Managing Without Standard Cost Accounting

By Jean E. Cunningham, President, Jean Cunningham Consulting and Bob Dean, Executive Vice President, TBM Consulting Group With lean manufacturing and lean business processes rapidly becoming the world’s standard, traditional financial reporting is a barrier to a focus on customer demand.

Accounting has long been a world unto itself with difficult-to-understand information and a language all its own. Finance is rife with special words. What exactly does revenue mean? What are variances? What is absorption? These all appear on financial statements, but the average business person probably doesn’t really understand them.

Lack of a common language in which the financial operations and the rest of operations can communicate has created the accounting function as an isolated silo in many organizations. Somehow, this isolation has been accepted in organizations for many years, but with lean manufacturing and lean business processes rapidly becoming the world’s standard, traditional financial reporting is not only isolated but a barrier to a focus on customer demand.

In a lean company, standard cost accounting methods are likely to inadvertently sabotage lean efforts. This happens because generally accepted accounting principles (GAAP) require some of an organization’s costs for people, buildings, and other things like excess materials -- which might not be adding value in our companies -- to be treated as assets.

Under GAAP, some of these costs are put on the balance sheet as inventory, and aren’t considered actual costs until that inventory ships. Why is this a problem for lean companies?

One of the first things that happens as companies institute lean processes is that inventory drops, and as inventory drops GAAP requires that we add these deferred costs to our income statement, which in turn makes our financial results look bad. Meanwhile, inventory reduction generates cash, which really is king, but the benefit of cash generation gets lost because companies are so used to measuring performance based on profit-and-income statements rather than actual cash generation.

The question companies must ask themselves is how to create clarity in their financial operations so that those operations are not completely disconnected from the lean processes in the rest of the organization.

Implementing lean accounting encompasses two steps. The first involves making the financial statements easy to read and understand and is called “plain English financials.” This makes the statements useful to managers and helps all employees connect their job to the company’s bottom line, which is a real motivator. Plain English financials also reorganizes financial metrics to reflect the lean product cycle and rewards lean behaviors.

The second lean accounting step is to apply the lean principles of waste elimination and one-piece flow to the financial operations themselves. This will dramatically reduce accountants’ focus and time on transactions, and provide time for value-added support to the entire organization -- improving planning processes, analyzing growth opportunities, being in kaizen events, and participating in customer value processes.

What nearly always happens is that companies begin adopting lean in manufacturing or operations first and as they make progress the finance part of the organization is not considered. In fact, finance starts getting in the way. The accountants may still be asking about standard cost variances, and yet that’s not at all relevant on the shop floor, where the important factors are performance in on-time delivery, reducing lead times, safety, introducing new products, and meeting increased customer demand with existing resources.

Occasionally we see that the leader of the company recognizes this gap and encourages the finance organization to get engaged and do things like read relevant books or participate in kaizen events, but they often meet some resistance because the finance people don’t understand why it’s important. To make headway and catalyze finance to become a value add resource, they must learn and apply lean principles to their processes and reports.

The learning process for conversion to lean accounting consists of three parts. One is learning how to support the change that’s going on in the organization by understanding how operational changes can affect the accounting function. Second is to make the financial information appropriate for the lean reality in operations by using a language that people can understand and to present that information in an optimal timeframe. Third is actual waste elimination in accounting processes.

It is hard for many finance people to imagine life without a standard cost system because that’s what they’re taught in the universities and it’s been universally used for nearly a century. But in reality, costing can be made much simpler and more useful. As inventory is reduced, much less information is needed. You don’t have to track transactional data every time you make a product. Lean accounting means creating product-line or value-stream accounting statements that don’t require standard costs.

The first question for many finance people is what do statements look like that do not use standard costs? This question is often asked with some fear and resistance because it is a deep, fundamental change to the accounting function. Once they’ve seen lean statement examples, though, they often go back and work on leaning accounting processes without changing their statements because they are still unsure of how to do so. Later, when they’ve applied lean principles and taken waste out of their processes, they start delving deeper into lean accounting and the statements get adjusted.

Increasingly, people are saying, “I really want a lean program for my finance and accounting organization worldwide. I want to change all of my financial and management accounting reporting or the company, and I’m ready to really take action.” That’s the phase many lean manufacturing companies are in now. Coaching and information are available to help organizations get to that next level, and once an organization has adopted sensible plain language financial statements, it has taken a big necessary step to call itself a lean enterprise.

TBM Consulting Group is a worldwide leader in “lean innovation” and business improvement in the manufacturing sector. For more information visit www.tbmcg.com.

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