Removing Standard Costs from the Income Statement

Removing Standard Costs from the Income Statement

Creating value stream income statements is the second part of a lean decision making framework that is not based on a standard costing system. The value stream income statement is an essential element of lean decision making due to how lean practices & methods impact profitability. It’s important for accountants to understand the “lean logic” behind a value stream income statement, as follows:

Value Streams – the lean definition of value streams is the sequence of activities from order receipt to shipment that are necessary to create the product to ship to the customer. Lean manufacturing companies organize, manage & control by value stream. The accounting definition of value streams is they are your company’s profit centers.Therefore, internally we will want to look at value stream profitability.

Flow – the lean definition of flow is to move all orders as fast as possible through a value stream from receipt to shipment by employing lean practices and eliminating waste.  From an accounting viewpoint, maximizing flow maximizes value stream profit. Improving flow impacts both value stream revenue and costs. The faster the flow, the more revenue will grow. Eliminating wastes controls total value stream costs.

The first step to creating a value stream income statement is to understand your company’s value streams. I recommend accounting sit down with your company’s lean leaders to look at your value stream maps & discuss the value stream organization. Value stream maps show the flow of products through each value stream and identifies the process steps required in each value stream. The value stream organization is the actual people, machines & resources that work in each value stream.

From this discussion, it should not be difficult for accounting to assign the actual direct costs to each value stream, such a labor, facility and machine costs. All these costs are in your general ledger and usually assigned to departments or cost centers. I recommend accounting do a reconciliation between the departments/cost centers in the general ledger and the value streams. This reconciliation will serve as a template to create most of the value stream costs.

Material costs are most difficult to assign to a value stream. The general rule is to use the actual cost of material consumed during a period, which may not match exactly with the products sold. It is important for accountants to remember that a value stream income statement is for internal use only and needs to reflect actual costs.

What is important for accounting to remember is it is not trying to assign every manufacturing cost to a value stream, only the actual costs the value stream can control. In a value stream income statement, we don’t want to use cost allocations. I like to think of this cost assignment as putting costs where the spending decision is made.

When creating a value stream income statement, think of your customers – lean operations and management. What they value is knowing exactly how profitable each value stream really is based on actual revenue & actual costs, not based on artificial standard costs.

In the next blog, we will look at how to use the value stream income statement to make lean business decisions.