Auburn Works

Auburn Technical Assistance Center (ATAC)

How Lean Increased the Standard Cost of a Product

If I said that the Standard Cost of a product increased from $55/unit to $63/unit after Lean Improvements, would you say that the Lean countermeasures were a failure?  In a Standard Cost Accounting world, I would agree with you---however, what if I said that;

  • Inventory was decreased 80%
  • Lead Time improved 75%
  • Customer On Time Delivery improved 24%
  • Batch Size decreased 95%
  • Square Footage decreased 50%
  • Quality improved 75%?

Well still, we might say that the Lean Improvements didn’t ultimately reduce the unit cost, so these benefits are great, but we are in business to make money, so maybe the Lean improvements didn’t help us make money.

Let’s take a closer look at the Standard Unit Cost and how this metric hides other improvements listed above.  For example, before and after Lean Improvements, the Sequential Operations of a product is as follows:

Before                                After

Drill         12 min                  12 min

Insert        5 min                   8 min

Tape         6 min                   7 min

Inspect     3 min                    2 min

Pack        4 min                   5 min

Total      30 min                 34 min

 

If the following stays the same:

  • Material Cost = $15/unit
  • Labor Cost = $20/hour
  • OH Multiplier = 3 x labor rate

 

We can see that the Standard Cost will actually go up because after the Lean improvements, the total time increased by 4 minutes---what?  How is that good?

In Standard Cost accounting, it is not good when the unit cost went from $55/unit to $63/unit.  Standard Cost Accounting adds process times sequentially.  However, in Lean and reality, time isn’t sequential.  Lean would look at the drilling operation and say that is our bottleneck at 12 min, so no matter what we will only produce 5 units/hour (unless we are able to improve the drill cycle time). 

Now after seeing it in this light, if the above bulleted improvements are shown, I would say without a doubt that the Lean improvements were extremely successful and invisible to Standard Cost Accounting.  Standard Cost Accounting has the following limitations:

  1. Does not reflect actual costs---as shown in example above
  2. Generally outdated ---how often are standard costs updated?  Annually?
  3. Does not support continuous improvement ---- improvements listed above are good for the organization.
  4. Focus on the variance, rather than the process --- Absorption Variance, Material Price Variance, Labor Rate Variance, etc.
  5. Difficult to understand
  6. Encourages Overproduction --- the worst of the 8 manufacturing wastes

If you want to learn more about Lean Accounting, come join the ATAC team next year at the beach.

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