Month: January 2019

Shared Value Stream Costs

Shared value stream costs exist because resources or consumption of goods & services may be shared by value streams. Shared value stream costs are operational in nature and each value stream can influence the total cost through operational practices and decisions, however the actual spending decisions and management of the costs are outside of any one value stream.

Shared value stream costs are typically assigned to value streams when creating a value stream income statement in order to understand value stream profitability. Assigning shared costs to value streams should be done using the simplest method possible, based on how the value stream influences the shared cost.

The 3 primary types of shared value stream costs are facilities & warehouse; production monuments and operational support functions. Let’s look at each in detail.

Facility & Warehouse Costs

Facility and warehouse costs consist of the rent, interest, utilities, repairs, maintenance and depreciation. Value streams can influence total facility and warehouse costs by reducing the amount of space needed. Therefore, assigning facility and warehouse costs to value streams is best done based on space (square feet or meters).

Production Monument Costs

A production monument is a value-added process step shared by value streams.  Production monument costs consist of the direct costs of labor, material, machine and other costs. Value streams can influence production monument costs based on demand for the parts the monument must produce. Therefore, product monument costs should be assigned to value streams based on percentage of parts produced for each value stream.

Operational Support Costs

Operational support functions consist of purchasing, planning, engineering, quality, maintenance, receiving and material management. In the early stages of a lean transformation, operational support functions may exist as separate departments, which would mean these costs need to be assigned in some fashion to value stream income statements.

In the middle stages of a lean transformation, you may see some operational support work move into value streams, either by moving operational support people directly into specific value streams or moving the work into the value streams to use available capacity. The result is more direct value stream costs and less shared costs.

This process will continue as the lean transformation matures and the organizational structure moves towards more of a value stream organization, at which point there would be minimal shared costs.

Determining how to assign operational support costs to value streams can create a lot of interesting discussion, so it is best to go back to the standard explained earlier: Assigning shared costs to value streams should be done using the simplest method possible, based on how the value stream influences the shared cost.

For operational support functions that consist of primarily labor costs, it’s best to assign costs based on ratio of full-time equivalent operational support employees that work in each value stream to total employees in the function (whole numbers only). Don’t overthink this or attempt to create a complex tracking system in an attempt to be “precise.”

For example, use the 80/20 rule to determine “full-time equivalent”: If on average a certain number of employees in an operational support function spend 80% of their time in one value stream, use this number as full-time equivalent. And if this cannot be done simply and easily, don’t try to assign the costs because over time, it may get easier due to the maturity patch of shared operational support costs.

Value Stream Costing Categories

In value stream costing, we like to categorize value stream costs either as direct costs; shared costs or business support costs.

Direct value stream costs are the costs that a value stream controls through operational activities and decisions. Direct value stream costs are rather easy to identify once value streams have been identified and mapped. From an accounting perspective, value stream direct costs can easily be charged to one value stream when posting to the general ledger. The cause – the spending decision and the effect – the expense posted to the general ledger, are quite clear, direct and natural. The 4 primary types of direct value stream costs are material, labor, machine/equipment costs and other direct costs. Each of these will be discussed in detail later.

Shared value stream costs exist because resources or consumption of goods & services may be shared by value streams. Shared value stream costs are operational in nature and each value stream can influence the total cost through operational practices and decisions, however the actual spending decisions and management of the costs are outside of any one value stream. The 3 primary types of shared value stream costs are facilities & warehouse; production monuments and operational support functions. Each of these will be discussed in detail later.

Business support costs are all the other traditional organizational costs that would be considered selling, general and administrative costs. These costs are typically not assigned or allocated to value streams.

In manufacturing organizations, there could possibly be a 4^thcategory of costs – product development. Lean manufacturing organizations consider product development a separate value stream, beginning with product concept and ending with product launch and there would be applicable direct value stream costs for the product development value stream.

Material

Value stream material cost is the actual cost of material consumed by a value stream, and can be identified either at the point of purchase or the point of issuance. Purchased material is used when the 100% of the material goes into one value stream.

If purchased material is shared by multiple value streams, then the material cost would be based on material issued to a specific value stream.

Using material consumed to establish direct cause and effect relationships between material entering a value stream and the 3 operational outcomes – produce and sell (which is the desired outcome); scrap or stock.

Labor

Value stream labor cost is based on the employees assigned to work in specific value streams. Through the process of value stream organization, value streams become the primary unit of operational organization, replacing operational departments.

Once these employees have been identified, the simplest method to assign the costs are through a company’s payroll system. Payroll systems have fields such as cost centers or departments, and this allows companies to assign employees and auto post labor costs to the general ledger. Auto posting of labor costs to value streams can be accomplished by modifying the proper field in your payroll system.

If this level of detail poses an issue due to the confidential nature of salaries, it is possible to assign labor costs based on ratio of full-time equivalent employees in a value stream to total employees in all value streams. If this method is preferred, it is recommended to only use whole numbers of full-time equivalent employees and avoid fractions or percentages.

Machine & Other Costs

Value stream machine/equipment costs consist of the depreciation, repairs/maintenance, tooling and utility costs. Value stream maps identify the specific machines in each value stream, and actual costs can be recorded into the general ledger through accounts payable process.

Any other cost which can naturally be charged in the general ledger to one specific value stream can be considered a direct value stream cost. Avoid creating allocation systems in accounting to try to be precise. It’s also important to consider the materiality of any other costs because in most cases labor, machine and material costs make up the majority of direct value stream costs.

In the next blog we will look at shared value stream costs.

Lean is a multi-faceted business strategy, with a primary focus on employees and learning. Through the use of various lean tools, practices and methods, employees learn to master their work, solve the right problems and help an organization learn how to doing things tomorrow it cannot do today. That’s why we should always talk about “lean thinking” as opposed to “doing lean”.

In the broadest possible context, lean accounting is a financial learning system for the entire organization, not just the accounting function. Because the economics of Lean changes the relationships between operations and financial numbers, the whole business must learn the new relationships and incorporate the dynamic context of these relationships in their financial analysis.

Deeply rooted paradigms exist about understanding and managing costs, usually based upon traditional financial management practices, industry practices or external financial reporting requirements. Many of these paradigms conflict with lean thinking, and if these paradigms are not changed, then eventually there will be conflict between the lean strategy and cost management & analysis practices.

The solution to this problem is value stream costing, which is a set of new paradigms based on the true cause & effect relationships between lean operating practices and costs. In this series of blogs, you will learn:

• The lean thinking cost paradigms which must be established in lean organizations
• The difference between direct value stream costs and shared value stream costs
• How lean organizations define fixed and variable costs
• Examples of typical value stream direct & shared costs

Lean Thinking Cost Paradigms

Value stream costing makes a lot of sense if it is viewed through the lens of lean thinking cost paradigms, so this is the first step toward establishing value stream costing in a lean organization. As you read through the following paradigm comparison, ask yourself 3 questions:

• Which traditional cost paradigms are present in my organization?
• At what organizational levels are these traditional cost paradigms entrenched?
• What level of discussion should be established to begin changing thinking towards lean cost paradigms?

Labor

For financial reporting, labor is an expense and because of this reporting requirement, it has created traditional thinking paradigms that conflict with lean thinking. Traditional financial thinking says expenses must be managed & controlled and possibly reduced due to business conditions. This leads to managing headcount, controlling salaries and when necessary reducing the number of employees in an organization.

Lean thinking organizations view people as their most important asset. Through the use of various lean tools, practices and methods, employees learn to master their work, solve the right problems and help an organization learn how to doing things tomorrow it cannot do today. That’s the idea behind the phrase “lean thinking”. Continuously improving productivity is what matters the most to a lean organization, and as a result labor expense will be controlled.

Time & Costs

Another traditional cost management paradigm is the perceived relationship between processing time and costs: the longer it takes to produce a product or deliver a service, the higher the costs. The genesis of this paradigm is based on the desire to understand the cost of individual products or services.

Lean thinking organizations view time as their second most important asset and develop a deep understanding of value-added activities and non-value added activities. The never-ending goal is to eliminate non-value added activities (“eliminate waste”), free up capacity (time) and apply this capacity to value-added activities. The cause-effect relationship is between revenue and value-added activities: the more time resources (people and/or machines) spend on value-added activities, the more revenue will increase. Sure, eliminating waste may achieve some direct cost savings, but it will not be to the degree that revenue will increase.

Cost Analysis

Traditional cost analyses are usually based upon complex allocation schemes in order to understand costs from many aspects, such as product/service costs, business unit costs and the cost of serving customers. The primary issue with cost allocation schemes is they try to allocate as many costs as possible and the allocation bases can be quite subjective.

Cost, or an expense on an income statement is an outcome, due to operating practices or managerial decisions. Lean organizations apply “lean problem-solving methodology” to cost analysis through understanding the dynamic relationships between operating practices and spending decisions, which results in preventing costs from being incurred.

Cost Management Objectives

The two primary traditional methods to manage costs are “actual-to-budget” analysis and requiring costs to be reduced. Both are “top-down” methods where the organization sets the goals and the rest of the organization must “make it happen”.

Contrary to what some people think, lean organizations are very concerned about costs. The general goal is to reduce costs over time through:

• Continuous improvement
• Clearly understanding the dynamic cause-effect relationships between operating performance, capacity requirements and actual costs.

Fixed & Variable Costs

Traditional definitions of fixed and variable costs are usually based on conventional cost accounting systems in manufacturing, where labor, material and overhead are assigned to products. In this environment, direct labor is often considered variable and in some systems a portion of overhead is considered variable.

Lean organizations tend to shy away from using these traditional definitions of fixed and variable costs. Variable costs are defined as costs that vary with volume in the short term. Fixed costs do not vary with volume in the short term and are typically influenced by management decisions.

In the next blog we will look in detail at value stream costing.