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Tuesday, September 1, 2009

Lean Accounting at Watlow Electric

Many organizations are having success implementing Lean practices but very few have accepted lean accounting. Orry Fiume, who led The Wiremold Company conversion to lean accounting in the early 1990’s before retiring, now spends time sharing the virtues of lean accounting at the Lean Enterprise Institute.

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.

While lean accounting can provide a clearer picture of a company’s lean improvements it has been slow to adopt for several reasons.

"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."

"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

Watlow Electric has found that lean accounting or what they call “value stream management” has given them a better understanding of its cost structure. Ed Grinde, business unit controller for Watlow Electric Manufacturing, offers 9 tips and best practices for implementing lean accounting.

1.Upper management support is critical.
2.Everyone must understand that lean is a growth strategy-not a cost-cutting strategy.
3.Properly identify your value streams.
4.Don't try to attain perfection before setting up your value streams.
5.Keep metrics and methods simple and manual in the beginning.
6.Do not set hard goals.
7.Value stream leaders need autonomy to be "little general managers."
8.Put as much of your costs as possible directly into the value streams.
9.Use the five principles of lean as your criteria to make decisions.

Grinde provides some more insight on these tips in the article worth reviewing in your own organization. These are even good strategies for implementing lean thinking in your organization.

I wonder how many organizations are practicing lean accounting. We will do an informal survey of readers. Send a comment if your organization is practicing lean accouting. If you care to share your experience, include that as well.

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