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chapter
27(12)
Lean Principles, Lean
Accounting, and Activity
Analysis
______________________________________________
OPENING COMMENTS
Just-in-time was introduced briefly in Chapter 18(3). This chapter provides an opportunity to expand on
that topic by applying the concepts of just-in-time to lead time, plant layout, employee empowerment, and
supplier partnering. The chapter also presents the costs of quality and the differences between value-
added and non-value-added activities.
After studying this chapter, your students should be able to:
1. Describe lean manufacturing practices.
KEY TERMS
activity analysis
appraisal costs
476 Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis
electronic data interchange (EDI)
employee involvement
enterprise resource planning (ERP)
external failure costs
internal failure costs
lead time
lean accounting
lean enterprise
process
process-oriented layout
product-oriented layout
pull manufacturing
push manufacturing
STUDENT FAQS
• Why is lean, or just-in-time, manufacturing considered made-to-order, custom-order, short, or lean
manufacturing?
• What is the difference between value-added lead time and non-value-added lead time in just-in-time
manufacturing?
• Why does just-in-time emphasize product-oriented layout, whereas traditional manufacturing
disregards setup time as an improvement priority?
• Why is all in-process work combined with raw materials to form a new account “Raw and In-Process
(RIP) Inventory” under just-in-time manufacturing?
Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis 477
• What is so special about a Pareto chart of quality costs?
• Why is direct labor put into a cost account called “Conversion Cost” under just-in-time accounting?
OBJECTIVE 1
Describe lean manufacturing practices.
SYNOPSIS
Learning Objective 1 describes lean manufacturing. It is an attempt to produce products with high quality,
low cost, fast response, and immediate availability. To become lean, manufacturers must focus on eight
issues or dimensions: inventory, lead time, setup time, production layout, employee involvement,
production scheduling, quality, and supplier/customer relationships. Exhibit 1 compares lean
organizations and traditional manufacturers on these eight dimensions. Lean manufacturing views
inventory as wasteful and thus attempts to eliminate or reduce it. But, as shown in Exhibit 2, reducing
inventory often reveals a number of previously hidden production problems. If immediate availability is
desired but inventory isn’t, then reducing lead times becomes critically important. Exhibit 3 describes
Key Terms and Definitions
• Batch Size - The amount of production in units of product that is produced after a setup.
• Electronic Data Interchange (EDI) - An information technology that allows different business
organizations to use computers to communicate orders, relay information, and make or receive
payments.
• Employee Involvement - A philosophy that grants employees the responsibility and authority to
make their own decisions about their operations.
• Enterprise Resource Planning (ERP) - An integrated business and information system used by
companies to plan and control both internal and supply chain operations.
478 Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis
• Non-Value-Added Lead Time - The time that units wait in inventories, move unnecessarily, and
wait during machine breakdowns.
• Process-Oriented Layout - Organizing work in a plant or administrative function around
processes (tasks).
• Product-Oriented Layout - Organizing work in a plant or administrative function around
products; sometimes referred to as product cells.
• Pull Manufacturing - A just-in-time method wherein customer orders trigger the release of
finished goods, which triggers production, which triggers release of materials from suppliers.
• Push Manufacturing - Materials are released into production and work in process is released
into finished goods in anticipation of future sales.
Relevant Example Exercises and Exhibits
• Example Exercise 27(12)-1 Value-Added Lead Time
• Example Exercise 27(12)-2 Features of a Lean Manufacturing System
• Exhibit 1 – Lean versus Traditional Manufacturing Principles
SUGGESTED APPROACH
Just-in-time (JIT) processing is not just a method of reducing inventory. It is embraced as a philosophy
that emphasizes eliminating waste from all processes. Inventory is simply a buffer that protects a process
against unreliability (such as poor supplier delivery or machinery that breaks down frequently). Reducing
inventory levels without correcting the problems that create unreliability will stop production.
Constructing a reliable system will eliminate the need for an inventory buffer.
Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis 479
IN-CLASS SIMULATION—Just-in-Time Manufacturing
The instructor’s materials for Chapter 18(3) included instructions for conducting an in-class simulation
demonstrating the effect of a demand-pull system with manufacturing cells. If you did not have time to
run this simulation when introducing JIT in Chapter 18(3), consider doing it now. Even if you used the
simulation, you may want to repeat it. This JIT simulation provides a powerful example of the changes
that occur when a manufacturer moves from a process-oriented push system to a product-oriented pull
system. For convenience, the instructions for this simulation will be repeated here.
Just-in-time is essentially a pull system. Products are not made until they are needed by the customer, and
component parts are not made until they are needed by the next stage of production. Just-in-time
significantly reduces inventories, allowing manufacturers to reduce costs incurred in moving and storing
inventory. Just-in-time also emphasizes quality.
Run this simulation a second time, but this time institute a pull system. Instruct all workers that they are
not to make a new product (or component) until it is needed for the next stage of production. Also ask
them to focus on quality, not quantity. In addition, change to a product-oriented layout by physically
moving the students who are writing letters close enough to the student stapling the papers so that an
expediter is not needed to move the papers from one station to the next. Allow your students to work for
30 seconds. At that time stop production, announce another ink color change, and collect any work in
process as scrap. Start up the production line again for another 30 seconds. Ask your customer to count
the completed products received and note the cycle time.
480 Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis
GROUP LEARNING ACTIVITY—Results of Just-in-Time Manufacturing
Simulation
Divide your class into five groups. Ask each group to discuss the results of the manufacturing simulation,
concentrating on one of the areas listed below.
Group 1: Amount of Inventories
LECTURE AID—Value-Added vs. Non-Value-Added
Each activity performed by an organization creates cost. If the activity does not create any value for the
customer, its cost represents wasted resources. The following questions can aid students in determining if
an activity is value-added or non-value-added.
1. Given a choice, would the customer pay for this activity?
2. If you quit performing this activity, would the customer care?
GROUP LEARNING ACTIVITY—Value-Added vs. Non-Value-Added
TM 27(12)-2 lists the activities used by a catalog sales company to process and ship a customer order.
DEMONSTRATION PROBLEM—Within-Batch Wait Time
Any student who has ever waited in line at your college’s advising or financial aid offices will agree that
wait time is non-value-added. To illustrate within-batch wait time, make a comparison to a hypothetical
doctor’s office. Assume that a doctor spends, on average, 10 minutes with each patient. Of course, some
Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis 481
to be seen in each batch has 20 minutes of non-value-added wait time (assuming the doctor is on
schedule) and 10 minutes of value-added time with the doctor. This may be efficient from the doctor’s
point of view, but it is not efficient from the patient’s perspective. The patient’s lead time is increased
because of the batch concept. If the doctor moved to a one-piece flow concept and scheduled one patient
every 10 minutes, theoretically, the wait time would be eliminated.
The lead time can be analyzed as follows:
Lead Time % of Total
Value-added lead time (processing time) 5 minutes 5%
Non-value-added lead time (within-batch wait time) 95 minutes 95%
Total 100 minutes 100%
OBJECTIVE 2
Describe the implications of lean manufacturing on the accounting system.
SYNOPSIS
Learning Objective 2 discusses the impact that lean manufacturing has had on the accounting system.
Accounting systems that have adopted the lean philosophy have few transactions and ledger accounts,
they track nonfinancial measures, and they attempt to trace more overhead directly to products than
traditional systems (e.g., indirect labor is directly assigned to product cells). Backflush accounting
simplifies the accounting system by eliminating the accumulation and transfer of product costs by
departments and instead pulling material and conversion costs directly to finished goods. In this system,
Key Terms and Definitions
• Backflush Accounting - Simplification of the accounting system by eliminating accumulation
and transfer of costs as products move through production.
• Conversion Costs - The combination of direct labor and factory overhead costs.
482 Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis
Relevant Example Exercises and Exhibits
• Example Exercise 27(12)-3 Backflush Accounting Journal Entries
• Exhibit 7 – Transactions Using Lean Accounting—Anderson Metal Fabricators
SUGGESTED APPROACH
The implementation of a JIT system will require modifications to an organization’s cost accounting
system. Use the lecture aids and demonstration problems that follow to illustrate these changes.
LECTURE AID—Accounting in a JIT System
Remind your students of the following characteristics found in cost accounting systems used by JIT
manufacturers.
1. Raw and In-Process (RIP) Inventory: One of the ways JIT seeks to reduce inventories is by using
supplier partnering. Materials are delivered in small batches and taken directly into production
2. Conversion Costs: Since workers are cross-trained to perform both direct labor and indirect labor
3. Direct Tracing of Overhead: Since production layouts are organized into specific product cells, it is
easier to trace overhead costs to products. For example, if you have three machines each making
three different products, the depreciation for the machines must be added up and divided among the
three products. If the layout is changed so that each machine makes only one product, you know
exactly how much depreciation needs to be assigned to each product.
DEMONSTRATION PROBLEM—Accounting in a JIT System
To simplify the accounting under JIT to a principles level, the text only illustrates scenarios where there is
no variance between actual and budgeted manufacturing costs.
Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis 483
First of all, point out that the conversion cost per unit is $3. This may be calculated as follows:
$400,000
Budgeted Conversion Cost Rate $4 per production hour
100,000
==
Conversion Cost per Unit $4 per hour 0.75 hours per unit $3= =
After recording materials, LeForge would need to determine the amount of conversion costs that should
be applied to the 11,000 dishes. LeForge’s conversion cost is $3 per unit; therefore, $33,000 of
conversion costs would be applied into Raw and In-Process Inventory.
Raw and In-Process Inventory 33,000
Conversion Costs 33,000
You may want to mention that actual conversion costs (such as wages paid to factory workers, supplies
used, depreciation on factory equipment, etc.) would be debited to the conversion costs account as they
are incurred.
The 11,000 completed units are transferred to finished goods based on their production cost, which
includes $2 per unit for materials and $3 per unit for conversion costs.
484 Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis
CLASS DISCUSSION—Nonfinancial Measures
Nonfinancial measures are performance measures that are not stated in terms of dollars but are
quantifiable, such as lead time, number of defects, or percentage of orders delivered on-time. These
measures are very important to the long-term success of an organization.
OBJECTIVE 3
Describe and illustrate activity analysis for improving operations.
SYNOPSIS
Learning Objective 3 discusses the usefulness of activity analysis in helping companies control the cost of
quality, value-added activities, and production processes. Producing high-quality products and services is
not accomplished with costs. The costs of quality are often described in terms of the costs of controlling
quality and the costs of failing to control quality. Exhibit 8 shows that each category of cost has two types
of costs: the costs of controlling quality consists of prevention and appraisal costs and the costs of failing
to control quality consist of internal failure and external failure costs. The relationship between costs of
quality is shown in Exhibit 9. As you can see, as prevention and appraisal costs increase or internal and
external failure costs decrease, the percent of good units increases. Gifford Company is introduced to
illustrate the management of quality costs. Exhibit 10 presents the company’s quality control activities
Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis 485
describes how the company was able to generate significant cost savings by analyzing this particular
process.
Key Terms and Definitions
• Activity Analysis - The study of employee effort and other business records to determine the cost
of activities.
• Appraisal Costs - Costs to detect, measure, evaluate, and audit products and process to ensure
that they conform to customer requirements and performance standards.
• Cost of Quality Report - A report summarizing the costs, percent of total, and percent of sales
by appraisal, prevention, internal failure, and external failure cost of quality categories.
• Costs of Quality - The cost associated with controlling quality (prevention and appraisal) and
Relevant Example Exercises and Exhibits
• Example Exercise 27(12)-4 Cost of Quality Report
• Example Exercise 27(12)-5 Process Activity Analysis
SUGGESTED APPROACH
TM 27(12)-3 lists the four categories of quality costs (prevention, appraisal, internal failure, and external
failure). Review these terms with your class.
486 Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis
appraisal, internal failure, or external failure cost. Next, ask them to produce a cost of quality report using
the format shown in Exhibit 10 in the text. A solution is presented on TM 27(12)-5.
CLASS DISCUSSION—Value-Added and Non-Value-Added Activities
Display TM 27(12)-4, which includes a list of the quality costs for Sycamore Manufacturing. Each of
these quality-related activities can be labeled as value-added or non-value-added. Ask your students to
categorize the quality costs.
You can probably spark a lively debate on this topic. Ask your students to assume they have taken their
tax information to an accountant in order to have their tax return prepared. The accountant will assign the
tax return to one of her staff to do the actual preparation work. After the return is completed, the
accountant will review it for accuracy. Ask your students if the review is value-added or non-value-added.
Most will consider the review value-added. Next, explain that they will be billed $40 per hour for the time
the staff member spent preparing the return and $80 per hour for the time the accountant reviewed the
return. Do they want to pay for this review? Is it really value-added? What could be done to eliminate the
need for a review?
CLASS DISCUSSION—Activity Analysis for a Process
TM 27(12)-6 presents cost information about the process of receiving raw materials at Logan
Manufacturing. This TM lists the steps in the process, the cost of each step, the cost of each step as a
percentage of the total, and the cost to process each raw material shipment. Ask your students to comment
on how management at Logan Manufacturing could use this data to improve operations. Your students
Chapter 27(12) Lean Principles, Lean Accounting, and Activity Analysis 487
Type Item Description LO(s) Difficulty
Time
Est
BUSPROG AICPA ACBSP - APC Bloom's EE Excel GL SMH FAI Service Real World Writing Ethics Internet Group
DQ 1 1 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 2 1 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 10 3 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 11 4 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 12 4 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
DQ 13 4 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Knowledge
PE 1A Lead time 1 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Application x
PE 1B Lead time 1 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Application x
PE 2A Lean features 1 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Application x
PE 2B Lean features 1 Easy 5 min. Analytic Measurement Managerial Accounting Features/Costs Application x
PE 3A Lean accounting 3 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Application x
PE 3B Lean accounting 3 Easy 10 min. Analytic Measurement Managerial Accounting Features/Costs Application x
EX 6 Calculate lead time 1 Moderate 15 min. Analytic Measurement Managerial Accounting Features/Costs Application x
EX 7 Calculate lead time 1 Moderate 15 min. Analytic Measurement Managerial Accounting Features/Costs Application x
EX 8 Lead time calculation for a service company 1 Moderate 25 min. Analytic Measurement Managerial Accounting Features/Costs Application x x x
EX 9 Supply chain management 1 Moderate 20 min. Analytic Measurement Managerial Accounting Features/Costs Application x x
EX 10 Employee involvement 1 Moderate 20 min. Analytic Measurement Managerial Accounting Features/Costs Analysis x x
EX 11 Lead time reduction for a service company 1,2 Moderate 20 min. Analytic Measurement Managerial Accounting Features/Costs Analysis x x
EX 12 Lean principles for a service company 2 Moderate 20 min. Analytic Measurement Managerial Accounting Features/Costs Analysis x x
EX 13 Accounting issues in a lean environment 3 Moderate 20 min. Analytic Measurement Managerial Accounting Features/Costs Analysis x
EX 14 Lean accounting 3 Moderate 25 min. Analytic Measurement Managerial Accounting Features/Costs Application x
EX 15 Lean accounting 3 Moderate 25 min. Analytic Measurement Managerial Accounting Features/Costs Application x
EX 16 Lean accounting 3 Moderate 25 min. Analytic Measurement Managerial Accounting Features/Costs Application x
EX 17 Pareto chart 4 Moderate 25 min. Communication Measurement Managerial Accounting Features/Costs Application
EX 18 Cost of quality report 4 Moderate 20 min. Analytic Measurement Managerial Accounting Features/Costs Application x x
EX 19 Pareto chart for a service company 2,4 Moderate 25 min. Communication Measurement Managerial Accounting Features/Costs Application x
EX 20 Cost of quality and value-added/non-value-added reports for a service company 2,4 Moderate 25 min. Analytic Measurement Managerial Accounting Features/Costs Application x x x x
CP 1 Ethics and professional conduct in business 1 Moderate 30 min. Ethics Measurement Managerial Accounting Features/Costs Synthesis x x
CP 2 Lean principles 1,2 Moderate 30 min. Analytic Measurement Managerial Accounting Features/Costs Synthesis x
CP 3 Lean principles 1,2 Moderate 30 min. Analytic Measurement Managerial Accounting Features/Costs Analysis x
CP 4 Value-added and non-value-added activity costs 4 Moderate 30 min. Analytic Measurement Managerial Accounting Features/Costs Analysis x
CP 5 Lead time 4 Challenging 1 hour Analytic Measurement Managerial Accounting Features/Costs Analysis x
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