There are at least three assertions in Lean Accounting that justify closer scrutiny: (1) Accounting is the problem,
(2) all conversion costs (in Lean Accounting, conversion costs are defined as all value stream costs except materials and purchased outside services) are fixed, and (3) claims for support of external reporting.
Accounting Is the Problem
First, in the reasoning by some in the Lean movement that accounting is the problem, LA uses a weak straw person
as its target and basis for the call to action-full absorption standard costing, which is infamous for its deficiencies in decision support. In the LA discourse, examples abound that highlight the perils of arbitrary indirect cost allocations in full absorption standard costing. In particular, the dangers of allocating overhead costs are highlighted. No one objects to the examples sighted because the credibility of full absorption standard costing was already demolished by activity-based costing (ABC) in the 1980s and early 1990s.
Nevertheless, the discussion often proceeds as if full absorption standard costing and all other traditional
approaches are equally flawed. But the fact is that a traditional approach like direct costing doesn’t absorb any overhead or even fixed costs; an approach like Resource Consumption Accounting (RCA) makes no arbitrary assignments at
all-i.e., the principle of causality governs every assignment (the word “allocate” refers to arbitrary cost mapping and the word “assign” to cost mapping based on cause-and-effect relationships-i.e., applying the principle of causality); and ABC has made advances in better understanding capacity costs and simplified data collection. In addition, many management accountants (including one of the authors, who was an SBU CFO at a large telecom) have used ABC for “process costing”-integrated cross-functional processes tied together to produce an output (similar to LAs
value stream). Making comparisons to a weak sister (full absorption costing) and putting all advances of the past 20 years into the same trash bin aren’t in the spirit of fact-based debate on behalf of the practitioner. We have long
stated that the management accounting profession needs to accelerate its transformation to increase its relevance, but comparisons to methods everyone knows are weak and to the “accountant” from 20 years ago (numbers cruncher in the back office vs. strategic business partner on the front lines of decision making) create an artificially wide gap between the current and aspirational states of the profession.
All Conversion Costs Are Fixed
Second, the assertion-or very strong implication-in the LA literature that all conversion costs are fixed isn’t
unique to Lean Accounting. The Theory of Constraints (TOC) can probably be credited with this view of cost behavior. This view is a hallmark of so-called simple solutions to management accounting and typically considers material cost
as the only cost relevant to a whole host of decisions. As we will show, what’s implied is that these “fixed costs” are actually unavoidable costs.
This practice (the “blended cost concept error”) confuses operational cost concepts (fixed and variable) with decision cost concepts (unavoidable and avoidable).
This error is least detrimental for decisions dealing with small changes within the relevant range when the two
sets of cost concepts more closely align (e.g., a variable cost isn’t that different from an incremental cost). But wider-ranging decisions that affect step-fixed cost relationships pose a serious challenge because the avoidable
cost in these instances comprises both fixed and variable costs. The blended cost concept error results in understating the benefits of wider-ranging decisions and eliminating these decision options or simply ignoring them (refer to the make-buy example below). The error also raises another question for Lean Accounting: unavoidable under which specific decision scenario? The principle of “different costs for different purposes” has been well understood
in management accounting for a very long time.
LA Can Transform External Reporting, Too
Third, when it comes to support for external reporting, Lean Accounting strongly implies that it has the ability to
transform traditional financial accounting (external reporting of financial and notes disclosures based on GAAP/FASB) just as it aspires to transform management accounting (decision support, planning, and control). Yet our review
of the existing Lean literature and presentations at the Lean Accounting Summit reveal that the only meaningful support in the area of financial accounting is inventory valuation. Other integration points with financial accounting are rarely mentioned. Does supporting them run foul of Lean’s aversion to transaction recording (too complex; why does the shop floor need transactionlevel detail to run the business?) and LA’s notion of a single cost object-its value stream? The need to isolate and capitalize certain costs (e.g., asset under construction), collecting and invoicing costs incurred for work done internally and paid for by an insurer or, similarly, work paid for by the original equipment manufacturer (OEM) under warranty or for recalls doesn’t seem to be considered by LA as “required” complexities under the law (add Sarbanes-Oxley to the mix).
The problem gets worse in service industries. For example, consider a repair facility that receives the customer’s item (e.g., a jet engine) or healthcare-both are required to provide the customer a detailed invoice that’s different for every item repaired or customer served.
Statement of Financial Accounting Standards (SFAS) No. 15!, “Inventory Costs-an amendment of ARB No. 43,
Chapter 4,” requires that excess/idle capacity cost be reported as a period expense and not absorbed to the product. This also poses a challenge for Lean Accounting. Excess/idle capacity costs exclude any variable cost. For
example, preventative machine maintenance is a fixed cost and must be included in excess/idle capacity costs, while repairs are considered a variable cost and would be excluded. We don’t believe that Lean Accounting can make this
distinction because of its blended cost concept error, which seems to consider all machine-related costs as fixed.
IMPLICATIONS OF THESE INSIGHTS
As we said, there seems to be a land rush to grab the gold mine potential some see in the Lean movement that’s
similar to the ABC land rush of the 1980s and 1990s, which-at least initially-created clutter and confusion, not costing advances for practitioners. For example, one presentation at the Lean Accounting Summit described rolling outlooks and other means to improve (if not replace) today’s planning and budgeting processes as “Lean planning.” An approach to simplify Sarbanes-Oxley compliance was referred to as “Lean SOX.”
Business process improvement, transformational change, and elimination of wasteful practices are not the sole domain of Lean, and expanding the net in this manner impacts credibility. But the planning and compliance ideas are good
ones and should stand on their own as delivering transformational value to practitioners.
The assertion that accounting is the problem is too simplistic and impairs the credibility of Lean Accounting as an
evolving body of knowledge with transformational potential. For example, the claim that accounting causes undue inventory build-up is obviously a problem in performance measurement and not accounting. The larger issue, in our view, isn’t accounting per se but the inconsistent application of the principle of causality in some traditional management accounting approaches. As we indicated, some approaches don’t commit this error, and the broad
guilt-by-association brush that LA applies to full absorption accounting is invalid.
The Lean Accounting claim for support of external reporting clearly requires more study, including an evaluation of the complexity of fully meeting all requirements. The point here isn’t that LA violates GAAP. We didn’t investigate its ability to provide compliance information in a vanilla manufacturing environment-given its manufacturing roots, we presume this isn’t an issue. Our concern is with a broader application of Lean principles and LA, e.g., in service industries such as transportation.
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