You have likely heard of many different types of accounting such as financial accounting, cost accounting, tax accounting, managerial accounting, fiduciary accounting, and now lean accounting. To better appreciate lean accounting, it’s best to first have a basic understanding of the different types and methods of accounting.
To start, the two types of accounting that are most relevant to lean are financial accounting and managerial accounting.
- Financial Accounting: Financial accounting is primarily focused on reporting the historical and projected financial performance of a company in a standard way to parties outside of organizations such as stakeholders, investors, and lenders. These financial reports are typically compiled annually and quarterly and typically adhere to Generally Accepted Accounting Principles (GAAP). That said, many countries including the United States are currently working hand in hand to harmonize their accounting principles with International Financial Reporting Standards (IFRS).
- Managerial Accounting: Managerial accounting is focused on tracking and reviewing information internally to assist decision-makers with decision making. The focus of managerial accounting is on the detailed performance of the company and since this information is used internally, there are no standards for what to track and when to report the information. Cost accounting is an important subset of managerial accounting.
Types of Costs
There are different types of costs
- Direct Cost and Indirect Costs
- Direct Costs: Costs that are directly related to producing an organization’s goods or services such as raw materials, assembly labor, or consulting time.
- Indirect Costs: Costs that are not directly related to an organization’s goods or services such as administrative personnel.
- Fixed Costs and Variable Costs
- Fixed Costs: Costs that do not change in correlation with an organization’s production level, such as rent and insurance.
- Variable Costs: Costs that change as production increases or decreases during a period such as raw material.
It’s important here to recognize one common distinction between lean and traditional organizations. While traditional organizations typically consider direct labor costs as variable, lean organizations often consider direct labor costs as mostly fixed. That is, lean organizations don’t generally try to adjust the number of employees based on short term workload changes.
There are two general methods of accounting that it’s good to be familiar with.
- Cash Accounting: More common among smaller organizations; with cash accounting, transactions are recorded when cash is received or paid. Although cash accounting accurately recognizes the cash position of the company, it doesn’t recognize potential liabilities or match revenues and expenses in specific time periods.
- Accrual Accounting: Larger companies tend to utilize accrual accounting which recognizes transactions when they occur, irrespective of when cash is paid or received.
To better understand the difference between cash accounting and accrual accounting, it’s helpful to contrast how companies practicing each method would handle a phone bill. A cash accounting company will only record the expense when it pays the bill regardless of when the bill was received. By contrast, an accrual accounting company will record the expense as soon as the bill is received, regardless of when it is paid because at that point the company is liable for the expense.
To understand the basics of financial reporting, the must understand the 3 key financial statements used to collect and report the financial status of an organization.
- The Balance Sheet: The balance sheet reports a company’s assets, liabilities and owner equity. It provides a snapshot of the financial standing of a company at a given point in time. Normally at the end of each month, quarter, and year.Assets equal liabilities plus shareholder equity. The balance sheet also includes assets, liabilities, and equity and each of these categories might have different accounts in them such as cash and accounts receivables as assets and accounts payable as a liability.The name balance sheet refers to the fact that per the fundamental equation, at any given time an organization’s assets must equal or “balance” with its liabilities plus shareholder equity
- Assets = Liabilities + Equity
Retained earnings on the other hand are considered a liability since those funds are technically owed to shareholders. The shareholders have allowed them to stay in the company to presumably be invested in instability and growth. Similarly, common stock is a liability since it’s effectively a loan from the shareholders.
- Income Statement: The income statement is also known as the profit and loss statement or P&L. It reports a company’s profitability over a specific period, such as a month, quarter, or year. The income statement tallies all revenues for the period such as a month, and then all expenses for the same period are subtracted to calculate the net income or profit.It’s important to note if companies use the accrual method of accounting, net income or profit doesn’t represent cash profit. The company may have invoiced a customer for a sale but hasn’t been paid yet or it may have purchased raw materials but has not paid for the goods yet.However, the revenue and expenses are aligned for the time period which provides an accurate representation of business performance over a given period.
- Cash Flow Statement: Reports changes to a company’s cash for a specific period. This is particularly important for companies that use the accrual method of accounting.
For effective lean accounting to be carried out in your organization, it also does require that you have a full understanding of lean concepts. Furthermore, you must see lean as the way to run every aspect of your business.