Lean Production Is an Innovative Production Technique

Lean Production is an innovative production technique of Japanese origin that aims at bring efficiency in production. The system comprises of various different techniques, all focusing on ensuring best quality and maximum levels outputs in minimum inputs. Minimum inputs here, not only refer to minimum in terms of materials, but also in terms of time and cost thus ensuring minimum wastage (Stevensons, 2008). Methods that are part of Lean Production include Kaizen, Kanban, Cell Production, Just In Time, and Total Quality Management.

Another thing that differentiated companies practicing Lean Production methods is the way they adhere to accounting principles. Also referred to as 'Lean Accounting' this method of cost accounting and managerial accounting allows accountants to efficiently divide their costs in processes and get accurate results rather than crude estimates. One of the pioneers in Lean Production and Lean Accounting System is the renowned automotive company, Toyota Motors.

A major and critical part of the decision making for any organization occurs, when the organization has to decide on its future investments. This may be any kind of investment decision such as buying a new machinery, new property, or investing in stocks. The decision is complicated because there are various factors that may influence the accuracy of investing in a certain project. Ignoring even one of the factors may result in a wrong investment decision, which might lead to heavy losses for the organization. In order to prevent any inaccurate decision making firms draw forecasted plans pertaining to the investment decision that lay ahead of them. These plans are known as Capital Budgeting. As the name suggests Capital Budgeting or Capital Redemption techniques refer to budget and evaluate the costs and return pertaining to making a capital investment. It is, in simple terms a cost benefit analysis that helps in determining the feasibility of a project.

Quality Control

The Toyota Motors is very particular about the quality assurance in the business, whether in terms of goods and services or in terms of performance of overall business operations. The Company adheres to strict Total Quality Management practices, where constant check and balance is maintained on every stage of business operation that is from receiving supplies to final delivery to customer (Waters, 1999). Being a large business, The Toyota Motors have a separate quality control department. However, the management still sets strict benchmarks and standards and ensures that the business is up to the mark. The business uses techniques such as lead time stock management system and cost efficient capacity management systems that ensures avoiding of over stocking and under stocking and inventories are maintained at acceptable levels (Houle, 2007).

It does have a separate quality control department amd the management of the company used Total Quality Management (TQM) practices in order to ensure consistency in quality. This is done by setting standards for each level of business operation and then maintaining quality checks to ensure that performance at that level is up to the standard. The Toyota Motors keeps uses simple quality management tools such as the Pareto chart, check sheets and check lists.

The quality control department is responsible for checking every morning that all the supplies are fresh and are up to the mark and in required quantity. Any shortages or flawed supplies are reported and arrangements are made to rectify it. Supplies such as defected raw materials are rejected and fresh supplies are arranged for. One person from the management makes surprise inspection visits to the manufacturing site in order to make sure that the quality reports which the quality control department submits is in compliance with the required standards. The inspector personally checks and inspects the operations for quality management.

The inspection personnel are required to maintain check sheets in which they record all their observation that is the consistencies and lacking that are in the company and that needs to be addressed these records are then charted on the Pareto chart (Houle 2007). This helps in addressing the root cause of the problem, in case one arises and eliminating it at that stage so that consistency in quality can be maintained.

How Capital Budgeting is Done?

When any firm makes an investment in a project, its objective is to maximize the returns that it will be gaining from the investment it will make. However, the case is not as simple as it sounds. There are two major factors that are considered when investment decisions are made. The first factor is the projects payback period. The payback period tells the investor that in how much time the investor will be able to cover his original investment back. The longer the payback period comes, that means the longer time will the project take to cover the original amount that was invested. This means that the cash will remain stuck up in the project until the capital is fully recovered.

What creates problem here is the fact that money loses its real value over a period of time due to inflation. For example the value of £ 100 today will be much less as compared to what it was ten years back. This is because inflation has increased over a period of time. Putting this example in context of capital budgeting, the longer the money is stuck in a project, the more it will tend to lose its real value. This means that investors will have to consider if their returns from investment justify the real value of money that they have earned. If the returns are higher in nominal terms, but the real value of money is less than the amount that was originally invested, than the project is not worth investing in.

Financial Decision Making

In order to make a final decision about what projects should a firm invest in, various methods are used. ToyotaInc uses four options that include the Payback method, the Accounting Rate of Return method, the Internal Rate of Return Method, and the Net Present Value method. All these methods are discussed under the following sections.

Payback Period

The Payback method involves selecting the project that recovers the investors' originally invested capital in the shortest possible time. This method is usually used in circumstances where the organization has limited funds available for investment and it needs timely circulation of cash flows in order to avoid any cash short falls. Under this method, investors generally set a maximum time period within which they expect to cover the invested capital amount. If a project's payback period comes out to be greater than the investor's maximum time period, then the investor is likely to avoid investing in that project.

Accounting Rate of Return

The Accounting Rate of Return or the ARR technique is a relatively obsolete technique as compared to the other methods of investment appraisal. This is because unlike other methods, the Accounting Rate of Return technique uses profits rather than cash flows to choose between the investment options. Under this technique, project with a higher ARR must be chosen. The biggest drawback with this technique is that ignores the time duration within which the invested amount will be recovered. It also ignores the fact that money will lose its real value over a period of time. Under ARR technique a project, which earns higher returns towards the end and has a longer payback period, but the overall ARR is higher is chosen over a project with a shorter payback period. This would obviously lead to misleading the decision makers and might also lead to severe cash flow problems for the organization.

In the case of Toyotathe ARR is a good 46% despite of a negative NPV. Looking at the Accounting Rate of Return figures in isolation, ToyotaInc. seems to be a very favorable option.

Net Present Value

As mentioned earlier, the real value of money depreciates over a period of time due to inflationary pressures. The longer the capital is stuck up in a project, the more real value it will tend to lose. The Net Present Value or the NPV technique takes this factor into account when deciding about investing in a particular project.

Present value expresses the expected future cash flows in terms of the current worth of money. This means that the technique converts the cash flow returns that the investment is likely to earn in future, into the current worth of money. In this way firms can determine how much real value of money is likely to be lost . The Net Present Value is the total sum of all present values over a period of time subtracted from the amount that was originally invested. A positive NPV means that the project will give favourable returns to the firm and is likely to be accepted. A negative NPV would mean that the firm will lose its money by investing in the project, and thus the project must be rejected. A zero NPV means that the project will neither add any financial gains to the firm, nor will it take out any money from the business. In such a case, acceptance or rejection decision must be made by looking at other strategic factors that are ignored by the NPV technique. In this case firm's use the IRR technique along with the NPV to make the final decision. The NPV for the proposed Toyotaprojects is highly negative. A possible behind this is that the cash flow information has suggested that the costs have compounded at a greater percentage as compared to the revenues. One of these costs also includes labor costs which have compounded at a rate of 7%. It is already known that the global economy is going through severe downturn. This would mean that under any unforeseen circumstances, if labor costs increase even higher than the considered percentage, greater negative pressures will occur.

Internal Rate of Return Method

The Internal Rate of Return, unlike other techniques, tells how efficient a project will be for the company. This technique involves using discount rates where NPV is equal to zero. The higher the NPV is, the more favourable a project will be for the company. Similarly, the lower the NPV is the more unfavourable a project will be. Suppose a Toyota assembly plant project has an Internal Rate of Return of 19% which favors the project being in a positive zone. However, since the economic environment is still going through uncertainties therefore other factors have to be taken into consideration. The factors have to be from both financial and non-financial environment.

Other Factors to be Considered

It is advisable that firms consider some real options in order to take its final decision. Considering the uncertainties involved the Abandonment option is of immense importance in this case. Firms must be in a position to withdraw its money out of the venture if at any time it feels that the venture will not financially perform as expected. The company must keep some margin of flexibility so that it can bring about changes in its financial allocations where necessary. This is important because if for example certain cost areas compound at a greater rate than expected, the company must be in a position to allocate funds from another area to the area in need. Moreover, the operations must be flexible enough to allow for breakeven or minimal loss abandonment at any point of time.

Cost Accounting

In the job order costing systems and process costing systems jobs and processes are broken into parts and each job and/or process is accounted for in itself. Direct costs are those costs that can be attributed directly to a manufacturing process of a product. These usually include costs such as direct materials, direct labor costs (calculated by multiplying wage rate per hour by direct labor hours) and direct material (Harper, 1995).

Overhead costs on the other hand are generally fixed costs and are not attributed directly to a manufacturing process. These are often referred to as indirect costs. Examples of such costs may include factory rent or fuel costs for the machinery.

Unlike direct costs, indirect costs are allocated to the process costing system using an overhead rate that is predetermined. This is because overhead costs include large and various types of costs that are difficult to broken up and quantify as separate units of measurement. They are therefore allocated with a support of direct cost drivers to various processes and jobs. Although tracing these costs are difficult, the fact that these remain generally constant and do not vary according to change in seasons or demand factors, makes their allocation much easier.

Application of Overhead Costs

Overhead costs cover a large variety of fixed and indirect costs that are difficult to trace, track down and account for to processes and jobs that do not complete the whole product but are merely part of the total manufacturing process (Dury, 2006). The actually figure of the overhead costs, given their fixed nature, can only be determined at the end of the year when the company accounts are closed off. Contrary to that a process may complete several times in a year. In a company, costing have to be accounted for as soon as they occur, which means one cannot wait for the year to be completed in order to allocate these costs to the process that has occurred much earlier and that too several times with an year. As a result companies tend to use predetermined overhead rate allocation method, allocated as per direct cost drivers, which makes the task of accounting for large overhead units fairly simple. Say for example if a company estimates its total overhead costs for a given year to amount to $100,000 and the total direct labor hours are estimated to be $10,000 then the predetermined overhead rate for the year would be $100,000 divided by $10,000, which equals to $10 per labor hour. This means that the overhead rate that would be accounted for in each process would be $10 for every labor hour that is consumed in the process (Williamson, 1996).

As stated earlier, overhead rates are predetermined and their allocation to processes is directly dependent on the cost driver units which are direct labor hours. All the overhead rates are estimated as it is not technically feasible to use the actual figures. If these cost driver units are underestimated, and that too to a significant extent, than the consequence will be that overhead rate for each process will be overstated. Taking the same example used earlier, where annual overheads were estimated at $100,000 per year and direct labor hours were estimated at $10,000 the overhead rate would be $10 per direct labor hour. Instead, if direct labor hours are underestimated to be $5,000, than overhead rate will amount to $20 for every labor hour that is consumed. Consequently, if the overhead rate would overstated the total process costing for each process would be overstated as well.