Many organizations find early in their lean journey that their accounting approach does not mesh well with lean thinking. While lean can help a company become far more effective and efficient by reducing waste, we should be able to account for those improvements. However, common accounting practices often fail to adequately measure lean improvements. An alternative, lean accounting approach is necessary.
Traditional Accounting Vs Lean Accounting
The idea of lean accounting is often met with raised eyebrows. Maintaining compliance with Generally Accepted Accounting Principles (GAAP) is a typical rationale many organizations claim to justify not adopting lean accounting methods. Specifically, the perceived need for standard costing is quite common. That said, it’s vital to recognize up front that there is nothing in GAAP that requires the use of standard costing.
How Traditional Accounting Sabotages Lean Initiatives
Not only does traditional accounting not support the lean journey, but it can also actually undermine lean success. There are many reasons for this.
For starters, traditional cost accounting considers inventory to be an asset that can actually motivate people to produce as much as they can, further driving the additional waste of overproduction (over-making and over-ordering).
Because traditional accounting tracks costs by department, siloed thinking often results where employees prioritize their own department’s success over the success of other departments and even over the success of the overall organization.
Siloed thinking is clearly evident at the end of the fiscal year when departments rush to spend their remaining budget to avoid losing budget dollars the following year. Thus, money is often spent on unnecessary items just so the current allocated budget can be depleted. This result is precisely why many companies that adopt lean accounting, eventually see the budgeting process as a waste, eliminating it completely.
Another common way siloed thinking sabotages organizational success is in the decision making of the procurement function. Procurement and purchasing professionals often make decisions with reckless disregard of the impact those decisions have elsewhere in the organization, purely because of where costs have arbitrarily been attributed.
For example, while Supplier-A might charge a lower price for commodities, Supplier-B may charge slightly more for the price of the materials, while eliminating all inbound shipping costs to the manufacturer, reducing standard lead times, carrying three months of dedicated on-hand inventory, and improving product safety and reliability. Even so, because those benefits aren’t associated with the procurement function and are measured elsewhere, purchasing dismisses them, choosing Supplier-A, with the cheaper price, while driving costs elsewhere in the business.
Sadly, many procurement and purchasing professionals will even readily acknowledge that their decision making is solely concerned with achieving functional goals (e.g. reducing material costs) at the expense of sabotaging organization goals (e.g. increasing replenishment costs). Amazingly, many times the company even incentivizes this behavior. Unfortunately, Falcon’s lean consultants see this far more frequently than we care to admit.
Conversely, lean organizations seek to determine what customers’ value and what the cost of that value is. Simply put, the price is set by the customer and with continuous waste elimination, costs decrease across the organization, and profit rises.
Traditional accounting can be expensive and wasteful because it measures things in extraordinary detail which requires far more manpower to prepare documents that few people understand and even fewer utilize. Additionally, the information is often delayed and most importantly, it rarely aligns with what the customer values.
Traditional accounting can also be wrong, misleading, or counterproductive. Consider, labor costs are often considered variable but, the variance is often negligible.
As mentioned, traditional accounting can be complex and confusing to most people in an organization, inhibiting good decision making. Terminology such as debits and credits, depreciation, double-entry bookkeeping, general ledger, overhead absorption, variances, and other terms aren’t intuitive or easy to understand without sufficient training and application.
The complex requirements to track and report everything in elaborate detail is a common contributing factor to accountants becoming isolated from the rest of the organization and perceived as unimportant, detached “bean counters”.
A further consequence of traditional accounting’s complexity and lack of influence is that the people in the organization responsible for making improvements don’t have the knowledge or resources required to develop and quantify improvement initiatives. In these scenarios, from the perspective of outsiders, the financial function is often seen as equivalent to a Magic 8-Ball; mysterious and unpredictable.
By contrast, in lean organizations, as transactions are eliminated and measures are simplified, accountants are empowered to become strategic partners in helping the team continuously improve the value the organization delivers to customers.
To begin freeing accountants to be able to add more value as internal consultants, first, it’s important to define what we mean by the term “lean accounting”.
Lean Accounting Defined
Unfortunately, many people mistakenly think that lean accounting is simply applying lean techniques such as 5S to the accounting function. While this is certainly acceptable as a partial definition, it’s far from comprehensive.
It’s vital to recognize that lean accounting also refers to the different approaches to accounting that accountants take to support decision making throughout lean organizations. Lean accounting ensures the right people have the right information at the right time to make the right decision in the areas of pricing, production, sourcing, inventory management, performance measuring, etc.
Eventually, as accountants begin to comprehend and apply lean accounting to their organization, they’ll transition from being a roadblock in the lean journey to a lean foundation.
Lean Accounting Requirements
For the lean accounting reality to materialize, the accounting function must support the following five principles of lean as follows:
- Value Streams: Value stream costing takes precedence over traditional costing.
- Flow and Pull: Timely visual information support flow and pull.
- Customer Value: Performance measures focus on creating customer value.
- Empowered Employees: Intuitive measures provide employees with actionable Insights.
- Continuous Improvement: All associates strive to improve the organization over the function.
While principles guide behavior, a new set of lean accounting tools will be needed to effectively execute behaviors. These tools include value stream costing, box scores, target costing, and “plain language” statements. Later in this series, we’ll cover each of these tools in more detail.