| EXECUTIVE SUMMARY 
Lean accounting concepts are designed to better reflect the financial performance of a company that has implemented lean manufacturing processes. These may include organizing costs by value stream, changing inventory valuation techniques, and modifying financial reports to include nonfinancial information.
Value stream management (VSM) is a different way of measuring and evaluating a company’s results and involves changes to decision-making processes. For Watlow, VSM resulted in better communication, reduced inventory and improved decision making.
Steps to implementation at Watlow Electric Manufacturing Co. included identifying the company’s main value streams; mapping out key metrics to monitor achievement; organizing into three or four value streams per site; changing chart-of-accounts structure to a few value stream groupings rather than by traditional departments; zeroing out labor and overhead rates from the system and stopping collection of these data; and splitting out material costs from other COS conversion costs and using a memo line in internal financial statements to increase visibility of inventory purchases.
Early challenges included anxiety among many employees and some product managers. It only took a few weekly reviews for the employee team members to take ownership of their assigned metrics. Product managers received decision-making templates and training that pricing should be market-based rather than cost-plus-based
Watlow now plans to pursue the transaction simplification and elimination aspects of lean accounting. The company will simplify shop floor transactional processes, incorporate more visually managed processes, and implement better pull-based material flows.
Jan P. Brosnahan, CPA, CMA, is the Measurements and Controls Division controller for Watlow Electric Manufacturing Co. Her e-mail address is jbrosnahan@watlow.com. Many companies have pursued lean manufacturing in recent years as a key strategy for profit growth. However, most companies have kept in place traditional measurement and management tools, preventing them from fully realizing the broad benefits of lean. The finance team at Watlow Electric Manufacturing Co. discovered how to unleash the full power of lean through the implementation of a nontraditional approach to measuring and managing the company, called lean accounting. Lean accounting concepts are designed to better reflect the financial performance of a company that has implemented lean manufacturing processes. These may include methods such as organizing costs by value stream, changing inventory valuation techniques, and modifying financial reports to include nonfinancial information. Lean manufacturing encompasses a variety of concepts and tools, all aimed at simplification of a business to the essential elements, with an eye to meeting the requirements of the customer in a more effective, and therefore profitable, manner. Lean accounting follows the same mantra as lean manufacturing: Identify value in the eyes of the customer; organize in value streams; apply flow and pull; empower employees; and continually pursue perfection. Like many companies, Watlow began pursuing lean as a growth strategy for our business a few years ago, using many lean tools to improve operations. As a participant in many kaizen events (focused incremental process improvement projects), the management team knew progress was being made in many areas, yet found it difficult to quantify the improvement using traditional measurements. In fact, some of the financial measures seemed to contradict some of the improvements that had been made, making the team question whether the payoff for the time invested in applying lean practices and tools was worthwhile. We had heard the term “lean accounting,” thinking that it was simply applying the same lean toolset (pull, flow, etc.) to streamline the financial transactional flows of a business. Our CFO, Steve Desloge, discovered an excellent book, Practical Lean Accounting, by Brian Maskell and Bruce Baggaley, and provided copies to all of the site controllers to read. We learned that the authors, as well as other leading lean accounting practitioners, would be at the inaugural Lean Accounting Summit in Dearborn, Mich., and made arrangements for 17 of our finance and continuous operational improvement (COI) leaders to attend. We learned at the 2005 conference how lean accounting helps transform entire businesses, through a process called value stream management. VALUE STREAM MANAGEMENT
Value stream management (VSM) is a different way of measuring and evaluating a company’s results and requires changes to decision-making processes. Rather than managing and measuring results by traditional departments such as customer service, purchasing, manufacturing, engineering and accounting, a company organizes into value streams and manages and measures results by value streams. A value stream includes all of the functions and people required to fully support the operations of the value stream. For instance, an order fulfillment value stream goes from the front end (sales and order entry) through manufacturing and through after-sales support. A value stream leader is responsible for the overall coaching and profitability of the value stream. Specific metrics are identified for the value stream to monitor. Among others, we created metrics to measure safety, quality, delivery and cost (SQDC) (see Exhibit 1).
Each week, the value stream team gathers around the value stream metric board, and the members report the prior week’s metrics, which include the operational, capacity and financial aspects of the value stream. Standard costs, variances and allocations are not used in VSM. Only the directly incurred costs of the value stream are used for decision making. Decisions are evaluated from the projected impact on the operational, capacity and financial metrics of the value stream rather than looking at the supposed profitability of a single product. We had expected that lean accounting/VSM would help provide better visibility to our improvements and help improve our decision making, but the actual benefits have been so much larger than this initial view. The use of VSM has really changed the whole way we manage our business, more directly engaging and involving all of our employees.  Better communication. Better communication and coordination to meet customer needs has also resulted from VSM, as functional silos have been removed, resulting in improved cycle times for many processes. Everything benefits as the value stream team works together to improve product flow through the value stream, from new product launches through to shipping customer orders. Value stream management has helped each employee better understand the key drivers or metrics that make a difference in our business and how they contribute to the company’s success by helping move those metrics in the right direction. Reduced inventory. Inventory has been reduced by more than 30% (see Exhibit 2). We changed our metric from the traditional inventory turn measurement, at a macro site level, to a days-of-inventory (DOI) measurement at the site and value stream. We assigned the DOI metric to staff members responsible for buying materials for each value stream. Since buyers must report each week on the amount of inventory purchased and remaining onhand in their value stream, they have exhibited greater interest in managing inventory levels than ever before. Previously, our buyers seemed more interested in placing orders and getting the best price than in improving the pull and flow of inventory and in reducing inventory levels. Although we had a goal of a two-turn improvement in total inventory, it wasn’t evident to the buyers how their specific actions contributed to the turn reduction, since it was difficult to tie the overall site improvement to actions of individual buyers. In some ways it was like asking our buyers to eat an elephant! By changing the metric to DOI at the value stream level, a much closer correlation was drawn between improvement to actions taken—the buyers began to “eat the elephant” (reduce inventory) by taking one bite at a time. A reduction in days of inventory is much easier to see and get excited about versus a one-tenth of a point improvement in a site inventory turn under traditional measurement systems.  Improved decision making. Value stream management also led to greatly improve decision making. A light bulb went off when we realized we had been treating certain costs as variable costs when in fact the particular costs don’t necessarily vary with increased production volume. For example, total direct labor cost doesn’t necessarily increase as additional volume is put through a factory, if available capacity exists or is made available through improvement initiatives. Our previous decision-making models always assumed direct labor varied completely with volume. We discovered, through value stream decision making and analysis, that perhaps we had been limiting ourselves in the way we had been treating such costs, perhaps turning down business that would have provided additional profitability from a value stream perspective.
STEPS TO IMPLEMENTATION
The basic steps we took to pursue VSM included the following (see Exhibit 3 for a timeline): 
We identified the main value streams of the company, which included demand creation value streams, new product and business development value streams, and order fulfillment value streams.
We mapped out the key metrics that our company would use to monitor the achievement of the company’s main strategies. We identified a set of metrics at the enterprise level, then cascaded the metrics down to the individual division/site, then down to the value stream level, and finally down to the cell level. We identified the frequency of the measurements: monthly for certain enterprise and site-level metrics; weekly for value stream metrics; and daily for the cell metrics.
We looked at our processes and followed the guideline that a value stream should comprise between 25 to 150 employees. We organized into three or four value streams per site (one value stream includes members at more than one site); and we developed metric workbooks and supporting value stream financial statements, centered around a one-page summary called a box score, which helped the value stream team monitor their operational, capacity and financial metrics. More than 90% of our employees were assigned to value stream teams, leaving only a small general support group at each site that consisted primarily of functional managers who worked across the value stream teams to improve functional processes. For example, a material excellence leader works to implement kanban processes (specific guidelines regarding the frequency, quantities and logistics of parts replenishment) across the order fulfillment value stream.
We changed our chart-of-accounts structure to a few value stream groupings rather than maintaining costs by traditional departments. We maintained a separation of inventoried cost of sales (COS) from that of selling, general and administrative (SG&A) to make end-of-month capitalization of labor and overhead costs simple to identify.
We zeroed out labor and overhead rates from our system and stopped generating and collecting labor and overhead variance information. Like many companies, we found that most of the standard cost and variance information was received too late and involved too many transactions to be of any use in improving our business. We replaced end-of-month variance reports, rarely fully utilized by management, with very visual live hourly and daily operator-generated reporting that is reviewed and acted upon daily by the value stream team. This change contributed to active improvements of production processes.
We split out material costs from other COS conversion costs and used a memo line in our internal financial statements to increase visibility of inventory purchases, which our value stream procurement employees reported on each week.
CHALLENGES
We needed to overcome a few challenges in our day-to-day accounting processes. Traditional functional spending reports no longer exist (that is, HR department spending). Spending is analyzed by value stream instead, and the few functional excellence personnel in the general support group share a “department” in the general ledger. This met with some resistance initially, but the general support group has since realized that they generally do not incur much of the site spending, and the value stream spending is reviewed in detail each week during the value stream metric reviews. This has greatly reduced the number of general ledger accounts used and made forecasting and budgeting much simpler. Fully burdened standard costs no longer exist. We now maintain material standard costs, based on detailed bills of materials, and value our inventory at the end of the month using a “macro” valuation based on average COS conversion cost per day times the estimated number of days of inventory on hand at the end of the month. This is a very simple calculation that is straightforward and easy to understand and maintain. VSM has completely changed the way we manage our business. We have a higher level of involvement of employees at all levels and a better understanding of the key drivers of our business and how each employee supports the business. We maintain fewer, but more meaningful, metrics, which are reviewed weekly and really understood and owned by our employees. When we first began our VSM journey and transferred ownership and accountability of the value stream metrics to the supporting value stream employees, many employees displayed some anxiety because this responsibility had typically fallen to the functional department manager rather than the front-line employees. Most were not used to speaking in front of others from outside their (traditional) functional area. However, it only took a few weekly value stream metric reviews for the various team members to take ownership of their assigned metrics. Metric owners started looking forward to sharing their metric results and leading discussions of trends and root causes of issues they uncovered. It became fun for the metric owners to share the successes they had in improving their metrics. Similarly, some product management employees were anxious when we announced that we would be zeroing out labor and overhead from standard costs. They were unsure how they would approach decisions regarding things like pricing without such guides. We trained them on decision making under VSM, provided them with some decision-making templates, and reinforced to them that pricing should be market-based rather than cost-plus-based. We also stressed the need to involve the value stream leader in evaluating the impact of the opportunity on the machine and people capacity of the value stream. Decisions are now made more as a team rather than by function. We have fewer surprises on the production floor as opportunities are no longer “thrown over the wall” from sales and marketing to production before capacity is taken into consideration. RESULTS
We’ve strengthened and streamlined our sales and operations planning process, tailoring it to a value stream structure. Our process begins with evaluating the future sales demand, with specific analysis of impact of the demand on available machine and employee capacity as well as the availability of materials to meet the demand. We project the operational, capacity and financial results likely to be generated by the demand and update the projected metrics accordingly. We then meet as a management team to review the issues raised by the projected demand. As a result, we have been able to increase sales volume by more than 15% while increasing return on sales by a similar margin. We were able to implement the value stream management aspect of lean accounting throughout our Winona, Minn., facility in a very short time. Part of the success was achieved by engaging our executive management and corporate accounting teams from the start, in the project’s design phase. Their understanding of the lean accounting concepts, buy-in to the shared-end vision and assistance in transforming the topside financial statements were extremely helpful. In addition, by having the controller and COI staff of the next implementation site participate in the training and implementation of our site, as an “understudy,” we were able to make a smooth transition of developed tools and lean accounting processes to subsequent Watlow sites. WHAT’S NEXT?
In our initial assessment, we decided the first step in our lean accounting implementation would be to implement value stream metrics. We now plan to focus on simplifying and eliminating unnecessary steps or transactions on the shop floor. To do this, we will use more visually managed processes and implement better pull-based material flows, using kanban techniques that share consumption data with suppliers. We are aware of the need to carefully design process flows so adequate internal controls are maintained, while waste is driven out of the processes. We are excited about this next chapter in our pursuit of lean accounting and look forward to generating magnitudes of improvement similar to what we have already experienced with the value stream management aspect of lean accounting.  AICPA RESOURCES JofA article
“The Lowdown on Lean Accounting,” July 04, page 69 CPE
Lean Accounting and Management: Improving Profitability by Streamlining Operations , a CPE self-study course #731275) For more information or to order, visit www.cpa2biz.com or call the Institute at 888-777-7077. OTHER RESOURCE Conference
The 4th Annual Lean Accounting Summit, Sept. 17–18, Las Vegas, www.leanaccountingsummit.com | 
