STREAMLINING THE CHART OF ACCOUNTS

The chart of accounts is where many problems start. The complex GL packages have made a serious misjudgment with regard to the need for myriad accounts. The financial controller and CFO need to be alert to the problems of a large chart of accounts.

AVOID MONTHLY COST APPORTIONMENT

Traditionally, we have spent much time apportioning head office costs to business units to ensure they have a net profit bottom line. However, few ask the budget holders and business unit managers whether they look at these apportioned head office costs. I have never found any business unit managers who showed much interest other than to complain about the cost of information technology (IT), accounting, and other apportioned costs.

In fact, these cost apportionments, besides slowing down reporting, often lead unit managers to complain about strategic costs, which cannot be reviewed for a few years due to locked-in agreements (e.g., the accounting system).

The hours spent processing levels upon levels of apportionments to arrive at some arbitrary full costing are not creating management information that leads to decision making. Corporate accountants can arrive at full costing approximations through a more simplistic route. Some better practices are:

• Keep head office costs where they are, as budget holders see them as uncontrollables in any case.
• Use product costing as periodic one-off exercises to understand a full costing situation, after you have understood value stream accounting.
• Analyze head office costs by activities rather than account codes, for example, where the head office IT costs are spent—delivering new projects, correcting errors, providing one-to-one training, provision of equipment, and so forth. Compare these over time and against third-party benchmarks.
• Set targets in the future where you expect to see head office costs, and show this as a baseline in your graphs of the historic trend. These can be expressed as acceptable ratios to sales. Naturally, you will have researched the lowest-cost operators as benchmarks (e.g., By 20__, we want finance cost to be between __ percent and ___ percent of revenue). This sets a general direction for the head office teams and helps curb empire building.

If you have on-charged head office costs to the operations and it is creating the right environment, then continue with the process. There are a number of case studies where on-charging head office costs appears to work well. They, however, are the exception rather than the rule.

VALUE-STREAM ACCOUNTING

A good definition of a value stream is that it is a sequence of steps, both value adding and non–value adding, required to complete a product, document, or service from beginning to end.

As Brian Maskell and Frances Kennedy⁵ point out, “For companies that have chosen the lean journey, it is important that their accounting, control and measurement methods change substantially.”

The Finance and Management Faculty of the Institute of Chartered Accountants in England and Wales is an excellent source of cutting-edge articles, and it was the first place where I read about value-stream accounting. The faculty welcomes membership from other accounting bodies, and I am sure that you will find it the best-spent US$130 annual subscription you have ever invested.

Value stream accounting takes a different look at what is a variable cost and divisional accounting. The differences include:

• The existing labor force is not treated as variable unless you need to employ extra staff.
• Value streams are cross-functional, including all people and resources involved in the value stream.
• Value streams are a collection of products that share the same processes.
• Standard costs and price and volume variances, a backbone of Charles Horngren's work, are abandoned.
• Very few allocations are used other than allocation of occupancy costs.
• No manufacturing variances are calculated as we are producing to customer orders, not to budget.
• Costing of a product is not related to the amount of labor or machine time expended; it is based upon the rate of flow through the value stream. This impact is shown in a later section.

There is a marked change in the way we report performance to management when using lean accounting. Instead of showing performance in a conventional way, as shown in Exhibit 15.1, we now look at the value streams (see Exhibit 15.2). These value streams can be one product, or a cluster of products that go through a similar process. In Exhibit 15.2 we are looking at a company that makes only two products, which in this case are quite different.

The main differences between the conventional way and value stream accounting include:

1. Removal of the budget and variance column, as manufacturers are producing to customer orders, not to budget. Reporting against standard costs and prices and volume variances are also abandoned.
2. Value streams are cross functional, including all people and resources involved in value stream. For example, the accounts payable and receivable staff would be allocated to value streams, as their work is critical for the purchasing of supplies and the eventual sales of finished products. Value streams are a collection of products that share the same processes.
3. Labor and machine costs are assigned directly to value streams using some simple cost drivers, but such allocations are held to a minimum, certainly not using activity-based costing models. The existing labor force is not treated as variable unless you need to employ extra staff.
4. Sustaining costs are necessary costs that support the entire facility, but cannot be directly associated with particular value streams, and are shown in a separate column. Sustaining costs include management and support, facility costs, information technology, and human resource management costs that are not associated directly with a value stream.
5. The corporate overhead is shown here as the corporate allocation. This would comprise costs that do not have a direct link to the value streams. The salary and related costs of the accounts payable and accounts receivable staff are now treated as a direct cost as you cannot produce anything without buying supplies and selling the finished product.
6. The inventory movement is reported separately as below-the-line adjustments and reported for the entire entity, not the separate value streams. This allows the value stream managers to assess their individual value streams without the complexities of the inventory changes affecting the value stream profit. If the company succeeds in adopting just-in-time inventory methods, the issue would largely disappear. Consequently, the motivation for manipulating inventory values also disappears.
7. Occupancy costs are actually assigned to value streams according to the amount of space used. Such items as utilities and property taxes are included here. Assignment of these costs provides motivation for the value stream teams to reduce occupancy costs. However, no attempt to absorb all of the occupancy costs is required. Space not used by a value stream is charged to sustaining costs. As a result, occupancy costs are handled in a similar manner to traditional accounting, but they are assigned to value streams instead of other cost objects such as products or divisions.

ACTIVITY-BASED COSTING IS BROKEN

Many of us have gazed wistfully into the distance, thinking how marvelous it would be to have the cost of producing a product at any time of day. Activity-based costing seduced the accounting profession, very much like the sirens in Greek mythology.

Right from the start, the writing was on the wall. The consultants were more expensive, they talked in a language we hardly understood, and they disappeared into the bowels of the organization for months on end. We knew they were somewhere, as their Porsche was parked in the visitors' parking lot.

In a lean company, the cost of a product can be derived by dividing the value stream costs by the units of production. Yes, it is a primitive number, but certainly good enough. A lean company's closing inventory could be as little as a few days of production with some longer-term holding in strategic stocks for overseas sourced materials. So why have an ABC system?

Given that we are not expecting much movement in closing inventory, we can now just charge the current period with all overheads incurred. We can take the view that the overhead is a sustaining cost and fully absorbed in the current period.

PDF DOWNLOAD

To assist the finance team on the journey, templates and checklists have been provided. The reader can access, free of charge, a PDF of the suggested worksheets, checklists, and templates from www.davidparmenter.com/The_Financial_Controller_and_CFO’s_Toolkit.

The PDF download for this chapter includes:

• Some examples of lean accounting articles first published in ICAEW's Finance & Management journal