Learning and practicing lean accounting
“Lean accounting” has been around for about 30 years, but its adoption is not widespread. Is that true?
When those of us who have long been involved with lean accounting try to convince other financial executives to adopt it, the response we get is usually something like “we need to follow GAAP accounting and we can’t do lean accounting”. Just as Jim Womack regretted using the word “lean” to describe the concepts, principles and practices of Toyota’s business, I also regret the adoption of the phrase “lean accounting”, because it implies that it is an alternative to Generally Accepted Accounting Principles (GAAP). But that is not quite the case.
The first thing to understand about accounting is that there are several sets of requirements that serve different purposes. For example, GAAP defines the requirements for financial statements provided to shareholders, to creditors, to the Securities and Exchange Commission (SEC) and for other U.S. public reporting. The Internal Revenue Service defines the requirements for financial reports used to determine tax liabilities. The Government Cost Accounting Standards (CAS) set the requirements for providing financial information for government procurement contracts. International companies follow the International Financial Reporting Standards (IFRS). In addition, there are different accounting standards for specialized organizations, such as non-profit organizations, government, etc.
When we talk about lean accounting, we are talking about managerial accounting… sometimes called management accounting. While the other forms of accounting must comply with requirements set by third parties, management accounting has no such constraint. Because it is not intended for external users, it can be tailored to the needs of its intended users… management. As a result, it can differ from company to company and from industry to industry. It is whatever management deems best to help it better understand the business and make better decisions.
The other aspect of lean management accounting is that it is made up of two subsets. The first is the application of lean concepts, principles and practices to the company’s business and accounting processes. Since one of the goals of lean is to reduce the time it takes to do everything by eliminating non-value-adding activities (that is, waste), it would not be unreasonable to call this subset “lean accounting”. The other subset covers the information provided to management in the form of metrics and financial statements. This subset is generally called “accounting for lean”.
All companies use metrics. The most important thing to understand about them is that they need to support the company’s strategy. Since a lean strategy is very different from a traditional strategy, many of the metrics a company should use when implementing a lean strategy are different from those used previously. A review of the company’s metrics should be done to determine which existing metrics will support the new lean strategy, which can be modified to do so, which cannot and should be discontinued, and which new ones should be adopted.
For about a century, most manufacturing companies have used standard cost accounting as their managerial accounting system for recording transactions and product financial statements. This system was developed in the early 1900s and is obsolete for today’s business environment, both in general and specifically in the context of a lean strategy. Companies that have discontinued it have replaced it with some form of plain-language financial statements (see the book “Real Numbers: Management Accounting in a Lean Organization”, in English). These statements are easier to understand for people without an accounting background and provide much more transparency into the company’s work.
Back to the first sentence of this article… is it true that most companies have not adopted lean accounting? Unfortunately, there are no studies that I know of that definitively answer this question. However, the anecdotal evidence is that many companies pursuing a lean strategy start applying lean concepts, principles and practices to their business and accounting processes. They see this as the logical extension of eliminating waste. However, the anecdotal evidence is also that very few companies have given up their standard cost accounting systems. This is unfortunate at best, since the presentation of standard costs and variances provides no useful information to management in an environment that is constantly changing. And at worst, it is dangerous, because it hides the real improvements that are taking place and may report them as negative events that can undermine the company’s lean efforts.
Why are financial executives so reluctant to abandon standard cost accounting? My personal opinion is that there are two reasons. First, financial executives are, by nature, very uncomfortable with change. I have seen this in conversations with many financial executives. They are reluctant to try something “new”. I explain to them that I too was skeptical at first, but I became so frustrated with the lack of useful information in standard cost accounting financial statements that I was willing to try running plain-language statements in parallel with the standard cost accounting statement for more than a year. In the end, I was convinced that the plain-language statements provided much better transparency into the economics of our business and helped us see the results of the improvements that were taking place as we implemented our lean strategy. At that point, abandoning standard cost accounting was easy… intellectually. From then on, we relied on the plain-language statements and lean-oriented metrics.
However, it took a few years to untangle our systems from the standard cost structure, but those reports were no longer used and never left the accounting department.
One last point… some advocates of plain-language financial statements do not believe they need to comply with GAAP accounting. I disagree. Although tax accounting financial statements do not comply with GAAP, no one outside accounting sees them. However, everyone sees the public GAAP statements and, if management accounting statements report different sales or profit numbers, that can only create confusion… which is the “real number”?. Plain-language financial statements can report the same revenue and profit as GAAP financial statements, but in a way that lets you clearly see the items that are merely GAAP requirements… for example, capitalizing labor and overhead for goods produced but not sold.
How do we get from where we are to where we want to be? This year was the 15th annual Lean Accounting Summit. Every year, there are impressive presentations from companies that have adopted lean management accounting. However, these companies are a minority. Fifteen years ago, we at the first Lean Accounting Summit believed that the combination of a good idea and hard work would change the landscape of management accounting. The reality is that, despite that belief, we have had to face the fact that getting financial executives to experiment with and abandon standard cost accounting is harder than we expected. It is like asking them to challenge what they were taught at the beginning of their accounting careers in college and have practiced ever since.
So the final question for accounting professionals reading this article is “do you want to keep doing what you have always done, even if it contributes no real value to your company, or are you brave enough to try something different that will help your company be more successful?”. And for those in accounting academia, “are you willing to take the risk of teaching that standard cost management accounting is obsolete and lean management accounting is better suited to today’s business world?”. Over the last fifteen years of attending and speaking at the Lean Accounting Summit, I have met accounting professors who are willing to teach the next generation of accountants that there is a better way. Until we get the academic accounting community to understand this and remove obsolete management accounting methods from the curriculum, we will continue to fight an uphill battle.
On the other hand, it is encouraging to see the number of companies that have adopted lean management accounting grow over the last fifteen years. The number of industries beyond manufacturing that now attend the Lean Accounting Summit, and the enthusiasm this next generation of accountants shows for experimenting with ideas beyond the traditional standard cost accounting model, are encouraging. I believe this bodes well for the future, as this generation moves into senior financial management positions. I also believe that, with LEI bringing this subject into a broader discussion of lean practices with its new “Lean Accounting Learning and Practice” section on its website, the non-accounting community will realize that it does not have to be frustrated with traditional management accounting. I hope this gives them the information they need to have a meaningful discussion with their accounting partners about experimenting with alternatives that serve their business better.
Lean accounting software spotlight – November 2019:
LeanThink Software
Jean Cunningham
At last week’s AME conference in Chicago, I visited Nick Katko of BMA, who introduced me to an interesting new product for the lean and lean accounting communities – LeanThink Software, designed to run operational and financial analyses in lean organizations. LeanThink supports decision-making in areas such as continuous improvement, capacity planning and the evaluation of business growth opportunities.
LeanThink Software is based on well-established lean accounting principles and creates alignment between lean thinking and an organization’s analytical and decision-making practices. After seeing LeanThink in action, I can see how it will serve as an excellent communication tool between operations, accounting and senior leadership, thanks to the visibility and transparency of the information.
During Nick’s demonstration, I asked him: “What problems does LeanThink solve for its users?”. Nick’s answer was: “LeanThink creates relevant and reliable information that improves decision-makers’ ability to predict outcomes”.
To learn more about LeanThink Software, visit www.leanthinksoftware.com or write to Nick Katko at [email protected].
