Activity Based Cost Accounting Hinders Lean Six Sigma

In a recent post 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 American 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 begining. 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.

Bill offers one alternative to ABC, which is described in a book called Real Numbers. Another is Throughput Accounting, which is based on Goldratt’s Theory of Constraints. Both methods are far more simple than ABC.