CHAPTER 16: LEAN ACCOUNTING, TARGET COSTING, AND THE BALANCED SCORECARD

Lean Manufacturing

Lean manufacturing is an approach designed to eliminate waste and maximize customer

value. It is characterized by delivering the right product, in the right quantity, with the right quality
(zero-defect), at the exact time the customer needs it and at the lowest possible cost. Lean
manufacturing systems allow managers to eliminate waste, reduce costs, and become more efficient.

Five principles of lean thinking:

1. Precisely specify value by each particular product.

 Value is determined by the customer—at the very least, it is an item or feature for
which the customer is willing to pay. Customer value is the difference between
realization and sacrifice. Realization is what a customer receives.

2. Identify the “value stream” for each.

 The value stream is made up of all activities, both value-added and non-value-added,
required to bring a product group or service from its starting point to a finished
product in the hands of the customer. There are several types of value streams, the
most common being the order fulfillment value stream. The order fulfillment value
stream focuses on providing current products to current customers.
 A second type of value stream is the new product value stream, which focuses on
developing new products for new customers.

3. Make value flow without interruption.

 In a traditional manufacturing setup, production is organized by function into
departments and products are produced in large batches, moving from department
to department. This approach requires significant move time and wait time as each
batch moves from one department to another and waits for its turn if there is a
batch-in-process in front of it.

4. Let the customer pull value from the producer.

 Lean manufacturing uses a demand pull system to reduce waste.

 JIT inventory

 Reduces inventory levels

 Requires close relations with suppliers

 Suppliers benefit from

 Long term relations

 Better competitive position

5. Pursue perfection.
 The objective is to produce the highest-quality, lowest-cost products in the least
amount of time. To achieve this objective, a lean manufacturer must identify and
eliminate the various forms of waste.

Lean Accounting
  Traditional cost management systems may not be compatible with Lean Accounting.
Lean Accounting makes product costs more simple & direct. More labor and
overhead costs are assigned to products through direct tracing rather than
allocation.

FOCUSED VALUE STREAMS

 Are more simple & accurate in product costing

 Have limitations
o Initially, labor costs may be difficult to assign if people are employed in
several value streams
o Labor costs should have assigned proportionately
 Are organized around a family of products

Value Stream Costing with Multiple Products

Product Costing with multiple products, product costs for value streams are calculated using an
actual average cost:

Value stream product cost = Total value stream cost of period/Units shipped of period

Value Stream Decisions

 May lead to

 Short term decisions

 May not reflect long term consequences

Performance Measurement

 Lean accounting replaces standard cost system measurements with a Box Scorecard that
compares a) operational, b) capacity, & c) financial metrics with prior week performances. A
mixture of financial & nonfinancial measures is used.

Life-Cycle Cost Management and the Role of Target Costing

  Product life cycle is simply the time a product exists, from conception to abandonment. Life-
cycle costs are all the costs associated with the product for its entire life cycle. They include
development (planning, design, and testing), production (conversion activities), and logistics
support (advertising, distribution, warranty, and so on).
 Whole-life cost is the life-cycle cost of a product plus its postpurchase costs, costs such as
operation, support, maintenance, and disposal that are incurred by the customer after
buying the product.
 The value chain is the set of activities required to design, develop, produce, market, and
service a product (or service). For a lean manufacturer, the value chain is made up of the
innovation (new product) value stream and the order fulfilment value stream.
 Thus, life-cycle cost management focuses on managing value-chain activities so that a long-
term competitive advantage is created.
 Target Cost: Is the difference between sales price needed to capture a predetermined
market share & desired per-unit profit.
o Uses 1 of 3 methods: Reverse engineering - Tearing down a competitors’ product to
discover design features that create cost reductions
o Value analysis - Attempting to assess the value placed on product functions by
customers
o Process improvement
 Life cycle costing includes development costs unlike conventional cost systems. Inclusion of
more cost information can be useful for assessing effects on costs and benefit future design.

The Balanced Scorecard: Basic Concepts

The Balanced Scorecard is a strategic management system that defines a strategic-based

responsibility accounting system. The Balanced Scorecard translates an organization’s mission
and strategy into operational objectives and performance measures for four different
perspectives: the financial perspective, the customer perspective, the internal business process
perspective, and the learning and growth (infrastructure) perspective.

 Financial perspective

 Economic consequences of actions taken in other 3 perspectives

 Customer perspective

 Defines customer & market segments where the business unit will compete

 Internal business process perspective

 Describes internal processes needed to provide value for customers, owners

 Learning & growth (infrastructure) perspective

 Defines capabilities that an organization must have to create long term growth &
improvement

Strategy Translation
  Strategy, according to the creators of the Balanced Scorecard framework, is defined as
[C]hoosing the market and customer segments the business unit intends to serve,
identifying the critical internal and business processes that the unit must excel at to
deliver the value propositions to customers in the targeted market segments, and
selecting the individual and organizational capabilities required for the internal,
customer, and financial objectives
 Strategy translation, on the other hand, means specifying objectives, measures, targets,
and initiatives for each perspective.
o Is the ways in which a company implements it strategy for profit & growth within
the balanced scorecard framework. It includes choices of type of customer,
product, market, internal & business processes, etc. Strategy translation means
specifying objectives, measures, targets & initiatives.

The Role of Performance Measures

Must be balanced between:

 Lead measures (performance drivers) – are factors that drive future performance
(e.g., hours of employee training).
 Lag (outcome) measures - are outcome measures, measures of results from past
efforts (e.g., customer profitability).
 Objective (quantifiable & verifiable) measures - are those that can be readily
quantified and verified (e.g., market share)
 Subjective (more judgmental) measures - are less quantifiable and more judgmental
in nature (e.g., employee capabilities).

 Financial & nonfinancial measures - are those expressed in monetary terms,

whereas nonfinancial measures use nonmonetary units (e.g., cost per unit and
number of dissatisfied customers).

 External measures - are those that relate to customers and shareholders (e.g.,
customer satisfaction and return on investment).

 Internal measures - are those measures that relate to the processes and capabilities
that create value for customers and shareholders (e.g., process efficiency and
employee satisfaction).

Linking Performance Measures to Strategy

  Testable strategy

 Using cause & effect

 Link objectives to overall goal

 Double loop feedback

 Managers receive information on effectiveness of strategy & its underlying

assumptions

 Single loop feedback

 Emphasizes only effectiveness of strategy

The Four Perspectives and Performance Measures

 Flows from other 3 perspectives

 Revenue growth - Several possible objectives are associated with revenue growth.
Among these possibilities are the following: increase the number of new products,
create new applications for existing products, develop new customers and markets,
and adopt a new pricing strategy.

 Cost reduction - Reductions in the cost per unit of product, per customer, or per
distribution channel are examples of cost reduction objectives. The appropriate
measures are obvious: the cost per unit of the particular cost object(s).

 Asset utilization - Improving asset utilization is the principal objective.

Customer Perspective

Source of revenue component within the financial perspective

 Core objectives & measures - are those that are common across all organizations. There are
five key core objectives: increase market share, increase customer retention, increase
customer acquisition, increase customer satisfaction, and increase customer profitability.

 Customer value

 Difference between what customers receive and what they have given up

 Delivery reliability

Process Perspective
  Process value chain made up of 3 processes

 Innovation process - anticipates the emerging and potential needs of customers and
creates new products and services to satisfy those needs. It represents what is called
the long-wave of value creation.

 Operations process - produces and delivers existing products and services to

customers. It begins with a customer order and ends with the delivery of the product
or service. It is the short-wave of value creation.

 Cycle time & velocity

 Manufacturing cycle efficiency

 Day-by-hour report

 Postsales service process - provides critical and responsive services to customers

after the product or service has been delivered.

Learning and Growth Perspective

The learning and growth perspective is the source of the capabilities that enable the
accomplishment of the other three perspectives’ objectives. This perspective has three major
objectives: increase employee capabilities; increase motivation, empowerment, and alignment; and
increase information systems capabilities.

1. Employee Capabilities - Three core outcome measurements for employee capabilities are
employee satisfaction ratings, employee turnover percentages, and employee productivity
(e.g., revenue per employee).
2. Motivation, Empowerment, and Alignment Employees - must not only have the necessary
skills, but they must also have the freedom, motivation, and initiative to use those skills
effectively.
3. Information Systems Capabilities Increasing - information system capabilities means
providing more accurate and timely information to employees so that they can improve
processes and effectively execute new processes. Measures should be concerned with the
strategic information availability.