Objectives of this Workshop

© BMA Inc. 2009. All rights reserved.

• Understand why traditional accounting, control & measurement methods need to change as the company continues the lean transformation

• Overview the primary methods of Lean Accounting that will be important to the company

• Develop a ‘Go Forward’ plan for your organization

Objectives of this Workshop


A Brief History of Lean Management

1934 on…1945 on…

1926 19791979

Toyota starts producing vehicles, developing Kaizen teams in 1936

Toyota develop ‘Pull Production’ (producing only for actual sales) in response to resource shortages. This was inspired by a visit to a US supermarket chain

Taiichi Ohno develops ‘The Toyota Production System’ (TPS) based on Ford’s principles of 1926

1911-1915

Henry Ford influenced by Frederick Winslow Taylor’s ‘Principles of Scientific Management’

Ford introduces mass production

TodayToday……


The Toyota Production System

• The idea of pull production (producing only for actual sales) was inspired by a visit to a US supermarket chain - ‘Piggly Wiggly’- shortly after WWII

• Levels of demand in the Post-War economy of Japan were low and the focus of mass production on lowest cost per item via economies of scale had little relevance

• TPS is a whole management system - it is not just about production


The Philosophy of LeanMaximize competitive

advantage through operational excellence

Why would you perform any

activity that the customer is not

willing to pay for?

A time-based strategy – flexibility & speed of response to the customer & speed through the production/ service delivery process

Improve the flow and you

improve profitability


The Five Principles of Lean Production

Specify value in the eyes of the

customer

Identify the value stream & eliminate

waste

Make value flow at the pull of the

customer Involve & empower employeesContinuously improve in the pursuit of perfection


Traditional thinking and lean thinking are in conflict

ASSUMPTIONS

• Profit comes from full utilization of resources

• Direct labor is the most important conversion cost

• Control the business thru detailed tracking

• All excess capacity is bad

Traditional Standard Costing

ASSUMPTIONS

• Profit from maximizing flow on pull from customers.

• Waste is resources impeding the flow

• Control thru continuous attention to flow & waste

• Excess capacity provides flexibility

Lean Thinking


Why Lean Accounting?

• Traditional Standard Costing was developed for mass production

– The philosophy is that profitability is maximized when labor and machine utilization are maximized

• The focus of Standard costing is on lowest cost per item through economies of scale

• This does not apply in a high variability, multi-product environment

– Here profitability is maximized when the rate of flow is maximized


What’s the problem?

Traditional management systems:– Actively work against Lean Manufacturing &

other lean improvements.– Are expensive and wasteful.– Provide misleading, wrong, and harmful

information.– Motivate people to do the wrong things.– Are complex and confusing to people.

Here’s a Few Simple Examples


Actively work against lean manufacturing

Drill on CNC

Machine

Machine on Lathe

Batch 2500

Grind

Inspect & Pack

1 minute

4 minutes6 minutes

4 minutes

Total labor time: 15 minutesLabor cost: £5.00Overhead cost: £15.00Material Cost £1.50TOTAL COST: £21.50

Lead Time: 6 weeksInventory 25 daysBatch size 2500 (10 days)On-Time delivery = 82%


Lean manufacturing changes

• Create a cell.• Use an drilling machine with quick change

over.• Reduce the batch size.• Reduce the lead time.• Reduce inventory.• Almost perfect delivery.• Created additional capacity on the CNC

machine.


Lean improvements

Drill on Drilling Machine

Machine on Lathe

GrindInspect &

Pack

4 minutes

4 minutes6 minutes

4 minutes

Total labor time: 18 minutesLabor cost: £6.00Overhead cost: £18.00Material Cost £1.50TOTAL COST: £25.50

Lead Time: 2 daysInventory 5 daysBatch size 250 (1 day)On-Time delivery = 98%

Lean Cell


The problemWe have made great improvement.

BUT…. the product cost has gone up and the project is cancelled.

In fact, the changes were highly beneficial both operationally and financially.

It is the standard costing that is leading us in the wrong direction.


Traditional income statement

What does Gross Profit

mean?

Why have the earnings fallen

so much in period 2?

How would you explain this someone in production?

Period 1 Period 2REVENUE

OEM £998,977 £1,039,440Systems £1,002,466 £1,009,246

£2,001,443 £2,048,686

Cost of Goods Sold £1,621,169 81% £1,687,800 82%

GROSS PROFIT £380,274 19% £360,886 18%

ADJUSTMENTSPurchase Price Variance (£60,466) (£59,467)

Materials Usage Variance £94,533 £96,733Labor Variance (£19,718) (£93,895)

Overhead Absorption Variance £38,341 £182,577

SG&A £129,889 6% £135,215 7%

NET PROFIT £197,695 10% £99,723 5%


“Plain English” Income statement

What does Gross Profit

mean?

Why have the earnings fallen

so much in period 2?

How would you explain this someone in production?

Period 1 Period 2REVENUE

OEM £998,977 £1,039,440Systems £1,002,466 £1,009,246

£2,001,443 £2,048,686

Materials £829,936 41% £849,526 41%Direct Labor £305,767 15% £312,984 15%

Support Labor £340,245 17% £342,421 17%Machines £113,862 6% £116,550 6%

Outside process £60,043 3% £53,731 3%Facilities £40,250 2% £41,200 2%

Other Costs £12,009 0.6% £9,664 0.5%TOTAL COST £1,702,112 £1,726,076

GROSS PROFIT £299,331 15% £322,610 16%

Inventory Adjustment (£41,593) (£161,426)Corporate Allocations £60,043 £61,461

NET PROFIT £197,695 10% £99,723 5%


Misleading cost information

Actual Production Cost = £580 per hourMaterial cost = £42 per item

Product Cost = ?

Prepare for Mounting

Align &Secure

Inspect & Pack

6 minutes

6 minutes6 minutes

6 minutes

Product B

Output10 per hour

3 minutes

4 minutes4 minutes

6 minutes

Product A

MountComponent

s


Misleading cost information

Product A

Standard Cost = £90.06Material £42Labor 17 mins @ £24.23/hr = £6.87Overhead 600% = £41.19

Actual Cost = £100 Material £42 Production £580/10 = £58

Standard Cost too low

Product B

Standard Cost = £109.85Material = £42Labor 24m @ £25/hr = £9.69Overhead 600% = £58.18

Actual Cost = £100Material £42Production £580/10 = £58

Standard Cost too high


Poor decision making: Outsourcing product B

Traditional Approach

Standard Cost = £109.85

Outsourced Cost = £85.00

“Savings” of £24.85 per unit

Actual Impact

New Material Cost = £ 85Old Material Cost = £ 42

Increase in Actual Material Cost = £ 43

Actual production cost per hour = £ 580 because no resources were eliminated

Actual costs increase due to outsourcing


There is no “Standard” Cost!

In a lean environment, the cost of the product is related to

flow…

•Waste affects cost so that there is no one ‘standard’ cost of a product

•Cost varies with production, FPY, scrap, mix, quality, downtime etc

• If you control the flow, you control the cost

• By improving flow through the Value Streamwe improve capacity = flexibility


Performance MeasurementsTraditional accounting performance

measurements motivate non-lean actions.Measuring labor efficiency, machine

utilization, and overhead absorption leads to large batches and high inventory.


Sales policies mismatch with lean capability

Level

Schedule

Value StreamSuppliers

Pull System

Single Piece Flow

Week1

Week2

Week3

Week4

Sales Orders &Shipments

Result:High inventoryLate deliveriesHigher costsConfusion

Conflict


Transaction-based control systems cost too much

Entering and administering transactions is wasteful and time-consuming.

EXAMPLE:A production plant with 150 people, 120 products, and revenue of £15M required over 4,000,000 transactions per year.

Job costing, procurement, inventory control, accounts payable, accounts receivable:

38 equivalent heads spent processing and using the transactions.

12.7% of revenue


Two Aspects of Lean Accounting

Applying Lean Thinking & Methods to the Company’s

Accounting Processes

Accounting for Lean & Supporting the Lean

Transformation

•Cost accounting, labor reporting, production reporting & work orders

•Purchasing & accounts payable

•Inventory tracking & valuation

•General ledger simplification

•Month-end close, etc

•Reporting & decision-making to support lean manufacturing & other lean processes

•Financial reporting that is immediately understandable & useable to everyone

•Single lean accounting system for management accounting & external reporting

•Accounting processes focused on customer value, value streams, pull, empowerment, & continuous improvement


Lean is a set of collaborative and inquisitive behaviours

that result in a culture of continuous improvement.

Eliminating waste is done by people using rigorous

problem-solving methods

Involving people in lean is at least as important as

lean tools.

Behaviours that focus on

improvement & problem-solving

The aim of lean is a production system that highlights problems and a human system that

produces people who are willing and able to identify and solve them

Lean is a People Process

All of this All of this requires Trustrequires Trust


Lean Accounting has Seven Aims

Performance measures that

motivate lean–cell & value stream

measures

Value Stream Costing, replacing Standard Costing =

Value Stream Profit & Loss Account

Support relevant, accurate & timely decision making

using contribution costing

Elimination of

unnecessary accounting

transactions

Highlighting impact of lean improvements

– eliminate waste, improve capacity,

improve flow

Drive the growth of the business by

increasing customer value using Target

Costing

Motivate lean behaviour in the

planning process – SOFP


Box Score - Financial Impact

Caspian CompanyPAMotors GOAL

Current 5-Feb 12-Feb 19-Feb 26-Feb 5-Mar 12-Mar 19-Mar 26-Mar 31-Mar

Units per Person 31.77 30.46 32.51 32.19 33.71 35.2

On-Time Shipment 96.2% 98.2% 98.5% 97.6% 97.2% 98.0%

First Time Thru 42% 44% 43% 47% 54% 62%

Dock-to-Dock Days 12.50 11.9 10.94 9.33 8.90 8.0

Average Cost £115.78 £115.78 £114.62 £112.66 £111.74 £107.01

AP days - AR days 8.0 8.0 8.0 8.0 8.0 8.0

Productive 22% 22% 22% 21% 21% 22%

Non-Productive 58% 58% 58% 41% 41% 37%

Available Capacity 20% 20% 20% 38% 38% 41%

Revenue £366,487 £321,499 £331,546 £325,481 £326,240 £325,000

Material Costs £112,196 £109,812 £113,243 £111,172 £111,431 £111,007

Conversion Costs £92,564 £95,743 £95,233 £99,463 £98,194 £94,039

Inventory £310,622 £295,712 £271,857 £231,848 £221,163 £198,798

Value Stream Profit £161,727 £115,944 £123,070 £114,846 £116,615 £119,953

Value Stream ROS 44.13% 36.06% 37.12% 35.29% 35.75% 36.91%

46.00% Hurdle Rate -1.87% -9.94% -8.88% -10.71% -10.25%

OP

ER

AT

ION

AL

CA

PA

CIT

YF

INA

NC

IAL


Example: Italian ClientWeek 36 Week 37 Week 38 Week 39 Week 40 Week 41

Downtime % 1.10% 1.67% 0.00% 0.00% 0.00% 0.00%Rework (number) 191 286 205 297 414 218Rework (secs) 16,703 43,615 17,048 30,114 48,197 17,030On-Time Delivery % 96.8% 78.9% 83.0% 86.5% 90.1% 93.0%Supplier Materials Days 15 15 15 15 15 15Finished Goods Inventory Days 5 5 5 7 7 10Total Units produced 4,709 2,851 4,178 3,789 3,276 2,325Hours Worked 129.30 131.60 106.60 126.60 110.25 58.30Units per Hour 36.42 21.66 39.19 29.93 29.71 39.88

Productive Capacity 41.55 39.83 17.86 32.29 39.41 33.95Non-Productive Capacity 2.65 5.71 1.58 4.46 2.79 1.58Available Capacity 55.80 54.46 80.56 63.25 57.80 64.47

Revenue € 41,919 35,121 27,541 51,605 32,717 23,421 Material Cost € 27,937 38,961 29,171 33,338 33,798 9,867 Direct Operative Labour Cost € 2,586 2,632 2,132 2,532 2,205 1,166 Direct Support Labour Cost € 4,900 4,900 4,900 4,900 4,900 4,900 Energy Cost € 1,060 1,067 983 1,051 995 819 Facilities Cost € 240 240 240 240 240 240 Depreciation € 1,750 1,750 1,750 1,750 1,750 1,750 Other Direct Costs € 0 0 0 0 0 0 Total Cost € 38,473 49,550 39,176 43,811 43,888 18,742 Value Stream Profit € 3,446 -14,429 -11,635 7,794 -11,171 4,679

Value Stream Return on Sales %8.22% -41.09% -42.25% 15.10% -34.14% 19.98%

Average Value Stream Cost per unit €

8.17 17.38 9.38 11.56 13.40 8.06


UK Client Box Score - Delivery Value Stream

Week No. 25 26 27 28 29 30 31 32 33 34 35 TARGET

Units / FTE 67 64 87 71 63 72 90 82 49 70 65

Revenue / FTE 1,656 1,411 2,595 1,091 1,374 881 1,796 1,492 1,268 2,141 1,408 2,000

Scrap Costs 101 98 122 120 82 96 88 93 94 80 86

OTR Performance 71.40% 87.40% 86.30% 64.60% 65.30% 72.40% 87.60% 87.70% 91.90% 78.95% 91.00% 90%

OTP Performance 88.73% 91.04% 93.68% 75.61% 90.80% 95.05% 92.56% 92.13% 95.40% 80.26% 91.07% 95%

OED Performance 6.3 5.5 7.2 7.2 7.9 5.4 3.8 3.2 3.2 3.5 4 3

Inventory Turns 10.71 10.71 10.71 10.94 10.94 10.94 10.94 11.11 11.11 11.11 11.11 15

Rework Costs

Sales revenue 47,520 41,262 75,227 30,221 40,244 24,711 46,862 37,479 31,643 45,994 21,050 58,000

Materials Purchased 11,785 10,233 18,656 6,588 8,773 5,387 10,216 7,084 5,981 8,693 3,978 10,730

Conversion Labour 9,274 9,274 9,274 9,245 9,245 9,245 9,245 9,610 9,610 9,610 9,610 9,500

Other Costs 5,184 5,184 5,184 5,135 5,135 5,135 5,135 4,008 4,008 4,008 4,008 4000

Costs Total 26,243 24,691 33,114 20,968 23,153 19,767 24,596 20,702 19,599 22,311 17,596 24,230

Value Stream Profit 21,277 16,571 42,113 9,253 17,091 4,944 22,266 16,777 12,044 23,683 3,454 33,770

Value Stream Profit % 45% 40% 56% 31% 42% 20% 48% 45% 38% 51% 16% 58%


Value Stream Profit and Loss Account

Required ROS 15.0%Corporate Overhead 3.3%

Support Costs 4.0%New Product Design 23.7%

Value Stream Hurdle Rate 46.0%

HURDLE RATE CALCULATIONTHE VALUE STREAMS MUST MAKE A MINIMUM OF 46%

Motors Systems Spare Parts

New Product Design

Support Costs

TOTAL DIVISION

Sales £326,240 £748,894 £453,215 £1,528,349Additional Revenue £0 £0 £12,422 £12,422

Material Costs £111,431 £232,774 £149,561 £87,909 £12,764 £594,439Conversion Costs £57,628 £70,406 £81,579 £203,769 £37,645 £451,027

Outside Process Costs £32,433 £22,991 £22,661 £7,531 £85,616Other Costs £16,040 £57,816 £29,459 £72,721 £176,036

Tooling Costs £4,843 £12,544 £6,588 £23,975

Value Stream Profit £103,865 £352,363 £175,789 (£364,399) (£57,940) £209,678ROS 31.8% 47.1% 38.8% -23.7% -3.8% 13.7%

£925,314£918,807(£6,507)

£51,147

£152,024

9.9%Division ROS

Corporate Overhead

Division Profit

VALUE STREAMS

Opening InventoryClosing InventoryInventory Change


VALUE STREAM PROFIT AND LOSS ACCOUNT

Month ending 30/09/07: Weeks 36 to 39

Euro

Refrigeration Valves

Coffee Valves Water Valves General Purpose Valves

Manifold Trading Support/ Overhead

TOTAL

Revenue 156,186 555,755 365,296 175,198 182,696 1,220,000 0 2,655,1310

Direct Material Purchases 129,407 302,892 179,687 98,645 65,387 980,000 1,756,018Direct Operative Labour 9,882 14,967 9,095 10,188 4,976 30,000 79,108

Direct Support Labour 19,600 0 0 0 5,600 190,000 215,200Energy Usage 4,160 2,332 1,202 932 455 1,047 10,128

Facilities cost (m2) 960 960 960 960 1,567 40,000 7,000 52,407

Depreciation 7,000 3,500 3,500 3,500 10,500 10,000 38,000Other Direct Costs 0 0 0 0 0 0

TOTAL VALUE STREAM COST171,009 324,651 194,444 114,225 88,485 1,050,000 208,047 2,150,861

VALUE STREAM PROFIT -14,823 231,104 170,852 60,973 94,211 170,000 -208,047 504,270

Value Stream Return on Sales %-9.49 41.58 46.77 34.80 51.57 13.93 18.99

Total Units produced 15,527 59,450 19,645 26,212 1,225 122,059Average Value Stream cost per

unit11.01 5.46 9.90 4.36 72.23 17.62

Total Hours Worked 494.10 748.34 454.75 509.40 268.19 2,474.78Units Produced per Hour 31.42 79.44 43.20 51.46 4.57

Total Support Cost per Hour Worked this Month

84.07 84.07 84.07 84.07 84.07

Total Support Cost per Unit Produced for this Month

2.68 1.06 1.95 1.63 18.40

"Total Full Cost" per Unit for this Month

13.69 6.52 11.84 5.99 90.64

Italian Client Value Stream Profit and Loss

Account


Summary - Lean Accounting

Performance Measurement

Transaction Elimination

Financial Impact of Lean

Improvement

Value Stream Costing

Lean Decision Making

Target Costing

Primary method of lean control for meeting customer needs & driving continuous improvement

Save time, money, & confusion by radical

elimination of wasteful

transactions

Understand the financial impact of lean

improvement & create a money-making strategy

Simple, direct, & accurate way to create financial

reports. Very few transactions

Manage the business by value streams with accountability for

growth, profitability & continuous improvement

Drive the business from the customer value – not the cost


What Will Lean Accounting Do For Us?• Increase sales & reduce costs through better

decision-making information

• Clearly identify the potential financial benefits of lean programs

• Reduce costs through eliminating wasteful transactions & systems

• Motivate long-term lean improvement through lean-focused information & measurement

• Eliminate the problems caused by traditional costing methods

Documents

Objectives of this Workshop