Accounting For The Lean Enterprise

Management Control
Systems
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Statements on Management Accounting
Management Control
Systems
Accounting for the Lean Enterprise

Major Changes to the Accounting Paradigm
About the Authors
The IMA would like to acknowledge the work of Dr. Frances A. Kennedy of Clemson University and Brian
H. Maskell of BMA, Inc., on whose work this SMA is based, and Peter Brewer of Miami University, Gary
Cokins of SAS, and Jean Cunningham, Business Consultant, who served as reviewers.
Published by Institute of Management Accountants

10 Paragon Drive, Suite 1
Montvale, NJ 07645
www.imanet.org
2014 in the United States of America by Institue of Management Accountants All rights reserved
Table of Contents
Executive Summary...........................................4
Glossary.....................................................31
Introduction....................................................4
Additional Resources.................................33
Scope.............................................................7
Lean Principles and Accounting
Exhibits
Implications....................................................8
Major Changes to the Accounting Paradigm.....9
Exhibit 1: Traditional and Value Stream
Value Stream Costing......................................10
Income Statements....................11
Value Stream Income Statements............10
Exhibit 2: New Order Decisions................13
Value Stream Unit Costs..........................11
Exhibit 3: Make or Buy Decisions...............15
Decision Making.............................................13
Exhibit 4: Box Score Format......................17
Margin and Profitability Analysis..............13
Exhibit 5: Product Rationalization
Product Pricing and Quoting..................14
Format.......................................17
Make vs. Buy Decisions............................14
Exhibit 6: Impact of Product Decisions......18
Performance Measurements....................15
Exhibit 7: Measuring Short-Term Financial
Financial Reporting..................................18
Impact of Change......................19
Product or Customer Rationalization.......18
Exhibit 8: Measuring Financial Impact of
Measuring Cost Improvement.................18
Increased Capacity.....................21
Transfer Pricing........................................20
Exhibit 9: Inventory Value Example...........22
Inventory Valuation..................................20
Exhibit 10: Impact of Bottleneck on
Summary of Decision Making in Lean
Product Cost..............................24
Accounting............................................23
Exhibit 11: Product Cost Conversion
Features and Characteristics.........................23
Chart.........................................25
Lean Budgets and Financial Planning..........26
Exhibit 12: Transaction Elimination Planning
Transaction Elimination..............................27
Example: Eliminating Work
Conclusion................................................30
Orders........................................29
Management Control
Systems
Executive Summary
effective by applying new techniques for production, delivery of service, design of products, and
As companies transition from traditional manage-
administration of support activities. But when
ment methods to a lean enterprise, their account-
you look more deeply at these new methods
ing, control, and measurement systems need to
known collectively as the lean enterpriseit be-
change. Traditional accounting systems such as
comes clear that this is not just another improve-
full absorption costingwere designed to sup-
ment program but a fundamentally new way of
port management principles like mass produc-
conducting business. These changes require dif-
tion, top-down command and control, depart-
ferent kinds of accounting systems. Transforming
mental optimization and budgeting, and a focus
a company through the application of lean think-
on shareholder (or owner) value. The principles
ing changes almost every aspect of its operation.
of lean thinking are quite different from those
These changes are based on different assump-
of traditional management methods. Traditional
tions about the business. Lean thinking changes
accounting systems can be detrimental to lean
the way a business is managed by moving from a
companies because they motivate behaviors that
command and control bureaucracy to an organi-
undermine the principles of lean thinking. Lean
zation based around empowered teams.1 Lean
accounting methods are designed to support the
thinking changes an organization, transforming
transition to a lean enterprise.
top-down, project-driven improvement led by
This Statement on Management Accounting
middle managers into continuous improvement
(SMA) is the second of three SMAs addressing
conducted throughout the company by locally
the impact of lean on organizations. The first,
empowered teams. A team-based organization
Lean Enterprise Fundamentals, serves as a start-
needs a different kind of financial and perfor-
ing point in the exploration and implementation
mance reporting system than a traditionally man-
of lean concepts. It illustrates core ideas and
aged one.
provides finance and operations professionals
Lean thinking changes the way a company
with a basic understanding of lean processes, its
views its customers. Lean organizations seek to
applicability to their organization, and its unique
maximize the value created for the customer.
challenges. This SMA focuses on the information
They are outward-facing organizations focusing
necessary for value stream costing, a product fam-
on the customers needs rather than the some-
ily view of costs, decision making, budgets and
what inward-looking organizations prevalent in
financial planning, and transaction elimination.
the 20th century. Lean organizations recognize
A third SMA, Applying Lean Fundamentals
that their customers needs change, and often
beyond the Manufacturing Floor, expands the
rapidly, so they build flexibility into every aspect
lean accounting principles to the entire enterprise
of their processes. Rather than relying on middle
and discusses performance measurements
management heroes to expedite products
for lean organizations.
and services through poorly designed processes,
Introduction
flexibility and continuous improvement are built

on the foundations of the stability and standardization of company processes. This requires new
Organizations are changing the manner in which
kinds of financial information and performance
they produce and deliver products and services
reporting designed to enhance stability, motivate
in order to respond more quickly to changing

competitive environments. At first sight, these
changes appear to be just more programs
designed to make a company more efficient and
1 Womack, James, and Jones, Daniel. Lean Thinking: Banish Waste and Create Wealth for Your Corporation. New
York: Simon & Schuster, 1996.
Management Control
Systems
continuous improvement, and quickly identify is-
stream team is to create more customer value
sues, problems, and changing customer needs.
and eliminate waste throughout the entire value
Lean organizations are visually controlled.
stream using standard continuous improvement
The information required to run a business is
methods. Managing by value stream requires
posted visually at the places it is needed. Instead
that information be configured to reflect this new
of managers having meetings to discuss lengthy
organizational form.
reports, all routine management of a business is
There are different kinds of value streams.
conducted at the place where the work is done
Within manufacturing and distribution organiza-
using visual reporting, which is often displayed
tions, there are order fulfillment value streams
manually on tracking boards in the area. Empow-
and product development value streams. Order
ered teams and responsive processes require the
fulfillment value streams start at a sales process
availability of timely data presented in ways that
and run through the manufacture and delivery
people can readily understand and use. Control
of the products to the customer, followed by
systems move to clear and timely reporting that
invoicing and cash collection. Product devel-
everyone in the organization can immediately
opment value streams start with ideas for new
understand and use.
productseither initiated by needs expressed by
The traditional organization has many lay-
the customers or by people within the company
ers of supervisory management with functional
developing entirely new product concepts
reporting responsibilities. Information is reported
through to the specification, design, materials
up the chain of command, where decisions are
sourcing, launch into production, and launch into
made and communicated back down to the op-
the marketplace. These value streams cut across
erating level. Many organizations (not necessarily
the familiar departments of traditional companies.
lean) have moved to a more decentralized model
Information, materials, and cash flow horizontally
with fewer layers and decision making closer to
through the value stream rather than through the
the customer. The traditional organization has
vertically organized departments of the company.
come a long way but needs to go further still.
Service industry value streams similarly cut
Organizations that have transitioned to lean op-
across traditional departmental organizations.
erations have fewer layers of management. Fewer
The cardiac care value stream within a hospital
layers mean a greater span of control. In other
encompasses within it all the steps required to
words, a single manager has a larger number
serve the customer. They seek to eliminate waste
of direct reports for which he or she is respon-
from the process in order to provide the customer
sible. Decisions are pushed down to lower-level
with fast and effective care, delivered with a hu-
empowered employees who are closer to the
man face. Value streams within financial services
customers.
organizations travel across many traditional
Another structural change is the moving
departments in order to supply the customers
from a functionally-segregated organization to
with their mortgage, insurance policy, or pension
organizing by value streams. A value stream is the
plan quickly and easily. Educational institutions
sequence of processes through which a product
recognize that value is created for their customers
is transformed and delivered to the customer.
through many different aspects of the organiza-
By design, a value stream spans multiple func-
tions structure and seek to provide better value
tions, such as production, engineering, mainte-
by recognizing the horizontal flow required to
nance, sales and marketing, accounting, human
maximize the value for their multiple customers:
resources, and shipping. Similar value streams
student, parents, and employers.
can be identified within service organizations

such as hospitals and banks. The goal of a value
While lean thinking currently has greater

penetration in manufacturing and distribution
industries than in service industries, the same
Management Control
Systems
principles impact service organizations in similarly
professionals reassess the information and reports
radical ways.
supplied to a companys decision makers. First,
Moving a company from a departmental to a
traditional periodic departmental expense reports
value stream orientation can be achieved through
are typically supplied to functional managers who
reorganization of the business or by using a
are accountable for the costs originating in their
matrix management approach. It is not always
departments.
necessary to restructure the organization chart. It
In a value stream organization, the value
is important that the challenges of silo behavior
stream manager and his/her team are the primary
and performance incentives be addressed. (See
users of the financial information, which is used
the SMA, Applying Lean Fundamentals beyond
for cost control and decision making. Functional
the Manufacturing Floor.)
managers may also use this information, but it is
The product and process flow changes

from a forecast-driven push environment to a
customer-driven pull system. A typical push
oriented to the value stream rather than functional departments.

Second, traditional product costing methods
system will build product according to forecast
dictate that overhead costs be absorbed into
and store it until the sales force seals the deal
product costs. Absorption costing inherently
with the customer, which can result in high inven-
motivates overproduction because the more vol-
tories and greater risk of obsolescence. In a pull
ume produced, the lower the unit product cost.
environment, production is triggered when the
A value stream organization enables a simple
customer places an order. Consequently, custom-
summary direct costing with little or no allocation
ers individual needs can be met, and excess
of costs.
inventory and obsolescence is avoided. This
Third, the traditional mindset is that produc-
change in trigger from forecast to customer order
ing larger batches (or providing services only at
requires a rather different information flow within
scheduled times) reduces overall costs due to
operations.
the efficiencies gained from avoiding extra setup
In service industries, the push mentality results
and movement costs. This mindset is deeply
in airlines over-booking flights and bumping
embedded in traditional management thinking
customers. The push system mentality results in
along with the idea that division of labor creates
service centers staffed by the lowest paid and
efficiency. Traditional accounting systems often
least experienced employees trying to solve
reflect this mode of thinking. These tenets are
problems using databases. These people are
contrary to lean production, and lean accounting
measured and compensated by the number of
methods seek to provide financial information
calls they process rather than by the effectiveness
that supports lean thinking and lean methods.
of solving the customers problems. In hospitals,
The impact of lean changes will flow through
the push system manifests itself through schedul-
an organizations accounting systems and be
ing people across blocks of time and expecting
reflected in its financial statements. Many finance
them to sit around waiting for hours.
professionals within companies embarking on
Software companies that update your com-
such a transformation do not recognize that their
puter automatically but do not provide anyone
traditional accounting systemsbased on stan-
you can talk to when the update does not work,
dard overhead absorptionwill not accurately
relying instead on FAQs (frequently asked ques-
reflect the economic benefits from transforming
tions), also exhibit this mentality. Reorganizing
to a lean organization and, in fact, may present
into value streams and converting to a customer-
a distorted view of the economic impact of the
driven pull system necessitates that accounting
changes. While some organizations can ignore

the accounting problems because their executive managers have a high level of commitment
Management Control
Systems
to and understanding of lean thinking, other
outsourcing, without using standard costing
organizations may find that traditional accounting

reports, measurements, and methods will under-
as a base.

provide a product-family view of product
mine their lean transformation. New accounting,

control, and measurement methods are needed.
Given the importance of the accounting informa-
costs.

tion support system in an organization, accoun-
Budgets and financial planning reflect a value

stream reporting structure including box
tants must determine what information is needed

by people within lean organizations and in what
Features and characteristics cost calculations
score format and/or value stream statements.

form that information needs to be provided.
Transaction elimination challenges accounting to readdress the value of collecting and

recording data using transactions and reports
Scope
in favor of simple visual management methods.
This Statement on Management Accounting
The second SMA, Applying Lean Accounting
(SMA) is addressed to financial professionals who
Fundamentals beyond the Manufacturing Floor,
seek to provide information that is both decision-
strives to expand the lean accounting principles
relevant and increases process understanding in
discussed in this SMA to the entire enterprise.
organizations that are adopting lean principles.
Topics include:
The lean accounting concepts discussed in this
Performance Measurement Linkage: Key
document apply to:
to the success of any organization is the
thoughtful and explicit linkage of organi-
large and small organizations,

enterprises in the manufacturing and services

zational goals and objectives to the value
industries,
stream and cell goals and measurements.
public and private, and
This topic introduces how development of a

for-profit and not-for-profit organizations.
performance matrix in a value stream organization may be accomplished.
This SMA does not address general business
Accounting Organizations: Lean processes
practice; it specifically applies to companies
become a part of the way all areas of the
making the transition to a lean enterprise. These
organization perform their jobs. Accounting
companies apply the principles of lean thinking
and finance departments can look within
to every aspect of their organization, leading to
their own processes to identify wasted re-
radical change throughout the company.

Lean accounting practices are summarized in
sources and streamline processes.

Service Organizations: The heart of lean is
two SMAs. (A third SMA, Lean Enterprise Fun-
the management of processes. Though it is
damentals, discusses the impact of lean prin-
easier to visualize with a tangible product,
ciples on organizations as a whole). This first
lean principles also address organizations
lean accounting SMA, Accounting for the Lean
that provide services to its customers. In fact,
Enterprise: Major Changes to the Accounting
many service organizations naturally pull on
Paradigm, includes five topics:
demand from their customers as this is the

Value stream costing introduces an income
statement format to control costs, promote
nature of their business.

Sales and Marketing: Critical to the continu-
lean behavior, and monitor performance.
ing growth of the business, sales and market-
These income statements replace traditional
ing must be attuned to the changes and
statements and cost reports.
opportunities within the value streams. These

Decision-making methods summarize how to
make decisions, such as quotes, orders, and
Management Control
Systems
functions begin to think in terms of product
through traditional, project-based changes but
families and frequently readdress their plan-
through continuous improvement methods
ning mechanisms.
known generically as kaizenengaging the entire
Target Costing: In lean organizations, target
work force.
The backbone of lean processes is a carefully
costing is a major driver of change and
improvement throughout the value streams.
constructed conceptual architecture that supports
It starts by thoroughly understanding how
the structural, interpersonal, external, and internal
customer value is created by a family of
relationships governing a companys operations.
products or services and how the products
This architecture creates the platform for account-
and processes must change to create more
ing to support the decisions that govern these re-
value for the customer, and then drives pro-
lationships. The five principles of lean are derived
cess changes to bring product and service
from Womack and Jones.2 They include:
costs into line with the value needs of the
Value: Lean starts with a definition of what
customer and profit and cash needs of the
constitutes value from the customers stand-
business.
point in terms of the features and character-
Implementing Lean Accounting Practices: As
istics of the product or service.
operations demonstrate control over specific
Implication: Rather than targeting a
processes, the accounting practices that sup-
predetermined standard product cost
port each of those processes can adapt as
and motivating managers to overpro-
well, eliminating a myriad of nonvalue-added
duce in an effort to reduce variances,
transactions. Maturity paths useful for plan-
a lean enterprise continually redefines
ning implementation activities are outlined.
value based on the customer rather than

an internal standard. Lean organizations
Lean Principles and Accounting

Implications
have formal methods for defining and

calculating customer value.

Value Stream: The value stream is the
Lean production is a term used to describe a
sequence of processes through which a
manufacturing approach that combines the best
product is transformed from raw material to
elements of craft and mass production while
delivery at the customers site. Normally, a
seeking to avoid the high cost of the craft set-
value stream is defined by a group of related
ting and the rigidity of mass production. Lean
products or services that employ the same
concepts have now broadened to include service

companies and the entire organization. Conse-
process steps.

Implication: Traditional accounting seeks
quently, the term lean enterprise is a more in-
to calculate standard costs for a product
clusive descriptor. Lean enterprise goals include:
or service by assessing the labor and
improving quality and customer satisfaction, cre-
other (so called) direct costs required to
ating more value for the customers, eliminating
provide the service or make the product,
waste, reducing lead time, and reducing costs.
and then allocating associated support
Lean enterprise begins with a deep under-
costs to the individual product or
standing of how the organization creates value

for the customer and how this value is created
through the companys value streams. Lean orga-
2 The five principles of lean thinking given here differ
nizations continuously change their processes so
slightly from those presented by Womack and Jones.
that more resources are devoted to value-creating
The principle of empowered teams has been added to
tasks and so that tasks that create no value are
show the importance of people in the sustained success
minimized or eliminated. This does not occur
of a lean enterprise.
Management Control
Systems
service. Lean organizations do not focus
performance measurement seek to man-
on the cost of individual products or
age and control the process by provid-
services; they focus on the total cost of
ing people with appropriate and timely
the flow through the value stream. Tracking value stream costs and profitability
Perfection: Perfection is defined as 100%
provides understanding, insight, excel-
quality flowing in an unbroken flow at the
lent cost control, and leads to effective
pull of the customer.
continuous improvement.

information.

Implication: Traditional accounting
Flow and Pull: The production process is de-
defines perfection as meeting prede-
signed to maximize the flow of the product
termined standards. In a lean structure,
through the value stream, initiated by the
empowered teams at every level within
pull of customer demand.
the value stream strive to continuously
Implication: Traditional production
improve their processes so as to provide
planning and purchasing is based on
perfect, high-value products and/or ser-
a forecast-driven system that internally
vices to their customers. Improvement
generates demand and initiates mate-
is not driven by projects; this continuous
rial purchases and production orders.
improvement is relentless and perma-
Optimal production is considered as
nent. The accounting and measurement
being attained through large batches
systems need to actively support the
influenced by the false reasoning that
quest for perfection. They must provide
product unit costs are reduced with
timely, valid, and understandable infor-
large batches. Performing to budget
mation to provide control and motivate
rather than customer demand is a key
continuous improvement.
performance metric. This results in ex-
More in-depth discussion of these lean principles
cess inventory that utilizes resources and
can be found in Lean Enterprise Fundamentals.
increases risk.

Empowerment: The system of measurements
and controls provides each employee with
Major Changes to the Accounting

Paradigm
the information and authority to take necessary action at the time it is required.

Traditional accounting systems present a frozen
Implication: Traditional responsibil-
view of operations that doesnt reflect the con-
ity accounting provides information
tinuous improvement goals of the lean enterprise.
to managers and supervisors (usually
In order to provide a more balanced, dynamic
lagged) for them to use in managing
view of their performance, many organizations
outcomes. The result of this is that there
have supplemented their traditional accounting
is a tendency to manage people rather
systems with dashboards and scorecards reflect-
than processes. Recent advancessuch
ing key performance indicators (KPIs) based
as business process management (BPM),
on operational data. Lean accounting further
business intelligence (BI), operational
advances changes to the accounting paradigm
dashboards, balanced scorecards, and
by utilizing the following five principles that guide
strategy mapshave begun to address
accounting for lean processes.3
this issue. Lean techniques help facilitate
this evolution by providing information
Lean and simple business accounting applies

lean methods to accounting processes
that is real-timedeveloped and maintained by those using the information

in daily decisions. Lean accounting and
3 Developed at the 2005 Lean Accounting Summit.
Management Control
Systems
eliminating waste embedded in transaction pro-
stream, and creating high-quality processes for
cesses, reports, and accounting methods.
manufacturing products, providing services, and
Accounting processes that support lean
administering the support activities. In many lean
transformation focus on measuring and
companies, the value stream managers respon-
understanding the value created for the
sibilities include growing the business, increasing
customer by concentrating on the entire
customer value, eliminating waste from every
value stream rather than individual products
process, and increasing cash flow and profitabil-
or services.
ity. The value stream team needs timely, valid,

Clear and timely communication of informa-
and readily understandable financial information.
tion is evidenced by easy-to-understand ac-
Lean accounting provides income statements for
counting reports that are provided frequently
each value streamusually every weekand uses
and not locked in to a monthly reporting
these to control costs, make decisions, and drive
cycle.
improvement.
Planning from a lean perspective involves

people who are responsible for achieving
Value Stream Income Statements
results and are actively involved in setting
goals. The process begins with a top-level
Value stream income statements reorganize and
strategic plan (using methods like Hoshin
report information in user-friendly ways. Whereas
Strategy Deployment) and is then rolled out
traditional income statements present information
to business unit leaders and value stream
on cost of goods sold, applied overhead, and
teams (using methods like sales, operations,
manufacturing variances, value stream statements
and financial planning).
highlight material purchases, employee and
Strengthen internal accounting control when
equipment costs, and facility costs. It uses plain
eliminating transactions through prudent
language that all value stream team members can
planning. It is essential that accounting
understand. Exhibit 1 compares traditional and
controls and transactions not be eliminated
value stream income statements for a single facil-
prematurely, but only when operations dem-
ity having two value streams.

First, note that the top and bottom lines for
onstrates sufficient process control. Process

maps identify control risks and subsequently
the total facility are the same. What changes is
include changes to mitigate these risks.
the assignment of costs to value streams and

the lucid way in which these costs are presented.
Each of these principles steers the transformation
Whenever possible, costs are assigned directly
of accounting practices from traditional methods
to value streams rather than allocating to cost
to supporting leanby thinking lean. The remain-
objects. This includes costs associated both with
der of this document describes in greater detail
personnel and with machines. There are occasions
five key areas where accounting can actively sup-
where a particular resource is not dedicated to a
port lean processes.
specific value stream, but is shared across multiple
Value Stream Costing
value streams, and its use must be allocated using simple activity drivers. These allocations of
monument costs must be minimized. Other key
10
Managing the entire value stream is the core
differences include the following:
of successful lean enterprises. Value stream
Sustaining Costs: One difference is the
management includes value stream mapping,
separation of necessary costs that support
under- 7
the overall facility but cannot be directly
3 Developed at the 2005 Lean Ac-
counting Summit. standing customer value,
associated with value streams. These are
eliminating waste and delay throughout the value
considered sustaining costs and are shown
Management Control
Systems
Exhibit 1. Traditional and Value Stream Income Statements

Exhibit 1
Traditional Plant-Wide Income Statement
Sales
COGS at standard
Gross Profit
$5,563,374
$3,711,884
$1,851,490
100.00%
66.70%
33.30%
24,485
31,380
64,527
$34,392
$154,784
0.40%
0.60%
1.20%
0.60%
2.80%
$1,696,706
30.50%
$96,006
$429,797
1.70%
7.70%
$525,803
9.50%
$1,170,903
21.00%
Material Variances
Labor Variances
OH Variances
Scrap
Total Variances
Gross Operating Margin
Operating Expenses
SG&A
Distribution Costs
Total Operating Exp
Net OI
Value Stream Income Statements

VS1
VS2
Sales
$ 2,708,333
$ 2,855,041
Material costs
Employee costs
Equipment-related costs
Occupancy costs
$ 1,040,000
$
190,667
$
156,000
$
120,022
$
$
$
$
Other value stream costs

Value stream profit
$
$
$ 114,461
$ 1,063,308
46%
Inventory reduction or
(increase)
Profit
296,942
904,702
33%
691,189
393,575
357,682
234,826
Sustaining
Total Plant
$ 5,563,374
358,963
36,528
$ (395,491)
$ 1,731,189
$ 1,095,413
$
496,780
$
391,376
$
411,403
$ 1,437,213
28%
$
181,436
$ 1,255,777
Corporate allocation
Net OI
$ 1,170,903
ROS
84,874
21.0%
11
Management Control
Systems
separately on the statements. These costs
ry. The value stream team members can associate
often include facility costs, management and
actions and decisions with their impact more eas-
support personnel costs, and other functions
ily when dealing with information pertaining to
such as IT and HR that are not associated
the prior week. Reporting more frequently gives
with the value stream directly. There is no
the value stream managers better control of their
requirement to absorb these costs into the
costs.
value streams; they are reported and controlled separately.

Value Stream Unit Costs
Changes in Inventory: Lean methods result in

reducing stockpiles of inventory. In tradi-
Standard product costing practices are at odds
tional accounting these inventory changes
with lean principles. One problem is that standard
impact the profitability of the company. In
costs are predetermined and usually outdated
lean accounting, these inventory changes are
and inaccurate for current decision making be-
segregated and then applied as below the
cause lean organizations are constantly improving
line adjustments. These inventory changes
and changing. A second problem is that manag-
are reported for the whole entity, not the
ing operations within a standard costing system
individual value stream. This provides a clear
requires monitoring and explaining myriad manu-
understanding of the impact of inventory
facturing variances. Most of the information is too
change while giving the value stream manag-
late to have diagnostic value on the shop floor.
ers information about the real profitability
A third problem is that these variances are easily
of their value stream uncluttered by the
manipulated by building more inventory than
complexity of absorption costing. When
necessary. A fourth problem is that tracking and
value stream inventories become very low,
monitoring this information requires complicated
this issue largely goes away.
and wasteful reporting systems.
Occupancy Costs: Facility costs, such as elec-
Value stream costing provides a vehicle to
tricity and property taxes, can be assigned to
monitor the cost of products easily and currently.
value streams according to the square foot-
Value stream cost per unit is calculated by divid-
age actually used by each value stream. This
ing the total value stream costs (from the value
provides incentive for the team to figure out
stream income statement) by the total number of
ways to use less space. This freed capacity is
units shipped. For example, the total costs for the
highlighted on the value stream statements
first value stream in Exhibit 1 are $1,803,631, and
and underscores key areas of opportunity to
the number of units shipped is 150,000. This yields
grow the business. There is no attempt to
a value stream cost per unit of $12.02. Using ship-
fully absorb facilities costs. The value stream
ping units as a base provides incentive to reduce
managers are charged only for the space
inventory rather than to build excess inventory.
they use.
This average cost of products or services is used

as a performance measurement and is a general
The cost of the remaining space is charged to
indicator of process improvement. There are two
sustaining costs. A final aspect of value stream
issues that need to be addressed: the cost of the
income statements concerns the frequency of re-
products and the weekly variability of these costs.
porting. It is common for these statements to be
Lean companies aim for consistent cost reduc-
provided on a weekly basis. Weekly statements
tion and very little fluctuation from one week to
have the advantage of tapping into recent memo-
the next. Many companies find that weekly cost

reporting reveals previously unrecognized instability in their sales and shipping processes. This
instabilityoften caused by internal budgets and
12
Management Control
Systems
Exhibit 2. New Order Decisions
incentivesis damaging to flow, cost, capacity
ers is done using the profit and profitability of the
usage, and customer service.
value stream as a whole.
Decision Making
uct costs of an individual product can be mislead-
Comparing the price and the standard proding because the standard product cost does not
Once a facility has established clear value
show the true financial impact of the transaction.
streams, value stream costing is quick, simple,
Showing the profitability of the value stream as
easy to use, and provides the financial informa-
a whole provides correct and useful information.
tion to control the business and report externally.
Assume, for example, that a company receives a
But it does not provide product costs. In value
request for a quote from one of its major custom-
stream costing, we cost the value stream, not the
ers. For the next 12 months, the customer plans to
products. It may be difficult to see how a business
purchase 2,500 units of a standard product made
can be run without knowing the cost of its prod-
by the company each month, for a total of 30,000
ucts. These are some of the reasons companies
units over the year. The customer provides a
use standard product costs:
target price of $130 per unit. The standard cost for

Margin and profitability analysis,
the product is $137, and it appears the company

Product pricing and quoting,
will lose $7 on every unit. The logical decision

Make vs. buy decisions,
would be not to accept the order.

When we look at this proposed sale from
Performance measurement,
Financial reporting,
a value stream costing point of view, we see a
Product or customer rationalization,
different picture. In order to fulfill this order, the
Measuring cost improvements,
company will need to invest in new equipment
Transfer pricing, and
and take on three more employees. Exhibit 2
Valuing inventory.
shows the value stream cost information.

Adding this proposed order to the value
We will address each of these requirements and
stream is far from unprofitable. The proposed
show how they are accomplished using value
order would bring additional profit of $143,700
stream costing information.
each month and raise the profitability of the value

stream from 33.4% to 34.6%.
Margin and Profitability Analysis
The decision on whether to take the order is a

business decision. There are many other factors to
Assessing the financial impact of a new sales pro-
consider in addition to the costs and profitability
posal or request for quote, products, or custom-
of the order. But from a financial point of view, this
13
Management Control
Systems
order is quite profitable. The standard product
inadequate value for the prices they are asked
cost and margin give misleading information
to pay. Cost-plus pricing portrays an inward view
that in turn leads to poor decision making. Value
that is focused on recouping costs rather than
stream costing gives information that can lead to
maximizing the value for the customer.
better decisions.
Under lean accounting, most financial analysis
Successful value-based pricing requires more

than just understanding what the market will
for decision making is done using the effect of the
bear. It requires a proactive strategy for recog-
proposed changes on the profitability of the value
nizing customer value, creating products and
stream as a whole, not the individual products.
services that provide superior value, and pricing
The approach is consistent with the practice of
the companys offering to gain exceptional overall
some companies of using activity-based costing
profitability. In addition, value stream costs can
(ABC) for process costing.
be beneficial for understanding the profitability of

different product families.
Product Pricing and Quoting
Toyota Motors constantly demonstrates skills

in strategic value pricing. Toyota brand vehicles
Most organizations focus on customer value.
are priced at around $2,000 more than similar
Some are successful, many are not. Most are not
cars from U.S. manufacturers. The public buy
lean companies in terms of all the principles
these cars by the thousands because they place
of lean, but they use some elements of lean. A
high value on the vehicles reliability, design,
major contribution of lean is its heavy focus on
and features. When Toyota first introduced the
customer valueit is a primary principle of lean
Lexus brand, it designed a product to match the
thinking. Lean organizations have formal meth-
prestige European automakers such as Mercedes
ods for understanding and quantifying the value
and BMW, but it priced its cars at $10,000- $15,000
created for the customer. Target costing is one
below these competitors. Lexus sales soared,
method that establishes a framework for defining
and the European companies suffered severe
value and cost. All prices are set from a clear and
setbacks. Toyota recognized in the late 1990s that
profound understanding of the value created for
the car of the 21st century must be environmen-
the customer by the companys products, service,
tally friendly and urgently developed hybrid vehi-
and other attributes.
cles, such as the Prius. These vehicles were priced
A traditional approach to product pricing is to
much higher than Toyotas conventional cars but
include cost as an important factor in determining
sold rapidly because a segment of its customers
a products tentative selling price (to be subse-
values high gas mileage and low emissions.
quently adjusted, as needed, for other factors). A

simplified view of this approach would be:
Target costing and its applications are discussed in greater depth in the two SMAs titled
Implementing Target Costing and Tools and Tech-
PRICE = STANDARD PRODUCT COST + MARGIN

Lean organizations, utilizing target costing,
niques for Implementing Target Costing.
Make vs. Buy Decisions
turn this around:

Returning to our example above, if the comCOST = VALUE - REQUIRED PROFIT
pany had been unhappy with the profitability of

the product, they might decide to outsource the
Even traditional companies do not completely
item from a local supplier. The supplier quotes it
rely on cost-plus pricing because their sales
a price of $115 to make the product. With a target
and marketing people soon discover what the
price of $130 per unit, this provides a 12% margin.
customers will pay and what they consider to be
14
Management Control
Systems
Exhibit 3. Make or Buy Decisions
Though better than incurring a loss, this is still

considered a low margin for this company.
Comparing this approach using value stream
What behaviors are motivated by such measurements as earned hours, labor efficiency, and
machine utilization? The metrics are designed
costing is quite simple. The result is shown in
to motivate people to maximize the amount of
Exhibit 3.
standard hours earned in any one day or week.
There is no financial benefit from outsourc-
They motivate people to make large quantities.
ing this product to the local supplier. Based on
They also motivate people to manufacture large
this analysis it would be more advantageous
batches of products so as to minimize the effect
to make the product in-house. Once again, we
of change-over time. The production people
need to recognize that a business decision has a
will make large batches, manufacture out of
number of other issuesmany nonfinancialthat
sequence, and cherry pick production jobs
must be taken into account, but from a financial
that yield high earned hours. There may also
perspective, making the product in-house is more
be a tendency to make quantity at the expense
beneficial.
of quality, which leads in turn to the need for

increased inspection. In short, these measure-
Performance Measurements
ments motivate people to do the opposite of lean

manufacturing. They will motivate people to build
Traditional measurements associated with mass
inventory in order to maximize their efficiency and
production include both financial and nonfinancial
make large batches instead of single-piece flow.
measurements, such as labor efficiency, machine
These measurements will undermine a companys
utilization, earned hours, overhead absorp-
move to lean processes.
tion, purchase price variance (PPV), and similar
What behaviors are motivated by variance
measurements. Use of these measurements may
analyses like overhead absorption and PPV?
motivate nonlean behaviors.
These measurements create similar outcomes.
Does this mean that these traditional mea-
For example, if a supervisor, production line, or
surements are bad metrics? No. They are perfectly
cell has not earned enough overhead by the third
good metrics if you want to be a traditional mass
week of the month, what must be done to absorb
producer. They are inappropriate if you wish to
more overhead? Build inventory, of course. If you
be a lean manufacturer. There is nothing wrong
build additional inventory your overhead absorp-
with these tools, but they are the wrong tools for a
tion increases, as does the months apparent prof-
lean enterprise.
itability. What do you get if you focus on the PPV
15
Management Control
Systems
as the primary measurement for procurement?

Performance to customer demand, l Involve-
You get very large batches of low-price materials

leading to much higher raw material and compo-
ment activities of team members, and

Safety.
nent inventory, often delivered from suppliers that

are geographically distant. These behaviorsthat
Lean organizations also have performance mea-
are quite suitable for mass production are disas-
surements that address the plant or division of
trous to lean manufacturing because they increase
the organization. These measurements are again
inventory, sabotage material flow, severely limit
lean focused in order to motivate appropriate
flexibility, increase obsolescence, and undermine
lean behaviors and provide high levels of financial
the value to the customer.
and operational control across an entire organiza-
New kinds of performance measurements are

required for lean manufacturing. The measure-
The complete set of measurements is de-
ments used in lean production cells are often
veloped from the companys lean strategy and
focused around the hourly rate of production in
linked to ensure common motivations through-
comparison to the customer takt time (the time
out the companys empowered workforce. The
required to complete customer orders). These
measurements are always reported visually at the
measurements deal with the quantity manufac-
place where the work is completed, and they are
tured, the quality of the product, and the ca-
maintained largely manually by the people who
pability of the pull system. The measurements
perform the work. There is generally no need for
also provide the primary control system of a lean
any arithmetic roll-up of measurements to sum-
shop floor, eliminating the need for complex
mary levels. For example, day-by-the-hour is a
transaction-based control systems. A detailed
measure commonly found on cell metric boards
explanation of lean performance measurements is
whose purpose is to ensure production to takt
outside the scope of this SMA, but performance
time. Once the day is over, the board is erased
measurements for lean organizations are more
and aggregation is meaningless (although the
thoroughly discussed in Applying Lean Funda-
production quantities are often transferred to
mentals beyond the Manufacturing Floor.
spreadsheets so that trends can be identified).
Value streams also need a small but balanced
The impact at the value stream level is reflected
set of performance measurements designed to
in on-time deliveries and other customer service
drive the continuous improvement of the value
measures. Similar measures include set up times,
stream. These measurements are (typically) re-
first time through quality, operational equipment
ported weekly along with the value stream income
effectiveness, and so forth.
statement and box score (described below). Lean
There is usually a subset of metrics that are
measurements typically address such issues as:
considered key indicators of performance. A pre-
Productivity of the value stream as a whole
sentation method called a box score helps to
(e.g., sales per person),
keep these key metrics in the forefront. Exhibit 4

Materials and/or information flow rate
illustrates the format using the example company
through the value stream (e.g., dock-to-dock
numbers, separating the metrics into operational,
days or order to cash days),
capacity, and financial measures. This format

Capability of the value streams standard-
recognizes the immediate impact of changes on
ized work (e.g., first time through), l Overall
operational metrics and changes in available ca-
level of process control throughout the value
pacity. Financial impact usually lags these changes
stream (e.g., on-time shipment to customer
and depends largely on how newly available
request date),
capacity is used.
Value stream costs (e.g., average cost per

product),
16
tion comprised of more than one value stream.
Performance measurements are designed to

help run the business, serve the customers, create
Management Control
Systems
Exhibit 4. Box Score Format
Exhibit 5. Product Rationalization Format
17
Management Control
Systems
Exhibit 6. Impact of Product Decisions
improvement, and empower the entire work-
reason for this is that much of the cost included in
force. This approach contrasts with the traditional
the standard product costs for these low margin
emphasis on the use of measurements to monitor
items does not go away when the products were
and discipline the direct labor workforce.
removed. What happened is that the company

improved their service to the customers and made
Financial Reporting
capacity available within the value streambut

only a part of the value stream cost was reduced.
Standard product costs are not required for
The box score in Exhibit 6 shows the impact of
financial reporting. Value stream costing can be
these changes.
used for all financial reporting including internal
The removal of these troublesome products
reporting to operations, corporate offices, and
improved the companys operational performance
external reporting to stockholders, SEC, internal
but increased the companys average costs and
revenue, and so forth. The inventory valuation
reduced profits. At the same time, 34% additional
section (see p. 20) describes how to establish
available capacity was freed up. This is key. The
values for ending period inventory balances for
company only benefits from this new capacity if
external reporting purposes.
the free capacity is recognized and used to advantage by introducing new, highrevenue products
Product or Customer Rationalization
using some of the capacity freed up by the low

margin products. This idea is consistent with the
Decisions related to product and customer ratio-
experience of many companies who found that
nalization are also made using value stream cost
eliminating or reducing nonvalue-added activi-
information and the value stream box score.
ties as part of an ABC implementation was not
A company had identified products it considered to be less profitable than others using
enough by itself; they also needed to eliminate

the excess capacity or find productive uses for it.
productspecific information. It assumed that by

removing these products they would improve
Measuring Cost Improvement
their overall profitability. When the products were
18
removed, however, the profitability of the value
It is important when transitioning to a lean enter-
stream fell sharply, as shown in Exhibit 5. The
prise to have a clear understanding of the impact
Management Control
Systems
Exhibit 7. Measuring Short-Term Financial Impact of Change
of the changes being made. Many companies
make use of this newly freed up capacity. Exhibit 7
expect to see significant short-term cost sav-
shows an example from a value stream within our
ings when introducing lean manufacturing and
example company.
other lean methods. Over the longer term, lean
This company started its lean changes in this
manufacturing is the low-cost method of produc-
value stream by drawing a current state map.
tion; but these cost savings do not come in the
It then developed a future state map, which
short term. There are some short-term costs sav-
included a number of significant changes to elimi-
ings, but the significant savings generally come
nate waste throughout the value stream. Before
over a longer period as many aspects of lean are
embarking on the improvement projects required
introduced and become mature. It is important
to realize these improvements, the team calculat-
when making lean improvement to truly under-
ed the expected impact of the future state on the
stand the impact of lean changes and use these
value stream. As can be seen, there is significant
changes for the financial benefit of the company.
improvement in the operational measurements,
Significant short-term improvement in inventory
including much better on-time shipment, much
levels as measured by either inventory turns or
less inventory, and much improved quality. But the
days supply on hand should be noted. Some
financial impact is rather low. There is some cost
short-term savings are possible with significant
saving owing to the reduction of material scrap,
reduction in scrap, overtime, expedite costs, and
but very little else. Consequently there is little cost
warehouse rental costs.
reduction and little improvement in profit.
The primary goal of most lean improvement
One significant impact of these changes on
particularly in the short termis to eliminate
the value stream is the reduction in nonproductive
waste from the companys processes. When waste
capacity and the increase in available capacity.
is eliminated there may be cost savings, but most
The financial benefit of these changes to the value
of the reduced waste translates into available ca-
stream comes when this new available capacity
pacity. The financial benefit of these lean changes
is used to benefit the company. The available
is determined by what the company does to
capacity can be used to increase sales, allow the
19
Management Control
Systems
introduction of new products, provide additional
moved from batch-and-queue to singlepiece flow
services to the customers, produce inhouse prod-
cellular manufacturing.
ucts or components that are currently outsourced,
Exhibit 8 illustrates that there is plenty of room
and other changes that increase revenue and/or
for increasing the output of the value stream, as
reduce costs.
there is still a considerable amount of available
Another large impact of these changes is a
capacity remaining to be used.
significant decrease in inventory levels. This is

largely due to producing only to demand and fill-
Transfer Pricing
ing orders with finished goods inventory on hand.

The immediate impact is seen in inventory change
In most companies, transfer pricing is the only
measures, such as days supply of inventory and in-
legitimate need for assigning a product cost to
ventory turns. But it is extremely important to note
an individual product. When a product is mov-
that as on-hand inventory is depleted and inven-
ing from one location to another within the same
tory is moved from the balance sheet to cost of
organization, and when those locations are in dif-
goods sold on the income statement, there will be
ferent countries, it is necessary to have a transfer
a decrease in net income. This is due to expens-
price that is usually based on the product cost.
ing in the current period overhead costs that were
Some companies, however, calculate transfer
previously capitalized as finished goods inventory.
prices based on their product prices rather than
It is crucial that this negative financial impact be
their costs; most, however, use product cost as
anticipated and that upper level managers be
the basis for transfer pricing. When a product cost
educated to understand that this is a short-term
is needed for transfer pricing (or other require-
phenomenon. This is reversed as inventory levels
ment), the features and characteristics method
reduce to a desirably low level and orders are
of product costing, which we will discuss later (p.
filled mostly from production.
23), is recommended.
It is also possible to reduce costs by eliminating people and selling equipment. But successful
Inventory Valuation
companies making the lean transformation strive

to make a commitment to their people that no
As lean methods take hold within a company,
one will lose his or her employment as a result of
inventory levels fall dramatically. It is common for
lean improvement. You cannot empower people
lean companies to see 50%-90% inventory reduc-
to make lean changes and then let them go
tions. As inventory falls, the value of the inventory
when the changes occur. This would impede any
becomes much less significant; it has much lower
further lean improvement. Through employee
materiality. In addition to the inventory levels
attrition and by reducing overtime, however, re-
being lower, the material comes under better
duction in labor cost is a reasonable expectation.
control. This level of control is created by the
Reducing rented inventory space is also possible.
combination of low inventory, visual controls, pull
The key decision is to develop a plan for using
purchasing and inventory control residing within
and operational benefit to the company. These
the value stream team.
decisions must be made up-front at the beginning
20
systems with vendors, and the responsibility for
the newly available capacity to provide financial
When inventory is low and under control,
of the improvement process because it usually
simple inventory valuation methods can be used.
takes time for these plans to reach fruition and
When inventory is high and out of controlthe
bring significant financial improvement. In the
usual situation with many manufacturers, distribu-
case of our example company, it added new prod-
tors, and service organizations such as hospitals
ucts, in-sourced some subassemblies, and rented
it is necessary to use computer systems to track it,
out floor space that was freed up as production
product costs to value it, and physical inventory
Management Control
Systems
Exhibit 8. Measuring Financial Impact of Increased Capacity
(or cycle counting) to maintain accuracy. When
Material Cost Plus Days of Conversion Cost.
lean methods are used to bring the inventory
Some lean companies keep track of the mate-
under control, these wasteful methods are not
rial cost of their inventory and then apply the
necessary. Some examples of simpler inventory
conversion costs using the number of days. In the
valuation methods are given below.
example above, the material cost is already known
Days of Stock. It is common for lean compa-
to be a total of $115,000. This is already reported
nies to track the number of days of inventory they
as inventory on the balance sheet. At month end,
hold in purchased materials, WIP, and finished
the controller needs to apply the conversion costs
goods. This is used as a performance measure-
as a reversing journal entry to the balance sheet.
ment to gauge the rate of material flow through
There are 13.5 days of conversion cost to be ap-
the value stream. When they have this informa-
plied; 12 days of finished goods and 1.5 days of
tion, it is easy to calculate the inventory value.
WIP. The conversion cost that is debited to inven-
In Exhibit 9, the material cost for the month in
tory on the balance sheet would be
the value stream is $100,000, or $5,000 per day
13.5 * $7,500 = $101,250.
(in a 20-day month). The total conversion cost in
Quantity of Finished Goods. In companies
the value stream is $150,000, or $7,500 per day.
that have large finished goods inventory there are
If there are eight days of raw materials, then the
some methods to calculate finished goods value.
valuation is 8 * $5,000, or $60,000. The value of
Suppose the company has 90 units of finished
three days of WIP comes to three days of material
goods in stock and that it manufactured 150 units
cost and 1.5 days of conversion cost assuming
during the month. The value of the finished goods
the WIP items are half complete on average. The
inventory will be the total monthly value stream
value of finished goods is 12 days of material cost
cost ($100,000 + $150,000, or $250,000) multiplied
and 12 days of conversion cost.
by 90/150 (0.6). This comes to $250,000 * 0.6 =

$150,000. Consider that the company had 190
21
Management Control
Systems
Exhibit 9. Inventory Value Example
units instead of 90 units. This is more than the
become adept at lean methods within produc-
quantity manufactured this month150 units. In
tion and have very low purchased materials and
this case, the finished goods inventory is valued
WIP, but maintain high finished goods because
at the total cost of the value stream for this month
they are stored in warehouses in many different
and 40/150 of the toal cost of the prior month (if
geographic locations. They need a method to
the prior months production quantity was also
value their inventory until they solve the problems
150 units). The assumption is that the 150 made
necessitating the carrying of high inventory levels.
this month are all in finished goods inventory,
to track the quantity of finished goods on the
during the prior month. (In other words, a first-in,
computer systems and to maintain a product
first-out (FIFO) inventory flow is generally as-
cost for each item. This is traditional except the
sumed.) This assumption is true on average when
product cost is calculated using features and char-
the inventory is low, under control, and there is a
acteristics costing (F&C). F&C is usually simpler
pull system.
to calculate than a standard cost and is a more
Average Costs. It is common to track the
accurate number. It can be used for inventory
average costs of products in a value stream as a
valuation when there are high levels of stocks that
primary performance measurement each week.
are caused by problems remaining to be resolved.
The value of finished goods inventory can be
How do we know how much inventory we
calculated by multiplying the number of units in
have? Traditional companies hate taking physical
stock by the average product cost for the month.
inventory counts, yet they must do them. These
If there is more than one month of finished goods
counts can take several days to complete. They tie
inventory, then the average costs from prior
up resources counting, reporting, and reconciling
months (or weeks) will also be used. This method
the inventory figures. This process also disrupts
assumes first-in, first-out (FIFO) inventory manage-
production. While it may be of benefit to the audi-
ment, a well controlled inventory process, and a
tors, it is of no practical help to the company.
reasonable consistency of mix.

Product Cost. If a company has larger finished
22
Under these circumstances, it is necessary
together with 40/150 of the items manufactured
Many companies try to solve this by moving

to regular cycle counting. Instead of a full, annual
goods inventories, then the valuation will be more
stock count, the physical inventory is done little
traditional. There are many companies that have
by little each week. More expensive items are
Management Control
Systems
counted more often than inexpensive commodi-
accurately reflect the effect on costs of changes in
ties. These activities are wasteful of course, but
the activity level. Value stream accounting is such
they satisfy the auditors and keep the balance
a costing methodology. Making routine decisions
sheet accurate.
using value stream cost information is generally
Lean companies take the opposite approach.
quick, simple, and accurate. There is no need to
They move back to a full physical stock count; not
calculate a product cost; value stream costing
annually, but monthly or even weekly. The reason
provides better information leading to better
is that a full physical count is quick and easy.
decisions. The value stream information is better
When inventory is low and controlled visually, it
for decision making because:
is very easy to count. Often it is not necessary
to count the actual parts; you can just count the
the complex (often baffling) assumptions of
kanbans. The material and components are stored

in standard containers with a standard kanban
It is real information and does not contain

full absorption product costing.

The cost and revenue information is clearly
quantity in every container, and it is simple to
understood by the people using the infor-
count the number of containers or the number of
mation, which enables them to make more
kanban cards associated with them.
informed decisions.
It is common for lean organizations to no

The financial information is up to date, often
longer track inventory on the computer system. If
to the current week.
the visual control is effective, there is no need for
When making a decision, the true cost changes
a second, parallel tracking system.
that will occur are applied to the value stream

cost information. The impact of the suggested
Summary of Decision Making in Lean Accounting
actions is shown in the profitability of the value

stream. This provides accurate and understand-
When using lean accounting, regular decisions
able information that shows the true impact of
relating to such things as profitability, make vs.
the decision on the value stream. This cost and
buy, sourcing, product and customer rationaliza-
profitability analysis can be readily calculated
tion, and so forth, are made using value stream
because current value stream income statements
cost and profitability information, not the costs
are available, and the impact of the suggested
of individual products. Instead of calculating the
actions can be calculated quickly and easily.
margins for a product or an order, decisions can
Sometimes these calculations apply to a single
be made based on the effect on the value stream
option, but often there are several alternatives
as a whole.
that need to be assessed to understand the true
The calculation of individual product costs

using full absorption costing methods are not
helpful to companies using value stream costing.
financial impact of each alternative.
Features and Characteristics
These methodologies are flawed by their underlying assumptions and efforts to create more
There is little need in lean accounting to calculate
complex cost allocationswhile providing more
a product cost because the traditional needs for
accurate product costs. This has led to in-
product costs are no longer necessary:
creased complexity and wasteful transactions. In

4

In traditional companies, the price of a
general, it is important that the costing methodol-
product is often based to a large extent on
ogy utilized by an organization be able to
product cost. Lean companies price products

based on the value of the product to the
4 Kaplan, Robert S., and Anderson, Steven R. Time Driven

Activity-Based Costing. Harvard Business Review. November 2004.
customer or market.

Traditional companies need a product cost to

calculate the value of their inventories. Lean
23
Management Control
Systems
Exhibit 10. Impact of Bottleneck on Product Cost
companies have very low inventories and
through the value stream.5 F&C product costing
when inventories are lowthere are much
determines the features and characteristics of the
simpler ways to value inventory.
product that affect the rate of flow through the

Traditional companies use product costs to
make decisions about the profitability of an
value stream.
Consider the following example (see Exhibit
order, customer, or product family. They also
10). A value stream manufactures three products:
use product cost to make decisions relat-
X, Y, and Z. Each product goes through three
ing to make vs. buy or sourcing of products.
cells, each of which has a team of people and ma-
Lean companies use value stream costing
chines. Using value stream costing, we calculate
for these kinds of decisions; they assess the
the total conversion cost (excluding materials) of
impact of these decisions on the profit and
the value stream to be $1,000 per hour.
profitability of the whole value stream, not

the individual product.

Traditional companies evaluate manufactur-
How many Xs can we make each hour? Four.

The flow through the heat treatment furnace limits
the production quantity to four per hour. The
ing variances for efficiency monitoring. Lean
cycle time of the bottleneck (or constraint) opera-
companies rely on shop floor measures and
tion is 15 minutes; so the cycle time of the entire
box scores for understanding performance
value stream is 15 minutes. We can produce one X
and improvement impact. As the need for
every 15 minutes.
a product cost no longer exists, there is no
If the material cost for an X is $200 per unit
longer a need to maintain a complex system
and the conversion cost is $1,000 per hour, then
such as standard costing to calculate the cost
the total cost of the product is:
of each product. If the cost of a product is

required, it can be readily calculated on an
$200 + ($1,000 / 4) = $450
as needed basis.
When a product cost is required, features and
characteristics (F&C) costing is often used. F&C
recognizes that the cost of a product is not deter-
5 The features and characteristics method of product
mined by the amount of labor time (or machine
costing mirrors some of the methods developed by Eli
time) required to make the product; it is deter-
Goldratt and his companions in the Theory of Con-
mined by the rate of flow of the product
straints (TOC movement. TOC provided an excellent

academic framework for understanding that costs are
determined by rate of flow rather than labor time, and
this was demonstrated cleverly in the book The Goal.
A full explanation of throughput costing is given in
Thomas Corbetts book Throughput Accounting (North
River Press, 1998).
24
Management Control
Systems
Exhibit 11. Product Cost Conversion Chart
Product Y is similar. The value stream can make
through the value stream. In the simple example
four Ys per hour. If the material cost for a Y is also
above, the rate of flow through the heat treatment
$200, then the cost of a Y is the same as an X:
oven is determined by the size of the product

and the type of material: regular steel or stain-
$200 + ($1,000 / 4) = $450
less steel. Average conversion cost represents

the labor and support costs to convert material
It is evident from this example that the standard product cost calculation for X and Y provides
erroneous and misleading information. It would
show Y as having a higher cost than X because
into finished product. Exhibit 11 illustrates such a

conversion matrix
Product Z is a medium-sized product made
from regular steel. The cost of a Z is:
there is more labor and/or machine time used to

make the product (X=31 minutes; Y=32 minutes;
Material Cost + Average Conversion * 1.00
Z=34 minutes). In fact, the value stream costs are
$200 + ($200 * 1.00) = $400
not expended based on the number of hours

worked, but on the rate of flow through the value
stream.
Products X and Y are medium-sized products

made from stainless steel. Their product costs are:
Product Z, on the other hand, flows more

quickly through the value stream because its cycle
$200 + ($200 * 1.25) = $450
time through the bottleneck operation is only 12

minutes, and the value stream can make five Zs
From this simple matrix, we can calculate the
per hour. If the material cost for a Z is also $200
cost of any product when we know its features
per unit, then the product cost for a Z is:
and characteristicsin this case, the type of steel

and the size. This conversion cost is calculated
$200 + ($1,000 / 5) = $400
from the average cost for the products manufactured in the value stream, and this average cost
The cost of Z is lower than X despite Z taking

more total labor and/or machine time in the pro-
can be updated as frequently as required.

Material costs are usually calculated by
cess. The cost of the product is primarily related
exploding the bill of materials against the latest
to the rate of flow through the value stream, not
actual material cost or the latest average actual
the amount of labor or machine time required to
material cost. It is possiblein some casesto
make the product.
also derive the material cost using the same
The F&C method of product cost calculation
features and characteristics process. For example,
creates a simple matrix of the features and char-
a company making rubber seals finds that the
acteristics of the products (or the service, if we are
conversion cost of a product is determined by the
costing a service) that truly affect the rate of flow
type of rubber (which affects the cure time) and
25
Management Control
Systems
the number of cavities in the mold when the prod-
The SOFP process varies with different kinds
uct is pressed. A 20-cavity mold product is half
of organizations (manufacturing, distribution, ser-
the cost of a 10-cavity mold product. The material
vice, education, healthcare, etc.), but all organiza-
cost is also determined by the same two features
tions follows similar steps.
of the product. The type of material determines
STEP ONE. The sales and marketing people
the cost per pound, and the number of cavities
provide estimates of the expected require-
per mold determines the amount of material
ments to meet customer needs. These
required to make the product.
forecasts are expressed in operational terms,
The material cost and the conversion cost is
such as the number of products to be sold or
determined by the same features and
number of patients requiring service at the
characteristics.
AIDS clinic. Typically these forecasts are done
A word of caution: Calculating product costs
for each month over a 12-month period.
using the features and characteristics method
They are not expressed in terms of dollars
results in a more accurate product cost, and it is
or other financial numbers. The forecasts are
(usually) a much simpler method of calculation
done at a macro level. There may be a fore-
than a standard product cost based on production
cast for each value stream or product families
routing information, but it would still be inappro-
within value streams. Detailed level forecast-
priate for most decisions. The only legitimate uses
ing should be avoided for planning purposes
of product cost calculated this way are for transfer
because more aggregated numbers are more
pricing and for the valuation of finished goods
accurate. If new products and services are
inventory when the amount of inventory is high.
being added to the offering from the value
Lean Budgets and Financial Planning
stream, then these need to be included in

the forecasts of customer demand.
STEP TWO. The operations people fore-
Financial planning in lean organizations is more
cast the capacity that will be available each
dynamic than is usual in traditional companies.
month to fulfill customer needs. These fore-
The planning and budgeting process is done
casts are again by value stream or product
every month (typically) and is used to create an
family within value stream. The forecasts are
integrated game plan across the organization.
based on the value streams demonstrated
The process is commonly called sales, operations,
capacity in recent months and takes into
and financial planning (SOFP).
account the planned changes and improve-
The budgets are an outcome of a formal

planning process designed to ensure that the
company has all of the things in place to create
ments to the value streams over the next 12

months.
STEP THREE. The middle managers involved
maximum value for the customer and sufficient
in the forecasts get together for an SOFP
capacity is available to meet customer needs.
meeting. During this formal and strictly
Budgeting is not an end in itself but comes out of
agendadriven meeting, each value stream is
the planning process and uses the latest and most
reviewed, and decisions are made relating
reliable information. One criticism of traditional
to changes required to match the customers
budgeting processes is that they are done several
expected demand with the value streams
months before the new year starts and are often
capacity to meet those needs. Most of the
out of date even before they come into action. It
planning is completed within this formal
is said that business is so dynamic that traditional
meeting. There will be some issues, however,
annual budgets are not helpful for planning and
that the managers can either not agree on or
control.
for which they do not have the authority to

make changes. These issues are referred to
26
Management Control
Systems
issues coming from the SOFP process
the Executive SOFP meeting in Step Five
include:
below.
STEP FOUR. Using the information coming
Change staffing levels to meet future

needs,
out of the SOFP meeting, finance creates

budgets for the next 12 months. These bud-
Purchase or redeploy capital equipment,
gets are 26
Outsourcing decisions, 4 Raw material
derived from the most recent
and component planning,
and most accurate information available

to the company and from the value stream
Develop new marketing strategies,
costing information. There is short-term
Establish new product development

programs,
information relating to the expected monthend results and longer-term information
Establish long-term continuous improvement plans, and
relating to such things as the need for capital

purchases or changes to headcount within
Budgeting & financial planning.
the value stream.

STEP FIVE: The final step of the SOFP
The budgeting process is an outcome of the
process is the Executive SOFP meeting. This
broader planning process. SOFP is a formal, sys-
is presided over by the president of the orga-
tematic approach for planning the value streams
nization (or the most senior person within the
to create value for the customers. It requires
entity) and is a short, well-planned meeting.
considerable cooperation across the companys
Each value stream is briefly reviewed and ex-
processes, including sales and marketing, opera-
ceptions discussed. The companys executive
tions, new product development, administration,
team makes decisions and creates a jointly
and finance. SOFP is an effective approach to
agreed upon game plan for the organiza-
planning and budgeting because it encompasses
tion for the next 12 months. This game plan
all aspects of planning within a single, formal,
is updated each month. The purpose of the
effective process. SOFP replaces myriad formal
game plan is to create coordination across
and informal meetings with a single authoritative
the companys sales and marketing, opera-
process that creates a company-wide game plan.
tions, new product development, administration, and other processes to ensure custom-
Transaction Elimination
ers needs are fully met in the short term and

longer term.

The short-term issues coming from the SOFP
process include:
Establish production cycle times to
Companies employing traditional manufacturing methods frequently have processes that are
out of control. This lack of control is manifested
by late deliveries, large inventories, frequent
match customer needs,
expediting to meet customers needs, constant
Create level scheduling,
shortages of materials from suppliers and delays,
Recalculate kanban quantities,
complex processes, and so forth. Similar chaos
Determine manning levels for cells and

the value stream,
Finalize project plans for new product
and complexity can be seen in service industries,

schools, hospitals, and government agencies.
Does this mean that these organizations are
introductions and continuous improve-
run by incompetent managers? No. The reason
ment,
for the problems listed above is that there are so
Create month-end financial results in

advance, and
Initiate sales programs to make the
best use of resources. l The longer-term
many issues and problems within their processes

and those of their suppliers and partners that the
only way to provide any kind of acceptable service
to customers is to crisis-manage and expedite.
27
Management Control
Systems
These companies become successful by the he-
companys middle managers. These systems have
roic efforts of their employees.
been quite successful. Much of the increased pro-
It is the responsibility of the senior financial

executive to provide valid and accurate financial
information both internally and externally. In order
use of these kinds of information systems.

Lean organizations take a very different ap-
to do this, the company must have systems to col-
proach. When there is instability or lack of control
lect detailed financial information throughout the
with a process, they seek to address the root
companys processes and report what has actually
causes of the problem and eliminate it. As these
occurred. When a company has processes that
root causes are eliminated, it is no longer neces-
are out of control, it is imperative to have systems
sary to have complex systems to provide financial
that collect the actual information throughout
and operational control because the control is
the company in order to provide financial reports
built into the processes themselves.
that meet the needs for regulated external reporting and internal business management.
There are two approaches to out of control
A simple example would be helpful to expand

on these points. What kind and how many transactions are needed to provide financial control
processes. One approach is to apply a complex
to a company that has 80% on-time delivery,
technology solution; the second is to bring the
six-week production lead times, high levels of
processes under control. For the most part, West-
scrap and rework, constant expediting, WIP that
ern companies have taken the first approach. The
varies considerably from one day to the next,
introduction of Materials Requirements Planning
and a monthend meet the numbers mental-
(MRP) systems in the 1970s was designed to bring
ity? The answer is thousands of transactions. The
materials procurement under control. This was fol-
processes are fundamentally out of control, and
lowed by Capacity Requirements Planning, which
there is a need to track the individual processes
was designed to bring shop floor machine loading
in great detail every day to provide valid financial
under control.
information.
During the 1980s, Manufacturing Resource
Now say that this company embarked on a
Planning (MRPII) was developed. It couples the
lean manufacturing transformation. The produc-
production and materials planning with shop
tion lead time fell to three days, on-time delivery
floor execution and closes the loop between
reached 98%, inventory is low and consistent
the plan and the actual performance in the plant.
owing to an effective pull system, and there is
The 1990s brought Enterprise Resource Planning
reasonable linearity of demand and production.
(ERP), which linked all the companys operations
The company has not yet become world class,
into a single integrated (sometimes multina-
but the managers have worked hard to bring a
tional) system. The companys sales and market-
first level of lean flow through the plant. How
ing processes, materials processes, accounting
many and what kind of transactions are required
processes, HR processes, engineering processes,
under these new circumstances? Because there
production processes, and distribution processes
is a good deal of control and stability within the
all run on the same large, complex system. Similar
companys processes, the answer is not many.
systems were developed to address banking,
Lean companies transfer control from the
insurance, stock broking, logistics, transportation
traditional transactional control to building control
services, government agencies, healthcare, and
into the operational processes. As the operational
other industries.
process are brought under control using lean root
These systems recognize the chaotic nature of
cause analysis and visual lean methods, there is
business and attempt to overcome these issues
no longer a need for complex transactional con-
by tracking, recording, analyzing, and reporting
trol systems.
the processes so they can be managed by the
28
ductivity of American companies is credited to the
Management Control
Systems
Exhibit 12. Example For Planning Transaction Elimination: Work Orders
29
Management Control
Systems
Does this mean that lean organizations are
and measurements, then a maturity path plan
against computer systems? No. There is an
can be developed that maps out the step-by-
important place for information systems within
step changes required to introduce the lean
lean organizations but, by and large, information
methods and bring them to a point where
systems are not required for daily operational con-
the processes are under good operational
trol of, for example, a production shop floor. Lean
control and the transactions can be elimi-
organizations are not anti-systems, but are more
nated.
pro-visual management and for self-controlling

Once these changes are made, the trans-
processes. If the most visual and lowest-waste
actional systems can then be gradually
method to bring the processes under control in-
removed as the processes are brought under
cludes computer systems, then computer systems
control operationally.
should be used. But generally this is not the case

because visual management is usually best served
It is always a good idea to bring auditors (internal
through more manual methods for daily opera-
or external) into these decisions. If the auditors
tional control.
are part of the design of the visual management

processes, then they will be able to better audit
Eliminating Transactions
the success (or otherwise) of these processes in

maintaining control. The audit rules and methods
Transactions are eliminated prudently and care-
need to be changed because there is no longer
fully. Transactional controls are only eliminated
a need to audit transactions. Instead, the need is
when they are demonstrably no longer needed.
to audit the operational processes to ensure that
It is usually best to determine in advance the cir-
operational and financial control is maintained.
cumstances that must prevail in order to remove

control systems. It is possible to develop a matu-
Conclusion
rity path plan where the controller can determine

what must be in place within the operation for
Industries are changing the way they produce and
particular transactional controls to be removed.
deliver products and/or services to customers in
Some transaction-heavy processes within
ments. Production companies adopting the lean
and production control processes, the purchas-
principles reconfigure manufacturing lines into
ing and accounts payable processes, and the
cells and reorganize them from functional depart-
inventory tracking and reporting systems. The first
mental units into value stream teams responsible
steps toward eliminating the work order processes
for the complete flow of material from receipt
could include:
to finished product delivery. Similar changes are
Start with identifying how many and what
made in service organizations where departments
kind of transactions are currently required to
are reorganized into value streams and processes
run the business.
are performed in cross-functional cells or teams.

Make a list of all the reasons for using the
work order and its associated transactions.

Establish howin the longer run as lean
methods take shape within the company
30
order to compete in rapidly changing environ-
manufacturing companies include the work-order
These changes represent a radical departure

from prior traditional structures that are vertically
control oriented with decisions made only at the
manager and supervisor level.
these reasons are eliminated or replaced by
Traditional management accounting has
lean tools. An example is given in Exhibit 12.
evolved over the years to better support opera-

Once the controller and the operations man-
tions as they change. As companies adopt lean
agers understand how the processes will be
principles and strive to reduce waste, promote a
brought under control using lean methods
smooth pull system, and provide stellar product
Management Control
Systems
and service quality, it is time to reflect on tradi-
CYCLE TIME. The time required to complete
tional management accounting practices and
one cycle of an operation. If cycle time for
how they can better support decisions within
every operation can be reduced to equal
lean-thinking organizations. The lean account-
takt time, products can be made in
ing practices and decision techniques presented

in this SMA offer alternatives for management
single-piece flow.
FEATURES AND CHARACTERISTICS (F&C)
accountants to explore when supporting their
PRODUCT COSTING. Method for cal-
organization as they embark on implementing
culating product costs by identifying the
lean techniques.
features and characteristics of the product
Glossary
that affects its rate of flow through the

value stream. The value stream average
cost is adjusted based on the product
This glossary provides definitions of words commonly used within lean organizations. For a more
comprehensive lexicon of lean terminology, refer
features and characteristics to yield the

product cost.
FIVE S (5S). Five related terms (each begin-
to Chet Marchwinski and John Shooks Lean
ning with an S) describing workplace
Lexicon: Graphical Glossary for Lean Thinkers,
practice conducive to visual control: sort,
referenced in the Resource List.
straighten, scrub, standardize, sustain. It is

a method of achieving workplace orderli-
3 REPORT. A standard method of summarizing

problem solving exercises, status reports,
and planning exercises; a Toyota practice.
ANDON BOARD. A visual control device in
ness to achieve visual management.

FIVE WHYS. Taiichi Ohnos practice of asking
Why five times whenever a problem
was encountered in order to identify the
a production area, typically a lighted
root cause of the problem so that effective
overhead display, giving the status of
countermeasures could be developed and
the production system and alerting team

members to emerging problems.
BATCH-AND-QUEUE. The mass-production
implemented.
FLOW. The progressive achievement of tasks
along a value stream so that a product
practice of making large lots of a part
proceeds from design to launch, order to
and then sending the batch to wait in the
delivery, and raw materials into a finished
queue before the next operation in the
products in the hands of the customer with
production process.
no stoppages, scrap, or backflows.
CELLS. The layout of machines of different
GEMBA. Japanese for actual place. Used to
types performing different operations in
stress the importance of lean improvement
a tight sequence, typically in a U-shape,
being done at the place where the work is
to permit single-piece flow and flexible
done using detailed visual observation.
deployment of human effort by means of

multi-machine working.
CHANGEOVER. The installation of a new type
HOSHIN KANRI. Japanese term meaning

deployment of the companys strategy.
The Hoshin process is used to provide a
of tool in a metal working machine, a dif-
formal method for deploying the compa-
ferent paint in a painting system, a new
nys strategy throughout the organization.
plastic resin and a new mold in an injec-
The Hoshin process seeks to create a high
tion molding machine, new software in a
level of consensus through collaborative
computer, and so on. The term applies
planning rather than top-down change
whenever a production device is assigned
management.
to perform a different operation.

31
Management Control
Systems
JIDOKA. The part of the production system
improvement methodology requiring the
that arise in the production process.
proposal of a change, the implementa-
KAIZEN. Continuous incremental improvement
tion of the change, measuring the effect
of an activity to create more value with less
of the change, and taking appropriate
waste.
action. Also called the Deming Cycle. 32
LEAN PROMOTION OFFICE. A resource for

a lean transformation. The team provides
value stream managers with technical assistance to use lean methods to transform
the flow within the value stream.
LEVEL SELLING. A system of customer rela-
POKA-YOKE. A mistake-proofing device

or procedure to prevent a defect during
order taking or manufacture.
POLICY DEPLOYMENT. Management process
that alignsboth vertically and horizontallya firms functions and activities with its
tions that attempts to eliminate surges in
strategic objective. A specific plantypi-
demand caused by the selling system itself
cally annual is developed with precise
(for example, due to quarterly or monthly
goals, actions, timelines, responsibilities,
sales targets) and that strives to create
and measures. Sometimes called strategy
long-term relations with customers so that
deployment or Hoshin. PULL. A system of
future purchases can be anticipated by the
cascading production and delivery instruc-
production system.
tions from downstream to upstream activi-
MATERIAL REQUIREMENTS PLANNING

(MRP). A computerized system used to
determine the quantity and timing requirements for materials used in a production
ties in which nothing is produced by the

upstream supplier until the downstream
customer signals a need.
QUALITY FUNCTION DEPLOYMENT (QFD).
operation. MRP systems use a master pro-
A visual decision-making procedure for
duction schedule, a bill of materials listing
multiskilled project teams; it develops a
every item needed for each product to be
common understanding of the voice of
made, and information on current invento-
the customer and a consensus on the final
ries of these items in order to schedule the
engineering specifications of the product
production and delivery of the necessary
that has the commitment of the entire
items. Rarely used in lean production.

MONUMENT. A machine, person, or depart-
team.
SEVEN WASTES. Taiichi Ohnos (Toyota
ment of a large scale that must be shared
manager, the father of lean thinking)
across more than one value stream.
categorization of the kinds of waste within
PACEMAKER. The process in the value stream
an organization: overproduction, waiting,
that sets the pace of production. The
transportation, unnecessary processing,
pacemaker may be the bottleneck op-
inventory, motion, and inspection.
eration that constrains the rate of of flow

through the value stream.
PERFORMANCE MEASUREMENTS LINKAGE
CHART. Method for linking corporate,
plant, value stream, and cell/process
SINGLE MINUTE EXCHANGE OF DIES

(SMED). A series of techniques for changeovers of production machinery in less than
10 minutes.
SINGLE-PIECE FLOW. A situation in which
performance measurements with the
products proceed, one complete product
companys strategy. The primary purpose
at a time, through various operations in
is to ensure that the measurements reflect
design, order taking, and production with-
the aims and balance of the companys
out interruptions, backflows, or scrap.
strategy.
32
PLAN-DO-CHECK-ACT. A systematic process
that reacts and responds to abnormalities
Management Control
Systems
STANDARDIZED WORK. A precise description
for the customer. Muda (vulgar Japanese
of each work activity specifying cycle time,
word for waste) is divided into Muda 1
takt time, the work sequence of specific
and Muda 2. Muda 1 is waste that creates
tasks, and the minimum inventory of parts
no value but in unavoidable with current
on hand needed to conduct the activity.
technologies and policies. An example
SUPERMARKET. A stocking point for inven-
would be the payroll process. Muda 2
tory that has low inventory that is visually
creates no value and can be eliminated.
controlled and is replenished using a pull
An example would be shop-floor labor
system.
reporting.
TAKT TIME. The available production time

divided by the rate of customer demand.
Resource List
Takt time sets the pace of production to

match the rate of customer demand and
Lean Accounting
becomes the heart of any lean system.

TARGET COST. The development and production cost that a product cannot exceed
if the customer is to be satisfied with the
value of the product while the manufac-
Fiune, Orest, and Cunningham, Jean. Real

Numbers. Durham, NC: Managing Time
Press, 2003.
Johnson, H. Thomas, and Broms, Anders.
turer obtains an acceptable return on its
Profit Beyond Measure: Extraordinary Results
investment.
through Attention to Work and People. Free
THROUGHPUT TIME. The time required for

a product to proceed from concept to
launch, order entry to delivery, or raw materials into a finished product in the hands
of the customer.
VALUE STREAM. All the actionsboth valuecreating and wasterequired to bring
Press, 2000. Maskell, Brian, an d Baggaley,

Bruce. Practical Lean Accounting. New York:
Productivity Press, 2003.
Solomon, Jerrold. Whos Counting: A Lean Accounting Business Novel. WCM
Associates, 2003.
Waddell, Willam, and Bodek, Norman. Rebith
a product from concept to launch (new
of American Industry. Vancouver, WA: PCS
product development value stream) or
Press, 2005.
from the sale through to delivery and

collection of cash (order fulfillment value
Implementing Lean Operations
stream). These include actions to process information, transform the product,

move the materials and the product, and
exchange cash.
VALUE STREAM COSTING. A simple summary
of the direct costing of value streams.
VISUAL MANAGEMENT. The placement in
Allen, John (ed.). Lean Manufacturing: A Plant

Floor Guide. Dearborn, MI: SME, 2001.
Dennis, Pascal. Lean Production Simplified, New

York: Productivity Press, 2002.
Keyte, Beau, and Locher, Drew. The Complete
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Administrative & Office Processes. New
activities, documentation, performance
York: Productivity Press, 2004.
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Liker, Jeffrey, (ed.). Becoming Lean: The Inside
methods for the control and improvement
Stories of U.S. Manufacturers. New York:
of the value stream. Visual management
applies equally in administrative and

service processes. WASTE. An activity that
consumes resources but creates no value
33
Management Control
Systems
Marchwinski, Chet, and Shook, John. Lean Lexicon: Graphical Glossary for Lean Thinkers.
Cross-Functional Management
Brookline, MA: Lean Enterprise Institute,

2003.
Rother, Mike, and Shook, John. Learning to
See: Value Stream Mapping to Add Value
and Eliminate Muda. Brookline, MA: Lean
Enterprise Institute, 1998.

Womack, James, and Jones, Daniel. Lean
Emiliani, Bob. Better Thinking, Better Results:

Using the Power of Lean as a Total Business
Solution. Kensington, CT: CLBM, 2003.
Ishikawa, Kaoru. What Is Total Quality Control?

Englewood Cliffs, NJ: Prentice-Hall, 1985.
Mann, David. Creating a Lean Culture: Tools
Thinking: Banish Waste and Create Wealth
to Sustain Lean Conversions. New York:
in Your Corporation. New York: Simon and
Productivity Press, 2005Monden, Yasuhiro.
Schuster, 1996.
Toyota Management System: Linking the
Womack, James, and Jones, Daniel. Lean Solutions: How Companies and Customers Can
Create Value and Wealth Together. New
York: Free Press, 2005.
Seven Key Functional Areas. Portland, OR:

Seddon, John. Freedom from Command & Control: A Better Way to Make Work. New York:

Toyota Production System and Just in Time
Visual Controls
Hirano, Hiroyuki. JIT Implementation Manual:
The Complete Guide to Just-in-Time Manufacturing. Portland, OR: Productivity Press,
1990.
Liker, Jeffrey. The Toyota Way: 14 Management
Principles from the Worlds Greatest Manufacturer. New York: McGraw-Hill, 2004.
Ohno, Taiichi. Toyota Production System: Beyond

Large-Scale Production. Portland, OR: Pro-
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Shingo, Shiego. A Study of the Toyota Production System from an Industrial Engineering
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1989.
34
Galsworth, Gwendolyn. Visual Workplace: Visual

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Network of companies assisting other
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Accounting For The Lean Enterprise

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Management Control

Statements on Management Accounting

Accounting for the Lean Enterprise

Published by Institute of Management Accountants

Exhibit 1: Traditional and Value Stream

Value Stream Costing......................................10

Value Stream Income Statements............10

Exhibit 2: New Order Decisions................13

Value Stream Unit Costs..........................11

Exhibit 3: Make or Buy Decisions...............15

Exhibit 4: Box Score Format......................17

Margin and Profitability Analysis..............13

Exhibit 5: Product Rationalization

Product Pricing and Quoting..................14

Make vs. Buy Decisions............................14

Exhibit 6: Impact of Product Decisions......18

Exhibit 7: Measuring Short-Term Financial

Product or Customer Rationalization.......18

Exhibit 8:  Measuring Financial Impact of

Measuring Cost Improvement.................18

Exhibit 9: Inventory Value Example...........22

Exhibit 10: Impact of Bottleneck on

Summary of Decision Making in Lean

Exhibit 11: Product Cost Conversion

Features and Characteristics.........................23

Lean Budgets and Financial Planning..........26

Exhibit 12: Transaction Elimination Planning

Example: Eliminating Work

Statements on Management Accounting

As companies transition from traditional manage-

administration of support activities. But when

ment methods to a lean enterprise, their account-

you look more deeply at these new methods

ing, control, and measurement systems need to

known collectively as the lean enterpriseit be-

change. Traditional accounting systems such as

comes clear that this is not just another improve-

full absorption costingwere designed to sup-

ment program but a fundamentally new way of

port management principles like mass produc-

conducting business. These changes require dif-

tion, top-down command and control, depart-

ferent kinds of accounting systems. Transforming

mental optimization and budgeting, and a focus

a company through the application of lean think-

on shareholder (or owner) value. The principles

ing changes almost every aspect of its operation.

of lean thinking are quite different from those

These changes are based on different assump-

of traditional management methods. Traditional

tions about the business. Lean thinking changes

accounting systems can be detrimental to lean

the way a business is managed by moving from a

companies because they motivate behaviors that

command and control bureaucracy to an organi-

undermine the principles of lean thinking. Lean

zation based around empowered teams.1 Lean

accounting methods are designed to support the

Exhibit 8: Measuring Financial Impact of