Accounting as Weapon

When Toyota announced it would make a profit on the new version of its Prius hybrid car, it got me thinking. Are Toyota's engineers really better than everyone else's, or is something else going on? I think there's something else.

For one, what does Toyota mean when it says “profit?” As anyone who has studied the most rudimentary basics of accounting knows, there are different ways of reporting profits. There can be an operating profit and a net profit. There can be fully accounted or variable profits.

Toyota, itself, reports two different sets of earnings every year, non-consolidated and consolidated. The first covers only the company's core operations; the other includes all its affiliates. It all depends on what you're counting.

For example, DaimlerChrysler bragged that it earned a profit of $1.4 billion in the third quarter. And it did, as long as you don't count the special charge it had to write off, in which case the company lost $1.9 billion. DaimlerChrysler was reporting what we call a pro-forma, or “adjusted profit.”

Calculating whether a product is profitable also depends on how or where costs get allocated. One of the ways Ford was able to justify making the new Jaguar XJ out of aluminum was to allocate much of the development cost to the Ford Science Labs. That way Jaguar didn't have to foot the whole bill, making the car — you guessed it — profitable.

When the Clinton Admin. began funding research for the domestic auto industry to develop 80-mpg (2.9L/100 km) hybrids, did the Japanese government sit back and watch? Or did it let certain Japanese auto makers know there would be generous tax breaks if they started developing their own equivalent of the now defunct Partnership for a New Generation of Vehicles? I wouldn't be surprised to learn that Toyota has been able to write off much of its hybrid development.

Consider this: It is impossible to buy a Toyota in the U.S. market without an engine featuring variable valve timing, from the cheapest Echo to the top-line Lexus LS 430. Yet, until recently it's been almost impossible to buy an engine from the domestic auto makers with this feature. They claim it adds too much cost, and their customers will not pay for it.

Toyota is able to carefully identify key technologies that will make its cars more desirable. Then it makes the commitment to introduce that technology across the board and put it into production for at least a decade. The initial installed cost of the technology is probably calculated on that assumed mass volume. That way, Toyota can introduce new technology well before its competitors and still make a “profit” on it.

Almost every auto maker in the world assiduously studies the Toyota Production System to improve manufacturing operations. They ought to put some additional effort into studying Toyota's accounting system as well. Its accounting system is a potent strategic weapon.

John McElroy is editorial director of Blue Sky Productions and producer of “Autoline Detroit” for WTVS-Channel 56, Detroit, and Speed Channel.