Internal accounting controls & transaction elimination

1. Internal accounting controls & transaction elimination Improving the value stream

2. Transaction elimination warm-up exercise STEP ONE On your flip charts, list the reasons why you use these processes in your company: • Work orders • Purchase orders & supplier invoices • Perpetual Inventory tracking. In most companies there are important reasons why these documents and their related transaction are used. Make a list of these reasons.

3. Why do we use a work order? • Authorize production • Track WIP inventory • Report labor used • To know the status of an order • Give instructions for making a product • Give a list of component and materials • Report completed production • Update raw material & component inventory levels • Update finished goods inventory levels • Schedule production & sequence • Identify the completed product • Calculate product cost • Report scrap • Report labor efficiency • Variance reports

4. Why do we use purchase orders and supplier invoices? • Authorize the supplier to ship raw materials & components to us • Legal contract between the two companies • Authorize receiving of the goods • Track material costs and PPV • Authorize to pay supplier • Give information of where and when to deliver the goods • Description of payment terms and discounts • The “3-way match” ensure the correct quantity & price • Product specification: technical, pack quantities, etc

5. Why do we need to track perpetual inventory records? • Accurate quantities • Inventory valuation • Inventory planning & control • Report measurements like RONA and stock turns • Production planning & scheduling • Identify obsolete and overstocks • To fill customer orders and give accurate available-to-promise dates. • Show where the material is stored • Allocate materials to production work orders sales orders • Pick material for sales or production • To report usage of each item for safety stock & planning

6. Transaction elimination warm-up exercise STEP TWO For each item on your list, explain how a truly leanorganization would address that issue without using transactions. As the processes come under control using lean methods and visual management, the need for transactional control diminishes. What would this look like in your company’s processes?

7. Why do we use a work order? (Customer order or kanban) (Visual control & pull system) (Value stream costing) (Short lead times) (Visual work instructions and standardized work) (Point-of-use & visual work instructions) (Don’t need it for make-to-order or supermarket) (Don’t need it if low inventory and pull from suppliers) (Don’t need it. FG is low, under control, & pull) (Level scheduling, SOFP, pull system) Visual. Standard containers, kanban) (Don’t need it. Value stream costing) (Cell performance measurements) (Don’t use it. Dangerous measurement) (Don’t do it. VS costing does not require them) • Authorize production • Track WIP inventory • Report labor used • To know the status of an order • Give instructions for making a product • Give a list of component and materials • Report completed production • Update raw material & component inventory levels • Update finished goods inventory levels • Schedule production & sequence • Identify the completed product • Calculate product cost • Report scrap • Report labor efficiency • Variance reports

8. Why do we use purchase orders and supplier invoices? (Supplier kanban from shop floor) (Blanket PO or contract) (Kanban) (Use actual cost from contract) (Use actual cost from contract) (Kanban) (Contract PO) (Voucher on receipt) (Contract PO) • Authorize the supplier to ship raw materials & components to us • Legal contract between the two companies • Authorize receiving of the goods • Track material costs and PPV • Authorize to pay supplier • Give information of where and when to deliver the goods • Description of payment terms and discounts • The “3-way match” ensure the correct quantity & price • Product specification: technical, pack quantities, etc

9. Why do we need to track perpetual inventory records? (Pull system & kanban) (Value stream costing) (SOFP, pull system & kanban) (Value stream costing and performance measurements)) (SOFP, pull system & kanban) (Low inventory & pull ensures there are none) (Visual management) (Visual point-of-use) (Don’t do it. Value stream costing) (Visual point-of-use or water spider) (Available from receiving transactions and/or bom’s) • Accurate quantities • Inventory valuation • Inventory planning & control • Report measurements like RONA and stock turns • Production planning & scheduling • Identify obsolete and overstocks • To fill customer orders and give accurate available-to-promise dates. • Show where the material is stored • Allocate materials to production work orders sales orders • Pick material for sales or production • To report usage of each item for safety stock & planning

10. We hate transactions!! Transactions are to the Lean Accounting what Inventory is to Lean Manufacturing. • Transactions are waste – inspection. • Transactions are used to bring financial control to an out-of-control process. • We must maintain control and remove transactions.

11. Lean Plants are Well Controlled Traditional Lean Controls are built into the work Kanban and visual signals—reduce obsolescence risk Low and level inventory—capped by kanban Day-by-hour charts—immediate identification and correction of problems Standard work—minimizes scrap and rework Short lead times—low and level inventory • Events are tracked after the fact • High/fluctuating inventory and process times • Frequent expediting • High rework and scrap • Poor factory organization • Longer lead times

12. Internal accounting controls Traditional controls rely on review and inspection of transactions and results against a standard, followed by correction of errors that resulted from the deviations (think: “auditing”) Lean controls work to prevent errors in the first place by building control into the structure of the work itself (think: “prevention”) Good lean controls reduce the materiality and frequency of errors

13. Why are traditional controls weak? They happen too long after the fact to be helpful to the process They fix the effects of the problem but not the root cause of the problem They generally have long feedback loops that are disconnected from root causes They are time consuming & costly

14. Why are lean controls strong? They are designed for prevention They are designed to perfect the system, not just to catch & correct errors that occur because the system has defects Reduce both the risk and significance of potential errors and misstatements

15. What happens with lean controls? Minimize Probability of Errors and Misstatements 5S and Visual Controls Standard work, Standard (TAKT) time, Standard inventory Hourly/by shift variance analysis of adherence to standard—work, time, and inventory at cell Culture of problem identification and solving Mistake proof (POKA YOKE) devices Weekly feedback at value stream—productivity, quality, delivery, cost Reduce Size (Materiality) of Amounts at Risk Short lead times—low and level inventory Visual Pull/kanban system caps inventory quantity—assures low inventories Stop to fix problems—little problems don’t grow to be big problems Regular Sales and Ops Planning to drive establishment of kanban and TAKT—balance capacity to meet planned demand

16. Lean manufacturing can cause more transactions • Daily deliveries from Suppliers • Small production batches • Single piece part-flow • Daily shipments to customers

17. 1. Shop floor control and tracking 2. Procurement and purchasing 3. Production planning and master scheduling 4. Cost accounting Four primary transaction flows:

18. The objective: remove wasteful transactions but don’t lose control The transaction elimination matrix process creates a maturity path to eliminate transactions when lean controls have been put in place The matrix identifies the trigger points that permit modifications to internal controls

19. How the transaction elimination process works Step 1: Let’s look at BMA’s Starter Set Use a “maturity path” approach Develop your own transaction elimination matrix Deploy lean controls Eliminate traditional controls with effective lean controls Get internal & external auditors involved early in the process Monitor the effectiveness of the new controls continuously

20. Step 1: Create your matrix.Figure out “What must be in place ?” BMA’s “starter set” Category Making a start with lean Lean Pilots in place Lean production Lean value stream management Lean enterprise Cycle Time • 12 weeks • Just beginning to understand lean concepts • Batches are smaller • 4 weeks • Value streams have been mapped • Start creating flow in pilot cells • Bottlenecks are reduced • 1 week • All production is linked for a balanced flow • Pull system in place • Producing to customer takt time. • 3 days • Cells continue to shorten cycle time • All production is linked to customer takt time. • 1 day • Supplier is linked to customer takt time • 100% customer service level. Inventory Levels • 3 turns • High raw, WIP and finished goods inventories • While inventories are high it’s not the right stuff. • 5 turns • Using kanbans • Using supermarkets and FIFO lanes • 20 turns • Kanban is used to pull from all internal areas • Visual systems • No supermarkets • Consistent level of inventory at point of use. • 30 turns • Kanban pull from customer • All inventory at point of use • 50 turns • Supplier making milk runs and monitoring inventory levels Kanban & Pull • MRP • Push System • No or very little kanban pull • Introducing kanban in cells • Kanban with some suppliers • Pull system used in pilot cells • Pull bottlenecks minimized • Pull system in all areas of organization • Pull system with all suppliers • No more batch jobs • 1 piece flow or equivalent • Kanban pulled from customer • Kanban throughout • Level production • Supplier kanban • 1 piece flow or equivalent. • Customer pull from us • Delivery directly to customer’s cell • Kanban from customers to suppliers Standard Work • Using Work instructions and routings that are used for standard costing • Standard work is used • Started 5S • Lines are balanced • Started eliminating sub-assemblies • Visual work instructions • Standard work for all cells • Workers are cross trained • Paperless • Standard work across value stream including non production areas • Lean team monitors performance • Visual systems • Continuous improvement • Line balancing based on customer takt time. Supplier Quality • Many suppliers but few are certified • No measurement system • Frequent supplier delivery problems • Receiving inspects most incoming material • Inspection shows erratic supplier quality • Identified core suppliers • Decreased the number of suppliers • Developed a supplier certification program • Have some certified suppliers • No longer inspect receipts from certified suppliers • Core suppliers are all certified • Certified suppliers delivering 99.5% direct to point of use • Most, if not all, other suppliers are certified • Frequent deliveries using kanbans • Measuring suppliers as responsible for quality • Moving to six sigma • All certified suppliers address quality issues • Value stream manages the inventory • Material is delivered directly to point of use • Certified suppliers are lean too • Six sigma • Customer is involved with supplier quality • All suppliers are lean • All suppliers are certified

21. Step 1: Create your matrix.Figure out “What must be in place ?” BMA’s “starter set” Category Making a start with lean Lean Pilots in place Lean production Lean value stream management Lean enterprise Cell Quality • Large batches • Scrap rework issues • Only 75% on time delivery to next operation • Formed cells • Using pull system • Smaller batches • Cross trained and certified the operators • There is better quality and less rework. • Single piece flow • Proactive on quality issues • Operators inspect • Time to stop and fix • Moving to six sigma • Quality is part of the process • Mistake proofing processes (“Poke yoke”) • Six sigma quality Performance measures • Using detailed labor reports for efficiency • Using machine utilization measures • Measures are primarily accounting • Start using lean performance measures, e.g., scrap, day by hour, 1st time through and other lean performance measures. • Running to takt day-by-hour report • Add more lean performance measures that are tracked by cell • Have a uniform measurement system for all cells. • Value stream measurements • Cell measurements that are linked to the value stream measures. • Cell measures and value stream measures are integrated with strategic goals • Continuous process of using measures to refine and improve. Visual systems • No visual systems. It is basically, paper, paper and more paper. • MRP work orders, and Ad hoc reports are used. • Measures are vital and visible. • Measure boards in cells. • Measures posted real time • Display is simple to understand • Line of sight • Measure boards are by value stream. • Kanban pull signals • Visual systems used throughout value stream. • Pull system triggered by customer orders (kanban) • Customer tied in to supplier. • Manage the customer order. Engineering data • Have multiple level bills of material • Routings and bill of materials are inaccurate • Bills of material and routings are simple and accurate • Engineering responsible to keep BOM and routings accurate • Cell personnel participate in concurrent engineering and process reviews • Cell takes appropriate actions to update the requirements • Bill of material and routings are maintained by value stream, continuous improvement team. • Paperless. • Information flows from customer to us to supplier. • Improvements by continuous improvement teams. Organization and control • Organized by department • Use department continuous improvement teams and only limited results. • Identified the value streams. • Started educating on value streams. • Formed some value streams. • Moving towards value stream. Buyer planner in cell. • Value streams clearly identified with some allocations and some direct costing. • Cross functional training • Addressing compensation structure for alignment. • Matrix management • All functions are in the value stream. • Organized and managed by value stream. • Support functions within value stream. • Measures by value stream. • Suppliers and customers are included in the value streams.

22. Step 1: Create your matrixIdentify transactions to eliminate BMA’s “starter set” Category Making a start with lean Lean Pilots in place Lean production Lean value stream management Lean enterprise Eliminate Labor reporting • Since labor is small % of total product costs, there is some backflushing and/or elimination of labor reporting. • Many units will still use detailed labor reporting • Some backflushing of labor • Detailed labor records are starting to go away. • For pay purposes, either salaried workforce or exception based reporting for hours. • For cost purpose, all labor (direct and indirect) is charged to the cell. • Exception based reporting minimized to labor law requirements • Non exempt salary workforce Eliminate production tracking & Inventory • Backflushing some material • Still running MRP • Still cycle counting for inventory problems • Eliminate receiving stock withdrawal tickets and associated moves by scanning parts in at receiving (supplier will barcode) • Developing plans for Kanban process • Full pull system • Scrap-exceptions. • Supplier managed inventories • Low value multiple use stock to be expensed when purchased. • Inventories are minimized • Eliminate cycle counting • No stockroom transactions • Stock is delivered to point of use • Complete pull system from customer through supplier. • Everything is period cost. • Inventory tracking has been largely removed from computer Eliminate Requisitions, Purchase Orders, Receiving, & AP • Have blanket PO’s with release schedule. • Implementing ERS to eliminate invoices and 3 way match • Implementing P Cards for low dollar non-inventory purchases • Implementing EDI purchasing • Set up long term agreements • Eliminate some PO’s with pull system. • Auto pay; no more invoicing and/or 3 way match. • Eliminate some PO releases by having kanban system. • No longer receive invoices • Web based purchasing • More ERS as suppliers are certified • More P cards • Beginning a pull system with supplier and have fewer monthly releases. • Expanding Web based purchasing • Backflush inventory and pay by backflush • Eliminate receiving function. • No PO’s since full pull system • Increase P card usage to inventory items (low value) • Supplier managed inventories • Initial blanket PO with no updates. Suppliers will be triggered electronically due to Kanban. • Backflushing based on shipments. • Initial blanket PO for each Part no. with annual review of pricing. • Purchasing group engineering group and accounting group are all part of the value stream. • Pay by backflush • Eliminate accounts payable function because of limited amount of checks to cut. • Eliminate receiving with suppliers delivering to point of use.

23. Step 2. Deploy lean controls • Work with lean leadership to understand: • Performance measurement for improving flow, quality, productivity & schedule attainment • Visual management practices such as pull systems & kanban • The supplier certification process to eliminate individual purchase orders & introduce kanban with suppliers • Cell measurements to monitor & control daily production activities Use this information to look for opportunities to get rid of transactions.

24. Step 3. Eliminate traditional controls as lean controls take root Here are some examples: Develop an understanding of why existing controls are in place and the risks they protect against Work out why and how lean controls replace existing controls Eliminate wasteful transactions! Many opportunities to do this will come your way. Look for opportunities and take prompt action.

25. Example 1: Work-in-process tracking and labor reporting

26. Example 2: Inventory control and valuation

27. Finally … Step 4. Include internal & external auditors in on planning Get buy-in on the conditions under which transaction controls will be eliminated Step 5. Monitor the effectiveness of the new controls Review new controls with operations management Build controls into the continuous improvement process … (more)

28. (continued) Integrate Internal Accounting Controls into Continuous Improvement Internal control is the process designed to provide reasonable assurance about achieving objectives related to: Effectiveness and efficiency of operations Reliability and materiality in financial reporting Compliance with applicable laws & regulations

29. The Five Components of Internal Accounting Control Control Environment – the atmosphere in which people conduct their activities, establishing the control tone of the organization Risk Assessment – identification & analysis of risks in operations, financial reporting and compliance Control Activities – policies, procedures & structures that ensure necessary actions are taken to address risks Information and Communication – methods information is identified, captures & communicated Monitoring the IC System

30. How Lean Controls are used to meet Internal Accounting Control Requirements Value stream maps Control environment Standard work Risk assessment Rapid Feedback loopsto find root causes Control activities PDCA problem solving Information & communication Visual systems Monitoring the IC system

31. Method for integrating internal accounting controls into continuous improvement Create a control matrix for each process step that includes control risks & methods to address risks Add control methods to value stream map to create controls maps for current & future state As continuous improvement occurs, revise control maps Here is an example

32. Supplier Customer Control Map – Current State Competitive Bid PO Approval Review usage vs on hand MRP Scheduling Order Purchase Order Purchase Forecasts Demand Forecasts Accts Rec aging and Follow up Track actual Quantities Track actual Quantities Track actual Quantities Track actual Quantities Budget/Actual Variance Analysis RM Process 1 WIP Process 2 WIP Process 3 FG Shipping Compare Receiving/ PO/Invoice Cy Track labor and materials Cy Cy Cy Compare invoice / shipper/ order Adjust Inventory to Actual Spending Track labor and materials Track labor and materials Standard Cost Variance Standard Cost Variance Standard Cost Variance TOTAL INVENTORY MORE THAN 30 DAYS Suppliers Raw Materials & Components Scheduling Process 1,2,3 Work in Process, Finished Goods Ship to Customer Purchase Order based on forecast Perpetual Records MRP based on forecast, adjust actual Work Order Control Perpetual Record Daily orders. Ship direct to customer PROCESS • PO to invalid supplier/ amount • Invoice wrong amount, parts • Quantities wrong • Material cost wrong • Customer changes order • Wrong parts ordered • Obsolete inventory • Undetected waste • Underutilized resources • Resource amounts/costs wrong • Quantities wrong • Material, labor cost wrong • Wrong product • Wrong customer CONTROL RISK • Compare Receiving/ PO/invoice • PO approval • Competitive bid Track actual Cycle count, adjust perpetual records Regularly review parts usage against balances on hand Track actual labor, machine hours and material used. Compare with standard costs Track actual quantities, cycle count, adjust perpetual records Compare invoice/ shipper/order Accounts receivable aging and follow up CONTROLMETHOD Key: = Control Procedure

33. Supplier Customer Control Map—Future State Purchase Forecasts Demand Forecasts SOFP Master PO Certified supplier Accts Rec aging and Follow up Pay Supplier Order Kanban Process 1 Process 2 Process 3 Shipping Value Stream measures linked to goals and improvements Supplier managed inventory Visual control; WIP/ SWIP Make to order Visual control; WIP/ SWIP DBH board, kaizen newspaper, FTT, standard work, GEMBA walks, standard inventory TOTAL INVENTORY LESS THAN 30 DAYS Suppliers Raw Materials & Components Scheduling Process 1,2,3 Work in Process, Finished Goods Ship to Customer Pull System Visual pull System Visual pull system based on customer orders Visual pull system based on customer orders Visual Pull System Daily orders. Ship direct to customer PROCESS • PO to invalid supplier/ amount • Invoice wrong amount, parts • Quantities wrong • Material cost wrong • Customer changes order • Wrong parts ordered • Obsolete inventory • Undetected waste • Underutilized resources • Resource amounts/costs wrong • Quantities wrong • Material, labor cost wrong • Wrong product • Wrong customer CONTROL RISK Certified supplier, Master PO, Pay on completion, Supplier managed inventory Visual inventory control, standard inventory, WIP/SWIP Visual inventory control, WIP/SWIP, SOFP Day by hour board, kaizen newspaper, FTT quality, standard work GEMBA walks Visual inventory control, standard inventory, WIP/SWIP Make to order, Accounts receivable aging and follow up CONTROLMETHOD Key: = Control Procedure

34. Transaction Elimination Summary Lean controls eliminate the need for traditional transaction controls Lean controls improve the internal accounting control system Transaction elimination should progress in step with lean operations controls Eliminate transactions. But maintain control Lean controls simplify Sarbanes Oxley requirements

35. Power CurbersMike Abernathy, CFOand Craig Neuhardt, VP Operations Transaction Elimination and Auditors

36. Marquip Ward UnitedJerry SolomonVice President Operations Transaction Elimination