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Thursday, September 22, 2011

A Lean Manufacturing Environment Benefit from Lean Accounting Practices


Lean manufacturing is nothing new — many manufacturers adopted this business model during the last decade. But did you know that lean accounting is crucial to operating in a lean manufacturing environment? Lean accounting focuses on two goals: 1) converting financial statements into “plain English,” and 2) eliminating waste by taking the focus off the minutiae.

Standard Costs vs. Lean Accounting Statements
The transparency of lean accounting is helpful in demonstrating the benefits of lean manufacturing initiatives and optimizing day-to-day business operations. Because standard cost accounting rewards overproduction, using standard methods to try to demonstrate the value of lean processes that eliminate production waste would be futile. Lean accounting, on the other hand, reveals savings and costs that might otherwise be misinterpreted or hidden — the true cost of labor and machinery, for example.

For manufacturers that run on lean management principles, not using lean accounting principles can, in fact, be downright harmful. Case in point: Standard profit and loss statements can put a negative spin on the inventory reduction that comes with the implementation of lean manufacturing processes. That’s because production isn’t completely absorbing overhead and labor costs, so these costs appear on statements as deferred costs. This can be a red flag for owners, executives and investors, preventing the benefits of lean manufacturing from shining through.

For example, if a manufacturer produces less product on a quarterly basis, standard cost accounting statements might indicate that the cost of manufacturing each unit goes up because labor and overhead aren’t being absorbed as quickly. In other words, standard cost accounting says that the higher a company’s production rate, the less each unit costs in terms of labor and infrastructure, as these costs will be divided up among more units. This not only can cause concern among owners, executives and investors, but also can lead manufacturers to price their products inaccurately, making them less competitive. Lean accounting methods, on the other hand, might reveal a lower actual cost per unit, because, in reality, the machines used to make the product are owned by the company and labor costs are minimal.

Lean accounting can avoid this problem by converting financial statements to plain English and using metrics that are clear and objective and support lean initiatives. Deferred labor and overhead costs, for example, have no place on a lean accounting statement.

Also, while traditional statements may account for a fixed-dollar amount of overhead for every dollar of inventory spent, lean accounting looks at these costs as variable, assessing the true costs of labor and overhead on a case-by-case basis. Statements should also align with value-stream maps — visual representations of the end-to-end production process — which can give owners and executives a clear picture of their companies’ financial situations.

The Lean Lag
While lean accounting provides accurate, easy-to-understand views of finances in lean manufacturing environments, hurdles to acceptance of lean accounting methods remain. Traditional accounting practices are still a compliance necessity because lean accounting won’t, for example, satisfy IRS requirements. Likewise, public companies are required to issue financial statements following Generally Accepted Accounting Principles (GAAP), and private companies may have to provide GAAP-compliant statements to lenders. So financials may need to be done twice.

Additionally, lean accounting requires a significant change in the way people think about accounting. Company accountants that know standard cost accounting and GAAP inside and out likely won’t be very familiar with lean accounting methods.

Finally, lean accounting requires buy-in from departments outside of finance, including IT, operations, engineering and customer service, because they must all adapt to using lean accounting metrics to measure and analyze performance within their departments.

Is Lean Accounting Right for Your Company?
Even though lean accounting can’t replace traditional accounting practices, it can go further in helping owners and executives make accurate, informed business decisions. It’s also a necessity for manufacturers who want to see the true financial effects of their lean manufacturing initiatives. Lean accounting may not be right for every organization, but manufacturers that are committed to and invested in lean manufacturing practices should consider supporting them with simplified, lean accounting processes.

Learning Lean Accounting
Traditionally, university accounting programs have shied away from “creative” accounting practices, teaching only Generally Accepted Accounting Principles (GAAP) and standard cost accounting. Lately, however, there’s been a perceptible shift in this thinking, and some professors are incorporating lean accounting into their curricula or offering entire courses devoted to the subject.

The Association for Manufacturing Excellence (AME) recently awarded scholarships to 10 students and 10 professors from several universities to attend the organization’s annual Lean Accounting Summit. The scholarships were given to those “interested in learning how adopting lean accounting principles in their management accounting systems can help organizations make better decisions in their lean transformation efforts.”

Even though some universities are taking lean accounting more seriously, roadblocks still exist. University accounting programs aim to groom students for good jobs in the field by placing emphasis on standard accounting, leaving little room for lessons on lean accounting. Lean manufacturers that hope to hire graduates with lean accounting knowledge should work with the universities from which they recruit to encourage professors and university administrators to add lean accounting to curricula.

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