Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
The purpose of this paper is to present a lean financial model developed to measure whether lean enterprise tools (e.g., just-in-time, jidoka, value stream mapping, 5-whys, etc.) actually reduce the costs of various types of waste as predicted by lean enterprise advocates. The paper includes five sections: 1) introduction, 2) research method, 3) interaction problems between lean and management accounting systems, 4) the new model, and 5) summary.
In this section the authors cover some of the previous research on the lean vs. management accounting systems issue to establish the need for a new model. Kristensen and Israelsen disagree with authors who argue that non-financial measurements are all that is needed in a lean environment and that cost accounting is a problem and should be abandoned. The new model grew out of a study of three companies that experienced conflicts between the implementation of lean concepts and their management accounting control systems. The authors' research questions were designed to study the problems created by traditional standard cost systems in a lean environment, and how these systems could be changed to enhance rather than detract from lean initiatives.
This research project and resulting model are based on a three year study of three companies. The research was guided by coherence theory and Merchant's six criteria for evaluating a management accounting system. Merchant's criteria include: congruence with organizational objectives, controllable by the manager who is influenced, and whether the information is timely, accurate, understandable, and cost effective. This section also includes a brief discussion of the three companies involved in the study.
Interaction Problems Between Lean and MAS
The authors listed ten problems that were identified in the three companies that implemented lean enterprise tools. Briefly they are as follows:
1. Difficulty in measuring profit improvements.
2. Difficulty in measuring lean progress in financial terms.
3. The cost of quality model used excluded some waste categories included in the lean approach.
4. Cost of capital does not include imputed cost.
5. Some capacity costs are allocated to the unit level confusing the identification of cost drivers.
6. Data on takt time is not used in the management accounting system.
7. Data collected in the value stream maps is not used in the management accounting system.
8. Learning curve effects are mixed with lean improvements.
9. Information from variance reports is not useful to line operators.
10. Traditional standard cost models do not support continuous improvement and mix expected and unexpected cost of waste.
The New Lean Financial Model
The model is presented using a modified example from one of the case companies studied. The example includes a graphic illustration of the flow layout and activity path for two value streams (See Figure 1), a table showing the steps in the production process for Value Stream 1 including various operators and support workers referred to as water spiders (Table 1), and a table showing a weeks production including all of the problems experienced during the period. In addition the example includes three types of reporting: 1) a traditional cost of waste financial report, 2) a regular lean report showing lead time, and 3) the new lean financial model report showing a wider variety of waste categories.
The example includes a considerable amount of detail that is beyond the scope of my summary, but adaptations of Figure 1 and Table 1 show how the example is set up into two value streams and three manufacturing cells.
|Adapted from Table 1 - Value Stream 1|
|Resource||Activity Path for Value Stream 1
Per unit - If not otherwise stated
|Stock 1||Stock 1 storage||5 days|
|Water spider||Transport of materials per batch||180 sec|
|Factory 1||Storage||1 hour|
|Water spider||Scheduling and planning per batch||2,500 sec|
|Water spider||Expected extra scheduling (rework)||2,000 sec|
|Materials||Bill of materials per unit||1 pcs|
|Cell 1 activities (per unit) - bottleneck (special tools)|
|Operator 1||1. Shaping components||310 sec|
|Operator 2||2. Getting special power tools||10 sec|
|Operator 2||3. Surface treatment||250 sec|
|Operator 2||4. Transport materials to WIP||10 sec|
|Operator 2||5. Time expected for problems||10 sec|
|Operator 2||Cell 1 imbalance (1)-(2+3+4+5)||30 sec|
|Cell 1 total standard time||620 sec|
|Factory 2||Work in process storage||2 hours|
|Water spider||Moving WIP into Cell 2||15 sec|
|Cell 2 activities|
|Operator 1||1. Drilling holes||280 sec|
|Operator 1||2. Moving between two power tools||7 sec|
|Operator 2||3. Montage||200 sec|
|Operator 2||4. Moving around the product unit to get in right position||15 sec|
|Operator 3||5. Welding||300 sec|
|Water spider||6. Inspection||25 sec|
|Water spider||7. Transport materials to WIP||20 sec|
|Operator 2||8. Time expected for problems power tools||20 sec|
|Operator 1+2||Cell 2 imbalance (5)-(1+2)+(5)-(3+4+8)||78 sec|
|Cell 2 total standard time||945 sec|
|Operator 1+2+3||Cell 1 and 2 imbalance (bottleneck process time 310 sec)||30 sec|
|Factory 1||WIP storage (average time)||1 hour|
|Machine 1 (23 painting slots in machine per batch)|
|Water spider||Moving WIP into machine 1 - per batch||300 sec|
|Operator||Loading machine with paint per batch||200 sec|
|Operator||Setup of machine per batch||200 sec|
|Machine 1||Machine 1 - painting the batch||4,500 sec|
|Operator||Managing and steering the machine per batch||4,500 sec|
|Operator/Machine 1||Machine breakage downtime expected per batch (waiting time)||200 sec|
|Water spider||Inspection of finished goods per batch||100 sec|
|Machine 1 total standard time per batch||5,500 sec|
|Machine 1||(imbalance with cells) available time on machine 1 per batch||2,030 sec|
|Materials||Paint used per batch in machine 1||10,000 ml|
|Materials||Paint wasted inside machine - not usable 2% per batch||20 ml|
|Operator||Adjusting - reworking some of the units per unit||13 sec|
|Water spider||Transport of finished goods to Stock 2 per batch||300 sec|
|Stock 2||Storage (average time)||10 days|
|Materials||Scrap of finished goods by inspection per batch||1 pcs|
|Direct hours||Total operator/water spider direct (hours) standard time per unit||1,795.43 sec|
|Unit hours||Total operator/water spider standard time per unit without waste||1,340 sec|
|Batch hours||Total operator/water spider standard time per batch without waste||7,200 sec|
Visual boards are used on the shop floor to show what is happening during the production process. This information is recorded by the water spiders (support workers) and used by operators and foreman to monitor the production process and to identify and solve production problems. The data from the visual boards are provided in Table 2 for the week's production in Value Stream 1.
|Adapted from Table 2 - Visual Board of Week's Actual Results for Value Stream 1|
|Actual finished units ( including scrap)||322|
|Actual finished batches||14|
|Scrap per batch||2|
|Total operator hours actual (6 operators 8 hours a day, 5 days)||240|
|Total water spider hours actual (2 water spiders 8 hours a day, 5 days)||80|
|Actual paint consumed less standard ml||100|
|Reported visual board deviations|
|Problems with tools in cell 1 ( incorrect processing) - working slower - 1 batch missed||2 hours|
|Cell 2 had trouble keeping up the pace and was 400 sec slower on one batch (no lost batch-not bottleneck)||400 sec|
Traditional Profit Reporting
This section includes two tables that show how the results of the week are reported in the traditional format. Table 3 provides the actual results in column 1, the flexible budget in column 2, and the budget or scheduled production in column 3.
|Adapted from Table 3 - Traditional Financial Reporting for Value Stream 1|
Production x Actual Price
Production x Standard Price
x Standard Price
|Direct labor (operator - water spider in cells)||3,718||3,666||4,115|
|Materials (bom + paint)||2,515||2,515||2,755|
|Contribution margin 1||23,166||23,219||26,131|
|Indirect variable costs (operators-water spiders)||3,932||4,160||3,599|
|Contribution margin 2||19,234||19,059||22,532|
|Materials loss (paint)||29||28||30|
|Contribution margin 3||18,622||18,740||22,090|
|Profit before interest||16,622||16,740||20,000|
Table 4 includes the cost of waste for direct labor (unexpected), materials loss (expected and unexpected), materials scrap (expected and unexpected), labor scrap (expected and unexpected), indirect labor (unexpected), and total cost of waste. The unexpected costs of waste are the differences between columns 1 and 2 in Table 3 except for the last amount indicated for indirect labor resulting from a lost batch. The expected costs of waste are from column 2 (the flexible budget) of Table 3.
|Adapted from Table 4 - Cost of Waste in Traditional Financial Reporting|
|1-2||Direct labor (unexpected)||53|
|2||Materials loss (expected)||28|
|1-2||Materials loss (expected)||1|
|2||Materials scrap (expected)||117|
|1-2||Materials scrap (unexpected)||117|
|2||Labor scrap (expected)||175|
|1-2||Labor scrap (unexpected)||175|
|1-3||Increase indirect labor (unexpected) 1 batch lost||334|
|Total expected cost of waste||319|
|Total unexpected cost of waste||679|
|Total cost of waste||998|
Lean Financial Reporting
The authors begin this section by stating that a cost model is needed in a lean organization even though traditional cost models are not compatible with lean thinking. For example, the traditional standard cost model promotes non-lean behavior, provides confusing information by allocating non-unit cost to the unit level, and hides waste in the standards. Their new lean financial reporting model uses standards, but includes separate categories for ten types of waste that have been identified in the lean environment. These include: rework/scrap, movement, transport, waiting time, incorrect processing, overproduction, inventory, imbalance time, inspection, and setup. Standards are needed to understand how the cost of waste is affected by changes in product mix and volume, and to determine available capacity compared to process consumption and waste.
Their model is illustrated in Tables 6 and 7. Kristensen and Israelsen's Table 6 includes the three columns as indicated in my adaptation of their table below. The main purpose of their new lean financial model is to show all types of waste that are aggregated and hidden in a traditional cost model. An advantage of this new approach is that each type of waste can be addressed with different lean tools. The new model supports continuous improvement by reducing and monitoring expected as well as unexpected types of waste.
|Adapted from Table 6 - Lean Financial Reporting for Value Stream 1|
Actual Production Volume x Actual Price
Actual Production Volume x Standard Price (Expected)
Scheduled Volume x Standard
|Unit-level labor (operators - water spiders)||2,739||2,736||3,071|
|Unit-level materials (bom and paint)||2,515||2,515||2,755|
|Unit-level Contribution Margin 1||24,146||24,149||27,174|
|Unit level materials loss (paint)||29||28||30|
|Unit-level scrap (labor)||261||130||140|
|Unit-level waiting time||350||0||0|
|Unit-level incorrect processing||117||67||72|
|Unit-Level Contribution Margin 2||22,590||23,241||26,202|
|Batch-level labor (operators - water spiders)||700||700||750|
|Batch Margin 1||21,890||22,541||25,452|
|Batch-level rework and rescheduling||39||39||42|
|Batch-level waiting time||19||19||21|
|Batch-level incorrect processing||0||0||0|
|Batch-level imbalance with cells||197||197||211|
|Batch-level Margin 2||21,529||22,180||25,065|
|Value stream sustaining (avoidable operators)||1,425||1,425||1,425|
|Available labor operators - not bottleneck cell||56||345||58|
|Available labor operators on bottleneck cell 1||28||172||29|
|Value stream sustaining - (avoidable w spiders)||1,398||1,498||1,463|
|Depreciation for available machine time||240||290||240|
|Depreciation for wasted machine time||322||272||292|
|Depreciation for machine time consumed||438||438||469|
|Value stream Capacity costs (engineer)||1,000||1,000||1,000|
|Profit before imputed interest||16,622||16,740||20,090|
|Raw materials stock||4||4||4|
|WIP storage materials - cost of capital||1||0||1|
|Finished goods - cost of capital||8||7||8|
|Stock facilities - cost of capital||87||81||87|
|Machine assets - cost of capital||29||29||29|
|Factory occupancy - cost of capital||288||288||288|
|Profit after imputed interest||16,206||16,330||19,674|
Although some authors have advocated using a cost model based on actual costs, it is difficult to compare actual costs because of inflation and changes in product mix and available capacity. In addition, an actual cost model does not provide the information needed to identify the various types of waste.
In addition to measuring all types of waste, the new lean financial model also includes a relativity measure that shows the relative percentage of cost for: 1) process consumed or value-added costs, 2) cost of waste, 3) cost of available capacity, and 4) value stream sustaining costs. Table 7 shows the details of the relativity measures for Value Stream 1. These measures are summarized in Table 8 (not included) which shows the following: For materials costs, 90.5% were process consumed or value added, while 9.5% of the costs represented waste. For labor costs, 43% were process consumed or value added, 14.4% represented waste, 7.4% were available, and 35.3% were value stream sustaining. For machine time, 43.8% was value added, 32.1% represented waste, and 24.2% was available.
from Table 7
Lean Financial Model Cost of Waste and Relatively Measure
|1. Process consumed (not available nor waste)||Unexpected||Expected||Relativity
|Labor (slower pace)||3||3,436||43.0%|
|2. Cost of waste||Unexpected||Expected||Relativity
|Materials loss (paint)||1||28|
|Cost of waste materials||9.5%|
|Cost of waste labor||14.4%|
|Wasted machine time||50||280||32.1%|
|Bottleneck cell available labor (operator)||-144||172||0.3%|
|Other labor operators available||-289||345||0.7%|
|4. Value stream sustaining||Unexpected||Expected||Relativity
|Total cost of waste (Unexpected + Expected from 2.)||1,840|
Table 7 indicates that the total cost of waste is 1,840 while the traditional reporting model in Table 4 shows only 998, a difference of 842. The lean model labels non-value adding activities as waste. For example, movement is a major type of waste in the lean model. For a cost model to be effective in a lean environment, it must be able to show whether the costs of waste have been reduced as a result of lean initiatives. The new lean model does this by measuring all types of waste, while the relativity measure is useful for analyzing the company's progress towards lean objectives in each waste category. The lean model also shows the different types of capacity including bottleneck capacity, other labor capacity, and imbalance capacity.
The lean financial model presented in this paper was developed after examining the operations and cost systems of three companies. The model integrates information from the visual boards, includes standards from the value stream maps, and separates cost variances into four categories including process consumed costs, cost of waste, cost of available capacity and value stream sustaining costs. The model provides a number of benefits that are listed in this section. For example, the new lean model provides information to support the shop floor by measuring all types of waste, by providing a way to calculate both expected and unexpected variances, by separating unit and batch costs, by separating lean improvements from normal learning curve effects, and by distinguishing between various types of capacity.
Note: This article is published in Mitchell, F., H. Norrreklit and M. Jakobsen, eds. 2012. The Routledge Companion to Cost Management. Routledge Companions in Business. (Contents).
Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part I. Journal of Cost Management (March/April): 23-27. (Summary).
Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part II. Journal of Cost Management (May/June): 24-30. (Summary).
Brosnahan, J. P. 2008. Unleash the power of lean accounting. Journal of Accountancy (July): 60-66. (Summary).
Goodson, R. E. 2002. Read a plant - fast. Harvard Business Review (May): 105-113. (How the rapid plant assessment (RPA) process can tell you if a factory is truly lean in as little as 30 minutes. The process includes two tools: The RPA rating sheet includes 11 categories for assessing leanness, and the RPA questionnaire includes 20 yes or no questions). (Summary).
Johnson, H. T. 2006. Lean accounting: To become lean, shed accounting. Cost Management (January/February): 6-17. (Summary).
Johnson, H. T. 2006. Sustainability and "Lean Operations". Cost Management (March/April): 40-45. (Summary).
Kapanowski, G. 2016. Lean fundamentals for accountants. Cost Management (January/February): 5-14. (Summary).
Kapanowski, G. 2017. Lean accounting. Cost Management (January/February): 37-41. (Summary).
Kennedy, F., L. Owens-Jackson, L. Burney and M. Schoon. 2007. How do your measurements stack up to lean? Strategic Finance (May): 32-41. (Note on Lean Accounting).
Martin, J. R. Not dated. Lean concepts and terms. Management And Accounting Web. https://maaw.info/LeanConceptsandTermsSummary.htm
Martin, J. R. Not dated. Profit Beyond Measure graphics and notes. Management And Accounting Web. https://maaw.info/ArticleSummaries/ArtSumJohnsonBromsGraphicsNotes.htm
Martin, J. R. Not dated. What is lean accounting? Management And Accounting Web. https://maaw.info/LeanAccounting.htm
Maskell, B. H. and B. L. Baggaley. 2006. Lean accounting: What's it all about? Target Magazine 22(1): 35-43. (Note).
Pickering, M. 2017. Implementing lean management reporting in lean enterprises. Cost Management (January/February): 28-36. (Summary).
Toyota Public Affairs Division and Operations Management Consulting Division. 1998. The Toyota Production System: Leaner Manufacturing for a Greener Planet. The Toyota Motor Corporation. (Summary).
Womack, J. P. and D. T. Jones. 1994. From lean production to the lean enterprise. Harvard Business Review (March-April): 93-103. (Summary).