Lean Accounting & GAAP – Part 1

The FASB in Concepts Statement No. 2 identifies the qualitative characteristics of accounting information that distinguishes better (more useful) information from inferior (less useful) information for decision making purposes.

The overriding criterion by which accounting choices can be judged is that of decision usefulness – providing information that is most useful for decision-making.

Business decision makers vary widely in the types of decisions they make, the methods of decision-making they employ, the information they possess or obtain and their ability to process the information.

For information to be useful, there must be a linkage between the users of financial information and the decisions they make. This linkage is provided by communicating the appropriate information in an understandable fashion.

Understandability is the quality of the information that permits reasonably informed users to perceive its significance.

Let’s compare Traditional Standard Costing and Value Stream Costing in terms of decision usefulness.

Most decision makers in a business reside outside of the accounting department, and most of them are not trained & experienced CPA’s. Is it reasonable for finance people to expect these decision makers to understand the inner workings of a traditional cost accounting system when using that information to make decisions? For them to be able to relate the numbers of traditional cost accounting to actions & decisions?

By using actual direct costs with little to no cost allocations, value stream costing is a cost management system designed for most of the decision makers in a business. Value stream costing is useful to operations people because they can now see a direct link between the behavior on the shop floor and costs.

So in terms of the GAAP concept of decision usefulness, which cost management system is better – Value Stream Costing or Traditional Cost Accounting?

 

How Standard Costs Impact Company Behavior

There are many things wrong with standard costing, but perhaps the most dangerous is when standard costing begins to drive company behavior. Here is an example.

I was working with a company recently on implementing lean accounting. The company manufactures products at one location, and sells those products in its stores. The stores also provide service on the products. The company uses a standard costing system.

The stores view themselves as the “profit centers” of the business and manufacturing as a cost center. A standard cost for every product is then required so each store can calculate its profitability. The conversation between stores and manufacturing typically revolves around manufacturing lowering its costs to improve store (and company) profitability

Upon further discussion it was revealed that the store managers & the sales force is being compensated on store profitability. Because of this compensation policy, there was resistance on the part of the stores to defining the true value streams of the company (which would include manufacturing) and calculating value stream profitability rather than store profitability.

As of the writing of this blog, this issue is still under discussion within this company and has delayed the roll out of lean accounting.

What can you learn from this story? It is vital to identify how a standard costing system is used within a company and what impact it is having on company behavior. Company management must create an action plan to move the company off using standard costing at the beginning of the lean accounting implementation process.