutes
Total processing 150 minutes
Move and wait time 40 minutes
Total batch time 190 minute
Allen Company – proposed manufacturing cell

30 minutes 50 minutes

Casting Machining

Painting Finishing

40 minutes 30 minutes
Processing time (ten units) Elapsed time
First unit 15 minutes
Second unit 20 minutes (processing begins
five minutes after the first)
-
-
Tenth unit 60 minutes (processing time)

Time saved over traditional manufacturing :

150 minutes – 60 minutes = 90 minutes
 Pull value

Lean manufacturing uses a DEMAND-PULL SYSTEM

It is producing the product ONLY when it

is needed and ONLY in the quantities
demanded by customers

This approach requires :

• Each operation produces only what is necessary to satisfy the demand of
succeeding operation
• No production takes until a signal from succeeding operation indicates need
to produce
• Parts and materials arrives just in time to be used in production
• JIT purchasing require suppliers to deliver parts and materials just in time to
be used in production
 Traditional inventory
Inventories of raw materials and
parts are carried so that a firm can
take advantage of quantity
discount and hedge against future
price increases
Objective : lower cost of inventory
Just in time
JIT achieves the same objectives
without carrying inventory
• Exploit supplier linkage by
negotiating long-term
contracts with few chosen
suppliers located close to the
production facility
• Suppliers are not chosen based
on price alone
• Performance, quality and
ability to deliver and
commitment to JIT purchasing
 Pursue perfection

• Zero setup time

• Zero defect
• Zero inventories
• Zero waste
• Producing on demand
• Increasing a cell’s production rates
• Minimizing cost
• Maximize customer value

Ideal outcome of lean manufacturing

The objective is to produce the highest- A lean manufacturer must

quality, lower-cost products on the least identify and eliminate the
amount of time various forms of waste
 To achieve such objective :
1. Identify forms and source of waste
2. Encourage employee empowerment
3. Total quality control
4. Inventories  lowering inventories
5. Activities based management
 Major forms and sources of waste
• Defective products
• Overproduction of goods not needed
• Inventories of goods awaiting further processing
of consumption
• Unnecessary processing
• Unnecessary movement of people
• Unnecessary transport of goods
• Waiting
• The design of goods and services that do not
meet the needs of customers
 Employee empowerment
• Employee involvement is vital for identifying and
eliminating all forms of waste
• In lean environment  increasing the degree of
participation increase productivity and overall cost
efficiency
• Managers seeks workers’s input and use their
suggestion to improve production process
• The management structure must change in response to
greater employee involvement
• Because workers assume greater responsibilities 
fewer managers are needed  organizational
structure becoming flat
 Total quality control
• Lean manufacturing necessarily carrying with it a
much stronger emphasis on managing quality
• Poor quality simply cannot be tolerated in lean
manufacturing that operates without inventories
• Simply put : lean manufacturing cannot be
implemented without commitment of Total
Quality Control
• TQC is essentially a never-ending quest for
perfect quality
 LEAN ACCOUNTING
Traditional cost management system
may not work well in the lean
environment

• Standard costing variance and departmental budgetary

variance likely encourage overproduction  against
demand-pull system
• Emphasize on departmental efficiency (e.g. machine
utilization rates)  cause non-bottleneck department to
overproduce and build work-in-process inventory

Should change the product-costing and operational control

approaches are needed when moving to value-stream-based
manufacturing system
 Lean accounting
• Focused value stream and traceability of
overhead cost
• Value stream costing with multiple product
• Value stream reporting
• Decision making
• Performance measurement
Focused value streamed and traceability of overhead cost

Production Operational
Equipment Facilities
support support

Cell labor Direct materials Maintenance Other

Product costing  most support cost are
exclusively to a focused value stream 
assigned to product using direct tracing

Increasing directly traceable cost

Increasing the accuracy of product costing

 Limitations and problems
• Initially  it may not possible to assign all the
people needed exclusively to a value stream
• There are some individuals working in more
than one value stream
• The cost of shared workers can be assigned to
individual value stream in proportion to the
time spent in each stream
Value stream costing with multiple products

Manufacturing cells within a

Value streams are
value stream are structured to
formed around
make a family of products or
products with common
parts that require the same
process
manufacturing sequence

Costs are assigned in the same way as for

focused value stream
 Allen Autopart
This week, April 6

Materials Salaries Machining Other Total

Order processing 12,000 12,000
Production planning 24,000 24,000
Purchasing 18,000 18,000
Stamping 250,000 25,000 19,000 12,00 306,000
0
Welding 100,000 28,000 23,000 8,000 159,000
Cladding 60,000 60,000
Testing 7,000 7,000
Packaging and shipping 6,000 6,000
Invoicing 8,000
Total 410,000 128,00 42,000 20,00 600,000
0 0
Product costing = total value stream cost of period
unit shipped of period

Allen auto parts produced and shipped :

• 1,000 units of model C
• 4,000 units of model D
• 5,000 units total

Using unit shipped instead of unit produced motivate managers

to reduce inventories
Some average unit cost calculation exclude materials  material
cost can be quite different between products

In this case  average unit conversion cost is calculated

The average conversion cost for models C and D is

= total value stream cost of period – material cost
unit shipped of period
= 600,000 – 410,000
5,000
= 38
 Value stream reporting
Allen autoparts
Aluminum Steel stream Sustaining Plant total
stream cost
Revenue 700,000 1,500,000 2,200,000
Material costs (280,000) (410,000) (690,000)
Conversion costs (70,000) (190,000) (260,000)
Value stream profit 350,000 900,000 1,250,000
Value stream ROS (return on 50% 60%
sales)
Employee costs (40,000) (40,000)
Other expenses (30,000) (30,000)
Change in inventory :
Current less prior period (500,000)
Plant gross profit 680,000
Plant ROS 31%
 Performance measurement : value stream box scorecard 
compare prior week performance with future desired state

Last week This week Planned future

(4/6/08) state (6/30/08)
Operational
Units per person 250 270 280
On-time delivery 90% 92% 97%
Dock-to-dock days 18.5 18 16
First time through 56% 58% 65%
Average product cost $128 $120 $115
Account receivable days 31 30 28
Capacity
Productive 21% 20% 25%
Nonproductive 45% 46% 30%
Available 34% 34% 45%
 Last week This week Planned future
(4/6/08) state (6/30/08)
Financial
Weekly sales 1,800,000 1,500,000 2,000,000
Weekly materials cost 800,000 600,000 600,000
Weekly conversion 400,000 300,000 400,000
Weekly value stream 600,000 600,000 1,000,000
profit
ROS 33% 40% 50%
 Life-cycle cost management and the role of
target costing

• The product design stage can have a significant

effect on costs to come
• In fact, at least 90% of the costs associated with a
product are committed during the development
state of product’s life cycle
• Thus, lean manufacturers should pay particular
attention to new product development
 The process
• Product life cycle  the time a product exist,
from conception to abandonment
• Life-cycle cost  all the cost associated with
the product for its entire life-cycle. They
include development (planning, design,
testing), production (conversion activities) and
logistic support (advertising, distribution,
warranty and so on)
 Life-cycle cost management (1)
• Total customer satisfaction - a vital issues in the new
business setting  whole life cost has emerged as the central
focus of life cycle cost management
• Whole life cost = life-cycle cost + postpurchase cost
• Postpurchase cost : cost such as operation, support,
maintenance and disposal that are incurred by the customers
after buying the product
• Whole life costing emphasize management of the entire value
chain
• Value chain  a set of activities required to design, develop,
produce, market and service a product
• Thus life-cycle cost management focuses on managing value-
chain activities so that a long-term competitive advantage is
created
 Life-cycle cost management (2)

• Cost reduction
• Whole-life product cost
• Role of target costing
 Cost reduction
• Since 90% or more of a product cost are committed
during the development stage, it make sense to
emphasize management of activities during this phase
of product’s existence
• Studies have shown that every dollar spent on
premanufacturing activities saves a $8 - $10 on
manufacturing cist
• The real opportunities for cost reduction occurs before
the manufacturing begins
• Managers need to invest more in premanufacturing
asset and dedicated more resources to activities in the
early phases of the product life-cycle
 Whole-life product cost
Product cost is made up of four major elements :
1. Nonrecurring cost (planning, designing, and
testing)
2. Manufacturing cists
3. Logistic costs
4. The customer’s postpurchase cost
Measuring, accumulating and reporting all of a
product whole-life cost allow managers to better
assess the effectiveness of life-cycle planning
 Role of target costing
• Life cycle cost management emphasizes cost reduction,
NOT cost control
• Thus, target costing becomes a particularly useful tool
for establishing cost reduction goal
• A target cost  the difference between the sales price
needed to capture a predetermined market share and
the desired per-unit profit
• The sales price reflect the product specification or
function valued the the customers
• If the target cost is less than what is currently
achievable, then management must find cost reduction
 Cost reduction methods (1)
• Reverse engineering  it tears down the
competitor’s product with the objective
discovering more design features that create cost
reduction
• Value analysis  attempts to asses the value
place on various product functions by customer
• Process improvement  redesigning process to
improve their efficiency
• Short life cycle  it is important for firms that
have product with short life cycle
 Life cycle costing - example
• See exhibit 16-10
• Performance report  see exhibit 16-11
Balance scorecard (BSC)
Measuring manager performance by
combining financial measurement and
NON-FINANCIAL measurement, such as :
• Market share
• Customer complaints
• Personal turnover ratio
• Personal development
 BSC
Is a strategic management system that define a strategic-
based responsibility accounting system to :
• Communicate what they are trying to accomplish
• Align day-to-day work that everyone is doing with strategy
• Prioritize project, product and service
• Measure and monitor progress toward strategic targets

The BSC translates an organization’s mission and strategy

into operational objectives and performance measure
through 4 perspectives
 BSC

Financial Customer
perspective perspective

Internal
Learning
business
and growth
process
perspective
perspective
 BSC

• Describes the economic consequence of actions taken from

Financial
other three perspectives

• Defines the customer and market segments in which the

Customer
business unit will compete

• Describes the internal process needed to provide value for

Internal customers and owners
business

• Defines the capabilities that an organization needs to create

long-term growth and improvement: employee capabilities,
Learning and
growth information system capabilities, and employee attitudes
 BSC for Ashley hotel -1
Objectives Measure
Financial perspectives
Operating revenue • Total daily operating revenue
• Revenue per available room
Operating cost • Operating expense relative to budget
• Cost per occupant
Customer perspective
Customer satisfaction • Customer satisfaction ratings
• Number of monthly complaint
Customer loyalty • Number of new reward club
members
• Percent of returning guess
 BSC for Ashley hotel -2
Objectives Measure
Internal perspectives
Employee turnover • Employee turnover rate
• Number of employee complaints
Response to customer • Percentage of complaints receiving
complaints response
• Average response time
Learning and growth
New market • Growth in reward club membership for
identification new demographic segments
Employee training and • Percentage of employee participating in
advancement training courses
• Survey scores pre-and post-training
sessions
Align to mission and strategy by aligning actions
with strategic objective
 Strategy translation

Vision and mission strategy

Objective Measure Target Initiatives

Financial
Customer
Internal
business
process
Learning and
growth
 Example

Objective Measure Target Initiatives

Financial :
Grow revenue Percentage
by introducing revenue from 20% total • Innovate
new products the sale of new revenue must product
products be from the design
sale of new • Promote
product intensively
The component of successful organization

Financial
Strength
Profitability product,
Earning before interest
and taxes

Customer satisfaction
Market share, survey scores, complaints

Business process improvement

Cycle time, defect, activity cost

Organizational learning
Training time, staff turnover, staff satisfaction
Linking performance measure to strategy

Testable strategy

A set of linked objectives aimed at

an overall goal

Testability strategy is achieve by

restating the strategy into a set of
cause-and effect hyptheses
Example of sequence of if-then statement
If design engineer receive quality training, then they
can redesign products to reduce the number of
defective units;

If the number of defective units is reduced, then

customer satisfaction will increase;

If customer satisfaction increase, then market share

will increase

If market share increases, then sales will increase

If sales increase, then profit will increase

 Testable strategy illustrated

Financial
Increase sales Increase profit

Customer Increase customer

Increase market share
satisfaction

Internal
process Redesign product Reduce defective units

Learning and Quality training

growth
 Internal (process) perspective

Post-sales service
Innovation process Operation process
process

Cycle time
Measure
responsiveness
Velocity

Manufacturing
cycle efficiency
 Formula for common process time measurement

Time required to Cycle time = Time

Cycle time produce a product Unit produced

The number of units of

Velocity outputs that can be Velocity = Unit produced
produced in a given Time
time

Manufacturing Processing time

cycle efficiency Processing time+Move time+Inspection time+Waiting time