WHATISLEANACCOUNTING?

BrianHMaskell
President,BMAInc.

Lean Accounting is the general term used for the changes required to a companys
accounting,control,measurement,andmanagementprocessestosupportleanmanufacturingand
leanthinking.Mostcompaniesembarkingonleanmanufacturingsoonfindthattheiraccounting
processesandmanagementmethodsareatoddswiththeleanchangestheyaremaking.Thereason
for this is that traditional accounting and management methods were designed to support
traditional manufacturing; they are based upon mass production thinking. Lean manufacturing
breakstherulesofmassproduction,andsothetraditionalaccountingandmanagementmethods
are(atbest)unsuitableandusuallyactivelyhostiletotheleanchangesthecompanyismaking.
Classicexamplesofthesekindsofproblemsare:

Leanimprovementsshowingcostincreasesasaresultofthewaystandardcostingapplies
laborandoverheadcosts.Thereismanyanexcellentleanstrategythathasbeencancelled
orheldbackbecausethestandardcostingsystemshowsanegativeimpact.

Traditionalperformancemeasurementsmotivatingthepeopletotakeantileanactionslike
buildinginventory,runninglargebatches,cherrypickingproductionjobstomaximize
earnedhours,combiningjobsintomoreefficientruns,buyinglarge(socalled)economic
orderquantitiesofrawmaterials&components,andsoforth.Theseproblemsarecaused
by measurements like labor efficiency, machine utilization, purchase price variance, and
perhapsworstofalloverheadabsorptionvariance(andothervariances).

Theleanteamworkinghardtoeliminatewastefromthevaluestreamonlytofindthat
profitabilitygoesdownowingtotheadjustmentsmadebysignificantinventoryreduction.
Lookingattheothersideofthissameproblem,thefinancepeoplearetoldaboutallthe
savingsbeingmadeinoperationsbuttheysee(atbest)nofinancialimprovement;andoften
anegativeimpact.

Underlyingtheseratherobviousissuesisabroaderproblem.Leanthinkingturnsinitshead
mostofourgivenwisdominmanufacturing.Why?Becausethefundamentalassumptionsof
traditional mass production are contrary to the assumptions of lean manufacturing. Lean
manufacturingisnotasetofinterestingandusefulshopfloortools.Itisaverydifferentwayto
managethebusiness.Yetinmanycompaniesembarkingonleanmanufacturing,theseradical
changesdonotmoveoutsideoftheproductionfloor.Sure,somecompaniesareapplyingleanflow
intheoffices,andothersareusingleanstylemethodsinproductdesign;butthereisamuchbigger
cultural impact to changing the way you think about the accounting, measurement, control,
decisionmaking,andmanagementoftheenterprise.
Figure1showsanoverviewoftheprimarytopicsofLeanAccounting.

BMA Inc

More info: http://www.maskell.com/leanAcctg.htm

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Visual
Management

Value Stream
Management

Cell
Performance
Measurement

Value Stream
Measurements

Elimination of
Transactions

Financial
Benefits of
Lean Change

Plain English
Financial
Statements

Value Stream
Costing

Continuous
Improvement

Box Score

Lean
DecisionMaking

Value Stream
Cost &
Capacity

Features &
Characteristic
Costing

Sales,
Operations &
Financial Plan

Target
Costing

Life-Cycle
Costing

Capital Project
Justification

Figure 1 Tools of Lean Accounting

WhatWillLeanAccountingDoForUs?
ThereareseveraltoolsincludedinLeanAccountingandtheyeachworktogethertocreate
aframeworkforthecontrol&managementofaleanenterprise.ThebenefitsofLeanAccounting
include:
1.

Leanaccountingincreasessalesbecauseitprovidesbetterinformationfordecisionmaking.
If you use standard cost information for decisions relating to such things as pricing,
quoting, profitability, make/buy, product rationalization, capital investment, and new
productintroduction,youwillveryoftenmakethewrongdecisions.Standardcostsarejust
plainwrongwhenitcomestothesekindsofdecisions.Leancompaniesneedbettertools
likeValueStreamCostingandLeanDecisionMaking.

BMA Inc

More info: http://www.maskell.com/leanAcctg.htm

Email: bmaskell@maskell.com

Page 2

Wehaveworkedwithmanycompaniesoverthelastfewyearsthathavebeeninthehabit
ofturningdownprofitablebusinessbecausestandardcostsshowittobelowmargin.
These companies also tend to outsource products or processes that would be highly
beneficialifdoneinhouse,becausethestandardcostishigherthantheoutsourceprice.
Figure2showsandexampleofamake/buydecisionusingvaluestreamcostinginsteadof
standardcosts.

CURRENT STATE OF
THE VALUE STREAM
Units

VALUE STREAM WITH VALUE STREAM WITH

OUT-SOURCED
NEW PRODUCTS
PRODUCTS
MADE IN-HOUSE

8600

9800

9800

Revenue

$877,200

$1,147,200

$1,147,200

Materials Cost

$464,400

$607,200

$553,200

Employees
Machines
Facilities
Other Costs
TOTAL CONVERSION

$277,500
$39,800
$50,400
$19,780
$387,480

$285,000
$39,800
$61,600
$31,360
$417,760

$292,500
$41,790
$56,000
$22,540
$412,830

VALUE STREAM PROFIT

$25,320

$122,240

$181,170

2.89%

10.66%

15.79%

RETURN ON SALES

Figure 2. Example of Lean Approach to Decision-Making for Make/Buy.

2.

Lean accounting clearly identifies the financial impact of lean improvements. Most
companiesusetraditionalcostsavingmodelstoassessthebenefitofleanimprovement,
andmanycompanieslookforshorttermcostreductionsasaresultofleanchanges.These
companiesarefrequentlydisappointed.Butthefinancialpeoplehavenoothermethodsto
assessthefinancialimpactofleanimprovement.
Leanaccountingrecognizesthattheprimaryimpactofwasteeliminationisthecreationof
availablecapacity.Thefinancialimpactofleanimprovementisalmostentirelydependent
uponwhatyoudowiththatnewlyavailablecapacity.Youcanlaypeopleoff,increasesales
&growthebusiness,orusethecapacityinotherways.Butyoumusthaveastrategyfor
makingmoneyfromtheleanchanges.Inourexperience,manycompaniesembarkonlean
manufacturingwithouthavingaclearstrategyforusingtheirnewlyacquiredleanskillsto
benefitthecompanyfinancially.Leanaccountingmethodsmaketheseissuesveryclear.
Figure3showsaliveexampleofassessingthefinancialimpactofleanimprovement.

BMA Inc

More info: http://www.maskell.com/leanAcctg.htm

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Page 3

OPERATIONAL

Future State
Lean Step
One

Future State
Lean Step
Two

Future State
Longer Term

Dec-02

Jan-Jun 2003

Jul-Dec 2003

Jan-Jun 2004

$224,833

$224,833

$224,833

$277,031

6.5

10

15

20

Average Cost per Unit

$31.32

$31.32

29.88

24.25

First Time Through

81.00%

95.00%

90.00%

95.00%

Lead Time in Days

25.00

5.00

5.00

2.50

Productive

55%

52%

52%

79%

Non-Productive

42%

40%

12%

12%

Available Capacity

3%

8%

36%

9%

Revenue

$4,062,000

$4,062,000

$4,062,000

$5,686,000

Sales per Person

Inventory Turns

FINANCIAL

CAPACITY

Current State Before Lean

Material Costs

$1,164,184

$1,164,184

$1,109,327.16

$1,552,839.55

Conversion Costs

$1,483,416

$1,483,416

$1,483,416

$1,657,500

Value Stream Profit

$1,414,400

$1,414,400

$1,469,257

$2,475,660

34.82%

34.82%

36.17%

43.54%

40.00%

Value Stream ROS

Hurdle Rate

-5.18%

-5.18%

-3.83%

3.54%

Figure 3. Example Showing the Financial Impact of Lean Changes and a

Longer Term Strategy.

3.

LeanAccountingsavesmoneyandreducescosts.Haveyoueverworkedoutthecostof
youraccountingsystems?Mostcompanieshavenoideawhattheycostbecausetheyare
deeplyembeddedintothecompanysprocesses.AsanorganizationmatureswithLean
Accounting they are able to systematically(yet prudently) eliminate 1000s & 1000s of
transactionsandthereports,reconciliations,&meetingsthatgowiththem.Theseareall
waste;andasyoubringyourprocessesundercontroloperationallyyouwillbeableto
eliminate most of the traditional accounting & control systems and their required
transactions.

Workordersontheshopfloortogetherwithallthetrackingandreporting(orbackflushing)
oflaborhours,jobsteptracking,scrapreporting,andotherwastefultransactionscanover
time be eliminated. The majority of the procurement and purchasing processes can be
eliminatedasthepullingofmaterials,components,MROitems,andsuppliesarebrought
under control using lean manufacturing and supply chain methods. This includes the
traditionalAP3waymatchasyoubegintoexpensematerialsonreceiptorbackflushthem
onshipment.Muchoftheperpetualinventorysystemscanbeeliminatedasyoubringyour
inventory down and bring it under tight operational control through the use of visual
managementandpullsystems.
TheuseofValueStreamCostingandPlainEnglishFinancialStatementsradicallysimplifies
thefinancialaccountingreports,leadingtomuchlessworkonthepartofthefinancialteam
andthepeoplewhohavetousethem.

BMA Inc

More info: http://www.maskell.com/leanAcctg.htm

Email: bmaskell@maskell.com

Page 4

Period 1
Sales
Cost of Sales
Gross Margin
Total Adjustments
Net Operating Margin
SG&A Expenses
Other Expenses
Earnings Before Tax

$2,956,435
$1,942,360
$1,014,075
$298,312
$715,763
$122,436
$0
$593,327

Period 2
65.7%
34.3%
10.1%
24.2%
4.1%
0.0%
20.1%

$3,500,000
$2,359,000
$1,141,000
$575,649
$565,351
$104,333
$822
$460,196

67.4%
32.6%
16.4%
16.2%
3.0%
0.0%
13.1%

Traditional Standard Cost-Based Income Statement

Period 1
Sales

$2,956,435

Procurement Costs
Conversion Costs
Distribution Costs
Support Costs
Total Costs
Margin
External Overheads
Change in Inventory
Earnings Before Tax

$271,992
$1,921,683
$206,950
$37,842
$2,438,468
$517,967
$167,068
$242,428
$593,327

Period 2
$3,500,000
9.2%
65.0%
7.0%
1.3%
82.5%
17.5%
5.7%
8.2%
20.1%

$346,500
$2,317,000
$241,500
$35,700
$2,940,700
$559,300
$197,785
$98,681
$460,196

9.9%
66.2%
6.9%
1.0%
84.0%
16.0%
5.7%
2.8%
13.1%

Plain English Income Statement

Figure 4. Contrasting Traditional Income Statement

with a Plain English Statement.

ValueStreamCostingeliminatestheneedfortraditionalcosttrackingandthethousands
ofwastefultransactionsthatgowithit.ValueStreamCostingprovideseasytounderstand,
timely,valid,andactionablecostandprofitabilityinformationwithafractionofwork.
Figures5showsaValueStreamIncomeStatement.Figure6showsaconsolidatedIncome
Statementacrossmultiplevaluestreams.

OEM Products

Current
Profit & Loss Report
Mar-04
$197,341
$3,144

Per Unit
$362.760

% of Sales
544

$71,503

$131.439

36.23%

$15,625
$33,795
$5,233
$10,881
$9,564
$2,485

$28.722
$62.124
$9.620
$20.002
$17.581
$4.568

7.92%
17.13%
2.65%
5.51%
4.85%
1.26%

Value Stream Profit

ROS

$51,399

$88.705

24.45%

Facilities Costs

$6,375

$0.43

$171,797
$1,420,858
($400,417)

8.9
36.0
28.0

Sales
Additional Revenue
Material Costs
Conversion Costs
Productive
Non-Productive
Available Capacity

Outside Process Costs

Other Costs
Tooling Costs

25.64%

Units

24.45%
15,000

Sq.feet

Cash Flow
Inventory
Accounts Receivable
Accounts Payable

days
days
days

Figure 5. Example of Value Stream Costing P&L

BMA Inc

More info: http://www.maskell.com/leanAcctg.htm

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Page 5

Industrial
OEM Products Products
R&D
200,485 $ 306,269 $
Revenue $
544
1,450
Units Shipped

Material
Conversion
Outside
Total

$
$
$
$

71,503
66,702
10,881
149,086

$
$
$
$

111,431
84,829
32,433
228,693

$
$
$
$

Profit $

51,399

77,576

ROS
Cost/Sales $
Cost/Unit $

25.64%

274.06

25.33%

157.72

Sustaining
$
-

Total
506,754

$
$
$
$

$
$
$
$

194,936
188,071
43,314
426,321

(33,317) $

(15,225) $

80,434

0.00%
6.57%

0.00%
3.00%

15.87%

12,002
21,315
33,317

15,225
15,225

ADJUSTMENTS
Corporate Allocations
Field Sales Allocation

Inventory Change
Last Month $
This Month $

$
$

5,560
9,750

(889)

120,432
121,321

NET PROFIT

ROS

60,453
11.93%

Figure 6. Example of a Consolidated Value Stream P&L for the

Company.

Sales,Operations,&FinancialPlanning(SOFP)providesanorderlyplanningthatisintegrated
acrossvaluestreams.Theresultisexcellentplanningwithmuchlessworkthantraditional
companiesusuallyexpend;andwithmuchbetterresults.SOFPprovidesmonthlyrolling
budgets that are uptodate and actionable, and eliminate most of the wasteful annual
budgetingprocessesmostcompaniesgothrough.

4.

LeanAccountingmotivateslongtermleanimprovementthroughleanfocusedinformation
and measurements. Lean Performance Measurements are the cornerstone of visual
managementandcontrolforleanproductioncells,thevaluestreams,andtheoverallplant
orcompany.Similarperformancemeasurementsareusedatthenonproductioncellsand
processes.Theseperformancemeasurementsaredesignedtomotivatethoroughlylean
behaviorandtodrivecontinuousimprovementateveryleveloftheorganization.
Figure7showsthesetofperformancemeasurementsusedbyonecompanyforcelllevel,
valuestreamlevel,andplantlevelmeasurements.Thesemeasurementsallderiveoriginally
forthecompanysbusinessstrategy.

BMA Inc

More info: http://www.maskell.com/leanAcctg.htm

Email: bmaskell@maskell.com

Page 6

STRATEGIC
ISSUES

STRATEGIC
MEASURES

VALUE STREAM
MEASURES

CELL/PROCESS
MEASURES

Increase Cash
Flow
Increase sales &
market share
Continuous
improvement
culture

Sales Growth

Sales per Person

EBITDA

On-Time Delivery

Day-by-the-Hour
Production

Inventory Days

Dock-to-Dock Time

On-Time
Delivery

First Time Through

Customer
Satisfaction
Sales per
Employee

Average Cost per

Unit

WIP-to-SWIP
First Time Through
Operational
Equipment
Effectiveness

AR Days
Outstanding

Figure 7. Example of Performance Measurements Reflecting Lean Motivation and

Focus on the Companys Strategy

TheBoxScoreisusedwidelyinLeanAccountingandshowsathreedimensionalviewof
avaluestream;operational,financial,andcapacityusage.TheBoxScoreisusedtoprovide
an A3 summarized report of a value stream. It can be used for weekly value stream
reporting,forstrategicdecisionmaking,forfinancialimpactcalculations,andothertimes
whenthereisaneedtoshowvaluestreaminformationsuccinctly.Figures8&9showthe
useofBoxScoresfordifferentkindsofvaluestreamreporting.
TargetCostexemplifiesthefirstandfifthprinciplesofleanthinking;focusoncustomer
value, and the pursuit of perfection. Using the methods of QFD (Quality Function
Deployment)andValueEngineering,wethoroughlyunderstandthevaluecreatedbya
productforthecustomer.Fromthiswecancalculatethetargetcostfortheproduct(or
product family). This target cost is driven down through the value stream to initiate
improvementandcostreductionprojectstobringthevaluestreamcostsinlinewiththe
targetcosts,providinghighlevelsofcustomervalueandtherightlevelofprofitabilityfor
thecompany.Theoutcomeisaseriesofimprovementinitiativestouchingoursales&
marketing, product design, procurement, operations, and administrative processes,
resultinginsignificantlybettercostandprofitability.

BMA Inc

More info: http://www.maskell.com/leanAcctg.htm

Email: bmaskell@maskell.com

Page 7

Operational

13-Jun

Capacity

27-Jun

4-Jul

11-Jul

18-Jul

25-Jul

1-Aug

8-Aug

15-Aug

FUTURE
STATE

Units per Person

15.18

15.63

14.70

15.91

15.90

16.59

20.70

On-Time-Shipment

100%

100%

100%

100%

100%

100%

100%

Dock-to-Dock Days

6.00

First Time Thru

80%

80%

80%

85%

85%

85%

85%

Average Product Cost

$343

$337

$362

$338

$337

$325

$262

42

42

42

42

37

37

37

ARDays

Financial

20-Jun

Productive

29%

29%

29%

28%

28%

28%

40%

Non-Productive

54%

54%

54%

52%

52%

52%

33%

Available Capacity

17%

17%

17%

20%

20%

20%

27%

Revenue $470,900 $484,750 $455,942 $490,050 $487,910 $525,635

$576,375

Material Cost $172,085 $175,385 $178,685 $181,935 $184,685 $187,010

$189,160

Conversion Cost $119,584 $119,584 $119,584 $119,584 $142,584 $152,584

$158,084

Value StreamGross Profit $179,231 $189,781 $157,673 $188,531 $160,641 $186,041

$229,131

ROS 38.06%

39.15%

34.58%

38.47%

32.92%

35.39%

39.75%

Operational

Figure 8. Example of a Box Score used for Weekly Value Stream Reporting

Current Value
Stream
Jan-03

Remove "Low
Margin" Products
Jun-03

Introduce New
Products
Sep-03

Units per Person

466

395

505
99

On-Time-Shipment

92

99

Dock-to-Dock Days

15

First Time Thru

65

75

75

$112.75

$120.94

$109.23

42

35

35

Average Product Cost

Financial

Capacity

AR Days
Productive

24%

18%

28%

Non-Productive

63%

35%

42%

Available Capacity

13%

47%

30%

Revenue Monthly

$10,667

$9,866

$12,800
$4,073

Material Cost

$3,758

$3,185

Conversion Cost

$2,547

$2,547

$2,547

Value Stream Gross Profit

$4,362

$4,134

$6,180

Figure 9. Example of a Box Score to Show Strategic Decisions

There is rarely a need to know the cost of an individual product when using Lean
Accountingbecausetheimportantreportinganddecisionmakingisdoneatavaluestream
levelratherthanaproductlevel.Butwhenproductcostsareneeded,theycanusuallybe
calculatedsimplybyusingFeatures&CharacteristicsCosting.Features&Characteristics
Costingcreatesacostforindividualproductsfromanunderstandingofwhattrulyaffects
thecostofoneproductasitflowsthroughthevaluestream.Therateofflowofproductis

BMA Inc

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Page 8

aprimedriverofconversioncost.Weidentifythefeaturesandcharacteristicsofaproduct
thataffectthisrateofflow.
Features&CharacteristicsCostingisafaster,easier,andmoreaccuratewayofcalculating
a product cost. It is also quite intuitive for people across the company, from sales &
marketing,throughengineering,andproduction.Figure10showsanexampleofafeatures
&characteristicscosttable.

Number of Ends
O-Rings

2
Yes

2
No

3
Yes

3
No

4
Yes

4
No

Material Cost
MachiningCost
PlatingCosts
O-RingCosts

$17.65
$13.72
$0.79
$1.56

$17.65
$13.72
$0.79
$0.00

$22.06
$20.58
$1.19
$2.34

$22.06
$20.58
$1.19
$0.00

$26.48
$27.44
$1.58
$3.12

$26.48
$27.44
$1.58
$0.00

$33.72

$32.16

$46.17

$43.83

$58.62

$55.50

$6.861 perEnd
$0.780 perEnd

TOTALCOST

Figure 10. Example of a Features & Characteristic Cost Table

WhatisLeanAccounting?
Accounting, control, measurement, and management methods that truly reflect lean
thinkingandleanpractice.LeanAccountingleadstobetterdecisionmakingbyprovidingaccurate,
understandable,andactionablecost&profitabilityinformation.LeanAccountingsavestimeand
moneybyeliminatingmuchofthewasteassociatedwithtraditionalaccounting&controlsystems.
LeanAccountingmotivatesleanimprovementoverthelongertermbyprovidingmeasurement
andreportinginformationthatisthoroughlyleanfocused.LeanAccountingenablescompanies
to make more money by identifying the potential financial benefits of lean improvement and
developingstrategiestorealizethatprofit.LeanAccountingmethodssuchasTargetCostingand
SOFPprovideshorttermandlongtermfocusoncustomervaluethroughthevaluestream,and
the teambased continuous improvement required to grow the business, eliminate cost, and
improveprofitability.

HowDoYouImplementLeanAccounting?
LeanAccountingdoesnotstandalone.Itsupportsleanmanufacturing,leanproductdesign,
leanlogistics,andsoforth.LeanAccountingistheservantoftheoperation.Thereisaprudentand
orderlymaturitypathtotheimplementationofLeanAccounting.Asyourcompanymatureswith
leanmanufacturing(andotherleanprocesses)moreandmoreofthebenefitsofLeanAccounting
canbeimplementedandrealized.

BMA Inc

More info: http://www.maskell.com/leanAcctg.htm

Email: bmaskell@maskell.com

Page 9