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Journal of Manufacturing Technology Management
Emerald Article: Lean production: mistakes and limitations of accounting
systems inside the SME sector
Andrea Chiarini
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To cite this document: Andrea Chiarini, (2012),"Lean production: mistakes and limitations of accounting systems inside the SME sector", Journal of Manufacturing Technology Management, Vol. 23 Iss: 5 pp. 681 - 700
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REGULAR PAPER
Lean production: mistakes and
limitations of accounting systems
inside the SME sector
Andrea Chiarini
Chiarini & Associates, Bologna, Italy
Abstract Purpose – Implementation of lean production introduces the problem of what kind of management accounting to use. The purpose of this paper is to analyse aberrations that are typically created when traditional accounting is used in a lean organisation. Furthermore, the purpose is to discuss whether activity-based costing (ABC) and value stream accounting are suitable for lean production. These three accounting systems are compared under the particular conditions of a small-to medium-sized enterprise (SME) that is in an early stage of lean implementation. Design/methodology/approach – The paper is based on a case study carried out within a SME illustrated by three examples. In the first and second examples the SME analyses how the introduction of improvements, by the means of lean production, can lead to cost product mistakes when traditional accounting calculations are used. The second example deals with a comparison benchmark between traditional accounting and ABC. The third example analyses value stream accounting as an alternative to ABC and discusses the implications and limits for the SME. Findings – The results of the examples show first, the possible mistakes introduced by traditional accounting, and second, how the costing of a manufacturing lot varies when using traditional accounting and ABC. In addition, the results illustrate the interrelationships between lean production, ABC and value stream accounting. In particular, ABC seems to introduce some difficulties in terms of IT automation, and there are difficulties with value stream accounting because it requires a particular value stream-based organisation not particularly suitable for this SME. Research limitations/implications – The generalisability of the research findings is limited because of the use of a case study within a SME in which lean production is in an early stage of application and has a particular flexible organisation. This implies a need for further studies on other SMEs in different organisational situations. Practical implications – The implications are useful for SMEs that are implementing lean production and are thinking of a changeover from traditional accounting. The results can guide SMEs in the selection of the most effective accounting system considering particular factors such as the state of lean implementation, whether the organisation is value stream oriented or type of products manufactured. Originality/value – The paper discusses for the first time the implications of ABC and in particular of Value Stream Accounting inside a SME that is implementing Lean Production.
Keywords Small to medium-sized enterprises, Lean production, Accounting systems, Activity-based costing, Lean accounting, Value stream accounting, Traditional accounting
Paper type Case study
Introduction The market scenario has changed dramatically over the past 20 years and many companies, including small- to medium-sized enterprises (SMEs), have gradually abandoned “mass production” to implement “lean production” or “lean thinking”
The current issue and full text archive of this journal is available at www.emeraldinsight.com/1741-038X.htm
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Received 24 December 2010 Revised 23 May 2011, 24 August 2011, 8 November 2011, 19 December 2011 Accepted 3 January 2012
Journal of Manufacturing Technology Management Vol. 23 No. 5, 2012 pp. 681- q Emerald Group Publishing Limited 1741-038X DOI 10.1108/
and the possibility of improving financial aspects in the short term. While Gosselin (2006) after having listed techniques inside ABC highlighted how it can be used for measuring value-added inside processes. In the past few years, lean accounting (Kennedy and Huntzinger, 2005) based on the concept of value stream or value stream accounting (Baggaley and Maskell, 2003a, b, parts I, II), seems to be the new frontier of accounting systems that are specifically dedicated to lean production. Because value stream accounting is based on the principle of value stream organisation it is by its nature focused on a continuous cutting down of wastes, and helps managers plan for the short as well as the long term (Cooper and Maskell, 2008). As shown in the next sections, value stream mapping (VSM) is a very powerful tool that makes waste in processes immediately apparent. VSM also increases economic and financial performances in the short and long term (Rother and Shook, 2003). Many companies that are implementing lean production are investigating what the most suitable accounting system for lean production would be (Cooper and Maskell, 2008). There are several articles about applications of ABC inside companies that have implemented lean production (Cooper, 1995; Kim and Ballard, 2001; Ittner et al., 2002; Pohlen and Coleman, 2005) and the results analysed and discussed seem to show a positive relationship between the two systems. Other authors investigated value stream accounting especially in large companies with repetitive and high quantity products, and demonstrated that it is particular suitable for organisations that have processes based on value stream (Maskell, 2000; Baggaley and Maskell, 2003a, b, parts I, II; Maskell and Kennedy, 2007; Huntzinger, 2007). However, there is a lack of literature concerning value stream accounting inside SMEs. SMEs often need a tailored methodology and to consider flexible target areas (Deep et al., 2008). In view of this, this research based on a SME case study has two main objectives:
(1) Evaluating what kind of mistakes traditional accounting can introduce within lean production projects. (2) Understanding whether ABC and value stream accounting are suitable or unsuitable for SMEs that have embraced lean production.
In this way, the results of this research will be a useful source of information for the SME sector when implementing lean production.
Research methodology The research employed an empirical approach within a SME case study. It was based on accounting data from the operations of a plant in mechanical production. The plant employs approximately 200 staff of whom 140 fall under the direct workforce with a turnover of e45 million per year. The company has an 8-hour shift per day and the labour cost in production is from e10 to e18 per hour depending on the skills of the worker. Its production is divided into four product families plus a large number of personalised products for single customers. In particular, the company manufactures rotary shaft seals and o-rings and it is a so-called “tier 1”, insofar as it supplies directly to the customers. The company has been implementing lean production for one year in order to reduce wastes such as WIP and improve processes. However, the company has not yet reached a “mature” stage of application. For example, the value stream process redesign is incomplete and wastes are still high.
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Indeed starting from an estimated amount of e500,000 WIP per month, it is now around e400,000 per month. The researcher spent one day per week in the company as an observer over a period of six months. The senior management of the company suspected that the implemented traditional accounting led to mistakes regarding the cost of products and was not suitable for lean production. For instance, using the traditional accounting, a product family designed ten years ago and still in production seemed to have the same cost as a new product with a similar production cycle. However, because it was a new product it was affected by high design and marketing costs. How was this possible? Furthermore, when lean improvements reduced transportation costs this sometimes was difficult to detect in the product cost. These and others situations rang alarm bells that led senior management to evaluate and compare different accounting systems. The research stages can be summarised as:
. (^) Analysis of traditional accounting system and the possible introduction of mistakes. In this stage by the means of the two first examples, it is shown how, after the introduction of lean improvements, traditional accounting can lead to cost product calculation mistakes. In particular, the second example directly compares the cost product calculations using traditional accounting and ABC after a lean reorganisation inside a cell. . (^) Comparison between the ABC calculations and the possibility to introduce value stream accounting. In this stage, starting from the results of ABC calculations that help to understand how the cost of product is structured, it is discussed whether or not value stream accounting can be implemented in this SME. In particular it is analysed and discussed whether a value stream organisation can be applied in this SME and if the cost of product results can be similar to the ABC ones.
The company compared and analysed the cost of product results in order to evaluate what kind of accounting system was the best for its own situation and should have substituted the current based on traditional accounting. The limitation of this research is the lack of generalisability of the results that is typical of a case study approach (Bryman, 1988).
Traditional accounting Traditional accounting is normally linked to mass production (Kaplan, 1983), which is still in use in particular markets (Gamble et al., 2004), that is based on the principle of the increasing production lot antithetical to lean organisation (Shingo, 1989). Indeed, in the mass production the use of big lots typically led to the achievement of the following targets:
. (^) customer service by means of high supply levels; . (^) high margins given by the maximum exploitation of machines (Hounshell, 1984); . (^) detailed calculations related to the “actual” costs for each cost centre; . (^) pursuit of standard product costs (Collins, 2001); and . (^) low indirect costs directly proportioned to the amount of workforce necessary to make the product.
By producing big lots, it is obvious that the percentage of direct costs, particularly workforce, becomes very high compared to indirect ones or overheads. In a market
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centres do. Essentially, the cost centre becomes the process. Such reasoning is easier to explain than to put into practice (Covey, 1991). In fact, it implies, for example, that designers have to register every day how many hours planning they have dedicated to a product/service. All costs become direct by means of the cost “driver” concept: this is the leading factor directly linked to the cost of the activity. For example, the number of handled products can be the driver of the transport activity. Consequently, to analyse the cost of a lot, or of products handled in a specific period, the number of these products has to be multiplied by the unit driver cost. By means of this outline, the cost driver arrives at the cost of the product by adding up the costs of all the activities of the processes concerned with that product, beginning with research and development, design, marketing and so on (Karlsson and A˚ hlstro¨m, 1996). The ABC accounting system seems complex because:
. (^) It is necessary to realise a detailed mapping by dividing the processes into activities and in some organisations a product “goes through” hundreds of activities. . (^) For every activity it is necessary to identify the correct driver and its standard unit value. . (^) It is necessary to register in a software or paper report the number of drivers in a specific period of time for each activity.
In the early 1990s and 2000s, ABC seemed to be achievable when considering the increasing capillary diffusion of PC networks, bar code decoders, Wi-Fi and so on. By means of these systems, many calculations related to activities can be computerised (Groover, 2008). For example, the use of bar code systems makes knowing how many products with a specific code a conveyor has handled in a day relatively easy. In fact, although theoretically interesting, ABC has turned out to be complicated and difficult to apply. Moreover, managers and software developers who were culturally used to traditional accounting systems have often rejected it. Today, companies are talking a great deal about lean production and Six Sigma (Chowdhury, 2001) but industrial accounting (at least the official one) is sometimes still stuck at the calculation of mass production.
Lean accounting – value stream accounting A review of the literature shows that it lacks a clear explanation of what lean accounting is. Lean accounting is normally based on process reengineering using the VSM tool and organisation based on value streams. For some authors, especially practitioners, it is considered a breakthrough (Maskell and Baggaley, 2000; Huntzinger, 2007). VSM is one of the most important lean production tools for mapping processes. According to Rother and Shook (2003, p. 4): Value Stream Mapping (VSM) is a tool that helps to see and understand the flow of material and information as a product makes its way through the value stream [.. .] is the simplest way [.. .] to see value, and, especially the sources of wastes.
VSM uses codified icons such as a process/activity box, in which important data concerning cycle time (C/T) and changeover time (C/O) are entered. Value stream accounting, similar to ABC, tries to avoid calculations of overheads: all costs become direct in respect of the value stream (Maskell, 2000; Maskell and Kennedy, 2007).
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The centre of gravity of this accounting system is therefore the extended value stream organisation, from design to shipping. The highest level of marginality in the sale of products/services is obtained by the continuous reduction of lead times and by the acceleration of order-to-cash (Hines et al., 1998). Beginning from this logic it does not make much sense to talk about overhead costs or standard costs. This latter aspect becomes a target to reach that is typically related to the budget, especially in traditional accounting. The reduction of costs by means of traditional accounting mostly occurs by reducing the time of direct workforce (Bossidy and Charan, 2002) because the indirect costs item represents a melting pot that cannot be investigated. From this reasoning emerge standard C/Ts and the consequent standard costs as an attempt to maximise the use of resources and to bring down the product cost. Such reasoning is more than logical in the era of big lots and low indirect costs, but today wastes are mostly included in many indirect costs, and C/T has to be especially conceived to line up with takt-time. No less important is the fact that intense use of standard costs/times implies the specialisation of productive roles according to the Tayloristic model (Lindbeck and Snower, 2000), and clearly this is the antithesis to the need of flexibility that is necessary in the trade-off of cells/processes. This point underlines that it is necessary to unhinge the concept of standard cost in order to focus on value stream and on the stream speed, because it is not usually possible to reduce process wastes by means of the standard cost.
Mistakes introduced by traditional accounting: first example Many authors have demonstrated the weakness of the traditional accounting system in manufacturing operations (Zuk et al., 1990; Greenwood and Reeve, 1992; Cooper and Kaplan, 1998; Adler et al., 2000; Brimson, 2007). The SME analysed in the case study has been using traditional accounting since the 1990s. Computations are based on a complex hardware and software system installed in a dedicated UNIX server and upgraded to Euro currency in 2000. This first example shows in a simple way how improvements achieved by lean in some cases can lead to aberrations in cost of product calculations. Two working lines, A and B, dedicated to two different families of products, work as cost centres. The cost of a lot of products (about the same amount and demand in a week) from both lines is calculated according to Table I.
Cost centre A Cost centre B
Cost of semi-finished products and raw materials ¼ e 30
Cost of semi-finished products and raw materials ¼ e 28 Cost of direct workforce ¼ e 160 Cost of direct workforce ¼ e 120 Plants amortisation ¼ e 10 Plants amortisation ¼ e 12 Overhead share ¼ (amount of indirect costs of the perioddirect workforce time in the centre)/total amount of direct workforce ¼ (e56016 h)/ 28 h ¼ e 320
Overhead share ¼ (amount of indirect costs of the perioddirect workforce time in the centre)/Total amount of direct workforce ¼ (e56012 h)/ 28 h ¼ e 240 Total cost of lot A ¼ e 520 Total cost lot of lot B ¼ e 400
Table I. Cost of a lot using traditional accounting
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The first-in-first-out conveyor constitutes an inventory as well. Indeed the visual inspection activity is slower than the earlier one. The press uses 1.5 minutes for each product but the C/O lasts about 330 minutes. The map in Figure 1 is called VSM “as-is” because it depicts the initial situation before the improvements. The “clouds” represent possible Kaizen events for improving the situation. In this case, a U-cell design and a single minute of exchange of die (SMED) could help the company to reduce the lot size. The operator places him or herself inside a “U” so that everything can be reached and the operator works one piece at a time, reducing lot size (Monden, 1998). SMED reduces the set-up time or C/O that allows further reduction in lot size. Figure 2 shows the VSM “future-state” or how the process should be at the end of Kaizen events. The lot size decreases from 250 to 25 and the welding machine is now entirely dedicated to the product, consequently there is no more WIP before welding.
Figure 1. VSM before the Kaizen event (as-is)
Visual Inspection
250
FIFO
Welding Press
Dimensional Inspection
FI
FO
Lot preparation
C/T = 2' per product, 500' per lot
C/T = 4.5' per product
C/T = 4.5' per product
C/T = 1.5' C/O= 330'
C/T = 6.5' per product
SMED
U Cell
Figure 2. VSM after the Kaizen event (future-state)
Visual Inspection Welding Press
Dimensional Inspection
FIFO
Lot preparation
C/T = 3' per product, 75' per lot
C/T = 4.5' per product
C/T = 4.5' per product
C/T = 1.5' C/O= 26'
C/T = 6.5' per product
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A so-called “supermarket” (Monden, 1998) can be noticed; it reduces WIP between lot preparation and visual inspection activities. Indeed inside the supermarket the operator can load up to 75 products (three lots of 25 each). The conveyor could instead store up to 1,500 products. Figure 3 shows the improvements obtained after a change in the layout by means of “U”-shaped cell and the SMED application on the press. Operators involved in the cell are the same five of the earlier situation. Some activities with no added value, highlighted in grey, have been eliminated; set-up times of the press have been drastically reduced from 330 to 26 minutes, but the time for the preparation of the lots has been increased by 1 minute for every single product.
Figure 3. Activity analysis worksheet
Activities Worksheet
Area: Plant 1 Part number: T Process: T147 cells Kaizen Team: n°23 (Continuous improvement)
Before (date): After (date):
WorkMovementTransportWaitingInspection
Activity Time DistanceWorkMovementTransportWaitingInspection
Activity Time Distannce 2’ 30 Movement towards preparation
2' 30
2’a Lot preparation
3’a
4.5’a Visual Inspection
4.5a
3’ 15 Welding (^) 4.5a
2’ (^15) Press Set-up 26’
4.5a Press 1.5a
2’ 10 Dimensional Inspection
6.5a
330’
1.5a
Movement towards preparation
Lot preparation
Visual Inspection
Movement towards buffer
Movement from buffer to welding
Welding
Movement towards press
Press Set-up
Press
Dimensional Inspection
6.5a
Note: a^ average time per product
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cost driver; for offers, for example, this is “number of offers”. Lastly the cost of the activity in the period is the multiplication of the cost driver by the number of offers made. The revised results are shown in Table IV. The unit cost of products decreases by e10 cents after the Kaizen event has been applied to the cell. Apart from the unit cost of semi-finished goods, an invoice coming from a supplier, and plant amortisations, each process has been divided among the activities that concern the product, and the driver has been determined with its cost. By splitting the “cell cost” line that is highlighted in grey, the accounting reasoning that led to the demonstration of the e10 cents saving can be analysed in detail. In addition, Table IV highlights the improvements determined by the Kaizen team in terms of elimination of activities with no added value (Senge, 2006). The highlighted lines in the last column of Table IV, named “cost of the lot (after)”, represent the activities that have been eliminated after the event, that are at zero cost. For example, the second line named “lot preparation” presents the minutes of labour as drivers. Consequently, the unit value of 1 minute of labour (e0.25) in the third column is multiplied by the 500 minutes that are required to prepare the lot (Figure 1). Because the activities of the cell were linked to the lots, the industrial accountant had to calculate the costs related to the lots in order to eventually obtain, in the final line, the product’s unitary cost by dividing by the number of products of the lot: first 250, then 25. The ABC in Table IV shows precisely the benefits obtained both through the elimination of activities with little or no added value and through the reduction of set-up time of the press.
Value stream activities (highlighted in grey the eliminated activities) Cost driver Cost of the lot (before) Cost of the lot (after)
Movement towards preparation
No. of handled lots
0.25 ( £ 1) ¼ 0.25 0.25 ( £ 1) ¼ 0.
Lot preparation No. of prepared products
0.25 ( £ 500) ¼ 125 0.25 ( £ 75) ¼ 18.
Visual inspection No. of inspected products
0.6 ( £ 250) ¼ 150 0.6 ( £ 25) ¼ 15
Movement towards buffer No. of manual movements
0.1 ( £ 250) ¼ 25 0
Movement from buffer to welding
No. of manual movements
0.2 ( £ 250) ¼ 50 0
Welding No. of welded products
0.6 ( £ 250) ¼ 150 0.6 ( £ 25) ¼ 15
Movement towards press No. of handled lots
0.30 ( £ 1) ¼ 0.30 0
Press set-up Workforce minutes
0.2 ( £ 330) ¼ 66 0.2 ( £ 26) ¼ 5,
Press No. of pressed products
0.8 ( £ 250) ¼ 200 0.8 ( £ 25) ¼ 20
Dimensional inspection No. of inspected products
0.6 ( £ 250) ¼ 150 0.6 ( £ 25) ¼ 15
Cost of the lot ¼ 916. unit cost of the product ¼ 3.
Cost of the lot ¼ 89.2 unit cost of the product ¼ 3.
Table IV. Details of the costs within the cell using ABC
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Analysis and discussion about the possibility of implementing value stream accounting Value stream accounting inherits ABC principles in that it does not distinguish between direct and indirect costs. All costs are direct in relation to the value stream, as much as in ABC all costs become direct in relation to the processes that influence the realisation of the product/service (Maskell and Baggaley, 2000). However, whereas in ABC it is necessary to divide the processes into activities, determine activity drivers and the unitary driver cost in order to eventually add up all the costs of process activities, value stream accounting implies a further simplification in the calculation. ABC has received some criticism concerning difficulties in its implementation (Gosselin, 2006; Kaplan and Anderson, 2007) and this was the reason why the company decided to compare it with value stream accounting. The company after managing the second example noticed that it had to do a huge process analysis, finding activities, their drivers and above all introduce widespread electronic data gathering. For instance an ABC system should automatically register each transportation of the conveyors in order to calculate this activity cost. This is not impossible but for the company it entailed a big change-over from the hardware system dedicated to the traditional accounting. The first issue to consider when analysing value stream accounting as a possible alternative to ABC is value stream organisation. Maskell and Baggaley (2000) dealt with the subject claiming that first of all the organisation should be based on specific value streams. According to Maskell and Baggaley (2003, p. 142, part II), in large companies costs and expenses associated with non-stream value activities should not be allocated to the value stream because: “non-value stream costs are inevitably small because most of the work of the organisation will be associated with value streams”. However, because of their nature SMEs are sometimes not able to dedicate staff to a single value stream or product family, and consequently non-value stream costs might be not so small. This is especially so for the sales force, designers and supply chain managers (Siqueira and Cosh, 2008), and they are inevitably dedicated to several value streams, as in this case study. Indeed, going over Table III the industrial accountant immediately understood that processes and staff from row 2 to 8 were dedicated to at least four value streams at the same time. Only the cell in the ninth row was entirely dedicated to a unique value stream along with the cost of semi-finished products in row
- The industrial accountant tried to sort out the problem by allocating the costs dedicated to processes from row 2 to 8 to the four value streams using methods different from ABC drivers. But this allocation should have been made using formulas derived from traditional accounting, introducing up to 17 per cent of difference from the ABC calculations. In addition, it was even difficult to dedicate the cost of the machines in the tenth row to a single value stream. Indeed it is not easy to transfer and dedicate big machines called “monumental” systems, such as presses and ovens, to a single value stream. Table V shows the ratio between value stream costs and non-value stream costs within Table III. It is clear how non-value stream costs are not so irrelevant with respect to value stream costs. Finally the analysis and discussion above demonstrate that in this SME non-value stream costs are not so small. Another consideration, quality costs, was presented more clearly for analysis in Table III. At the beginning of the lean journey, defectiveness is usually high
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. (^) Costs related to quality (quality management, quality inspection, laboratories, etc.) have to be low and the processes have to be kept under control, that is with low defectiveness, otherwise it becomes necessary to calculate the amounts of quality costs, including cost of poor quality. . (^) All the products should be divided into value streams including very personalised and/or unique products.
Taking into account all the limits discussed above, this SME considered value stream accounting a specific system for firms whose processes are already stabilised by lean improvements, and with an organisation that is strongly aimed at the value stream. Too many approximations would have given wrong product cost calculations. Consequently, ABC has been judged the best accounting system even if about half a million euros has been spent on process analysis, identification of cost-drivers, servers, PCs, personal digital assistants, software, data-warehouses and many other IT tools. This strong automation that uses IT processes has led to more red tape; people are supposed to fill in screens for every transaction inside a process with little slowing down of the work. However, for senior managers and the industrial accountant once this situation becomes a habit no one will grumble about it.
Conclusions The SME analysed by the means of these three examples has clearly shown that:
. (^) Traditional accounting can lead to mistakes in cost of product calculations because of the process of overhead sharing based on direct workforce time. In the second example even a Kaizen event risked being rejected. . (^) ABC seems to work well with lean organisations because an accountant can immediately understand all the impacts of Kaizen activities on product costs. The second example shows how ABC reveals the improvement carried out by a Kaizen team. . (^) ABC is not as easy to implement as other accounting systems. Automation and software are supposed to be implemented pervasively. . (^) Value stream accounting requires that all the costs become direct in relation to the value streams. When this condition is verified then value stream accounting becomes accurate and extremely simple in its calculations. However, the third example shows how this is not always possible in this SME.
Discussion of value stream accounting in the case study has revealed that its accuracy depends, first of all, on the maturity of implementation of lean tools. Normally, when a company starts implementing lean, wastes such as defectiveness, transportations and inventories are relevant and affect activities that cannot be easily transformed into direct costs for the value streams. However, even when lean is well-implemented and wastes reduced there are other issues that cannot be overcome. Value stream has to be extended to the design of product and process, marketing, quality, purchases, shipping and so on. In this SME, however, it is practically impossible to find staff and machines entirely dedicated to a single value stream.
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Last, but not least, all the products should be classified into value streams. However, this SME, along with many others, manages a small quantity of very personalised products that cannot be included in any existing value streams. ABC was the best accounting system for the SME and value stream accounting was not considered such a breakthrough. However, the price that has to be paid with ABC is a huge implementation of IT throughout the company with the consequence of more red tape.
Agenda for future research The results of this paper point to interesting future directions of research. First, academics should investigate and define what exactly is lean accounting. There are few academic papers on lean accounting (Maskell, 2000; Kennedy and Huntzinger, 2005; Johnson, 2006; Kennedy and Widener, 2008) and the relationship between lean accounting and value stream accounting is unclear. Is it really based on value stream organisation or can it be implemented using techniques derived from ABC? This SME case study proves, for instance, that lean accounting based solely on value streams is not suitable for companies in the early stages of lean production implementation with staff who are not entirely dedicated to a value stream because of the size and non-repetitive production. Is this finding due to the particular conditions of the case study or can it be generalised? Practitioners, in this way, could carry out similar case studies and academic researchers could investigate using surveys and quantitative research. Lastly, practitioners and academics should investigate the difficulties in implementing ABC within SMEs. The huge requirement to invest in IT within processes, and the consequence of more red tape, could become antithetical to the concept of lean and ultimately a new source of waste.
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