The Introduction of Lean Accounting

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Accounting has always been done the same way for many years. There are standards and traditional ways of accounting within the business environment. But since a Japanese company began to use a different type of manufacturing process the accounting standards have had to change to account for it. This change in manufacturing process has brought about the use of lean accounting. Lean principles can bring both benefits and risks to a company, but traditional manufacturers have a hard time switching due to employee resistance.

Lean manufacturing began in Japan with the automotive manufacturer Toyota. Toyota's ideas originated from some of the base principals and ideas from Henry Ford. Ford was the pioneer who helped make the American assembly line and mass production famous in the early 20th century. Ford taught Toyota the principals of minimizing the activities that added no value to the product. This became Toyota's well known Toyota Production System ("Lean Manufacturing").

Just in Time manufacturing, or pull manufacturing, is the system that limits the amount of excess inventory in the company. Producing only what is needed saves the company time and resources. By having products only produced when needed cuts down on the number of stored raw materials and final products. Storing less raw materials in inventory cuts down on capital costs and only having final products when needed eliminates the chance of the products becoming obsolete or unwanted after they have already been produced ("Tutor2u").

Waste elimination is a continuous process in lean manufacturing. Waste is anything that does not add value to the customer (Coldwell). Examples of waste are defects, scrap, reproducing products, redundant activities, machine wait times, and other things that do not add value. Reducing defects will reduce the total amount of labor and materials needed to produce a product because the finished product will only need to be produced once, instead of two or more times with a defect. Another aspect of lean is to not over produce. The American way of manufacturing was to mass produce products. This would require a large amount of raw materials in inventory, thus higher material storage costs, and final products that had to wait to be sold. ??????

The major difference between traditional and lean manufacturing from the production standpoint is the push vs. pull mentality. Traditional manufacturing operates in a push type of function. The goal is to produce an excess of products in anticipation for customer demand. If customer demand is high then the system will work as planned, but lack of demand creates problems and this can lead to excess inventory sitting on company floors and products that are wasted. Lean manufacturing operates on the pull mentality. When a manufacturer uses pull manufacturing the product is only produced when there is a known customer demand. Raw materials are ordered as needed to meet customer demand, and products are produced only when customer orders are received. No longer is excess inventory and raw materials being stored because all the products produced are made for a customer and this reduces the amount of product in inventory waiting to be sold (Smart).

Traditional accounting is best suited when products are to be mass produced. This mass production has ingrained values and ideas into managers and floor workers that are simply the opposite of lean. These values make lean hard to implement because changing workers ideas on what they have historically known as successful is no longer the goal. If standard costing is still used while lean is being implemented, costs will appear to increase and this could then lead to increased resistance by employees and abandonment of the project. Changing the mentality of employees is the only way to successfully implement lean. This task is easier said than done and if the employees minds are not open to the change then the switch to lean is often abandoned (Maskell).

Lean manufacturing requires that inventories of raw materials be reduced. One way of achieving this goal is to use the same parts across different products in the same industry. Using the same radios in different model cars, or the same chips in different model computers are examples where this is practiced. But the inherent problem with is it that if the part used in the wide variety of products goes bad, the company is in for a serious problem. Instead of having to recall and or repair one product line, all the products the company produces can be compromised causing huge recalls. This was evident when the Toyota gas pedal defect affected multiple models and cost the company large amounts of money. But money is not the only problem for Toyota. Due to this lean manufacturing trick to save costs, their brand image is compromised. Having to recall one car makes that car seems unsafe and will drive down sales, take the Ford Pinto for example. But to a recall to multiple cars make the entire company seem unsafe and sales to all the product lines suffer (Wakabayashi). So what is the trade off? Implementing this aspect of lean will do wonders for the company in terms of costs, and if the product's components have gone through appropriate testing then there should not be an issue or recall. But by cutting the corner of not having unique parts the company runs the risk of damage to their image and sales across all product lines.

Lean manufacturing does have advantages. The process of reducing waste and increasing efficiency will decrease the time it takes to produce a product. This lower lead time will save the company time by lower the amount of time machines are running, the amount of time employees are working, and lower the amount of other utilities such as electricity which will decrease costs. In addition to the decreases in labor and utility costs, increase in efficiency means less floor space is taken up in the warehouse by unnecessary machines. This extra floor space could be used to install new machines to make the process even more efficient, or be used as storage space for raw materials and finished products waiting to be shipped. Having the extra floor space means a company could consolidate its warehouses and factories and pay less rent and utilities on the additional facilities it no longer needs ("Lean Manufacturing").

Implementing lean manufacturing will radically improve the production process, and over time the process will continuously become more efficient than the year before. Once lean is implemented, the problems in the production system will become clear. The benefit of lean is that when a problem occurs, there is an emphasized effort to fix the problem. Once the problem is fixed, protective measures are put into place to prevent its reoccurrence (Meier). At first these problems might scare off managers to want to go back to their old ways, but by fixing and preventing these problems the manufacturing process will eventually run smoother and more efficient.

Not only is the production process improved, but the value stream process is also improved. Improving only the production process will lower divisional costs but improving the value stream will decrease even more costs. Improving the value stream allows a company to cut costs both upstream and downstream. The improved process of receiving parts from suppliers can allow for extra savings and improvements in the way parts get to their manufacturing stations. Improving the way final products get to the customer will not only reduce costs, but it can also improve customer relations and reduce lead time. These benefits to the customer can potentially mean an increase in sales from current customers and the addition of new customers (Maskell).

Lean accounting is something that should be applied when a company is using lean manufacturing. With lean manufacturing comes a change in the production focus. These new manufacturing ideals need to be evaluated in a different manner. Without the change in place then the traditional ways of accounting will show negative impacts on the statements and can influence managers to abandon the project.

Lean accounting requires principals contrary to traditional manufacturing. Traditionally, success in a manufacturing plant was judged after the products are produced and the financial reports are realized. Managers look at the data for the previous days, weeks, and months and then judge their production facilities. This after the fact approach is the opposite of lean. Lean requires a focus on current productions ("Business Knowledge").

This current focus on production allows for better control of the manufacturing process. Wasted activities are more apparent when they are being performed than are noticed weeks after they happen. If the company floor is being watched by managers and a defect occurs, the defect is able to be found, traced, and eliminated before it occurs again. Having managers at a different location and looking at past data will not show the correct efficiency of the plant. The traditional managers have a series of calculations and measurements that they use to measure success ("Business Knowledge").

Lean manufacturing is not without its problems. Lean is not easy to implement. As discussed earlier, lean goes against everything employees know. Workers were previously taught to produce as much as possible and as fast as possible. Telling them to focus on quality over quantity might come with resistance and would take time getting used to. Also changing what managers focus on is no easy task.

The hardest part is that people are resistant to change. It will take time to fully implement the lean manufacturing method because people do not want to change what they are doing. Over time employees will adjust but this process can create its own problems and eventually the project can be abandoned because the employees are refusing to participate ("Business Knowledge").

Managers coming out of higher education and that have been in the field for a number of years are all told to look for the same measurements. Changing the way a company produces its products and using new measurements will take time for the managers to realize the results ("Business Knowledge").

The traditional way of measuring the success in a company is by using average cost. This method will give you the cost to produce each unit but striving for low average cost only works in mass production. This is not an appropriate measurement because to lower average cost one can simply increase production. A larger denominator means that costs will be lower per unit, but then there is the potential for wasted final products and unnecessary labor and material costs. The model Toyota uses for cost is to keep total cost low. Since products are only produced as needed the wasted material and labor costs of overproducing to lower average costs is not apparent (Johnson).

Another problem with using measurements is that the measurement will be the focus of production. Managers that know they are being judged on average cost or on another measurement will simply produce products to achieve lowest average cost, forgetting other costs and production strategies that will not influence that measurement. This will lead managers to do what is best for them and not what is best for the company. The overall focus should be on improving efficiencies and effectiveness which will then benefit the company and eventually the managers will get the correct measurements they were looking for (Minter).

The focus on bottom line financial numbers is a primary reason that lean ideals have not translated well from Japan to America. If a company is to look at only the bottom line, they will only change short run performance or show losses and abandon the lean shift altogether. Lean is about changing the flaws and unnecessary processes in a manufacturing system and doing this just to cut costs for the financial goals is the inappropriate way to use lean accounting. Elimination of waste should be to help improve the business processes and allow the production cycle to run smoother, thus reducing costs and increasing efficiency. This connection that American manufacturers have with cost and waste is the reason that American companies still cannot properly implement lean (Johnson).

Target costing can help a company continue to reduce costs. Once the finance department has determined the market price, a company can then determine how much a product should cost them to produce their desired amount of revenue. Once the target cost is then set, determining how to get current product costs to the target cost can take place. Accounting personnel have an inside knowledge of all the costs to produce a product. Seeing all the costs to make a product can help discover where the major costs lie (Maskell).

An aspect of lean accounting that differs from traditional accounting is the way costs are associated to departments. In traditional accounting, overhead and other costs are attributed to a department. Once a company makes the switch to lean, the costs should be attributed to the value stream of the product ("Journal of Accountancy"). Since value stream improvements are part of lean accounting, the costs throughout the entire value stream will be apparent.

Frequently when a company becomes lean it only focuses on turning only their manufacturing side of their operations lean. Without making their accounting and finance departments lean, the company is not eliminating all of their waste. Accounting and finance staff can reduce costs and waste by using less paper, reducing redundant activities and unnecessary activities, and helping control product costs. According to Brian Maskell and Bruce Baggaley, "This is achieved in the same way waste reduction is achieved anywhere else, through continuously eliminating waste from the transaction processes, reports, and accounting methods throughout the organization" (Maskell, and Baggaley 35-43). Without the accounting departments trying to reduce wastes, the entire company from the bottom up might not feel as if they are all part of the lean. Accounting may resist change and feel as if they are being left behind, or they will not fully understand how and why the production cycle is becoming lean (Maskell).

The differences with lean and traditional accounting add to the difficulties in the switch. While a company is implementing lean, their initial efforts will produce negative results in traditional accounting systems. This is due selling off inventory and producing fewer products to decrease their inventories and changing how they produce products. Another issue with the switch is that inventory and work in process is no longer an asset. Historically, indirect labor and overhead are applied as an asset in work in progress. In lean accounting these are seen and expenses and until the company finishes the switch to lean they will appear as losses on traditional financial statements ("Journal of Accountancy").

Additionally other benefits of lean will not directly appear on the financial statements. While in the process of implementing lean companies will increase efficiencies and greatly reduce waste. These efficiencies, such as decreased lead times and on time deliveries, are not line items on a financial statement. This means that if the company is only looking at bottom lines and measurements, then the company can be quick to abandon their switch to lean because of poor financials. If they would have just waited they could have potentially gained benefits with their suppliers and customers, as discussed earlier ("Journal of Accountancy").

Another thing that will not directly appear on financials is waste. Decreasing the amount of scrap and reworked products will save the company money. But scraped parts and reworked items do not appear on the financial statements and the company will have to wait to see the results. If a company abandons the lean switch too soon they may not realize the money and time that could have been saved ("Journal of Accountancy").

While lean manufacturing and accounting can bring numerous benefits to company, the overall implementation process can be risky and employees disconnect with the goal can cause problems. Of course Toyota had its problems with implementing their system but it seems they were able to get their employees over the initial hump and their process has now become the standard. A problem with implementing lean is the fact that employees are scared. From top management to factory workers, everyone is fearful of losing their jobs. So when a company hotshot comes and tells everyone that they have to switch the way they do their job that they have been doing for 15 years they will be nervous and resistant. They feel that their way of doing the process will be the best and that they do not need to switch, but they will mostly be fearful of losing their employment.

While in the process of eliminating waste, positions that are unnecessary will began to be removed from the company. Employees will quickly learn whether their position is one that will not be needed. It reminds me of an episode of the television show "The Office." The regional manager is told to cut down on employees and asks his accounting department to find positions that are not needed in their branch. The accounting department beings to crunch numbers and the quickly stumble upon a department that has too many people. It was the accounting department. They discover that the job that three of them are doing really only needs to be done by two people. Did they report it? No. Are all three of them still working there two to three seasons later? Yes. This is a perfect example of employees avoiding the lean way to save their own jobs and is what can happen. The lean switch can be challenging with employees not on board because of their fears.

Not only can employees make the switch difficult, changing your entire production and accounting systems is radical change. With a radical change comes a lot of risks. If the machines do not perform the way they were expected to under lean, there will be large costs to either fix the machines or replace them. The employees that know they might get laid off could sabotage the books or their output to make themselves look better and so they can hold on to their employment. Also if the entire project fails, the company will have to revert back to its old ways, not only costing lots of money, but potentially customers and employees along the way.

If we return to the layoffs that are associated with lean we find another potential problem. People are the greatest asset within a company. Without these people then the company cannot operate unless it is 100% automated, which there are few to none of. When the lean layoffs occur then the company can lose some of its greatest assets. These employees are knowledgeable within a company and laying some of them off can result in producing and reporting problems. For instance if one employee had dealt with a certain problem on a machine and never reported it, that employee is laid off through lean cuts, and then the problem occurs again. The company could go through hours and spend money on costly repairs that the one employee knew how to fix immediately (Caldwell). These fears should not keep companies from switching to lean but it is a potential problem for the company.

Lean is a process that will vastly improve a company's efficiency and eventually lower their costs. This change though is usually met head on by the human resistance discussed above. The aspects of production and accounting that need to be changed are too far from the normal way of thinking for most American manufacturers, that completely converting to lean is something that I believe should not be done. This being said there is still a place for lean in the American business environment.

The benefits of the efficiencies and lower costs are something that every company can use. Using lean principals and ideals can help a company achieve these goals without going through radical change and potential employee problems. Improving value stream relations with both suppliers and customers will yield results in terms of lower costs to obtain raw materials and increased sales and retained customers. All companies that are not already 100% lean have wastes that they can eliminate without changing the way their plants currently operate. Simply moving a machine or having one employee run two machines. The employee can set up and run the second machine while the first machine is busy with its current batch. Changing the way the company accounts for inventories however is something that should be done only if the company is going to switch to lean. The nature of the business is to produce products, and changing the way they value customer demand and their inventories seems too big a step to be done half heartedly.