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Lean is more than a different way to manufacture – it’s a completely new way of thinking about maximizing value for both the business and its customers.
It has become apparent during the past decade that the traditional accounting model originally created for mass production does not support lean thinking. To be successful with your lean transformation, a new accounting model is needed that accurately reflects the business consequences of activities and supports decision making within the lean enterprise.
Traditional Cost Accounting No Longer Fits Today’s Lean Enterprise
During your lean transformation, you’ll achieve significant improvements with non-financial measures including lead times, scrap rates and on-time deliveries. Yet these won’t be captured on GAAP financial statements. On the other hand, net income usually declines—albeit temporarily—during lean transformation. That’s because as the company works through its existing inventory, deferred labor and overhead move from the asset side of the balance sheet to the expense section of the income statement. This means a company’s financial statements may not reflect the true financial benefits of lean manufacturing. This dichotomy in actual vs. reported performance presents a challenge to accurately account for a lean company’s finances. Even though short-lived, the decline in net income causes concern among stakeholders, and may jeopardize the commitment to lean.
Other Problems with Traditional Cost Accounting
- Traditional cost accounting requires tremendous non-value add work to maintain an irrelevant approach to overhead cost absorption. When traditional cost accounting was developed in the early 1900s, most companies’ cost structures consisted of 60% direct labor, 30% materials and 10% overhead. Since overhead was so insignificant, this arbitrary method of allocating overhead wasn’t a big deal. Today, the percentage of direct labor in most manufacturing processes is somewhere between 5% and 15%. So, is direct labor still a good measure for allocating overhead?
- Traditional cost accounting focuses management’s attention on abstract measurements: inaccurate overhead allocations, expense variances and inventory valuation. This focus distracts from lean transformation’s goals of short cycle time, high quality, and lower overall costs.
Given these difficulties, it’s not surprising executives are looking for a better way to account for performance. As a company transforms itself from traditional mass production to lean manufacturing, the ways you count, control and measure are different.
 A new way of looking at the numbers is needed
Rather than categorizing costs by department, it’s a lean accounting model is organized by value stream, which includes everything done to create value for a customer with a product or product line. Value stream costing provides a clear portrayal of overhead expenses and their drivers, along with the negative impact of excess inventory and poor quality. And since cycle times and inventories are greatly reduced, the process for labor claiming and tracking WIP are simplified or even eliminated. Lean accounting also provides greater visibility into the causes of performance results, and greatly enhances decision making. With fully developed lean accounting processes, decisions can be based on the factors with the greatest impact on profits and strategic objectives.
How can we help?
Some of our Affiliates have been at the forefront of the development of lean accounting, and are the recognized thought leaders in this rapidly emerging practice. Working with your finance and accounting staff along with senior managers, our Affiliates are able to be your risk-sharing partner during the implementation of your company’s simplified lean accounting system. |
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