1 IMA’s 92 nd Annual Conference © 2011 Institute of Management Accountants. All rights reserved. Making Accounting Relevant in Lean Environments Presenter: Dr. Rosemary Fullerton, CPA Utah State University

Objectives of Lean Enterprise Serve customers Accelerate bottom AND top line growth Increase capacities Reduce inventories Do more with less through: Continuous improvement Waste elimination Process discipline Defect reduction Throughput time reduction 2

Lean Practices (Tools) TPM Lean Accounting JIT 5S Teams Kanban Takt Time Value Streams Standard Work Poka Yoke Visual Factory One-piece Flow Kaizens Work Cells

Strategic Lean More than a shop-floor tool Process improvement should be applied throughout organization Support functions must participate and contribute to lean journey for it to succeed Lean is a total business strategy

5 Lean Principles Flow and Pull Customer Value Value Streams Perfection Empowerment

What are the implications for Accounting?

Implication #1 Sequences of processes transforming material into customer value Value Stream Assigns direct costs and allocates support to products Traditional Accounting Assigns VS costs directly to VS and avoids allocations Lean Accounting

Implication #2 Lean defines VALUE from customer’s standpoint CUSTOMER VALUE Standard costing focuses on Internal financial targets Traditional Accounting Helps define and calculate customer value Lean Accounting

Implication #3 Maximize Flow  Triggered by Customer Flow and Pull Encourages large batches to reduce cost and meet budgets Traditional Accounting Metrics encourage smooth flow and minimizing inventory Lean Accounting

Implication #4 Information and authority to act when needed Employee Empowerment Provides information to Managers  Manages people rather than processes Traditional Accounting Targets process information to decision-makers  Manages processes rather than people Lean Accounting

Implication #5 100% quality; unbroken flow at the pull of the customer Reach for Perfection Focus on meeting Internal standards Traditional Accounting Highlights opportunities for continuous improvement Lean Accounting

Traditional vs Lean Thinking Traditional Departments (silos) Batch production Push System Management makes all decisions Controlled by transaction reporting Standard costing system Numbers are what count Lean Value Streams Single piece flow Pull system Empowered teams make most decisions Controlled by visuals on plant floor Value stream costing Process is what counts

Lean Accounting vs Accounting for Lean Lean Accounting: Use of same Lean tools in accounting department as on manufacturing floor: 5S, value stream mapping, standard work, kaizens Accounting for Lean: Scorekeeping for Lean company. Accurate, timely, and understandable information for motivating lean transformation

Accountants and Lean Accountants generally are not exposed to lean do not know how to measure lean improvements do not participate in lean activities

Lean-up Accounting Processes  Attack Waste  Accounts Payable  Payroll  Implement Standard Work  Streamline Closing Process  Reduce Batch Size  Adopt 5S

Accounting and Lean ? Partners or adversaries ? Accounting is the number one enemy of productivity Eliyahu Goldratt Why is accounting accused of not only being irrelevant, but actually detrimental to Lean?

Invisibility of Lean oImprovements are often invisible to accounting oThe greater the initial success with lean, the more likely profits will be depressed oBenefits of reduced set-ups, improved productivity, improved lead times, and capacity increases are not reflected on bottom line

Typical Plant Cost Structure Where do we focus our improvement efforts? Jerry Solomon 2006

Traditional Company Sequential Operations Drill – 12 min. Insert – 5 min. Tape – 6 min. Inspect – 3 min. Pack – 4 min. Standard Product Cost Material cost - $15 per unit Labor rate - $20 per hr OH multiplier – 3X labor rate Related Metrics Avg Inventory – 10,000 units Lead time – 8 weeks On-time delivery – 70% What is the total product cost? Lot size – 1,000 units

Kaizen Improvements  Moved processes to a cell  Changed insertion and taping process  Reduced lot sizes  Increased quality  Reduced lead time  Increased on-time deliveries

Cell Operations Drill – 12 min. Insert – 10 min. Tape – 7 min. Inspect – 2 min. Pack – 5 min. Standard Product Cost Material cost - $15 per unit Labor rate - $20 per hr OH multiplier – 3X labor rate Related Metrics Avg Inventory – 2,000 units Lead time – 2 weeks On-time delivery – 90% What is the new total product cost? Lot size – 50 units Traditional Company After Kaizen

Great Improvements Made MeasureBeforeAfter Improvement Inventory10,0002,00080% Lead Time8 Weeks2 Weeks75% On Time Performance70%92%24% Batch Size1, % Sq. Footage8,0004,00050% Quality60 PPM15 PPM75% Throughput5/hour No change Flexibility & TeamworkPoorImprovedDramatic Unit Cost per Cost Acct$55$63(15%) Adapted from Jerry Solomon, 2006

Standard Costs Do not reflect actual costs Generally outdated Lead to poor decision making Focus on variances, rather than processes Historical based Difficult to understand Encourage overproduction

Standard Cost Reporting Does it: Identify what to improve? Identify waste? Identify obstacles to flow? Encourage inventory reduction? Provide timely information? Provide information on lean improvements?

Lean value streams focus on creating value for the customer. Accountant’s role is to supply information that supports that objective. Value Streams

Value Stream Costing Once Value Streams identified and charted... Identify and accumulate all value stream costs Record labor (office and shop), machines, materials, support services, and facilities in value stream Use only costs directly associated with value stream Avoid allocations 26

Value Stream Costing Requirements for effective Value Stream Costing: Few shared resources (machines or labor) Stable processes Relatively low inventories Tracking of scrap and rework Labor reporting by Value Stream Minimal required allocations Visual performance measures Adapted from BMA

Value Stream Costing Traditional standard costing motivates non-lean behavior and perpetuates wasteful activities. Value stream costing supports lean organizations through its simplicity and ties to continuous improvement strategies. 28

Monthly Full absorption costing Can you look at this tell me: Did we increase or decrease inventory? What do we know about capacity? How much available capacity do we have? 29 Traditional Plant P&L

Plain English Plantwide P&L Simplicity Lack of Allocations Highlights Inventory Change Plant Sales$5,563,374 Material Costs$1,731,189 Employee Costs$1,095,413 Equipment Costs$ 496,780 Occupancy costs$ 391,376 Other VS costs$ 411,403 Operating profit$1,437,213 Inventory (reduction) increase 26% $ (181,436) Net operating profit$1,255,777 Corporate allocation$ 84,874 Net OI$1,170,903 ROS21%

($000)VS1VS2SustainingTotal Plant Sales$2,708$2,855$5,563 Material Costs$1,040$ 691$1,731 Employee Costs$ 343$ 394$ 359$1,096 Equipment$ 139$ 358$ 497 Occupancy Costs$ 120$ 235$ 37$ 392 Other VS costs$ 297$ 114$ 411 Gross VS profit$ 769$1,063$ (396)$1,436 28%37%26% Inventory change: increase (reduction)$ (181) Profits$1,255 Corporate Allocation $ (85) Net OI$1,170 ROS21% Value Stream Statements Prepared Weekly Highlights Capacity

Unit Costs Total Value Stream Costs = Avg. VS Cost/Unit Units Shipped VS 1 $1,938,937 / 100,000 Units = $19.39 /unit  Tracked regularly: good gauge of overall process improvement.  Shows instability that was previously hidden.  Provides incentive to ship from FG when possible

COGS & Inventory Costing Traditional accounting requires lots of time tracking labor to value COGS & ending inventory Lean accounting arrives at same COGS through tracking labor hours in ending inventory ONLY

34 Monitoring Progress: Box Score Last Week Oct 4 This Week Oct 11 Next Week Oct 18 Planned future state 12/31/xx Units per person On-time shipment98%94%98% Dock-to-dock days First time through46%42%50% Avg product cost$388$349$317 AR days Productive10.8% 24.7% Non-productive54.8% 23.4% Available34.4% 51.9% Revenue$1,101,144$1,280,400$1,408,440 Material Cost$462,480$512,160$535,207 Conversion$250,435$231,884$208,696 Value stream gross profit $388,228$536,356$664,537 Operational Capacity Financial Weekly Tracking Never lose sight of goal Highlights Capacity

Benefits of Lean Then what? Eliminate Waste Streamline Processes Free Up Capacity

Capacity-Related Decisions Key objective of lean is to increase capacity Successful only when accompanied with a moderately aggressive growth plan.

Capacity Decisions Two decisions that play right into this Special Order Decisions Outsourcing (Make or Buy) Decisions

Prior to Lean Thinking Decisions: Made per product margin Based on a comparison to standard cost

Special Order Decision 1,000 units at $46 requiring stitching an extra patch Strong support for NOT accepting order Per Unit Analysis Standard Product Special Order Sales$52$46 Material Costs1516 Direct Labor89 Overhead1011 Std Cost$33$36 Margin$19$10 ROS36.5%21.7%

After Lean Thinking Maximize contribution to the value stream as a whole The object is to increase throughput If capacity, make more product  In-source previously outsourced product  Accept special orders that previously would have been refused

Decision Framework Use current and future state analysis Viewed from VS perspective, evidence indicates acceptance Value Stream Analysis (‘000 omitted) Current State Future State Sales$1,730$1,776 Material Costs VS Conversion Costs 785 VS Profit$ 290$ 320 ROS16.8%18.0%

Lean Decision Summary Consider impact of any decision on the VS as a whole. Rule of thumb: If capacity exists… conversion costs are free or minimal. If capacity is limited… must consider the product mix, bottleneck, and throughput.

Decision Key The key is to Maximize Contribution to the Value Stream

So….Why ‘Lean Accounting’ ?  Measures and manages visually  Focuses on value streams  Improves decision making  Motivates continuous improvement  Simplifies financial reporting  Eliminates unnecessary, redundant controls  Applies Lean thinking to accounting processes  Turns accountants into strategic advisors 44

Resistance to Change Cultural Barriers Loss of Trend/Comparison Data Lack of Top Management Support Inventory Valuation Difficulties Your Business is Different Not Compatible with GAAP Obstacles (Excuses) to Lean Accounting Transition

Conclusion Make Lean total business strategy Support process change with appropriate accounting system Simplify accounting processes. Work on accuracy, rather than precision Provide visual, easy-to-understand information. Develop performance measures that motivate Lean behavior Make accountants part of Lean transformation process

How to Learn More Read Real Numbers, Fiume and Cunningham Who’s Counting, Solomon Accounting for World Class Operations, Solomon and Fullerton Practical Lean Accounting, Maskell and Baggaley Benchmark others Attend workshops and seminars Lean Accounting Summit, IMA Conference, Shingo Conference, AME Conference Subscribe to “Lean Accounting News”