Tour Notes 3 – Accounting

by BILL WADDELL

In the course of giving my Lean Accounting / Lean Business Model seminars over the course of the last several weeks, inevitably we would get to the subject of lean accounting, and inevitably someone would ask about how to reconcile lean accountting with theur mandatory GAAP financial statements.  And inevtably that would send me off on a rant that went something like this …

In far too many companies – the vast overwhelming majority of companies – financial accounting reigns supreme, while managerial and cost accounting is relegated to a lower level person reporting ultimately to the financial accountant in charge.  Financial accounting – complying with GAAP – Generally Accepted Accounting Principles – serves the sole purpose of supporting the needs of investors, lenders and tax authorities and makes no pretense of even trying to provide information to management to better run the company.

A huge problem is the cultural one, sending a loud and clear message to entry level and mid-level accountants that the path to career success runs exclusively through financial accounting.  One cannot hope to become the CFO unless they demonstrate mastery of GAAP, while mastery of costing, budgeting and information for management is not a prerequisite.

Worse is the absurd belief in the inherent supremacy and accuracy of GAAP information.  Based on this self-serving belief, costs and budgets are almost always required to flow from the externally reported GAAP data.  In short – external reporting comes first and management gets whatever information they can derive from the GAAP reports.  Standard costs must reconcile to the GAAP compliant P&L, as must budgets and variance calculations.  Never mind the fact that the GAAP data is meaningless drivel.

In manufacturing companies, GAAP compliant P&L's all center around inventory accounting.  Since GAAP dictates that all sorts of costs having nothing directly to do with whatever is being produced must be allocated or assigned to production units, management accounting must be based on the same nonsense.

You spend $100 lighting and heating the plant for a day and plan to make 100 products.  Accounting decided that each product should bear $1 a day for the cost of light and heat, even though anyone with a lick of common sense knows the heat and light has nothing to do with what was produced that day or how many of them were made.  Accounting decided that because an alcoholic engineer from DuPont decided to do it that way at General Motors 80 years ago, and the Financial Accounting Standards Board codified it into law in 1953.  So no matter how silly that is, manufacturing managers waste time calculating such nonsense, and explaining variances from the $1 when they actually make 99 things or 101 things.

To saddle manufacturing management with such a colossal waste of time and absolutely useless information is shameful.  What makes it worse is that accounting routinely violates their own sacred GAAP code when it is convenient.  The driving principle in GAAP inventory accounting is that inventory must be valued at the lower of cost or market.  In spite of that, almost no inventory is ever valued at its market value. 

The market value for everything you buy is something less than cost.  This is true personally, and it is equally true in manufacturing.  Even something as routine as $100 worth of steel is worth less than $100 after you buy it.  No one will pay you the $100 you paid if they can buy exactly the same thing for exactly the same price from the original manufacturer.  Why would they?  Would you pay $100 for something purported to be new on EBay when you can buy it for the same &100 and know with certainty it is new at Walmart? 

Worse are all of the labels and custom molded parts you bought that have absolutely no value to anyone but you because their only use is when they are embedded in your product; or the market value of all of the half-made stuff in your WIP  The market value of that inventory is its scrap value, yet most accountants not only fail to value it at the lower market value, they value it at greater than cost by allocating the freight cost it took to get it to you to its inventory value, and by the labor and overhead that went into half-building it into finished products.

In the end, accounting hides behind GAAP as their excuse for not taking on the tough work of helping the company understand what is going on, and contributing to the tough work of developing strategies for success.  They turn their brains off and simply follow GAAP rules when it is convenient, and throw GAAP out the window when it is easier to do so.

The solution is to place management accounting first.  Establish the supremacy of information that best enables management to run the company first.  Then send the financial accountants into some back room, out of the way of the real business, and tell them to take that management data and do with it whatever they have to do to comply with GAAP for external purposes.

Nowhere is the old adage of "lead, follow, or get out of the way" more appropriate than with accounting.  The stubborn insitance on the supremacy of GAAP is nothing more than a refusal to do any of the three, and it is an unacceptable position for accounting to take or management to tolerate.