Bad Accounting Costs You Very Dearly

In my kind of work I get to meet up with a lot of good people in manufacturing, healthcare, financial services and other companies. Often we get into a discussion about how accounting systems need to change for companies on the lean journey – or LSS or TOC or BPI or CI or TQM or …..  Usually it is fun to talk about these issues because I have a passion for it and most companies are grappling with these problems. But sometimes it goes the other way. They say to me that their accounting system uses standard costing and this gives them great information.

Here’s a recent story from Todd Atkinson that shows the fallacy of this. Mr. Atkinson has years of experience in manufacturing and currently works for company making memorialization products in Tennessee. When you read the story, ask yourself why the manager thought the pre-cut steel had a higher cost than the uncut steel.

In my youth I wSaw Blades 3elded band-saw blades for industrial OTC and mail-order customers. The established practice was to wait for the order ticket, then cut the prescribed length(s) of blade from the roll stock, weld & dress and take it up to the counter for sale.

It didn’t take long to realize that there were a limited number of end-article permutations for each variety of roll stock, and typically with very predictable consumption patterns. So I broke tradition and started to make-ahead the most common sizes, capitalizing on the same efficiency as making two pizzas instead of one. I was way ahead of Little Caesar, but way behind Ray Kroc.

Everything was going great: sales volume increased, customer wait times decreased, conversion cost went down due to touch-labor efficiency improvement, quality improved due to consistency of short-series instead of one-off production, and I got to do proactive production planning including buying an expanded quantity of roll-stock to serve increased demand, instead of just being a reactive weld-monkey. Until one of the managers got tired of noticing the increasing number of pre-made blades in stock and decided to calculate this (I believe his actual term was ‘do some cipherin”). Holy cow – that’s thousands of dollars worth of end article sitting on the shelf, that if it were left un-converted roll stock would only be hundreds of dollars. Can’t have that… I

I was instructed to go back to the old way, since we had so much money tied up in roll stock in the first place and shouldn’t run up that cost even further by converting it ahead of time. I told him that if inventory valuation was his concern he didn’t need to value it as end-article, it’s WIP until I do the ‘final inspection and packaging’ prior to delivery to the customer. No dice.

Band sawHis fears were realized when within a couple of months customer wait times increased, sales volume decreased, and now the additional volume of roll stock I had accumulated over the last few quarters languished due to lower sales volume. See – he told me it was a bad idea and look – it ended poorly. Look at all this excess roll stock inventory! No duh…

Did the pre-cut steel cost more than the un-cut steel. Of course not. The man did not work any extra time to cut the steel – no additional labor cost. Did the overhead costs go up? Of course not. Overheads are fixed. Material costs, the same. The pre-cut steel had no additional cost than the un-cut. Yet, the manager’s decision was based upon traditional cost accounting and it cost him badly. It also bankrupted GM and Chrysler in 2009.

Sadly, in my line of work, I see this kind of thing rather frequently. Fortunately there are some simple and compliant ways to prevent this madness.