AMS Talks Lean Accounting With Arkansas Business

Monday, Sep 15, 2008

'Lean Accounting' Described as Aid To Manufacturing
By Gwen Moritz
arkansasbusiness.com

The only thing about the manufacturing process that is still recognizable from the post-war economic boom of the 1950s is the way plant managers and their accountants determine how much it costs to make a product.

Standard cost accounting, which made sense when single-line manufacturing plants were working nonstop to feed virtually unlimited demand, is now the biggest impediment to implementing efficient "lean" manufacturing methods, according to Dan Medley, chief operating officer of Missouri Enterprise.

Medley will present a workshop on "lean accounting" in Little Rock on Thursday as part of Arkansas Manufacturing Solutions' 2008 Manufacturing Matters conference.

"The less you know about standard cost accounting, the more sense lean accounting will make," said Medley, whose employer is the Show-Me State's counterpart to Arkansas Manufacturing Solutions. Both organizations are quasi-governmental agencies that provide low-cost consulting services to help manufacturers become more competitive and profitable.

AMS defines lean manufacturing simply: A systematic approach to identifying and eliminating waste through continuous improvement techniques. But, Medley said, the traditional way of determining how much a manufactured unit costs - by dividing total operating expenses by the number of units produced - creates an incentive for manufacturers to be anything but lean.

"Standard costing assumes you need to keep equipment and people busy at all times in order to spread the overhead against more products," Medley said. In that system, the only way to reduce the cost of a single widget is to make more widgets.

Very often the end result, he said, is inventory without buyers. The cost per widget has been reduced, only to have crates of widgets growing stale or getting damaged on the plant floor while newer models take their place.

In this way, standard costing "winds up creating a problem [by] giving off a signal that our costs are actually lower than they appear on the profit and loss statement," Medley said.

Widgets Inc.

Many businesses, including manufacturers, have gradually moved away from pure standard cost accounting, according to Dan Curtis, who took over as director of AMS in January. The interim stop on the way to truly lean accounting is activity-based accounting, which does a better job of determining the costs and profit margins associated with different products, which may vary widely within the same organization.

"Once you have activity-based accounting, the next step is to implement lean in your plant, and then go back to the accounting and ask what measures are going to be useful in tracking value," Curtis said.

The idea of value is key to the entire lean approach. Lean manufacturing divides the process of making products into "value streams," the activities that directly create value for customers and, ultimately, for the company. Lean accounting does the same for the costs associated with those value streams. Overhead expenses are accounted for separately rather than embedded so deeply into the standard cost equation as to be indistinguishable from the actual costs of production.

"We know what total overhead is, and once we capture it and we can see it, we can try to minimize it," Medley said. "But right now no one sees it because it gets allocated out."

That homogenization of costs ends up masking the benefits of lean manufacturing, Medley said. He gave this example:

An inefficient widget maker has a six-week backlog of orders and then delivers widgets on time only 80 percent of the time. Using standard cost accounting, this manufacturer is spending $20 to produce one widget every 10 minutes. Therefore, the cost of production seems to be $2 per minute.

By dividing the production line into lean work cells, the same manufacturer can reduce the lead time to two weeks and deliver on time 98 percent of the time. But the new configuration of the equipment has added two minutes to the average time it takes to produce a widget. The standard costing method says it now costs $24 per widget.

"We actually have companies that don't make these improvements because standard costing is telling them that it's not the right thing to do," Medley said. The problem is the $2 per minute estimate includes costs that haven't increased just because the average time of production has. What's more, reducing the cost per unit by making more widgets does nothing to reduce those extraneous costs.

"When you set up lean, what you want is a value-stream manager, and you want that person to only control the costs that they can control. And they can't control the overhead costs," Medley said.

Standard cost accounting, he said, is "an estimate at best, and all estimates are wrong. With lean accounting, we know the actual cost of running that value stream. And if we have extra capacity to make more, unit costs are going to go down."

Curtis took it a step farther. Lean accounting, he said, "gives you the right metrics that you need to reduce your lead time. That reduces time to market, but also reduces inventory. And all those things add costs to the business and create waste. As you make improvements, you get to the point where these costs go away."

Beta Test

Bringing Medley to speak to manufacturing executives attending this week's conference is a "beta test" to determine interest in bringing a lean accounting consulting program to Arkansas, Curtis said.

"If this turns out that a lot of companies are interested, then we'll use the Missouri people to start and then get AMS up to speed to help those companies."

Information about the conference, which starts Wednesday at the DoubleTree Hotel in Little Rock, is online at mfgsolutions.org.