Cost accounting has undergone evolutionary change in the last few decades. As globalization washed to American shores, increased competition and decreasing profit margins initially impacted the manufacturing industry. Forced to now search for sources of competitive advantage, manufacturers placed new emphasis on product costing to provide better information for pricing and build versus buy decisions.
The cost accounting that emerged from the mass production environment of the early 1900s was based on cost structures that consisted of 60% direct labor. But now, a century later, the percentage of direct labor to total cost has shrunk to an average range of 5% to 15%. Under a traditional cost accounting system, overhead is allocated to products based on direct labor. With an inverted labor cost pyramid, this approach no longer makes sense.
In the late 1980s “Activity Based Costing” came to the forefront in an effort to more accurately track the true costs of multiple products. So-called cost drivers were identified and used to better assign overhead cost to products. However, ABC costing could be difficult to implement and costly to maintain.
In recent years “Lean Accounting” has emerged as a by-product of the lean manufacturing method developed by Toyota. According to Wikipedia, Lean Accounting has two main thrusts: 1) the application of lean methods to the accounting process in order to eliminate waste, speed up the process and reduce errors and 2) to fundamentally change the accounting process to motivate lean change and improvement to provide a better understanding of customer value. The result is that Lean throws out variance accounting, standards costing and activities based costing. Instead, it organizes costs by value streams rather than departments and focuses on direct costs rather than the sometimes arbitrary allocation of overhead costs. Because lean manufacturing is demand driven, inventories are negligible and may even be immaterial to the external financial statements.
Since 2003 the accounting world has been consumed with Sarbanes Oxley and external reporting requirements. Currently, efforts to merge accounting standards with IFRS are at the forefront as standards setters are proposing far-reaching measurement and reporting changes. Yet, businesses will miss out if they focus only on financial reporting compliance and rules changes rather than on the Lean Accounting practices that foster continuous improvement, waste reduction and quality improvement. Although Lean Accounting has emerged from the transaction-heavy world of manufacturing, it is being considered and adopted in other industries that are seeking the benefits of simplification and transparency.
You may want to look into Lean Accounting to consider how your business can make this transformation rather than be driven solely by the constantly changing demands of external financial reporting. Don't let the vision for the possibilities of your accounting system and processes be hollowed out by the ever-evolving landscape of reporting compliance.