Lean Accounting's Quest For Acceptance

Lean Accounting's Quest For Acceptance

Despite growing interest, proponents say there's still a long way to go before lean accounting becomes a mainstream practice.

When Orest "Orry" Fiume was vice president of finance and administration for The Wiremold Company, a West Hartford, Conn.-based manufacturer of cable and wiring products, he recalls management meetings in which executives had difficulty stifling yawns while analyzing the company's standard cost accounting-based financial results.

"After about 30 seconds, you could see everybody else's eyes glaze over," Fiume recalls. "Because when you look at those statements, they're just unintelligible to anybody that doesn't have a degree in accounting."

Fiume, who led Wiremold's conversion to lean accounting in the early 1990s and went on to co-author "Real Numbers: Management Accounting in a Lean Organization," notes that once the company switched to a simpler financial statement that reflected the improvements being made by its lean efforts -- the "plain-English P&L," as it's called in the book -- the tone of those meetings changed dramatically.

"Once we went to the plain-English P&L, we could have a good management discussion about what was happening, because everyone could understand what they were looking at," Fiume says.

Fiume retired in 2002, but he still extols the virtues of lean accounting in various workshops presented by the Lean Enterprise Institute, where he is a member of the board of directors. In his presentations, Fiume shows how a standard cost-based P&L statement penalizes a fictitious manufacturer for reducing inventory, because the labor and overhead costs associated with the production of that inventory have been deferred to the balance sheet until the year the inventory is sold.

"When we reduce our inventory, or improve our inventory turns -- which is a good thing -- we have to take some of that labor and overhead from prior years that was capitalized on the balance sheet and we have to take it off the balance sheet," Fiume explains. "And the only place it can go is through the P&L."

Unfortunately, those deferred labor-and-overhead costs are buried on a standard cost-based P&L (usually showing up as an unfavorable overhead variance) -- which often prompts corporate brass to question the value of lean initiatives taking place in the company. The plain-English P&L, on the other hand, separates current operating information from the change-in-inventory information, presenting the latter on a separate line.

"Whereas standard cost accounting hides what is really happening [with shop-floor lean initiatives], lean accounting shines a light on it," Fiume says.

An Uphill Climb

Even with the growing popularity of lean manufacturing, Fiume laments that it's been a bit of an uphill climb to convince manufacturers to implement the plain-English P&L approach. An informal survey of his workshop attendees several years ago revealed that while more than 80% of respondents had begun applying lean concepts (such as waste removal) to their accounting operations, fewer than 20% said they had switched from standard cost accounting to simpler lean-reflective accounting statements.

Jean Cunningham, a lean consultant and co-author of the aforementioned "Real Numbers," asserts that there is plenty of interest among manufacturers in "changing their metrics to fit with their operational changes as well as interest in applying lean within their accounting operations." However, when it comes to manufacturers actually taking the plunge and switching to lean accounting-based financial statements, "there's certainly a lot more interest than action."

Gary Hourselt, executive vice president and CFO for Durham, N.C.-based TBM Consulting, is a firm believer that lean accounting "gives a much better picture of the company and its [lean] improvements" compared with traditional cost accounting methods. Ironically, though, the clarity of the financial information in the lean accounting-based P&L is a big reason why adoption of lean accounting has been slow, he notes.

Orest "Orry" Fiume

"Until the academic world starts telling the accounting profession that lean accounting is a legitimate way of looking at your financial information, people are going to be reluctant to adopt it."
-- Orest "Orry" Fiume

"Traditional accounting systems reward overproduction, and overproduction is a very common way for manufacturers to make their results look better," Hourselt says.

Hourselt points out that public companies have been particularly resistant to adopting lean accounting, in part because "the world of public [companies] thinks quarterly earning first."

"Public companies have a lot of investors rely on their accounting, and [lean accounting] is a pretty drastic change for them," Hourselt says. "It also exposes poor business practices -- we use the term 'it opens the kimono' -- and I've seen some very good people in public companies work very hard to shade the results so that the earnings per share look as good as they can and the stock price stays as high as it can."

Change is Hard

Ed Grinde, business unit controller for St. Louis-based Watlow Electric Manufacturing Co.'s Hannibal, Mo., operations, notes that Watlow is in the process of implementing lean accounting companywide. With the help of lean consultant Brian Maskell, Watlow business units have been identifying their value streams and posting simplified operational and financial data for each value stream on a weekly basis.

The implementation of the value stream management system, as Watlow calls it, has helped the company gain "a better understanding of our cost structure" and make better business decisions, Grinde explains.

"And even though right now the economy is down, here at Hannibal we're growing the business because we understand our costs better," Grinde says.

Grinde will be at the Lean Accounting Summit, scheduled for Sept. 22-23 in Orlando, Fla., to tell Watlow's story. But at the moment, Watlow appears to be a bit of an iconoclast. Grinde's sense is that "while there are not a lot of companies doing lean, there are even fewer companies doing lean accounting."

"One reason is because accountants have been trained for the last hundred years to do material-labor-overhead standard costing and doing P&Ls one way, and we've been telling businesses, These are your costs,' and now all of a sudden we're telling them something different," Grinde says. "Now we're saying, No, we were all wrong.' That's a big hurdle."

Fiume asserts that the major hurdle standing in the way of widespread adoption is the education system.

"We're still teaching standard cost accounting in schools," Fiume says. "Some schools have started teaching lean accounting as an adjunct to the traditional standard cost, but it's a very small minority. Until the academic world starts telling the accounting profession that lean accounting is a legitimate way of looking at your financial information, people are going to be reluctant to adopt it."

Clemson University accounting professor Frances Kennedy, who delves into lean when she teaches classes on cost accounting, is well-aware that she is in the minority when it comes to her inclusion of lean accounting in her courses. She points out that even some of her colleagues at prestigious business schools don't always understand lean. "I've actually had someone tell me that they don't think what I do is really accounting," Kennedy says. "I get a huge kick out of that comment."

Her students, on the other hand, "really do get lean."

"They get it because they don't have a paradigm already established, and because it just makes sense," Kennedy says. "And then I get students asking me, Why did you teach me all that other stuff?'"

While Kennedy, whose resume includes eight years in finance and accounting positions for Rubbermaid, clearly is a proponent of lean accounting, she notes that she strikes a neutral tone in her accounting classes.

"I frame the course in the beginning by emphasizing that it's important for an accountant to be able to match the correct cost accounting process with the appropriate manufacturing process," Kennedy says. She adds that "my personal belief is you can use lean accounting for just about all of it."

Kennedy believes that one of the reasons that standard cost accounting is emphasized in business schools is because public accounting firms "spend considerable face time with students" and provide financial support to schools, creating "a pull system."

"And they're very vocal about what they want students to learn," Kennedy says.

Kennedy's advice to manufacturers that want to see lean incorporated into accounting classes is to exert that same type of pull on business schools. She notes that this can be accomplished in a number of ways, from sponsoring a faculty or student scholarship for the Lean Accounting Summit to simply picking up the phone and calling the dean or the department chair. Kennedy suggests contacting the local student chapter of the Institute of Management Accountants (IMA) as a starting point.

Not All Doom and Gloom

While lean accounting is a long way from garnering mainstream acceptance in the manufacturing community, proponents of this accounting approach assert that it's not all doom and gloom. Cunningham points out that IMA, through a number of white papers and educational offerings, has shown that lean accounting is on its radar -- "that's a pretty good indicator that it's definitely moving toward mainstream" -- and she notes that more than two dozen college professors applied for scholarships to this year's Lean Accounting Summit, "and in their proposals they all talk about introducing lean accounting to their students."

Perhaps the biggest thing companies need to understand about lean accounting, Cunningham says, is that eliminating your standard cost accounting system doesn't have to be an arduous and expensive process.

"We find that once the financial leadership understands the thinking behind lean accounting, the actual transformation can be very quick on a location-by-location basis," she explains. "Small or medium businesses can probably get this done in less than a few months. And in larger companies, on a division-by-division basis, it doesn't take a long time to make this change, once you understand what it's about."

She continues, "Our challenge is to educate people on what [plain-English P&L] statements would entail, what they would look like and how you would read them. Once people understand that, they can see that this is actually quite a simple change, and most of the information that you need to make this change is readily available in your accounting system."

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