Lean Accounting

Lean accounting defined

Lean accounting is an accounting type that is designed for those companies who have implemented lean manufacturing techniques. Traditional cost accounting does not always accurately reflect the positive and cost saving measures that a lean system provides. But since many of a company's decisions are based on the numbers that the accounting department yields, many of these benefits are overlooked with traditional accounting methods. Just a few of the cost organization methods that lean accounting includes are value streaming, changing inventory valuation techniques and modifying financial statements to include non-financial information.

The principles of lean accounting are to measure and motivate. Lean accounting can measure positive gains through initiating lean alternatives in ways like reducing inventory, reducing cycle time, or improving production floor moral and thereby increasing overall capacity. Lean accounting works to motivate a company to continue to promote their lean initiatives rather than deliver numbers that are not necessarily an accurate reflection of company profitability such as is the case with attempting to meet machine efficiency quotas by producing an abundance of un-necessary inventory.

Standard cost accounting simply does not fit in with a lean manufacturing system. Traditional cost accounting reports were developed to present an accurate view of the company to outsiders, mainly shareholders who had the right to know in hard numbers how their investments in the company were being put to good use. Their purpose wasn't to help managers run their operations better. Lean accounting concepts better capture the performance of the lean manufacturing plant's operations, rather than show a skewed financial report that is just for show anyway.

Under lean manufacturing some non-financial measures simply aren't captured on GAAP (generally accepted accounting practices) financial statements. Now it is true that net income usually declines when a company switches to lean manufacturing. So traditional methods or not your accounting will reflect that change, but the decline is not necessarily something to get overly worried about at these declines are more often than not temporary. 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. Lean manufacturers also view inventory differently than would those following a traditional accounting method. In lean accounting, inventory is not an asset because of all the costs that are associated with it. Just to mention a few of these costs, you have handling costs, it takes up floor space and reduces cash flow. Treating inventory as an asset in traditional financial statement only makes sense if those assets are a guaranteed sale, which they often are not. In fact, historically excesses in inventory have either not sold at all or sold for much less than market value because the customers are constantly looking for the next thing or something better than what they have been offered before. In lean operations, the goal is to produce only enough products to meet demand this means reducing inventory to the point where there is no inventory at all in some cases. Having a guaranteed buyer for every product that is made translates into no wasted time, money, or resources on a product that will never make it past the doors of your warehouse.

How does lean accounting make up for where standard accounting methods fall short?

Traditional accounting was designed to support mass production. As lean manufacturers do not necessarily believe that mass production is the most value-adding method of production, many of the traditional accounting assumptions contradict lean manufacturing. As a result CPAs are being sought out by companies who have implemented lean initiative and now wish to also implement alternative accounting concepts to better capture their performance. Rather than categorizing costs by department, CPAs looking to implement lean accounting can make up for where standard accounting methods fall short by recommending companies organize their costs by a process called "value stream." Value streaming includes everything an entity does in creating value for a customer that it can reasonably associate with a product or product line. Among the costs in a value stream would be the expenses a company incurs to design, engineer, sell, market and ship a product as well as costs related to servicing the customer, purchasing materials and collecting payments on product sales.

Lean accounting may be able to make up for where standard accounting methods fall short, but that is not to say that CPAs should encourage companies moving to lean accounting to eliminate standard reporting entirely. Businesses should supplement their traditional financial statements with the addition of lean accounting information, information that captures the improvements lean manufacturing brings with it that are not typically represented in traditional accounting methods. Dismantling the traditional accounting process can help those implementing lean accounting to see just how the two types of accounting represent different aspects of the business and how the use of both can represent a standard reporting system and the underlying changes in operation that the company is going through in order to implement lean techniques.

In addition to making changes to their financial statements, companies that adopt lean processes often also include non-financial data in their "financial" statements. For instance, Caslavka of Landscape Structures increased the level of detail on his "sales discounts" statement. He describes his reasoning for doing so by saying: "Previously, we viewed this as one un-dissected pool of money. Now, we're taking a stronger look at how we spend the dollars and the benefits we get. For instance, the reports now show the number of sales leads generated by different promotional discounts."

Implementing lean accounting

As with any implementation of a change in the traditional way of operating implementing lean accounting will require the dedication of management as well as those accountants who will have the responsibility of doing their jobs in a new way. Most companies that choose to implement lean accounting will also continue to supplement their lean financial statements with traditional accounting statements, especially if the company is publicly held and there is a demand for the release of these financial documents.

Naturally this is a process that will not happen over night. When asked, many accountants who have successfully integrated both types of financial reports say that they were able to most effectively do so through creating parallel financial statements (one traditional and one based on the principles of lean).

Implementing lean accounting principles does not have to mean creating a completely new way of balancing the books. Most financial officers find the cost information they need to prepare lean financial statements already is available in their company accounting systems. It's just a matter of reformatting the data to fit the lean accounting needs. For instance, according to the Kaizen institute, "rather than including labor and overhead expenses in the cost of goods sold, a lean financial statement will show materials, labor and overhead as separate line items. That way the company will recognize labor and overhead expenses when it incurs them rather that having them get wrapped into inventory on the balance sheet."

When implementing lean accounting there are also issues of the reputation of the accountant to take into consideration. Not all companies smile on accountants who work in relative measures as lean accounting principles require. Daniel Szidon, a CPA and partner in Wipfli LLP in Wausau, Wisconsin says, "When CPAs work with numbers, the goal is to fully allocate costs to precise and stable cost centers," he says. In contrast, lean focuses on accounting for costs in a manner that's reasonably accurate. "The goal isn't a perfect allocation of costs. It's an accurate, relative measure of them."

Lean accounting terms and techniques

Lean accounting and traditional accounting methods conflict in several ways. It is important to understand these conflicts in order to fully understand what the information yielded by either technique actually means. Below you will find a brief list of accounting terms that you should be familiar with if you are implementing a lean accounting system:

• Product costing - Determining the true costs of individual products and components. Traditional accounting systems track only expenditures which leads to under or over valuing products in the lean accounting methods.

• Activity based costing - A technique that attempts to identify the factors that drive overhead costs. This process can often be extremely complex and confusing in lean implementation.

• Inventory cost analysis - Remember that conventional accounting methods may track inventory level well but the cost of holding that inventory is only included in lean accounting. These costs include space, warehouse personnel, insurance, utilities, etc.

• Micro costing - Micro costing systems are often setup to collect time and cost at each individual machine and operation. This can lead to errors caused by a difficulty to interpret and a failure to update data. Often times this non-value added activity of data collection is simply unnecessary in lean accounting.

• Non-financial metrics - Traditional accounting does not effectively measure investment in longer range objectives (objective that go beyond simply making a profit). Lean accounting takes more into account than just the financial metrics of the organization. Individual activities, processes and parameters within each activity or process require that metrics also contain non-dollar units that better represent the company's standing.