A Review of Lean Accounting

Through simplification and the removal of unnecessary work, accountants can achieve not just lean accounting, but leaner accounting. If done properly, the purpose of management accounting—to make better decisions—can be realized and even enhanced.

Gary Cokins of ABC Technologies states that the revolution brought about by Just-in-Time (JIT) techniques has now moved into the arena of cost accounting and performance measurement methods. Traditional systems are heavily involved in collecting and managing extensive cost accounting records. Unfortunately, the effort expended in this pursuit may exceed the benefits of the information provided.

Cokins states that the “lean management” community would prefer to see the accountants serve as change agents rather than as the “accounting police.” In pursuing traditional standard costing, accountants are trying to tell other sections of the organization where they need improvement without applying such techniques to their own operations. In this regard accountants should eliminate variance reporting, reduce the number of cost centers, eliminate detailed labor reporting, reduce the number of payable and receivable transactions, and cross-train within the accounting department. Transactions are likened to inventory in “lean” thinking—they are waste and should be eliminated.

Lean accounting seeks to break from the traditional absorption model, acknowledging that there are options to assigning costs. Ultimately, cost assignment comes down to the question, “What portion of variable costs do you include or exclude?” Taking this to an extreme is the idea of “materials-only costing,” in which materials are recognized as the only cost that is unique to the product. Any other costs are therefore costs of doing business—operational costs not related to any product. When followed in a textbook manner, material-only costing removes any recognition of heterogeneity in products. This results in over- or under-costing of products relative to actual resource consumption. In short, this “radical” approach ends up very similar to the traditional absorption model.

In stating basic principles of cost measurement, Cokins observes the following:

1) Allocating costs is bad. Allocation is, at best, arbitrary and does not provide any truly useful information for decision-making purposes.

2) Tracing costs is acceptable, but involves looking back in time, rather than being future-oriented.

What is needed is an understanding of how cost behavior varies in relation to other factors. Cokins contends that the rise in the percentage of costs that comprise overhead is due to diversity and complexity in products, services, and customers; quality level; and rates of needed change. To understand these behaviors requires the implementation of activity-based-costing (ABC) techniques. This approach will allow the accountant to obtain insight on what causes the magnitude of cost fluctuations for an activity. ABC does not replace the accounting system. It restates the same data and adds operating relationships which facilitates decision making.

Poor costing can have an adverse effect on the company’s bottom line. Misallocated costs can result in a profit condition where there are big losers and big winners. This cost subsidization has been shown to be very large, obscuring the true profitability of products. When constructing a profitability profile using ABC, it becomes apparent for many companies that by discontinuing the least profitable products, companies can significantly increase the profit picture. This profitability profile can be used to help determine the most profitable products, customers or services.

Applying these concepts to channel and customer costing reveals relationships that were previously not visible. In managing resources, decision making is enhanced through construction of an ABC/M Customer Profit & Loss Statement. The end result is better decisions are made because the data is more visible and the cost numbers have a higher degree of accuracy.

Cokins observes that lean accounting to support lean thinking is simply absorption costing, using principles of ABC/M. It must be understood that costing is a form of modeling and cost models are designed to give decision support to the purpose they are intended to serve. Leaner accounting, in Cokins’ words “involves removing some of the unnecessary work that generates little utility for the organization.” This is not the same as lean accounting.

Having dissected lean management, it is observed that lean is not the only popular management improvement program. Cokins forsees a blending of Six Sigma, Lean, and Theory of Constraints (TOC) with Target Costing and ABC/M. Each of these methods brings something to the table and can contribute to the creation of a more effective organization.