In a recent post on the Evolving Excellence blog, Bill Waddell tackles one of my pet peeves: activity-based costing, or ABC. Few things do more harm to lean Six Sigma than this method of accounting. In fact, it is my opinion that the accounting systems used by U.S. businesses are responsible for a great deal of our country's declining economic prowess. Hindering improvement activities are just one example, but it's the example nearest to my heart.
Let me give you one example to illustrate (it would take a book to describe all that's wrong with ABC.) Let's say we are trying to convince Mary that lean Six Sigma is a great idea.
"Mary," we say enthusiastically, "using lean Six Sigma will help you reduce inventory. Inventory is a bad thing. It takes up valuable space, it hides quality problems, it costs money to build it and it doesn't generate any revenue..."
Mary nods in agreement and tells us to stop badgering her with the obvious. Furthermore, she adopts lean for several important product families and her inventories drop dramatically.
Mary is likely to find herself out of a job if the company is using ABC. With lean Six Sigma Mary doesn't make something until it's needed by a customer. But if ABC is used, a unit built for inventory is valued as highly as a unit built for delivery to a customer. ABC's absorption accounting allocates overhead and other costs to units produced, why the units were produced doesn't matter to ABC.
Mary's lean approach won't look good, especially in the beginning. Consider that Mary might begin with two months inventory. Depending on takt time, she may not need to produce anything for several weeks. It's likely that Mary's boss will pay her a visit with a message something like "Whatever the hell you're doing, Mary, stop it. You're killing my numbers!"
There are many other things wrong with ABC, and with the generally accepted accounting principles (GAAP) on which ABC is based. Considering that these accounting methods are taught to MBA students at our elite universities, we can only hope our economy survives our accountants.
Waddell offers one alternative to ABC, which is described in a book called Real Numbers (Jean E. Cunningham, Orest Fiume, and Emily Adams; Managing Times Press; 2003). Another is Throughput Accounting (Janice Bell, Monte Swain, Jan Bell, and Shahid Ansari; McGraw-Hill/Irwin; First edition; 1998), which is based on Goldratt's Theory of Constraints. Both methods are far more simple than ABC.
Thomas Pyzdek’s career in business process improvement spans more than 40 years. He is the author more than 50 copyrighted works including The Six Sigma Handbook (McGraw-Hill, 2003). He provides online certification and training in Six Sigma and lean. Learn more at www.SixSigmaTraining.org
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ABC
JRomano
While I do not profess to be an MBA, I believe there are some inaccuracies in your article from the way I was taught ABC. ABC does not average overhead against items. An item made for inventory versus sale should have the activity cost of warehousing and storage; an item made for sale should not have those costs. A repeat sale item should not carry the cost of R&D versus a newly developed product. In my experience, most companies do not use ABC, it more difficult to track, computer costing systems do not account for most variations such as those noted above. If they were, six sigma costing would show immediate differences in the 'true' actual costs of producing an item for sale. Most companies today just smear costs across their product line which makes them less competitive and less understanding on how they actually made profit. It is very difficult to build R&D into the ABC cost model since few would be willing to pay the price for those first units (drug companies patents issues) versus generics. Please look at ABC as you would COQ.