Lean Accounting Summit. Solving the Standard Costing Problem. Brian H Maskell. Copyright 2013 BMA Inc. All rights reserved. Page 1

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2 Solving the Standard Costing problem WHAT IS THE STANDARD COSTING PROBLEM? VALUE STREAM ACCOUNTING: THE SOLUTION BOX SCORES Standard Costing is Anti-Lean Standard Costing Actively Works Against Lean Goals and Improvement Standard Costing is expensive and wasteful. Motivates people to do the wrong things. Provides misleading, wrong, and harmful information. Are complex and confusing to people HERE ARE SOME EXAMPLES Copyright 2013 BMA Inc. All rights reserved. Page 2

3 Actively Works Against Lean Goals and Improvement Drill on CNC Machine 1 minute Batch 2500 Inspect & Pack 4 minutes 6 minutes Grinding Machine on Lathe 4 minutes Total labor time: 15 minutes Labor cost: $5.00 Overhead cost: $15.00 Material Cost $1.50 TOTAL COST: $21.50 Lead Time: 6 weeks Inventory 25 days Batch size 2500 (10 days) On Time delivery = 82% Lean manufacturing changes Create a cell. Use an drilling machine withquick change over. Reduce the batch size. Reduce the lead time. Reduce inventory. Almost perfect delivery. Created additional capacity on the CNC machine. Copyright 2013 BMA Inc. All rights reserved. Page 3

4 Provides misleading, wrong, and harmful information. Machine on the Lathe 4 minutes Drill on Drilling Machine 4 minutes Lean Cell Grinding 6 minutes Inspect & Pack 4 minutes Total labor time: 18 minutes Labor cost: $6.00 Overhead cost: $18.00 Material Cost $1.50 TOTAL COST: $25.50 Lead Time: 2 days Inventory 5 days Batch size 250 (1 day) On Time delivery = 98% Actively Works Against Lean Goals and Improvement We have made great improvement. BUT. the product cost has gone up and the project is cancelled. In fact, the changes were highly beneficial both operationally and financially. It is the standard costing that is leading us in the wrong direction. Copyright 2013 BMA Inc. All rights reserved. Page 4

5 Complex and confusing to people Traditional Income Statement Period 1 Period 2 REVENUE OEM $998,977 $1,039,440 Systems $1,002,466 $1,009,246 $2,001,443 $2,048,686 Cost of Goods Sold $1,621,169 81% $1,687,800 82% GROSS PROFIT $380,274 19% $360,886 18% ADJUSTMENTS Purchase Price Variance ($60,466) ($59,467) Materials Usage Variance $94,533 $96,733 Labor Variance ($19,718) ($93,895) Overhead Absorption Variance $38,341 $182,577 SG&A $129,889 6% $135,215 7% NET PROFIT $197,695 10% $99,723 5% What does Gross Profit mean? Why have the earnings fallen so much in period 2? How would you explain this someone in production? Plain English Income Statement Period 1 Period 2 REVENUE OEM $998,977 $1,039,440 Systems $1,002,466 $1,009,246 $2,001,443 $2,048,686 What does Gross Profit mean? Materials $829,936 41% $849,526 41% Direct Labor $305,767 15% $312,984 15% Support Labor $340,245 17% $342,421 17% Machines $113,862 6% $116,550 6% Outside process $60,043 3% $53,731 3% Facilities $40,250 2% $41,200 2% Other Costs $12, % $9, % TOTAL COST $1,702,112 $1,726,076 GROSS PROFIT $299,331 15% $322,610 16% Inventory Adjustment ($41,593) ($161,426) Corporate Allocations $60,043 $61,461 NET PROFIT $197,695 10% $99,723 5% Why have the earnings fallen so much in period 2? How would you explain this someone in production? Copyright 2013 BMA Inc. All rights reserved. Page 5

6 Motivates people to do the wrong things. 6 minutes 6 minutes 3 minutes 6 minutes Mount Components Prepare for Mounting Product B Product A Align & Secure 4 minutes 6 minutes Inspect & Pack 4 minutes 6 minutes Output 10 per hour Actual Production Cost = $580 per hour Material cost = $42 per item Product Cost =? Provides misleading, wrong, and harmful information. Product A Standard d Cost = $ Material $42 Labor 17 m@ $24.23/hr =$6.87 Overhead 600% = $41.19 Actual Cost = $100 Material $42 Production $580/10 = $58 Standard Cost too low Product B Standard d Cost = $ Material = $42 Labor $25/hr = $9.69 Overhead 600% = $58.18 Actual Cost = $100 Material $42 Production $580/10 = $58 Standard Cost too high Copyright 2013 BMA Inc. All rights reserved. Page 6

7 Motivates people to do the wrong things: Outsourcing Product B Traditional Approach Standard Cost = $ Outsourced Cost = $85.00 Savings of $24.85 /unit Actual Impact New Material Cost = $ 85 Old Material Cost = $ 42 Increase in Actual Material Cost = $ 43 Actual production cost per hour = $580 because no resources were eliminated Actual costs increase due to outsourcing There is no Standard Cost! In a lean environment, the cost of the product is related to flow Waste affects cost so that there is no one standard cost of a product. Cost varies with production, FPY, scrap, mix, quality, downtime etc. If you control the flow, you control the cost. By improving flow through the Value Stream we improve capacity = flexibility = growth at no additional cost. Copyright 2013 BMA Inc. All rights reserved. Page 7

9 Standard Costing is Anti-Lean Standard Costing Actively Works Against Lean Goals and Improvement Standard Costing is expensive and wasteful. Motivates people to do the wrong things. Provides misleading, wrong, and harmful information. Are complex and confusing to people Copyright 2013 BMA Inc. All rights reserved. Page 9

10 Let s Do Some Standard Costing UNIVERSAL VALVE COMPANY ANNUAL BUDGET Given this annual cost information, calculate the Labor Rate and Overhead Rate (as a percentage of Labor Rate) required for Standard Costing. Copyright 2013 BMA Inc. All rights reserved. Page 10

12 What s the Margin? The company receives a request for quote from a customer for 3000 Pro Valve 602 s per month. The customer s target price is $45 per unit. Your company requires a minimum i of 15% margin. Work out the profitability using Standard Costing. Copyright 2013 BMA Inc. All rights reserved. Page 12

13 How About Outsourcing? The company has found a Far East supplier quoting a landed cost of $33.00 for the Pro Valve 602 s. The customer s target price is $45 per unit. Your company requires a minimum of 15% margin. Work out the profitability from outsourcing this product. Copyright 2013 BMA Inc. All rights reserved. Page 13

14 Lean Accounting Lean companies would never use a standard cost to make these kinds of decisions. They always look at the impact on the value stream as a whole. VALUE STREAM ACCOUNTING Solving the Standard Costing Problem WHAT IS THE STANDARD COSTING PROBLEM? VALUE STREAM ACCOUNTING: THE SOLUTION BOX SCORES Copyright 2013 BMA Inc. All rights reserved. Page 14

17 Value Stream P&L Profit & Loss Report 5-May-05 Per Unit Percentage of Sales Sales $326,240 $ ,876 Units Additional Revenue $0 Material Costs $111,431 $ % Employee Costs $49,515 $ % Machine Costs $8,113 $4.32 Outside Process Costs $32,433 $ % Other Costs $16,040 $ % Tooling $4,843 $ % Value Stream Profit $103,865 $ % ROS 31.84% 31.84% Hurdle Rate 42.00% Cash Flow Inventory $221, days Accounts Receivable $2,348, days Accounts Payable ($624,014) days Copyright 2013 BMA Inc. All rights reserved. Page 17

19 Monument Costs Resources that are Shared Between Value Streams PRODUCTION EQUIPMENT PEOPLE SHORT TERM Use a simple allocation method Allocate the people based on time. LONGER TERM Right size the equipment to each value stream Cross train so everybody is in a single VS All Allocation is bad and misleading. We always work to avoid & eliminate allocations. Support and Other Costs Resources Not in the Order Fulfillment Value Streams NEW PRODUCT DEVELOPMENT SALES & MARKETING ADMIN & OTHER SUPPORT Usually Separate NPD Value Streams Best in the Order Fulfillment VS s. Second Best Separate Sales VS s. ShownSeparately Separately as Support Costs. Not allocated to the VS s. Copyright 2013 BMA Inc. All rights reserved. Page 19

20 Company-Wide Income Statement VALUE STREAMS Motors Systems Spare Parts New Product Design Support Costs TOTAL DIVISION Sales $326,240 $748,894 $453,215 $1,528,349 Additional Revenue $0 $0 $12,422 $12,422 Material Costs $111,431 $232,774 $149,561 $87,909 $12,764 $594,439 Conversion Costs $57,628 $70,406 $81,579 $203,769 $37,645 $451,027 Outside Process Costs $32,433 $22,991 $22,661 $7,531 $85,616 Other Costs $16,040 $57,816 $29,459 $72,721 $176,036 Tooling Costs $4,843 $12,544 $6,588 $23,975 Value Stream Profit $103,865 $352,363 $175,789 ($364,399) ($57,940) $209,678 ROS 31.8% 47.1% 38.8% -23.7% -3.8% 13.7% Opening Inventory Closing Inventory Inventory Change Corporate Overhead Division Profit Division ROS $925,314 $918,807 ($6,507) $51,147 $152, % VALUE STREAM INCOME STATEMENT EVERYBODY UNDERSTANDS IT ACCURATE INFORMATION ON TIME EXCELLENT CONTROL CONTINUOUS IMPROVEMENT Simple, Real Information. No Accounting Adjustments. Real Revenue. Real Spending. Real Profits & Cash Flow. Typically Created Weekly. Value Stream Takes Action in Real Time. Frequent Review and Real Data Leads to Stability & Control. Fully Understandable Information Drives Continuous Improvement Copyright 2013 BMA Inc. All rights reserved. Page 20

21 Back to the Universal Valve Company Just as the purchasing guy was about to pick up the phone and order a boat load of Pro Valve 602 s.. The Value Stream Leader says What if we make these in house? Let s take a look.. Here s the current Value Stream Income Statement HERE IT COMES Copyright 2013 BMA Inc. All rights reserved. Page 21

22 Value Stream Costing Work out the profitability using Value Stream Costing. You need to get 2 new machines and 2 operators to support this volume increase to 3000 units/month Copyright 2013 BMA Inc. All rights reserved. Page 22

financial impact of the three approaches.

Solving the Standard Cost Problem WHAT IS THE

VALUE STREAM ACCOUNTING: THE SOLUTION BOX

Performance of the Value Stream The Box Score

of actions and decisions Leads to better

24 Solving the Standard Cost Problem WHAT IS THE STANDARD COSTING PROBLEM? VALUE STREAM ACCOUNTING: THE SOLUTION BOX SCORES The Box Score Summarizes the Performance of the Value Stream The Box Score shows a Three Dimensional view of the value stream Provides an understanding of the operational, financial, and capacity impact of actions and decisions Leads to better understanding and better decisions Copyright 2013 BMA Inc. All rights reserved. Page 24

27 BOX SCORE FOR WEEKLY PERFORMANCE REPORTING The weekly Box Scores shows the performance of the value stream over time. It shows the impact of changes and improvements. Copyright 2013 BMA Inc. All rights reserved. Page 27

28 Solving the Standard Costing Problem WHAT IS THE STANDARD COSTING PROBLEM? VALUE STREAM ACCOUNTING: THE SOLUTION BOX SCORES Brian Maskell President, BMA Inc Copyright 2013 BMA Inc. All rights reserved. Page 28