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As lean accounting starts gaining popularity among manufacturers we have to start taking a closer at the claims made by those who propound lean accounting as the best accounting method to use. We have to start asking questions of the claims that lean accounting makes so as to see whether what it says is really true and whether lean accounting is really an effective and good way to show the financial statements. We need to have a close look at every claim made both in the big picture and while broken down into smaller pieces. A change in accounting method would make a huge difference in how those who use the financial statements see the financial picture of the company. Therefore, it is very important for a company to know all of the potential positives and negatives about switching to a new accounting system so they know whether they should invest their time and money on the switch.
Lean accounting is based off of the lean manufacturing system. Lean manufacturing uses a pull environment that is order driven while traditional manufacturing uses a projection driven push environment. The pull environment requires different reporting than the push environment because the value stream managers are the primary users of the financial statements. Value stream managers primarily use the financial statements for decision making for the value stream instead of the functional departments like in traditional accounting.
Lean accounting is supposed to maximize the value created for the customer instead of maximizing the value of the company to the shareholders. (Haskin) It is supposed to make the financial statements easier to understand and show a more accurate picture of where the money in the company is spent. Lean accounting allows the company to more immediately see the effect on the financial statements of certain transactions where before lean accounting was introduced it may take year before they are able see the results of the transaction on the bottom line. Lean argues that lean manufacturing cannot be measured the same way that traditional batch manufacturing is.
Lean accounting is supposed to present a simplified view of the inputs and outputs of the production process giving the reader of the financial statements a clearer view of what went into the product and what was just overhead. It is thought that lean accounting will make decision making easier because of its simplified view. Lean accounting is supposed to eliminate excessive transactions, reports, and sign offs by management. Another quality of lean accounting is the breakdown of expenses into recognizable categories instead of overly broad categories to make reading the financial statements easier.
There are several primary questions we have to answer to see whether lean accounting is the best option for lean operators. The broadest question is: Does lean accounting really present a simplified view of a company's financial picture? The next broad question is: Does reclassifying these costs really make more sense than their current classifications? Another broad question that could be asked is: Will lean accounting make decision making easier? The last broad question to ask is: How recognizable are the categories that lean accounting puts the expenses into? After identifying these questions you can break each one of these broad questions down in to less broad questions. After that I will be able to look at the answers to these questions in the context of the other questions to come up with the answer to our final question: Does lean accounting provide true value to the reader of the financial statements.
The first questions we must look at is: Does lean accounting really present a simplified view of a company's financial picture and does reducing tracking costs simplify this process? The idea of this simplistic view is that you are not tracking costs in minute details. According to lean accounting the tracking of these minute details that according to traditional accounting helps reduce waste is actually a wasteful procedure. Lean accounting separates the different value streams. Lean accounting also reclassifies certain expense accounts into new categories. This is done because lean accounting is organized by value stream while traditional cost accounting is organized by function.
I would say that lean accounting does not give us a more simplified view of the company's financial picture in the strict sense. While per value stream it does give you a more simplified view of that value stream but according to Drickhamer each value stream has its own modified profit and loss statement. Though each profit and loss statement may be much simpler to read and understand, there would be much more information to try to understand making it less simple to look at as a whole. Because we are looking at whether lean accounting will give us a simplified view of a company's financial picture we must conclude that it does not. Just because each category may be easier to understand it does not mean that the financial picture as a whole will be. From my understanding lean accounting does not provide a lean amount of information if it gives us a profit loss statement for each value stream. On the positive side this would give value to the company for each value stream being able to analyze each value stream much easier than before.
The second part of this broad question asks whether tracking costs in a less minute detail really does reduce the waste of tracking them. I believe that it depends upon how large the company is and how many expenses might be involved in one value stream. If the company is very large it may decrease waste tracking costs in a less minute detail. In a very large company it would take a large amount of man power to track some expenses and if the expense is very small in the first place or has a small chance to affect the true value of the product or have problems with that expense than it would not be very cost effective to track these expenses fully. In a small company any small expense may have a significant impact on the bottom line especially if there is a problem found so you might want to track them a little closer.
As a general rule I do not believe that lean accounting is correct in saying that it is always best to cut down on tracking of costs closely. Cutting down on these costs that do not add value to the products does fit into the lean theme of the company because lean is supposed to maximize value to the customer and the tracking of costs does not add value. However, I believe this is a decision that should be made on a case by case basis in context of the size of the company because tracking these costs might add value to the decision making process. Following these costs can be very important in getting an accurate cost of a product and knowing if that product is actually profitable so following these costs could be very advantageous to the company. This might even be a moot point though because converting to lean accounting requires that the company has been lean for several years before you can implement this.
The next question we can look at is does reclassifying these costs really make more sense than their current classifications. This is a much simpler question. In the short run the answer is no. Reclassifying theses costs in the short run would confuse a lot of people making it a lot more difficult for people outside the company that do not understand this change to lean accounting to understand a new method or expense classification. Even the people inside the company would have a hard time with this change. People that have been with the company for a long time and are used to the current non-lean accounting system will have a very difficult time in seeing and understanding what is going on with these changes. A change to a lean accounting system would make the company financial picture a lot less clear than it would have been before just because most people would not understand what went on in the change to lean accounting.
In the long run however this change could be a good thing. Reclassified expense accounts could actually show a more accurate version of what is actually going into a product and what is actually a variable cost and what is actually a fixed cost. This could actually improve the way companies see whether a product will be truly profitable. If this is true in the long run people would be able to understand what is going on more easily than the current system. But as previously said this would have to be a long term process. You cannot expect people to understand what is going on with the reclassified expense accounts right away. It would take time for people to get used to and start to understand these new classification methods.
Recognizability and Ease of Use
The last major question we have to ask is: Are the new categories truly recognizable to the people that are using the financial statements? Lean accounting claims that one of the advantages to its system is that the types of costs are broken down to more recognizable categories. When looking at a lean P&L and comparing it to a traditional cost P&L we see that a lean accounting P&L has far fewer cost categories than its traditional cost accounting counterpart. The traditional cost accounting costs are categorized into very general ambiguous categories including cost of sales and other operating costs. This is compared to the lean accounting P&L which has much clearer categories of procurement, distribution, conversion and support which is a lot more descriptive of what the costs really are. This allows for a better value stream analysis.
The simplicity of the layout of the lean financial statements aides in the decision making process also. Since, the lean profit and loss statement is split costs into value streams instead of the traditional products or processes it is much simpler to make a decision with this easier to read financial statement. These costs are much clearer in what they are compared to the traditional P&L. With the lean accounting cost categories it is very easy to understand what kind of business you are dealing with. For example a high conversion cost reflects a capital intensive business. (DRICKHAMER) The only thing that is better with the traditional P&L is that there are many subtotals so it is easier to analyze things as a whole. With this we can see the difference between a total with and without say Sales Expense. Even with this small advantage that the traditional P&L has the answer to the question of whether the new categories are truly recognizable is yes.
The next broad question would be will Lean Accounting improve decision making? According to Drickhamer lean accounting will provide more relevant information which will in turn make it possible to improve decision making. It could help improve decision making in make or buy decisions, product pricing, or product or customer rationalization. I think that this is possible to improve decision making. One reason it could improve decision making on the value stream level is because of the individual value stream profit and loss statements. Though there are problems with looking at the financial position of the company from the value stream view looking at it from that level would help you see pricing problems or knowing when to make or buy a component easier.
Another reason why lean accounting could improve decision making is the reclassifying of some expenses. This is a long run idea. In the short run it would not help as much because people would be wary or the new information's reliability and would not be as familiar with the changes in general. In the long run, however, when everyone has become familiar with the system and have gotten used to the idea that these numbers could be a more accurate view of the financial position of the firm, this reclassification could greatly enhance the decision making efficiency. If these new numbers are more accurate in showing what costs go into a product and whether they are variable or fixed this would allow the company to know whether a product is truly profitable.
Another question we must ask is whether it is true that standard cost accounting hides what is really happening with a manufacturing company and whether lean accounting would help correct this and show what is really happening in the company. Orest Fiume gives the example of differed costs of reducing inventory. He says that standard cost accounting buries these costs on the P&L statement as an unfavorable overhead variance. Orest says that the "Plain English P&L," which is the lean P&L, separates current operating information from change in inventory information.
He says that the current system rewards overproduction. Traditional cost accounting promotes the manipulation of profit by absorbing fixed manufacturing costs into inventory when inventory is not sold so that the inventory they have looks more valuable that it really is instead of showing them as an expense. Lean accounting fixes this problem by assigning these costs to the amount of space the used by the value stream. I think that it is clear that with traditional accounting it is easy to hide what is really happening with the company. Lean accounting does solve many of the problems that we see with companies hiding costs, but as with most accounting solutions companies will always figure out new ways to hide problems. Overall, however, lean would be preferable in this situation than no change.
According to Orest the lean P&L will allow investors a much clearer picture of the company's financial statements and it will reveal bad business practices. Doing this would definitely improve the accounting system. The purpose of financial statements is to show shareholders and potential shareholders the company's financial position. If having a lean accounting system improves the transparency of the company's financial position then it is a good idea because it helps fulfill the financial statement's purpose. This will also help stakeholders with their decision making because this will be able to see the real financial position on the company.
I do believe that, overall, a lean accounting system does give the company a simpler view of the company's financial situation. To conclude this is not just to look at the simpler view factors such as the simpler view of the financial statements and the reduction of tracking costs but also looking at the recognizability of the categories. Even though I believe that the multiple P&L statements makes it more difficult to look at the company as a whole the rest of the factors increase the clarity of the financial statements enough to cancel out the negative of the multiple P&Ls. The restructuring of the P&L statements into more recognizable categories goes a long way in giving the viewer a simpler look at the financial statements because now even someone that is not familiar with the company could understand them.
The next question we looked at was whether reclassifying costs is the correct thing to do. I concluded that in the short run it would not necessarily be advantageous to reclassify the costs, however in the long run it would be. The problem was the switching cost to the new way of classifying. In the short run people would be even more confused making it much harder to understand what is going on with the financial statements for those who are used to the traditional way, but in the long run it would be much easier to understand because they would be used to it by then.
The next question we looked at was whether the new categories are really recognizable and easy to use. The categories are definitely more recognizable to the common person because the categories describe what they are, unlike the traditional ones which are very vague and if you are not familiar with them you would not have any idea what they actually consist of.
The last question I looked at was: Does lean accounting make decision making easier? I looked at the relevance of information lean gives you, the accuracy of the reclassified numbers, and the revealing of the information hidden by traditional cost accounting. I found that lean accounting definitely gives the financial statement user more relevant information and this is a very important factor in whether lean accounting is truly better and will therefor make decision making easier because you will not have to wonder whether the numbers are the more relevant. We also found that the reclassified numbers gives you a more accurate view to improve decision making. Finally, the revealed hidden information gives us more information to make the decision. Therefore, it can be concluded that lean accounting does make decision making easier because of the more relevant and reliable information given by it.
Now I must ask one more question. Does lean accounting provide true value to the reader of the financial statements? I believe that the answer is yes. When I looked at all of the questions that I had almost all of them I came to the conclusion that lean accounting is a better system than the traditional cost accounting. Lean accounting gives us more, relevant, reliable, and accurate information than traditional cost accounting which will provide true value to the reader of the financial statements. Though there are a few small problems with lean accounting, like not being able to implement it until lean manufacturing has been in place for a certain amount of time, the positives about this new system far out way the few negatives there are. All of these factors create more transparency of the financial situation of the company which creates more value for the reader of the financial statements.
Transparency is the driving force of why lean accounting should be implemented. Transparency provides a lot of value to the user because with lean accounting it reveals a lot of the information that with traditional cost accounting will be hidden or just hard to understand for the common financial statement reader. Transparency is needed so the users of financial statements will be able to see all of the information to make informed decisions without having to decipher hard to understand cost accounts.
I looked at many of the claims that are made by the people who propound lean accounting as the way a manufacturing company should be accounted for and I determined that they are correct. I tried to look at lean accounting from as many angles as I could and I found that in almost all of them lean accounting would improve some factor of how the financial statements would be view and used. It can be concluded that lean accounting is the better system for lean manufacturers that have been lean for several years than the traditional cost accounting method.