The Financial Accounting Standards Board (FASB) is looking at inventory accounting and contemplating changes in the rules. For those who don’t know the FASB sets the rules that essentially become law for how accounting has to operate. Inventory accounting and the accounting community’s sheep-like faith in whatever FASB has to say about it (and everything else) are the number one obstacles to manufacturing excellence – don’t hold your breath waiting for the FASB to reverse 62 years of wholly misunderstanding manufacturing, or for the accounting community to see the light.
Back in 1952 the FASB locked in on Research Bulleting 47 which is at the core of classifying inventory as an asset and essentially dooming the possibility of lean taking root in the United States back in its early years. Thank God the Japanese ran with it or the underlying principles would have been lost forever. With a chance to take another look at just how buying or making more than you need, putting up a building to keep it in, buying racks and forklifts to store and move it around, hiring a crew of folks to do all of that storing and handling, buying a big computer to manage the excessive stuff, then hiring managers to lead the whole endeavor, and the burying all of the costs associated with the above in overhead rates that make them almost impossible to see in their entirety can be viewed as creating an asset is a complete mystery to me and just about everyone else with a lick of common sense. But that’s what they did back in ’52 and in the ensuing 62 years nothing has come along to cause them to rethink the idea.
Let’s ignore that fact that nothing in the manufacturing world is the same in 2014 as it was in 1952 – products, processes, technology, markets … nothing – expect accounting thinking. The world pretty much looks the same to the accountants today as it did back in the Truman administration.
Instead, let’s look at two fundamental points: The purpose of financial accounting and the purpose of management accounting.
Financial accounting is the accounting that goes into paying the taxes and, for publicly traded companies, reporting to Wall Street. Bankers and judges like it too. Management accounting, on the other hand, is racking up the numbers for management to make decisions. All of the FASB stuff, including the nonsense from 1952 applies to financial accounting. It is GAAP –Generally Accepted Accounting Practices – the arcane stuff no one in the practical world cares about and it is the source of all of the accounting game playing and the origin of many prison sentences for people who play such games poorly.
Management accounting is completely different. There are no laws, no rules, the FASB could not care less about it, and GAAP has nothing to do with it. Management accounting is whatever management and the accountants decide is helpful for management. It is 100% accounting’s choice to gin up standard costs, budgets, calculate variances and run the whole management shebang in a manner that ties to the financial accounting/FASB/GAAP stuff. They don’t have to do so. They choose to do so. It is 100% on the backs of your accountants to explain why your business is running on the basis of 1952 thinking and classifying inventory as an asset when everyone who understands lean (and everyone who understands reality) knows it to be waste.
The logic behind the FASB stuff – classifying inventory as an asset – is to provide outside folks with an ‘accurate’ statement of what the business is worth should they want to buy it. Period. That is why the rules are based on the convoluted inventory logic. Should your management put the business up for sale the stuff in the warehouse has some value, as does all of that hardware you bought to hold it – not what you paid for it, but some value. GAAP accounting helps your management maximize the amount they can get when they sell the business. It was never intended to help them make better decisions if they wanted to run the business as a going concern. It isn’t supposed to help them grow, create jobs, take care of customers or anything else – just to be able to sell the business to someone else – or to tell the banker how much they can liquidate the business for in a foreclosure or bankruptcy. The P&L and the balance sheet serve this purpose only. Period.
So back to the purpose of management accounting and the accounting community’s insistence that the numbers you use to make decisions must reconcile to and be derivatives of GAAP. Please ask them why, if you and the rest of management are trying to drive a lean strategy that will enable the business to grow, prosper and contribute to the quality of life for all of the stakeholders for years and years to come, are they providing numbers and information based on the assumption that the most important consideration if what you can get by liquidating the business tomorrow?