As more manufacturing companies embrace the Lean Manufacturing concept, a new method of accounting has begun to unfold within them. Historically, the production side of the business would make tremendous gains during Lean implementation such as: reducing inventory, achieving one-piece flow work cells, reducing lead times, improving productivity, etc. But these organizations soon found out the "other side of the wall" (i.e. accounting staff) weren't capturing these improvements. As you can imagine, this caused tensions between departments and with management.

The reason traditional accounting measures weren't capturing improvements, at least early-on, is the old absorption method of accounting. This worked great when labor expenses made up the majority of expense. Allocating overhead was minimal and logical. But in today's business environment where labor costs are 10 to 20 percent of production costs and material costs are the big expense driver, it doesn't always make sense to allocate overhead based on labor.

As companies "go Lean" and reduce inventory, all the old, allocated overhead is transferred from an inventory account to a current period expense. That means prior period costs are expensed in the current period which makes the current period results look bad. This is where most companies abandon some or all of their Lean gains – because management and accounting aren't prepared for this near-term hit to profits.

Lean Accounting seeks to counter this old way of thinking and prepares management for the near-term reduction in income. Huge gains will be made on the cash flow side to offset near-term income and the company will be in better long-term position to dominate the market. Accounting transactions become less complex and more relevant to operations.

Companies that embrace Lean Accounting consider their accounting staffs as partners with production. Accounting is a vital change agent in these businesses. They work together to create metrics and goals that support Lean behavior. Complex accounting methods such as absorption accounting which very few engineers, operations managers and front-line workers understand is replaced with variable costing or material only costing. Value streams are developed which help track costs and profits and provide valuable make vs. buy decision-making. Labor costs become more and more fixed. Soon you have a team of people working together in a Lean Enterprise to serve customers especially well – which is what you're in business to do.

If you have questions about Lean Accounting, please contact your Rea associate.

- By Dustin Hostetler (Wooster office)

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