Activity Based Costing
and
Lean Accounting
Superfactory Excellence Program™
www.superfactory.com
© 2004 Superfactory™. All Rights Reserved.
1
Disclaimer and Approved use
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Disclaimer

The files in the Superfactory Excellence Program by Superfactory Ventures LLC
(“Superfactory”) are intended for use in training individuals within an organization. The
handouts, tools, and presentations may be customized for each application.
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THE FILES AND PRESENTATIONS ARE DISTRIBUTED ON AN "AS IS" BASIS WITHOUT
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Copyright
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are no known copyright issues. Please contact Superfactory immediately if copyright issues
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Approved Use
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Each copy of the Superfactory Excellence Program can be used throughout a single Customer
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that location, or on the intranet for that location. Contact Superfactory for authorization to
use the Superfactory Excellence Program at multiple locations.
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The presentations and files may be customized to satisfy the customer’s application.
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The presentations and files, or portions or modifications thereof, may not be re-sold or redistributed without express written permission from Superfactory.
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2
Outline
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What is Activity Based Costing?
Cost Accounting Systems
Traditional Cost Systems
Activity Based Costing
Implementing ABC
Benefits & Limitations of ABC
Lean Accounting
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3
What is Cost Accounting?
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Cost Accounting involves the measuring, recording, and
reporting of product costs
Both the total cost and the unit cost of products are
determined
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Objective of Cost Systems
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To provide product unit cost information for product pricing,
cost control, inventory valuation, and financial statement
presentation
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What Does A Cost System Do?
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Object of product costing is to:
 provide inventory costs for external reporting
 show consumption of resources (costs) caused by things
the firm makes for decision making
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What Does A Cost System Do?
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Object of product costing is to do what?
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To provide inventory costs for external reporting
To show consumption of resources (costs) by things the
firm does (actions, choices)
Which method does that “best”?
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One that does not result in material errors in external
reporting
One that tracks significant costs accurately to products or
services as needed for decision making.
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Is Better Cost Allocation the Answer to Process
Improvement?
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One way to improve allocation is to use ABC (activity based
costing)
This increases the number of cost pools used and allows the use
of non unit based cost drivers as well as unit based ones
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Is Better Cost Allocation the Answer to Process
Improvement?
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An alternative approach to improved allocation through
ABC is to do away with the problem (ABM or activity
based management).
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Conduct an ABC analysis.
Eliminate non value added activities.
Convert significant indirect costs into direct costs.
Simplify the product design and manufacturing
processes.
Conduct another ABC analysis….
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Cost Accounting Systems
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Job Order Cost System
Process Cost System
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Job Order Costing
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Costs are assigned to each job or batch
Each job or batch has its own distinguishing characteristics
and related costs
Objective: To compute the cost per job
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Process Cost System
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Accumulates and accounts for product-related costs for a
period of time
Used when a series of connected manufacturing processes
produce a large volume of similar products
Costs are accumulated by and assigned to departments or
processes
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Traditional Cost Systems
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Although it may be impossible to determine the exact cost of
a product or service, every effort is made to provide the best
possible cost estimate
The most difficult part of computing accurate unit costs is
determining the proper amount of overhead cost to assign to
each product, service, or job
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Traditional Product Costing
1.
2.
Costs
Consumed by:
Allocation:
Costs are
allocated to
products based
on assumed
linkages or
convenient
alternatives such
as direct labor
hours
3.
4.
Focus on the product in the costing
process.
Costs are traced to the product with
assumption to consuming of the
resources in proportion to the
volume produced.
These volume drivers, fails to
account for product diversity in the
form of size or complexity.
There is not a direct relationship
between production volume and
cost consumption.
Products
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Traditional, Volume-Based Product-Costing System
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Aerotech produces three complex printed circuit boards
referred to as Mode I, Mode II, and Mode III.
The following information is obtained from company
records:
Production:
Units
Runs
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Mode I
Mode II
Mode III
10,000
1 of 10,000
20,000
4 of 5,000
4,000
10 of 400
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Traditional, Volume-Based Product-Costing System
Additional information includes:
Mode I
Direct materials
$
50.00
Direct labor (hr/board)
3
Setup time (hr/run)
10
Machine time (hr/board)
1
Mode II
$
90.00
4
10
1.25
Mode III
$ 20.00
2
10
2
Mode I
Direct materials
$
50.00
Direct labor
60.00
Manufacturing overhead
99.00
Total
$
209.00
Mode II
$
90.00
80.00
132.00
$ 302.00
Mode III
$ 20.00
40.00
66.00
$ 126.00
Manufacturing overhead is determined as follows
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Traditional, Volume-Based Product-Costing System
Mode I
10,000
3
30,000
Units produced
Direct labor (hr/unit)
Total hours
Mode II
20,000
4
80,000
Total hours required
118,000
Budgeted manufacturing overhead
Budgeted direct-labor hours
$3,894,000
118,000
Mode I
Direct labor (hr/unit)
Overhead rate per hour
Overhead per unit
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Mode III
4,000
2
8,000
$
$
3
33
99
= $33 per hour
Mode II
$
$
4
33
132
Mode III
2
$
33
$
66
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Traditional, Volume-Based Product-Costing System
With these product costs, Aerotech established target selling prices
(Cost × 125%).
Mode I
Direct materials
$
50.00
Direct labor
60.00
Manufacturing overhead
99.00
Total
$
209.00
Cost per unit
Target selling price
Mode I
$
209.00
261.25
Mode II
$
90.00
80.00
132.00
$ 302.00
Mode II
$
302.00
377.50
Mode III
$ 20.00
40.00
66.00
$ 126.00
Mode III
$ 126.00
157.50
209.00 x 1.25
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Traditional Costing Systems
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Often the most difficult part of computing accurate unit costs is
determining the proper amount of overhead cost to assign to
each product, service, or job.
Unlike direct materials and direct labor costs which can usually be
easily traced to the product, overhead is an indirect or common
cost that generally cannot be traced.
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The Need for a New Costing System
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Companies that continue to use plantwide predetermined overhead
rates based on direct labor or machine hours, where the correlation
with overhead no longer exists, experience significant product cost
distortions.
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Overhead Costs
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A single predetermined overhead rate is used throughout the
year for the entire factory operation for the assignment of
overhead costs
In job order costing, direct labor hours or costs are commonly
used as the relevant activity base
In process costing, machine hours are commonly used as the
relevant activity base
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Activity-Based Costing
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Allocates overhead to multiple activity cost pools and assigns
the activity cost pools to products by means of cost drivers
An activity is any event, action, transaction, or work sequence
that causes the incurrence of cost in producing a product or
providing a service
A cost driver is any factor or activity that has a direct causeeffect relationship with the resources consumed
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Activity-Based Costing
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Allocates costs to activities first, and then to the products,
based on the product’s use of those activities
Activities consume resources
Products consume activities
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1.
Activity Based Costing
2.
Costs
Consumed by:
Activities
Consumed by:
Resource Drivers:
Costs are assigned to 3.
activities based on
effort expended
Activity Drivers:
Activity costs are
assigned to products
on unique
consumption patterns
ABC focuses on activities in the
costing process.
Costs are traced from activities to
products, based on the product’s
demand for these activities during
the production process.
ABC theory contends that,
virtually all of a company’s
activities exists to support
production and delivery of
services, they should all be
included as product costs.
Products
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Activity-Based Costing
ABC is extremely valuable to an organization, because it provides information on
the range, cost and consumption of operating activities. Specific benefits of and
strategic use for this information are:
More accurate product costs enable better strategic decisions regarding:
•
•
•
•
•
Product pricing
Product mix.
Make vs. Buy
Investments in R&D, Process automation, etc..
Increased visibility of the activities performed enables a company to:
•
•
•
Focus more on the management of activities, such as improving the efficiency of high
cost activities.
Identify and reduce non-value added activities.
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Activity-Based Costing
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ABC allocates overhead in a two-stage process:
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Overhead is allocated to activity cost pools, each of
which is a distinct type of activity,
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Overhead in the cost pools is assigned to products using
cost drivers which represent and measure the number of
individual activities undertaken or performed to produce
products or render services.
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Activity-Based Costing
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Not all products or services share equally in activities.
The more complex a product’s manufacturing operation, the
more activities and cost drivers it is likely to have.
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Activity-Based Costing System
Overhead Costs
Ordering
and
Receiving
Materials
Cost Pool
Setting
Up
Machines
Cost Pool
Machining
Cost Pool
Numbe
r of
POs
Numbe
r of
Setups
Machin
e Hours
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Assembly
Cost Pool
Inspecting
and
Testing
Cost Pool
Painting
Cost Pool
Supervising
Cost Pool
Numbe
r of
Parts
Numbe
r of
Tests
Numbe
r of
Parts
Direct
Labor
Hours
Products
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Unit Costs under ABC
Activity-based costing involves the following steps:
1 Identify the major activities that pertain to the manufacture of
specific products and allocate manufacturing overhead costs to
activity cost pools.
2 Identify the cost drivers that accurately measure each activity’s
contributions to the finished product and compute the activity-based
overhead rate.
3 Assign manufacturing overhead costs for each activity cost pool to
products using the activity-based overhead rates (cost per driver).
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Computing Overhead Rates
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Availability and ease of obtaining data relating to the activity cost
driver is an important factor that must be considered in its
selection.
The activity-based overhead rate is computed as shown below:
Estimated
Overhead per
Activity
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
Expected Use of
Cost Drivers per
Activity
=
Activity-based
Overhead Rate
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Setting OH Rates: Choices of Level of Aggregation
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Plantwide rate: simplest but most subject to distortion when
products vary in their use of resources
Departmental rates: more complex but subject to distortion
when costs that are not unit driven are substantial and products
use these costs differently
Activity Based Rates: more complex and potentially more
accurate
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Using A Plantwide Rate
Inspection
Engineering
Total OH
Mixing
Product 1
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Forming
Packaging
All products
pass through
the same
departments
& use the same
resources
in the same
way in each
OR
overhead costs
are small
Product 2
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Using Departmental Rates to Apply Overhead
Not all
products
pass through
the same
departments
Inspection
Mixing
Product 1
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Engineering
Forming
But when
they do,
they use
the same
resources
in the same
way in each
Packaging
Product 2
Thus, an
inspection in
mixing is the
same for per unit
of mixing cost
driver for all products
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Who Uses ABC?
Primary Objective
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Productive/Service Costing
Process Analysis
Performance Management
Profitability Assessment
Value-Based Management
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58%
51%
49%
38%
18%
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Who Uses ABC?
Industry
•
•
•
•
Public Sector
Service
Manufacturing
Consulting
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40%
24%
24%
11%
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Activity-Based Costing - Step 1
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Identify the major activities that pertain to the manufacture of
specific products and allocate manufacturing overhead costs
to activity cost pools
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Activity-Based Costing - Step 1
UNIT-LEVEL ACTIVITES
The work efforts that transform resources into individual products and resources
BATCH-LEVEL ACTIVITES
Manufacturing or service technology that affect multiple units of activity equally and
simultaneously
PRODUCT - LEVEL ACTIVITES
Support specific products or service lines
CUSTOMER- LEVEL ACTIVITES
Performed to meet the needs of specific customers
FACILITY-LEVEL ACTIVITIES
Support all of the organizations processes
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Activity-Based Costing - Step 1
TOP DOWN APPROACH
ABC teams of middlemanagement or above
develop the activity
dictionary.
RECYCLING
APPROACH
INTERVIEW OR
PARTICIPATIVE
APPROACH
Reuses documentation
of processes used for
other purposes.
ABC teams include or
interview operating
employees.
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Activity-Based Costing – Step 2
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Identify the cost drivers that accurately measure the activities
consumed and compute the overhead rate
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Activity-Based Costing – Step 2
The ABC teams should gather data on the costs of all
the activities identified in Step 1.
Examine
accounting
records for
recorded cost
information.
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Ask employees to
provide
information on
the time they
work on various
activities.
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Activity-Based Costing – Step 2
When estimating the cost of
an activity, only the costs
associated with the product
should be used (practical
capacity). The cost of
“unused capacity” should
not be applied to products.
EXAMPLE
Suppose we rent a 1,000
square foot warehouse for
$1,000 per month. Only 800
sq. ft. are used to store
Product A. The rest of the
warehouse is “unused”.
How much rent cost should be
allocated to Product A?
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41
Activity-Based Costing – Step 2
80%, or $800
should be assigned
to Product A
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20%, or $200 should
be assigned to
“unused capacity”
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Activity-Based Costing – Step 2
Two pieces of
information are
required to compute
the cost-driver rate:
Activity
Cost
÷
Activity
Volume
=
Cost-Driver
Rate
•Activity Cost
•Activity Volume
EXAMPLE
#1
EXAMPLE #1
XCo has
The 4proper
employees
activity
in in
itsthis
Quality
caseControl
is the #Dept.
of units
Salaries
produced.
and costs
for the departmentThe
total
cost-driver
$360,000 per
rateyear.
wouldXCo
be: produces 500,000
units of product
$360,000
a year.
÷500,000
What units
is the=appropriate
$.72 per unit
activity, # of
employees or units of product? What is the cost-driver rate?
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43
Activity-Based Costing – Step 2
EXAMPLE
#2
EXAMPLE #2
XCocustomers
has a customer
center
where
Since
areservice
charged
“per
call”,
customers can call to ask questions. Customers
the
proper activity in this case is the # of
pay a fixed fee for each call they make to the
callscenter.
handled
by the center.
service
In addition,
other XCo
departments also use the service center. It costs
The cost-driver rate would be:
XCo $1,260,000 a year to operate the center. The
center
receives÷120,000
120,000 calls
per year.
The center
$1,260,000
units
= $10.50
per
handles 1,000,000 minutes of calls.
call
What is the appropriate cost driver; total
minutes per call or number of calls?
What is the cost-driver rate?
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44
Activity-Based Costing – Step 3

Assign overhead costs for each activity cost pool to products
using the overhead rates
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45
Activity-Based Costing – Step 3
1. Identify all
the activities
related to a
given product
or service.
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2. Determine
how many
units of each
activity are
used per unit
of product.
3. Assign costs
to products
using the costdriver rates for
each activity
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Activity-Based Costing – Step 3
Example: Yazz, Inc. produces 130,000 units of Product A and 400,000
units for Product B. Using the following cost information, how
much overhead should be allocated to Product A?
Cost-Driver
Activity
Cost-Driver Base
Rate
Factory Floor Space Square Footage
$
50.000
Electricity
Kilowatts
$
0.050
Water
Gallons
$
0.160
Quality Control
Units Inspected
$
0.850
Packaging - Inner
Ounces of popcorn $
0.025
Packaging - Outer
Boxes
$
1.250
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Resources Used by
Product A
20,000 Sq. Ft.
15,000 KW
80,000 Gal.
135,000 Units
270,000 Oz.
135,000 Boxes
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Activity-Based Costing – Step 3
Cost-Driver
Activity
Base
Factory Floor
Square
Space
Footage
Electricity
Kilowatts
Water
Gallons
Quality Control
Units
Inspected
Packaging - Inner Ounces of
popcorn
Packaging Boxes
Outer
Cost-Driver Resources Used
Rate
by Product A Cost Assigned
$
50.000
20,000 Sq. Ft. $1,000,000.00
$
$
$
0.050
0.160
0.850
15,000
80,000
135,000
KW
Gal.
Units
$
750.00
$ 12,800.00
$ 114,750.00
$
0.025
270,000
Oz.
$
1.250
135,000 Boxes $ 168,750.00
$
6,750.00
Total Cost Assigned to Product A $1,303,800.00
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48
Activity-Based Overhead Rate
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Estimated Overhead Cost Per Activity /
Expected Use of Cost Drivers Per Activity
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Cost Driver
A characteristic of an event or activity that results in the
incurrence of costs. In selecting a cost driver, we must
consider . . .
Degree of
Correlation with
the cost
Behavioral
Effects of Using It
Cost of
Measuring the
Driver
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50
Homogeneous Cost Pools
A grouping of overhead costs in which each cost component is
increased/decreased in roughly the same way by some causal
factor (cost driver).
A homogeneous cost pool can use a
single cost driver and maintain
accuracy in cost allocation.
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51
Identifying and Classifying Activities
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Classification = grouping into homogeneous cost pools.
Is this class “homogeneous”?
Does how you classify costs matter in terms of its effect on behavior? Why
or why not?
What advantage do managers get from an ABC system (beyond “more
accurate costs”)?
You must understand the business before you can classify costs
into “like” groups.
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52
How Do You Decide on What Belongs in Which Pool
and How Many to Use?
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In real life, how does one know what activity causes what costs?
What does this imply about who should be involved in product costing?
What do you do if you cannot identify a cause and effect relationship to
use to assign costs?
 Do all costs have to be assigned to product?



Externally?
Internally?
Benefits received? Ability to bear? The peanut butter approach?
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53
Classifying Costs into Homogeneous Groups

Arrange costs into homogeneous cost pools for assignment to
product. Your goal is the smallest number of pools consistent with
"homogeneous" cost pools.
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54
Costs to be Grouped
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Costs to reset machinery for different packaging card sizes
Costs for plant security
Costs for receiving raw materials and supplies and placing them in
inventory.
Costs for storing inventory
Costs to maintain production equipment
Costs for employee lunch services (subsidized cafeteria for direct
labor)
Costs to issue raw materials for batches
Costs for purchasing raw materials and supplies
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55
Costs to be Grouped Continued
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Costs for engineers to design process modifications for products
Depreciation on machinery
Depreciation on packaging equipment
Building heat, light, air conditioning, etc.
Equipment power costs
Inspection after forming
Inspection after final packaging
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56
How big does a group of “like” costs have to be
to “deserve” its own category?
Does the cost of gathering the data matter?
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57
Storyboarding
A procedure used to develop a detailed process flow chart, which
visually represents activities and the relationships among
activities.
Useful in creating ABC cost pools and in tracing interrelationships
for ABM.
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58
Process for Allocation of Indirect Costs



Group them into “like” pools
Use a cause and effect relationship with a cost driver for
each to assign the costs to product (if possible)
ABC systems use more pools than a departmental rate system
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59
Assigning Costs to Activity Centers
Assign costs to the activity centers
where they are accumulated while
waiting to be applied to products.
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60
Selecting Cost Drivers
Assign costs from the
activity center to the
product (or other cost
object) using
appropriate cost
drivers.
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When selecting a cost driver
consider:
 The ease of obtaining
data.
 The degree to which the
cost driver measures
actual consumption by
products.
61
Possible Hierarchy for Pooling Costs Into “Like”
Groups




Unit based costs
 What would be included here?
 What makes these change (drives these costs)?
Batch based costs
 What would be included here?
 What makes these change (drives these costs)?
Product based costs (or customer based in marketing)
 What would be included here?
 What makes these change (drives these costs)?
Facility based costs
 What would be included here?
 What makes these change (drives these costs)?
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62
Benefits of Activity-Based Costing



ABC leads to more activity cost pools with more relevant cost
drivers
ABC leads to enhanced control of overhead costs since
overhead costs can be more often traced directly to activities
ABC leads to better management decisions by providing more
accurate product costs, which contributes to setting selling
prices that will achieve desired product profitability levels
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63
Benefits of ABC


ABC leads to better management decisions. More accurate
product costing helps in setting selling prices and in deciding to
whether make or buy components.
Activity-based costing does not, in and of itself, change the
amount of overhead costs.
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64
Limitations of ABC


ABC can be expensive to use, as a result of the higher cost of
identifying multiple activities and applying numerous cost
drivers
Some arbitrary overhead costs will continue, even though
more overhead costs can be assigned directly to products
through multiple activity cost pools
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65
ABC: Some Key Issues


The Past
Small number of products
which did not differ much
in required manufacturing
support.
Labor was dominant
element in the cost
structure.
© 2004 Superfactory™. All Rights Reserved.


The Present
Numerous products with
more and complicated
production requirements.
Labor is becoming an ever
smaller part component of
total production costs.
66
When to Use ABC





Product lines differ greatly in volume and manufacturing
complexity
Product lines are numerous, diverse, and require differing
degrees of support services
Overhead costs constitute a significant portion of total costs
The manufacturing process or the number of products has
changed significantly
Production or marketing managers are ignoring data provided
by traditional cost systems and are using bootleg cost
information to make pricing decisions
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ABC: Some Key Issues Leading to Increased Use


Use of ABC allows more costs to be directly traced to products
This reduces the errors in product costs generated by less-thantotally-accurate allocations
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When Is ABC Most Beneficial?



When products differ significantly in their use of firm resources
 Does ABC have to be limited to production costs?
When these resources (overhead ) are a significant cost (thus
when labor is relatively small)
What contributes to different usage of resources?
 Product diversity (functions used, inspections required, batch
sizes,….)
 Production complexity
 Customer diversity (order sizes, distribution requirements
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Both Volume and Complexity Can Affect Costs


Processing orders
 Number of different forms (complexity)
 Electronic or manual processing
Assembling product
 Number of units
 Number of unique parts
 Number and type of steps (unique processes)

Can design affect this?
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Symptoms of the Need for a
More Complex Cost System

The outcomes of bids are difficult to explain

Competitors’ prices appear unrealistically low

Products that are difficult to produce show high profits


Operational managers want to drop products that appear
profitable
Departmental managers do not believe the cost reports
and/or are using their own accounting system
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Symptoms of the Need for a
Different Cost System

The firm has a highly profitable niche all to itself

Customers do not complain about price increases

Competitors send you business

Sales are increasing but profits are not


Managers don’t have the information they need to address
problems
Product costs change because of changes in financial reporting
regulations
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An ABC Example: Setting Rates
Cost Pool
Cost
Cost driver
Activity
level
Engineering
$500,000
Hours spent
20,000
Setups
$450,000
No. of setups 800
Machining
$1,000,000
Machine hrs
100,000
Inspections
$400,000
10,000
Space
$125,000
Utilities
$90,000
Inspection
hrs
No. of
facilities
No. of
facilities
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Rate
Divide cost by
activity level
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An ABC Example: Setting Rates
Cost Pool
Cost
Cost driver
Activity
level
Rate
Engineering
$500,000
Hours spent
20,000
$25/hr.
Setups
$450,000
No. of setups 800
$562.5/setup
Machining
$1,000,000
Machine hrs
100,000
$10/MHR
Inspections
$400,000
10,000
$40/insp.
Space
$125,000
Utilities
$90,000
Inspection
hrs
No. of
facilities
No. of
facilities
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?
?
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Activity-Based Management

ABM is an extension of ABC, from a product costing system to
a management function, that focuses on reducing costs and
improving processes and decision making
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Functional-Based
Management
Model
Cost View
Resources
Operational View
Efficiency
Analysis
Functions
Performance
Analysis
Products
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Activity-Based
Management
Model
Cost View
Resources
Operational View
Driver
Analysis
Activities
Performance
Analysis
Products &
Customers
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ABM: What and Why?


Activity based management = using knowledge of costs gained by
ABC analysis to make pricing and product-mix decisions, to identify
and select cost reduction and process improvement projects, including
ones relating to product design
Knowing what costs are related to which product allows better
analysis of:
 which markets to emphasize
 which products to consider for CIPs (cost improvement programs)
 which customers to target for changes in pricing or service
delivery
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ABC in Service Industries





Identifying activities, cost pools, and cost drivers are similar
to manufacturing industries
A larger proportion of overhead costs are facility-level costs,
that cannot be directly traced to specific services rendered by
the company
Although initially developed and implemented by
manufacturing companies that produce products, ABC has
been widely adopted in service industries.
The general approach to identifying activities, activity cost
pools, and cost drivers is the same.
Labeling activities as value-added and nonvalue-added, and
trying to reduce or eliminate nonvalue-added activities is just
as valid.
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Lean Accounting


Lean Accounting is intended to replace traditional accounting and
measurement systems; it is not intended be an additional
analysis. Lean Accounting is right for companies that are well on
the path toward lean manufacturing.
Lean Accounting is more than a set of tools relating to
measurement, capacity usage, value, and continuous
improvement. Together these tools become a lean business
management system that is radically different from traditional
management.
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Lean Accounting – Element 1

Performance measurements that motivate lean actions - at the
cell level, the value stream level, and at the plant or corporation
level.
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Lean Accounting – Element 2

The elimination of most accounting and control transactions
through the elimination of the need for them.
 They (accounting transactions, shop floor control, inventory
records, labor tracking, etc.) are needed in traditional
companies because processes are out of control.
 In lean companies we can bring processes under control and
eliminate the need for the cost accounting, inventory control,
etc. Lean performance measurements become the primary
control manager.
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Lean Accounting – Element 3

A valid assessment of the financial impact of lean manufacturing
improvement.
 Many companies are looking for short-term cost cutting to
come from their lean efforts.
 They are usually disappointed. Lean manufacturing does not
cut costs; it turns waste into available capacity.
 The financial impact comes as you make decisions on how to
use this capacity (and the cash flow from reduced inventory).
 These are strategic decisions. Lean Accounting uses a specific
tool for understanding the impact of lean changes on the
company financially.
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Lean Accounting – Element 4

Replacement of standard costing with costing of the value stream.
 As a company seriously applies lean thinking they become less
like a job shop and more like a process manufacturer.
 Value stream costing becomes more relevant and "accurate"
for managing the value stream.
 This step (and its a big one for many companies) eliminates
almost all of the wasteful transactions associated with
traditional cost accounting. Plus it gives the value stream
manager (and other interested parties) more valid information.
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Lean Accounting – Element 5

Decisions that used to involve standard costs now use value
stream profitability and contribution margin.
 These decisions include pricing, profitability, make/buy, new
product introduction, product and customer rationalization,
etc.
 This aspect is similar to throughput accounting in that it
requires an understanding of flow through the bottleneck (or
constraint) operations within the value stream.
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Lean Accounting – Element 6

Driving the business from customer value. This is what we are
striving towards.
 QFD and target costing to drive our business from customer
value and not from cost.
 We need a profound understanding of how we create value for
the customer; we need an understanding of where our costs
are in the value stream; we compare where we create value
with where we expend cost; and we initiate kaizens (and the
like) to bring value and cost into line.

The best way to reduce cost is, of course, to increase sales.
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Lean Accounting – The Lean Transition

An important role for finance and accounting people in the lean
organization is to actively support and participate in the transition
to a lean enterprise.
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Lean Accounting – Management Accounting


A cornerstone of the lean business is performance measurement.
We have few measurements that are focused on the creation of
customer value and the achievement of business strategy.
Measurements are primarily non-financial and are established for
cells, value streams, plants, and corporations. Simplified costing
and financial planning methods support these measurements.
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Lean Accounting – Business Management


To manage the business we need timely and valid information.
Decisions are made using lean principles, not the traditional mass
production mentality.
Replace the department-focused structure with an organization
that is focused on customer value and the value streams. Drive
the business from value to the customer.
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Lean Accounting – Operational Accounting


The problems of standard costing need to be addressed. Standard
costing is an excellent costing method for traditional mass
production; but standard costing is actively harmful to lean
organizations.
Replace standard costing with value stream costing. Value stream
costing eliminates most transactions and does not rely on
allocation and full absorption of costs.
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Lean Accounting – Financial Accounting


While the majority of Lean Accounting affects internal processes,
Lean principles are applied equally to the company’s financial
accounting. There is much waste to be eliminated.
Finance and accounting people in the average American company
spend more than 70% of their time on bookkeeping and very little
time on analysis and improvement.
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