Brian Maskell, noted Lean Accounting expert and co-author of the book Practical Lean Accounting, was the featured presenter at an IndustryWeek-hosted webcast entitled "Why the Lean Enterprise Needs Lean Accounting," that was sponsored by SAP and itelligence. The audience asked more than 50 questions -- many more than could be addressed during the live event. Maskell generously offered to answer many of the additional audience questions in writing, which can be found below.
How does Lean Accounting compare to Throughput Accounting, which is based on the Theory of Constraints?
Maskell: Lean accounting uses some of the TOC approaches while not adhering strictly to Throughout Accounting. Understanding the constraint in the value stream flow is very important. When calculating product cost -- if you need to -- we use the constraint to understand the rate of flow.
What is the value stream?
Maskell: Here's a short answer. All the steps required to create value for the customer, organized into a team of dedicated people, equipment, and other resources to support families of products that take similar production flow.
How is value stream costing different from ABC costing?
Maskell: Value stream costing does not use ABC and - in some ways -- ABC is the opposite of value stream costing.
I'm in the auto supplier industry. About 1/2 of our manufacturing costs are what is considered "support" costs. How do you handle this situation?
Maskell: The organization of value streams is key to this. We want to create value stream organization so as to have teams of dedicated people (Including all the people required to fully support the customers value needs) so that the costs are largely included and dedicated to the individual value streams. The "support" costs not included in the value streams are the costs that do not directly relate to the value streams; plant manager, financial accounting, HR manager, for example. I recognize that life is not as simple as I am presenting it, but we work towards it.
What are some examples of Support Cost not in the value stream?
Maskell: Support costs not included in the value streams will often include the plant manager, IT team, HR, financial accounting (cost/mgmt accounting would be in if possible). These support costs need to be relatively low (maybe 5% of total). Some companies will also have specialist "coaches" or functional specialist leaders in the support areas. There are no rules here; you have to work out the operational, technical, and accounting issues.
How do you assign facilities cost to a value stream without an allocation?
Maskell: We always need to provide a tangible incentive for the value stream managers to use less space because facilities space is an important resource. This can be done using a square footage use measurement, or by allocating facilities costs to the value stream using square footage. If you allocate, only allocate the cost of the space used. Spare or common space is allocated to "support costs."
I can see the way Value Stream Costing would work with discrete products and product families. How would you apply the principles in a highly varied job shop environment where we are producing for unique products for 300 different customers, and need to identify cost to determine pricing for these products?
Maskell: Our experience is that your needs are more the rule than the usual. Most companies make a wide variety of diverse products. In fact, lean is designed for high variety. Custom, design-to-order production does require some different approaches because the value streams will most be the design process with the production steps in the later stages of the value stream. The value stream manager will have responsibility for both the design and production.
How do you establish a cost for your value stream materials if you don't have a standard cost for them? Or do you still use standard costs for materials, but analyze them within the context of the value stream P&L?
Maskell: We use the actual material cost -- ideally expensing it to the value stream on receipt. Life is not as simple as this, of course, and there are several variations on this theme.
Aren't you basically stating to use the net present value of discounted relevant cash flows to make these decisions?
Maskell: We don't often us DCF. Some capital equipment or more strategic decisions require DCF, but the decisions I was discussing in the webcast relate to more routine decisions.
How many value streams is there normally to evaluate performance for an entire company?
Maskell: Impossible question!! A rule of thumb is that a (order fulfillment) value stream generally has 25-150 people -- cross-functional team including traditionally considered "in-direct."
How would rework or line repair costs be identified and tracked to help make scrap or rework decision?
Maskell: Rework and scrap costs are much too important to be tracked by the accounting systems! These are identified hourly by the production cells on cell performance boards. The problems are fixed short-term and solved long term. The purpose is to solve the problems and improve the first-time-through measurement. Merely measuring and reporting the cost of scrap and rework is of very limited usefulness.
I understand that you use only direct costs in lean accounting. Does this mean we ignore indirect costs as those face the issue of fair allocation?
Maskell: Ideally the majority of (previously considered) indirect costs are included in the value stream and therefore become direct costs. We avoid allocations, but practicalities do lead to some allocation. Share monument machines are allocated, for example, until they can be right-sized to the value stream - which may be a long time.
What do you mean by transaction...order entry is a required transaction? What is understood as complex transaction-based systems?
Maskell: Transactions are all recorded information required to support the business. Some of these a required -- most are not and can be eliminated by removing the need for them. The starting point in most companies is the transactions related to work-orders, purchase orders and inventory tracking.
How do you value inventories under Lean Accounting? Is it done with unit costs, batch costs, or some approximation?
Maskell: Unit costs and quantities are used when the inventory is high (rule of thumb >60 days). When inventory is lower then there are several much simpler methods that do not require calculation at the individual level. If you need to track inventory on the computer, it is common to switch off the labor & overhead rates in the ERP system.
Are there any business models that don't lend themselves to lean accounting?
Maskell: I expect so.
How do you determine an appropriate sales price if you don't figure a standard cost on a part?
Maskell: All prices are set based on the value created for the customers. Having determined the price, it is of course important to understand if this is "good business" for the company and this requires an understanding of the value stream costs. In lean, Cost = Price - Profit (not the other way around). See Ohno's book "Workplace (or Gemba) Management".
How are outside users of financial statements reacting to financial reporting driven by lean accounting?
Maskell: Generally they cannot see any difference. All external reporting is required to be at actual cost. The internal cost accounting methods are not apparent.
For companies that have external reporting requirements, is there an efficient way to go from lean accounting to financial reporting in accordance with IFRS and GAAP(U.S.)?
Maskell: Lean accounting always adheres fully to IFRS and GAAP. Clearly we would always be cautious when making these kinds of changes. As a consulting firm, we have developed standard methods for introducing Lean Accounting that we call the "Maturity Path". As you become more mature with lean manufacturing and other lean methods, the Lean Accounting becomes simpler and easier.
How does lean accounting eliminate the 3 way match in AP? Our 3 processes to match are 1) place order, 2) receive product, 3) ensure we are invoiced for what we ordered and received. Which of these steps can be eliminated?
Maskell: There is a long answer. The short answer is that we remove the need for the matching. If you list all the reasons for mismatches and then remove them using lean PDCA methods. By and large the method is to have a long term contract containing material prices, and pay based on the contract prices. The supplier does not send us an invoice and there are no PO's because the pull system authorizes delivery. No PO and no invoice means that there is nothing to match. (Our books describe this more fully).
Without a PO or 3 way matching, how do you know how much to pay a vendor?
Maskell: Pay based on the actual prices contained within long-term supplier contracts. This does not apply to everything you buy - just most things you buy. Start with the "most things."
Are there scenarios or types of businesses/products where it is not appropriate to move from a 3 way to a 2 way AP match? (e.g. where the items and/or quantity vary significantly day to day)
Maskell: I expect so. In lean companies the majority of the need can be removed for the routine materials purchased.
Are all value streams able to be identified separately? In order to do the revised income statement is it a sum of the value streams?
Maskell: All value streams are identified separately - and this requires a good deal of thinking, care, and flexibility -- and the plant/division/company income statement is the sum of the value stream costs and the support costs.
Brian, what about satisfying external auditors with GAAP statements that "flow" costs to inventory and the balance sheet? Not a performance or reporting issue internally, but needed for the external reporting?
Maskell: The auditors need to understand how the costs flow and how the reporting system works. They are very concerned with control and appropriate inventory valuation. It is best to bring the auditors in as early as possible as it can take them some time to understand the changes because they are paradigmatically different.
What do you do when your value streams are constantly changing? For example if most of your business is low volume?
Maskell: No simple answers, but here's one. Create flexible value streams. Some companies have a single (order fulfillment) value stream.
How much of Product Engineering is typically charged to value stream costs?
Maskell: Most companies have "new product development" value streams. These costs are all reported by that value stream. Design-to-order companies include the design people in the order fulfillment value streams together with the production and logistics, etc.
Can you discuss the ways to develop target costing?
Where and how are you mapping the data from SAP to business objects?
Maskell: SAP has developed a tool for doing this mapping. This is what David Strothmann presented during the webcast.
How do you allocate freight, facilities cost etc.?
Maskell: There are no hard rules on this, but most companies want to include freight costs and facilities. Facility cost is often allocated using square footage (but the value stream only pays for the space they use. There is a lot of space that is not used by value streams). Freight we would generally not allocate as this will lead to meetings to argue about who gets what allocation. Some companies only charge "emergency" freight charges to the value streams as these can be clearly identified.
If you are not pulling through component inventory via transactions, how do you track your reorder points and maintain a baseline to validate your on hand balance?
Maskell: Kanban quantities and level scheduling is completed as a part of the SOFP (the monthly sales, operations, and financial planning). All we need to know is the amount and variability of the demand. This information is available without detailed inventory transactions -- when there is a pull system.
Has value stream accounting been applied to the continuous process industries- say paper making or petro-chemicals?
Maskell: Yes. And the value stream approach derives to some extent from process manufacturing where you address the process rather than the product.
Are all material costs expensed in the period they were purchased; or only the material that was produced and sold?
Maskell: Pull systems & low inventory makes these the same. I know life is not quite that simple - but it's a good start.
How do you determine unit selling prices when multiple products of the same family may be produced in the value stream?
Maskell: Selling prices are not related to cost. Pricing is set by the value created for the customer. (I know this answer begs a whole bunch of new questions.)
Isn't revenue based upon when the item is shipped? Is your cost assumption when the cash expense is incurred?
Maskell: We do not advocate 100% cash based, for the reasons you allude to. But low inventory and pull systems get you close to this.
How do you account for variability or specific complications with certain customers?
Maskell: Carefully!! This issue generally comes up when we need to study profitability by customer or market. This is more strategic than tactical, and does not required detailed on-going tracking, but a study. I was not really addressing this much in the presentation.
How do you forecast for next year without standard cost due to our increasing cost of goods?
Maskell: Financial forecasting is done using value stream costing, usually at a macro-level. This usually lends itself better to handling increasing (or reducing) costs. You will still have the BOM's for your products and you can explode these against expected future prices.
What is the best way to implement Lean into a distribution business?
Maskell: This is a hard question and broader than Lean Accounting. Can I pass on this? In general terms I would recommend many days of expensive consulting. ;-)
Is there any available support if we have questions in implementing Lean Accounting?
Maskell: At my company, BMA Inc., we do (of course) provide a full range of training, consulting, and implementation services. But please feel free to email me. Our website has a lot of information too.
View the Lean Accounting webcast on-demand