And On And On We Go

by BILL WADDELL

For those who haven't dug into lean deeply enough to understand how accounting is the real problem, and Lean Accounting is an absolute prerequisite to becoming truly lean, I'll give you a brief primer.  (if you really want to get immersed in this stuff you have to get your hands on a copy of my book)

The accountants have decided that inventory is supposed to be valued at "the lower of cost or market".  "Market", however, is a concept they defined, redefined, then virtually threw out long ago.  With the exception of a trivial fop they throw at inventory to write down the little bit of stuff that exceeds even the most unreasonable expectation of demand, they value inventory at what it cost to make it.  So if your company has 50,000 wigiclips – a custom designed component that serves no purpose and has no value other than to connect the whatchathingy to the doodad in a product only you make - the fact that no one in the world would buy those clips from you far anything above scrap value is ignored.

You have a standard cost for the wigiclips of $1 each, so you put $50,000 of the money your company spent into inventory and onto the balance sheet instead of on your income statement where it would have the effect of reducing profits. 

The "market" side of the equation is determined to be the cost of the wigiclips embedded in the price of the end product, so the market is essentially the cost. If you were to go under, imagine the surprise of your stockholders or lenders who thought they really had $50,000 worth of assets when they find that there is no market for those assets and the $50,000 is actually worth pocket change.  But never mind that for now. 

Now in addition to the philosophy of valuing inventory at what it cost to build it instead of its value, the accountants throw in the matching principle and the idea of full costing.  With these cockamamie thoughts, they decide that all of your costs are really there to make stuff and allof them should be assigned to inventory instead of deducted from profits now.  Then the costs will stay on the balance sheet until the products are sold … if they are sold.  Those cost include the light bulbs in the men's room and the cost of the thumbtacks back on your loading dock the boys use to pin up the girlie calendars they put up in violation of all of the sexual harassment laws.  In fact, they include just about everything, no matter how removed from making wigiclips those costs may be.

It doesn't take a real stretch of creative thought to figure out that the more wigiclips you build and put into inventory, the more irrelevant cost you can get out of the profit calculation and onto the balance sheet in the form of an asset.  Do that and – VOILA – your profits are higher and the book value of your business is greater.  Overstating the real worth of inventory is a great way to create wealth, on paper anyway.  So long as the books are kept this way, lean can never be any more than a superficial shop floor exercise.  Waste is actually good under this scenario – it is an asset.

So you gotta get your top management and accounting folks to the Lean Accounting Summit if you are ever going to get lean.

All of this is just a long-winded intro to telling you that collectively the United States of America has rejected these core principles of lean and has decided that creating wealth out of waste on paper is a good thing and honestly valuing assets is for suckers.

The Financial Accounting Standards Board has given a big old thumbs up to the Bankers to value the assets against which they lend money the same way the failing manufacturing companies value inventory.  Playing games with inventories in pursuit of short term profits is a one way ticket to ruin, and it lies at the root of GM's problems and every other big publicly traded manufacturer.  However, Wall Street loves paper profits and short term numbers games because investors on Wall Street think the long term can be measured in weeks, so any erosion of real value these practices lead to will be someone else's problem.  Now the heart of the US financial system has been licensed to play the same game.

Banks have been under requirements to value the assets they hold by a similar lower of cost or market principle, only their market value had teeth.  They have used what they call "Mark to Market" to continually value the real estate assets that serve as collateral for the loans they have outstanding.  The recent downward spiral of real estate has made their books look pretty ugly.  That house you paid $200,000 for, and borrowed $160,000 from the bank to finance, is now only worth $150,000.  So the bank has an outstanding loan to you that is $10,000 more than the worth of the collateral they hold.

This means that their stockholders have too much exposure, and they have a great deal of risk.  It also means that the government restricts them from lending any more money until the situation gets fixed.  The solution – get rid of Mark to Market, and let the bankers decide for themselves how much to say your house is worth.  With a stroke of the pen, your house is back to being worth $200,000, the banks are profitable again, and Wall Street is ecstatic.  Never mind that no one on this planet will pay you $200,000.  And if you default, the bank's stockholders are way up a creek.  That is not a worry, because it won't be these stockholders.  They will have sold their shares and moved on to some other game before the truth of the value of your house becomes a problem.  And when it does, the federal government will bail out the bankers and their stockholders again, and Wall Street will roll on and on and on.

Lean, value, waste reduction, truth, the future of the country, right and wrong ??? All of them are apparently concerns for working class chumps not bright enough to get on the next bus to New York and get in on the paper wealth game.