THE ARTHUR YOUNG ACCOUNTING COLLECTION Graduate School of Business Administration Library of the University of California Los Angeles STAT library Graduate School of Business Administration University of California Los Angeles 24, California PRINCIPLES OF COST ACCOUNTING BY JOHN R. WILDMAN, M.C.S., CP.A. PROFESSOR OF ACCOUNTING IN THE NEW YORK UNIVERSITY. SCHOOL OF COMMERCE, ACCOUN1S AND FINANCE 1916 NEW YORK UNIVERSITY PRESS WASHINGTON SQUARE EAST NEW YORK 40036 COPYRIGHT, 1911, BY JOHN R. WILDMAN The William G. Hewitt Press Brooklyn. New York C8W6 PREFACE The motive which prompted the author to prepare and publish Cost Accounting, was the desire to supply a demand for a text book on the part of the students in New York University School of Commerce, Accounts and Finance. In presenting it for public consideration it is desired to have clearly understood the fact that it is intended as a text book especially adapted to the needs of students, and is not in- tended as a general reference work. The supply of literature on the subject of cost account- ing is increasing rapidly. The quality of such literature is of a high order. The fault to be found with it from the point of view of a teacher is that it is too highly specialized. The tendency on the part of authors on this subject is to select some particular industry or line of production and describe a particular system, attempting to make such typical of the entire subject. Most systems are accompanied by elaborate forms. In fact it may be said that many systems are nothing more than a collection of forms. This practice has been carried to such an extent that it would not be extravagant to state that the average student looks upon the study of cost accounting as a matter of becoming familiar with certain specific forms comprising a particular system. In this maze of forms the student becomes lost and the principles underlying the forms are entirely overlooked. During the first few years of the author's experience in accounting work he devoted a great deal of time to collect- iii Preface ing forms of all kinds, especially those having to do with cost accounting. After having collected enough to half fill a medium sized steamer trunk he discontinued the practice. There were two reasons why. Being always so busy col- lecting them he never had time to refer to them. When he had occasion to devise and use a form he constructed it anew without reference to his collection. Having deter- mined the subject for which the form was needed and considering the use to which it was to be put, it was only necessary to make the form, through its construction and arrangement, call for the information desired. Experience taught him that a knowledge of what the form should recite was of vastly more value than familiarity with any particu- lar form, or than to be able to refer to a splendid collection. Little attention has been given to forms in the prepara- tion of this book. It is essentially a book setting forth the principles of cost accounting rather than a treatment of the subject in all its refinements. To the experienced cost ac- countant it will be of little value. To the engineer dealing with cost accounting problems it will be of less value. To the student, whether in the technical school of some univer- sity, or in the works department of a plant in some small manufacturing town, it is hoped that this book may give a broader conception of the subject, impress the principles un- derlying it firmly upon his mind, and so prepare him that he mey attack intelligently and successfully the problems which confront him and read and study to better advantage some of the more interesting literature now available and being prepared by specialists in this line of work. JOHN RAYMOND WILDMAN. New York, June 4, 1910. iv CONTENTS CHAPTER PAGE I. OBJECTS IN ASCERTAINING COST I II. CLASSIFICATION OF COSTS 5 III. SELECTION OF A SYSTEM 9 IV. ACCOUNTING COST SYSTEM 12 V. MANUFACTURING OR FACTORY COST SYSTEM 18 VI. ORDERS 26 VII. MATERIALS AND SUPPLIES 31 VIII. LABOR 37 IX. OVERHEAD 44 X. TYPES OF MANUFACTURING COST SYSTEMS .... 50 XI. WHEN DEPARTMENTAL DISTRIBUTION OF OVERHEAD is INDI- CATED 54 XII. DEFECTIVE GOODS, WASTE, SHRINKAGE AND IDLE TIME . . 58 XIII. DISTRIBUTABLE OVERHEAD AND BASES OF DISTRIBUTION . . 63 XIV. MACHINE RATES 67 XV. WAGE SYSTEMS 71 XVI. FIXING OF WAGE RATES 79 XVII. THE EFFICIENCY DEPARTMENT 81 XVIII. RECONCILING PREDETERMINED AND ESTIMATED COSTS WITH ACTUAL COSTS 88 XIX. REPORT OF THE COST DEPARTMENT 93 Principles of Cost Accounting CHAPTER I THE OBJECTS IN ASCERTAINING COST A discussion of the subject of Cost Accounting involves the consideration of three topics : 1 i ) The nature of the information being sought. (2) The means of obtaining the information. (3) The use to which the information is to be put, after it is obtained. A consideration of the first topic requires an inquiry into the objects in ascertaining costs. Briefly stated they are as follows : (a) To ascertain whether or not a business undertaking is profitable. (b) To serve as a basis for fixing selling prices. (c) To furnish information to the proprietor or admin- istrative officer which will guide him in forming his adminis-* trative judgment. In the simplest of business transactions the interesting element is that of profit A man who undertakes a business venture of any kind is primarily interested in knowing whether he is making or losing money. In either case, how much? He is secondarily interested in Knowing whether his business is sufficiently profitable. By this is meant, whether or not the return on the investment is up to the average for the line of business in which he is engaged. I Principles of Cost Accounting If he is engaged in trading, his first or gross profit is from the sale of his merchandise. In order to ascertain his profit he must oppose against the proceeds of his sales the cost thereof. If his cost is incorrect, his profit is incorrect. Strangely enough, the error in such cases is usually against him rather than in his favor. Such errors frequently re- peated are inclined to lead him suddenly, and often to his surprise, into a condition of insolvency. Hence the import- ance, even in the simplest transactions, of having informa- tion on the subject of cost which is correct and trustworthy. Competition as it exists today calls for the greatest of care in fixing selling prices. The exercise of such care re- quires business experience, a knowledge of business condi- tions and reliable information concerning costs. The suc- cessful contractor is the man who not only gets the contract by virtue of having submitted the lowest reasonable bid, other things being equal, but the man who can get his profit out of the contract after he has succeeded in securing it. If a loss results, or the margin of profit is too small, it means, upon repetition, one of two things must be done; either the selling price must be increased, or the cost must be decreased. Of these two expedients, the first is usually inadvisable, if not impossible, without resulting in a loss of business, and the business man looks to the second means for relief. Can he use this means intelligently if he is not absolutely sure of his cost? Obviously, not! Through the aid of accurate information concerning costs the proprietor or administrative officer is enabled to keep in close touch with conditions, shape the operating policy of the future and guide the operations as they mature. He is enabled: 2 The Objects in Ascertaining Cost a. To determine which lines of production or merchan- dise are profitable and which are unprofitable; to institute methods for extending and increasing the sale of such lines as are profitable and to retard the sale of, or withdraw en- tirely from the manufacture, or sale of, such lines as are unprofitable; to decide intelligently the lines on which com- missions may be allowed to salesmen and the extent of such commissions. b. To reduce costs; either through a reduction of the ele- ments composing costs, or through an increase in the pro- duction. c. To allocate "leaks" and stop unnecessary waste or ex- travagance. d. To develop the highest type of productive efficiency. To bolster up the weak points and harmonize the work of the different departments, or operating groups. e. To gauge the efficiency of managers, relatively speak- ing, by comparing one manager with another. The man- ager, whose cost of producing soil pipe per ton is $7.00, is obviously not as efficient or capable as the man who under precisely similar conditions can produce the same product at a cost of $5.00 per ton. /. To compare the work of similar foremen, depart- ments, machines, operatives, or other centers of production. g. To compare costs in general of one period with an- other. h. To compare actual costs with estimated or predeter- mined costs. The tendency today is toward standardization. Generally speaking from the standpoint of costs, standards are unattainable. A comparison of actual costs with stand- ard costs determines the percentage of efficiency. Modern business organization has become so complex 3 Principles of Cost Accounting as to have passed beyond the limits of individual observa- tion, unless the individual has some artificial means of tran- scending these limits. The time has passed when the admin- istrative officer can be in touch with all the details of the business. Cost statistics offer such a man a means of tran- scending his individual limits. They afford him an opportu- nity of having placed before him at stated intervals a picture, as it were, of his business operations. The administrative officer, or proprietor, draws his conclusions from the pic- ture, and is afforded thereby a basis on which to found his judgment as to future operations and policies. It is said of the late Mr. Harriman, that he owed his success in a meas- ure to his ability to interpret the operations of his many business enterprises from the statistical reports which he re- quired of his representatives from time to time. 4 CHAPTER II CLASSIFICATION OF COSTS Costs are frequently referred to without distinction as to whether manufacturing or selling costs are meant. That such a distinction should be made is important. Manufactur- ing cost, as will be seen in the classification appearing below, contemplates only such costs as arise, in the factory, in con- nection with the manufacture of the product. Selling cost has as its basis the manufacturing cost, to which is added the expense of selling the product, the expense of administration, and all other items of expense incident to the conduct of the business. The trader, who buys and sells merchandise, tech- nically speaking, has no manufacturing cost. His is a selling cost, having as a basis, however, an item of cost of purchase, corresponding relatively to the cost of manufacture. The details of each class of costs are as follows : 1. Manufacturing costs, composed of Prime cost and Manufacturing overhead, variously referred to as Factory loading " burden expense indirect Manufacturing expense "On cost." 2. Selling costs, the elements of which are (a) Manufacturing cost Principles of Cost Accounting (b) Selling expense (c) Administrative expense (d) Fixed charges or capital expenses (e) Provisions for reserves (/) Deductions from sales. A somewhat more detailed analysis of selling costs would include the following items : A. Manufacturing cost 1. Prime cost (a) Materials and supplies, including inward freight and cartage, and duty (b) Labor direct such as "cutting out " and "stitching" in the manufacture of shoes. 2. Manufacturing overhead (a) Labor indirect Foremen Helpers (not working on product) Porters Watchmen Messengers Teamsters (b) General factory expense Heat, light and power Shop supplies (so small as not to war- rant charging to stock) Repairs and renewals Office supplies Office expenses (c) Salaries Manager or superintendent Clerks keeping factory records 6 Classification of Costs (d) Depreciation of machinery and tools, or other operating equipment B. Selling expense (1) Salesmen Salaries Traveling expense Commissions (2) Advertising C. Administrative expense 1 i ) Salaries Officers Clerks keeping general records (2) Expense general office Printing and stationery Postage Telephone and telegraph Traveling officers and clerks Legal Miscellaneous D. Expenses of capital (subject to offset on account of other income) '(i) Cash discount on sales (2) Rent (3) Taxes (4) Insurance ( 5 ) Interest E. Provisions for reserves 1 i ) Defective goods returned (2) Doubtful accounts (3) Depreciation of plant F. Deductions from sales (i) Allowances 7 Principles of Cost Accounting (a) Loss (b) Breakage (c) Damage (2) Trade discounts (3) Rebates (4) Outward freight The above outline is intended to be indicative rather than exhaustive. The relation of selling cost to selling price, the elements of which are cost and profit, may be made apparent by the following illustration : SELLING PRICE Deductions from Sales I Provisions for Reserves | Expenses of Capital PROFIT | Administrative Expense | Selling Expense ( Manufacturing Overhead f Prime Cost 8 CHAPTER III THE SELECTION OF A SYSTEM Having determined the nature and extent of the infor- mation sought, the question of how it is to be obtained arises. What kind of accounting mechanism, or system, shall be employed for this purpose ? Product differs. What will serve in one case may not serve in another. Hence in order to decide intelligently as to the means to be employed in obtaining the required in- formation it will be necessary to study the question of pro- duction with regard to the type of product and try to dis- cover certain characteristics common to the various types. If a baker were to mix up a batch of dough, consisting of flour, eggs, milk, sugar, butter, baking powder, salt and flavoring, roll it out on a board and cut crullers therefrom, each ring of dough would contain the same quantity of in- gredients and have resulted from the same operations of labor. All having come from the same batch of dough, there could be no dissimilarity in the quality of the ingredients. If it were desired to find the cost per dozen crullers, the cost of the ingredients, the labor and any expense like lard for frying, and heat, would be combined and the amount divided by the number of dozen crullers resulting from the batch. This process may be repeated indefinitely and the result will always be the same, subject to fluctuation in the cost of the elements, namely, an average cost per unit. The unit will have remained the same throughout and the elements 9 Principles of Cost Accounting which the unit represents will likewise have remained the same. The operations will have been confined to the pro- duction of a single thing of a certain grade. Hence the term single unit production may be used to describe this and simi- lar situations. By single unit production is meant that class of production in which the units produced are identical with regard to the kind, quantity and quality of material used, require the same operations of labor and share equally in the distribution of the overhead. Single unit production is always attended by a uniform cost per unit and as a rule by a uniform sales price. If a manufacturer were engaged in producing steamer trunks, wardrobe trunks and sample trunks for salesmen, it is doubtful if any one having to fix the sales prices would take the average cost price of a collective batch of these trunks. True, they are all trunks, but they are sufficiently unlike to make it necessary to consider their cost separately. The wardrobe trunk and sample trunk are larger than the steamer trunk and contain much more material. The wardrobe trunk is more extensively fitted while the sample trunk is strongly built and reinforced in order to withstand the severe and almost constant handling to which it is subjected. Thus it will be seen that not only does the material differ but the peculiarities of the different trunks call for operations of labor which vary in their char- acter and extent. These variations affect the distribution of the overhead in the various cases and the result, if properly obtained, is cost on what might be said to be three classes of product. The dissimilarity is almost as marked as if the manufacturer were producing trunks, traveling bags and umbrellas. In the latter case no one would question the statement 10 The Selection of a System that there were three classes of units. With equal facility it should be seen that the situation is the same in the former case. The units are all trunks, but they may be so entirely different with regard to the kind, quantity and quality of material and the operations of labor that they may be consid- ered as units differing entirely in their nature. To describe such a situation, where the manufacture is confined to one article but the article varies in size, quantity or quality of material, or operations of labor, or where the manufacture extends to different classes of articles, the term multiple unit production may be used. Multiple unit pro- duction is attended by various unit costs and various sales prices. Production, then, as used in its relation to cost, may be classified as : Single unit Multiple unit The selection of the system to be employed in securing the desired information concerning the cost will depend upon the kind of production involved. Where the elements of cost may be thrown together and divided by the number of units produced, because one unit is, for practical cost purposes, like every other unit, one system, very simple in its character, will suffice. Where the elements of cost must be grouped in accordance with the segregation of units before division may be made, a different system, and one far more complicated, is indicated. The systems available for use, and which will be de- scribed in detail in subsequent chapters, are as follows : The accounting cost system The manufacturing (or factory) cost system ii CHAPTER IV THE ACCOUNTING COST SYSTEM The accounting cost system is the simpler of the two, in that it involves no books other than those usually embraced in the system of financial accounts. For this reason the ac- counting cost system is sometimes referred to as a "finan- cial" cost system. It contemplates a complete and compre- hensive classification of operating accounts in the general ledger such as were shown in the outline covering the ele- ments of selling cost. The arrangement of the accounts is somewhat changed, however, in order that the financial oper- ations may be clearly brought out and the source of profits allocated in preparing statements from the books. The asset and liability accounts appear in the general ledger as usual and the trial balance of same furnishes the information necessary to prepare the balance sheet and statement of income and profit and loss. It is essential that the latter should be tied into the balance sheet in order to prove its mathematical correctness, and it is the statement which be- comes the basis of the cost sheet In addition to the work contemplated by the ordinary system of accounting it is necessary that a record should be kept of the units sold and the units returned in order that the net sales in units may be ascertained. If the cost of net sales is obtained and the number of net units sold is known, it is obvious that by dividing cost by units an average cost per unit may be obtained. It is true of course that the cost 12 The Accounting Cost System may be slightly inaccurate on account of not selling in every case the physical units produced during the period, but if the units are of the same type the objection to the discrep- ancy will be so slight as to be almost nil when compared with the saving in time and expense which the use of the system accomplishes. It will be seen from the following statement of income and profit and loss that the accounting cost system may be adapted to single unit production and afford to the adminis- trative officer an excellent picture of the operation of the business and a basis for administrative judgment. General captions have been principally used here in order to con- dense the statement, but it should be understood that in practice the statement should embody all the detail accounts as set forth in the analysis of selling costs. Principles of Cost Accounting STATEMENT OF INCOME AND PROFIT AND LOSS FOR THE PERIOD ENDED.. Units Money Values Cost Statistics Average per Unit Less returns Deduction from sales : Trade discounts Allowances : Breakage Damage Loss Outward freight and cartage.... Total Income from sales Cost of sales (deduct) : Materials and supplies consumed Labor Direct Manufacturing overhead Difference in inventory of goods in process Difference in inventory of finished goods Total Gross profit on sales Selling expense (deduct) Selling profit Administrative expense (deduct).. Net profit on sales Income from operation Other income (add) Total Income Deductions from income Net income profit and loss Profit and loss credits (add) Total Profit and loss charges (deduct).. Profit and loss surplus for the period Profit and loss surplus beginning of period (add) Profit and loss surplus (per balance sheet The Accounting Cost System In connection with the preceding statement, a discussion may be had with advantage of the second section, or that dealing with the cost of sales. It is important that the rela- tion between the items making up the cost of sales, as shown in the statement, and the same items, as they are found in the subsidiary records, should be clearly established. The materials and supplies shown in the statement, are the ma- terials and supplies consumed in the manufacture of the product. The figure representing consumption is arrived at by starting with the inventory of materials and supplies on hand at the beginning of the period, adding thereto the purchases during the period, and deducting from the total of such amounts, the inventory on hand at the end of the period. The consumption of materials and supplies, to- gether with the direct labor and manufacturing overhead for the period, passes over theoretically into the account repre- senting goods in process. The consumption might have been arrived at by applying to the purchases the difference be- tween the inventory at the beginning, and the inventory at the end of the period. If the inventory at the end of the period is greater than at the beginning of the period, ob- viously, all materials and supplies purchased have not been consumed and the purchases are subject to a decrease on account of the increase in the inventory. Where conditions are the reverse, the purchases are subject to increase on account of the decrease in the inventories, for the reason that more materials and supplies have been consumed during the period than were purchased. The cost of the goods in process which during the period have been completed and transferred to finished goods, is arrived at step by step, through the following accounting processes. To the value of the inventory of goods in process 15 Principles of Cost Accounting at the beginning of the period, there is added an amount combining the materials and supplies consumed, the direct labor expended, and the manufacturing overhead. From the total of these amounts there is deducted the value of the inventory of goods in process on hand at the end of the period. The result obtained by these processes gives the value of the goods which have been finished and transferred to stock during the period. The same result might have been obtained by applying to the combined values of mate- rials and supplies consumed, direct labor, and manufacturing overhead, collectively, the increase or decrease in the inven- tories of goods in process, at the beginning and at the end of the period, respectively. The cost of the goods sold is obtained from the treat- ment of the finished goods account in a manner similar to the preceding; namely, adding to the inventory of finished goods on hand at the beginning of the period the value of the goods transferred to finished stock during the period, and deducting from the total of such values the inventory of finished goods on hand at the end of the period. The prin- ciple of applying to the value of the goods transferred dur- ing the period the increase or decrease in the inventories of finished goods may be carried out as well with this account as with the materials and supplies and the goods in process accounts. From the foregoing, the thoughtful reader will doubtless have reached the conclusion that the same result may be arrived at, by treating the items involved in the cost of manu- facture during the period with the increases and decreases in the inventories of both goods in process and finished goods. If to the purchases, after having been treated with the dif- ference in inventories of materials and supplies, there is 16 The Accounting Cost System added the cost of direct labor and the manufacturing over- head and the total of such three items is then affected by the difference in inventories of the goods in process and the fin- ished goods, the result will be precisely the same as that obtained by going through the accounts step by step and following each operation. A careful study of the following tabulations will undoubtedly serve to bring out the thoughts which the above remarks intend to convey. Materials and Supplies. Labor Direct. Manufac- turing Overhead. Goods in Process. Finished Goods. Inventory at beginning of period $4.. OOO $15 ooo $17 ooo Purchases IO,OOO l6,OOO 19,000 Total I4,OOO 3I,OOO 36,000 Inventory at end of period . . 6.OOO 12,000 9,000 Consumption $8,000 $6,OOO $2,OOO $I9,OOO $27,000 \ / $l6,OOO Presented in the form of a statement the figures appear as follows: Purchases $10,000 Deduct Increase in Inventory Materials and Supplies 2,000 Consumption $8,000 Labor Direct 6,000 Manufacturing Overhead 2,000 Total $16,000 Add Decrease in Inventory Goods in Process 3,000 Add Decrease in Inventory Finished Goods 8,000 Cost of Goods Sold $27,000 THE MANUFACTURING OR FACTORY COST SYSTEM Where multiple unit production is involved, the ques- tion of system becomes much more complex. More details are required, and consequently a more elaborate set of books. General books and general accounts are entirely adequate in the case of single unit production, but it is im- practicable, if not absolutely impossible, to obtain the neces- sary results in the case of multiple unit production. The accounting cost system answers the purpose so long as noth- ing beyond average costs is required, but it should be pointed out that the application of this system might result disas- trously if the identity of the various units were overlooked and average costs obtained. An average cost would be en- tirely satisfactory if accompanied by average sales; that is to say, if an equal amount of sales in each of the lines was made. The average cost of three (3) lines of production at $14, $15, and $16, respectively, might be $15, and no damage could result if there were a corresponding average sale of the three (3) lines. An increase in the demand for goods costing $16 and a decrease in the demand for those costing $14 would materially alter the situation, and the manufacturer, having at his disposal only the information that the average cost of his three (3) lines of product was $15, might be unable to account for the condition of insol- vency which would very likely fall upon him. In the use of the manufacturing cost system, it is neces- 18 The Manufacturing of Factory Cost System sary to distribute or apply the material and supplies, labor, and overhead over the various grades or units of production, and keep special cost records. It is necessary to determine the cost of each grade, or quality of product. Each lot, or unit, or group of small units, must be identified, usually by number, and each traced through the process of manufac- ture, the items of cost accumulating as the work progresses. The proprietor is primarily concerned with a cost upon which to base a selling price, but he may also desire infor- mation of a statistical nature, which will enable him to gauge or compare the efficiency of the management, or the opera- tives in some particular division of the work. There are three (3) elements making up the cost: Materials and supplies; Labor; Overheard; Manufacturing, General. The next question is, how to arrange the system so as to furnish the information as to how much of each element goes into the cost of the various units in process of manufac- ture? It is usually conceded that a departmental organization furnishes the best form for accomplishing these results ; not necessarily a physical division or department, but at least a division so far as the recording of the operations is con- cerned. By placing each department under the charge of some employe, a distribution of the supervision of the work and records is accomplished without complicating the ac- counting mechanism and working a hardship upon one, or a small number of employes. While the matter of classifying manufacturing cost sys- 19 Principles of Cost Accounting terns, with regard to the various types involved, will be taken up later, the author desires to confine his remarks at the present time to a discussion of the simple type, wherein in- formation having to do with materials and supplies, and labor, is obtained by the cost clerk direct from each depart- ment, instead of allowing the cost to accumulate on depart- mental records as the work progresses. The work in process is identified by a system of num- bers, under which each department reports the charges for material and supplies, and the labor which it has against these numbers. Where it can be avoided the overhead should not be allowed to become involved in departmental records. It is only necessary to complicate the work of the departments by loading them with overhead, where statistics for administrative purposes are required for the purpose of judging or comparing the efficiency of a supervising oper- ative, or foreman, a group of operatives, or the work of a department, and such distribution is not contemplated in the simple type of system. If indicated by special circumstances the records covering such distribution should be made sub- sidiary to the general cost records, and no department bur- dened with any overhead, which does not originate there, or fall under the responsibility or control of the head of the department. The value of statistics for administrative use is destroyed when, for example, an attempt is made to judge the efficiency of a manufacturing department by such items as salaries of officers, traveling expenses of officers, or any similar item not specifically affecting same. Let it be remembered then, that the departments are to report the charges which they have against the work in pro- cess to the cost department, which should provide a book in which these reports may be summarized. 20 The Manufacturing of Factory Cost System The stores department should be required to furnish a record of the materials and supplies issued, showing the number of the jobs or lots against which they are issued. This department should keep a detailed record of the cost of the materials and supplies, the receipts and issues of which should be summarized in the materials and supplies ledger. Labor departments report to the cost department the charges for direct labor against the work in process, and these are summarized to show the distribution over the jobs in process, and ultimately the total direct labor charge against each job. The items of materials and supplies, and labor constitute the direct charges. Overhead comes from the accounting department, and is allocated to the work in process through the medium of a distribution sheet, showing both the manufacturing and general overhead. The results of the charges for Materials and supplies; Direct labor; Overhead; Manufacturing; General, are summarized and carried in the cost ledger until the job is completed. At such time they are transferred to a finished goods ledger. From the above it will be seen that the books required in the manufacturing cost system are three (3), namely: Materials and Supplies Ledger; Cost Ledger; Finished Goods Ledger. Specimen pages of these books with transactions which 21 Principles of Cost Accounting may be traced from the various reports will be found on pages 23, 24 and 25. The reports referred to are three in number, as follows : Materials and Supplies from stores department see page 23. Direct Labor from operating departments see page 24. Overhead from accounting department see page 25- It should be noted that the three books comprising a part of the manufacturing cost system are controlled by accounts in the general ledger with which they should be in agreement. The connection between the books, reports, and the work as it passes through the factory, may be made somewhat clearer by the following illustration : MATERIALS & SUPPLIES DIRECT LABOR COST LEDGER FINISHED GOODS LEDGER 22 The Manufacturing of Factory Cost System HH PQ g ! f) E Hi * a 00 C! CO s 1 ! * "S t. o> 3 o 00 ~ n) w Q 1 - 1 -.5 Amount o in 00 8 o c S o o 55- U in C CO i *o h U ,Q 'S E c 3 1-1 O S V c. C 1 1 *S a o CO u u ; d v Q as ^ > ' o Q Principles of Cost Accounting SPECIMEN PAGE COST LEDGER Lot Number 280 Put in Process Dec. 15-22. Completed Dec. 21-28 Dozens 1224 Quality #4 Cost per Dozen $16.073341 Date Total Materials and Supplies Labor Manufact- uring Overhead Overhead General Date Transferred to Stock 1908 Dec. 10 $7,311.28 $7,311.28 " 10 924.23 $924.23 " 17 1,540.39 1,540.39 " 24 2,464.62 2,464.62 " 31 1,232.33 1,232.33 " 31 6,200.98 $1,347.31 $4,853.61 $19,673.77 $7,311.28 $6,161.57 $1,347.31 $4,853.61 Dec. 31/08 24 The Manufacturing of Factory Cost System SPECIMEN PAGE FINISHED GOODS LEDGER Quality 94 Production Sales Date No. Lot No. of Doz. Cost Per Dozen Amount Date Inv. No. No. of Doz. Cost Per Dozen Amount 1908 Nov. 30 268 742 $17.32 $12,851.44 1909 Jan. 3 73 1000 $17.32 $12,851.44 742 Dec. 31 280 1224 *16.07 19,673.77 258 *16.07 4,146.92 "$16.073341 CHAPTER VI ORDERS Before passing on to the detailed discussion of the ele- ments comprising cost and the methods of handling same, some attention should be given to the system of orders which is used for controlling the operation of the plant and the goods in process. It is customary to allow no material to be used and no labor to be expended without an order. These orders origi- nate in the factory office, are prepared by the order clerk, or some of the office-help, and are always authorized by the manager or superintendent, or someone designated by the manager with the authority to give the order; never by the workmen. Orders are divided into three classes, which, together with their uses, are shown by the following: 1. Plant: (a) Extensions. (b) Equipment. (c) Repairs and maintenance. 2. Production: (a) Stock, sometimes called standing orders. (b) Special, specifications accompanying. |(c) Stock repair. 1. Goods damaged before shipment. 2. Goods returned by customers. ( a ) Repaired at plant's expense. (b) Repaired at customer's ex- pense. 3. Shipping: 26 Orders It may not seem within the province of a discussion of cost accounting to include under the head of orders, plant extensions, equipment, repairs and maintenance. As a tech- nical matter it is not, since cost accounting implies such ac- counting in connection with the product manufactured. The material and labor incident to work on the plant are often so intimately associated with such items entering into the prod- uct and the principle governing their control so identical, however, that it does not seem amiss to include such orders in the general scheme for control. Materials and supplies intended for plant use will as a rule be, or should be, put under the control of the stores department and should not be issued without the proper order. Labor on plant may be performed by some of the oper- ating force or by a special staff consisting of carpenters, ma- chinists, etc., engaged for such purpose. In either case the orderly and systematic record of the work requires that an order for same, properly describing and identifying it, shall be issued. The illustration which follows is intended to cover the essential features of such an order without attempt at polish. Principles of Cost Accounting EMPIRE HAT MANUFACTURING COMPANY f Extensions. -,. PLANT ORDER: 1 Equipment. t Maintenance and repairs. Date SUPERINTENDENT OR FOREMAN: You are hereby instructed to proceed with the following described work; to draw on the stores department for the necessary materials and supplies and to charge all labor expended in connection with the work to the above order number. DESCRIPTION OF WORK Manager. WORK TO BEGIN WORK TO BE COMPLETED . . ISSUED IN QUADRUPLICATE: i. Office or order department. a. Factory. 3. Stores department. 4. Cost department. The plan of manufacturing differs with different concerns and in accordance with the peculiarities of the different lines of business. Some concerns manufacture for stock, regard- less of whether or not sales orders have been received, while others begin the work of producing on special orders only after sales orders have been received. Other concerns do both. The practice will depend entirely on the experience of the manufacturer as to which plan shall be followed. On staple articles, where orders are large, numerous, and steady, manufacturing for stock will usually be found, since 28 Orders special orders would delay shipment beyond a reasonable time. In lines of business where styles play an important part and are inclined to change frequently and quickly it would be taking more than the average risk to produce any considerable amount of stock in advance. A great variety of production order forms will be found in practice, framed to fit the needs of the particular cases, but in principle they are represented by the following: EMPIRE HAT MANUFACTURING COMPANY f Stock. NQ PRODUCTION ORDER: ....... < Special. DATE (_ Stock repairs. SUPERINTENDENT OR FOREMAN: You are hereby instructed to proceed with the production of the follow- ing described articles; to draw on the stores department for the necessary materials and supplies and to charge all labor expended on same to the above order number. WORK TO BEGIN GIVE ORIGINAL ORDER NUMBER __ IN CASE OF STOCK REPAIRS. Manager. ISSUED IN QUADRUPLICATE: 1. Office or order department. 2. Factory. 3. Stores department. 4. Cost department. The principle underlying shipping orders is that all fin- ished goods shall be in the custody of the stock clerk or the shipping clerk and that nothing shall be shipped without an order. The shipping order, when completed by the shipping clerk, with his notation to the effect that the goods have been shipped, is returned to the factory or general office and becomes the basis for preparing the sales invoice which is sent to the customer. 29 Principles of Cost Accounting Provision is sometimes made for connecting the shipping order with the sales invoice by a manifold process. The shipping order, which is a partially completed carbon copy of the sales invoice, is supplemented after being taken from the billing machine with such information as is needed by the shipping clerk but does not concern the customer. This scheme where practicable has the advantage of reducing clerical labor somewhat. The illustration which follows shows a combination, shipping order and sales invoice. The two carbon copies which go to the shipping clerk, one of which he returns while retaining the other for his files, contain all the infor- mation shown on the face of the invoice except the price and amount. These are prevented from being copied on the carbons by shields. Date Jan. 10, 1908 John C. Brett and Company, 712 7th Ave., Pittsburgh, Pa. TO EMPIRE HAT MANUFACTURING COMPANY, 32 Waverly Place, New York Invoice No. 1 Shipping Order No. 1 Ship at once prepaid Via American Express Pack 3 Doz. to the Case Label J. C. B. & Co. Date 1908 Jan. 9 Qual. 4xlw olw Style Bos. Derby Stetson 2 Color Brown Black Doz. Price $16.50 14.00 Less Discount 10% Net 1 Amount $198.00 84.00 $282.00 28.20 $253.80 SIZES 7 7Ys CHAPTER VII MATERIALS AND SUPPLIES Under this heading four things should be considered: First : A place to keep them. Second: The records employed by the stores depart- ment. Third: The system used by the stores department. Fourth: Reports issued by the stores department. With regard to their location and custody it is of course necessary that they shall be under the immediate supervision of some one individual who will be responsible for their safety and preservation. Such an individual should be pro- vided with the proper means of safeguarding the materials and supplies, as it is absolutely unjust to hold a man respon- sible for stores without providing him with adequate physical means of protecting them. The materials and supplies of like nature should be to- gether. They should be arranged in an orderly manner to the end that they may be easily located and the arrangement may adapt itself to the taking of the physical inventory. Generally speaking, they should be arranged in sections or classes, alphabetically, or in the order that the accounts ap- pear in the material and supplies ledger and within the va- rious sections they should be arranged in racks, tiers, bins, closets or drawers, depending upon their nature. With regard to records, broadly speaking, it is desired to know 31 Principles of Cost Accounting What comes in, What goes out, What remains. The record in each instance should show the name of the materials and supplies, the class, units, price per unit and cost. The original record of what comes in is the invoice. The original record of what goes out is the requisition. The ledger should show what remains. The invoice is the basis for taking up the stock by the stores clerk and constitutes his authority for so doing. In- voices are usually entered in a book of record in order to prevent the receipt and issue of stores without any trace thereof being found. Such a book of original entry is also valuable in that a summary of the cost of the invoices ob- tained therefrom supplies a means of securing a general or balancing account in the materials and supplies ledger. The requisition is the authority for the issue of materials and supplies. A knowledge of what it should recite is more essential than familiarity with some particular one of the various forms used. It should first of all receive a number; should recite the number of units required and give an accu- rate description of the materials and supplies to be issued; the lot, job or account number to be charged, and should bear the signature of some person in authority. It is not the practice to insert prices on requisitions until such time as the materials and supplies have been issued unless it is de- sired that specific materials at specific prices be issued. Or- dinarily, they are considered as issued in the order received, with accompanying prices. A summary of the requisition in a book of record is desirable especially for the purpose of supplying totals for the general or balancing account in the materials and supplies ledger. 32 Materials and Supplies The ledger should contain an account with each class of materials and supplies and should be so arranged as to show the details of receipts and issues, setting forth in the case of receipts ; the Date Number of invoice or number of summary Units Price per unit Amount and with regard to issues; the Date Number of requisition or number of summary Units Price per unit Amount. While the general or balancing account previously re- ferred to is not absolutely necessary since the materials and supplies ledger is controlled by the materials and supplies account in the general ledger, such an account facilitates the work of the stores department in that it is relieved of the necessity of constantly checking with the controlling account in order to ascertain if the ledger is in balance. The form of the ledger to be employed is largely a matter of choice. It matters little whether a bound book, loose leaf, or card system is used. The operation of the system obtaining in the stores de- partment requires that as to invoices they shall be numbered consecutively as received and the date of receipt noted thereon. Goods and prices should be checked and extensions verified, if same has not already been done. The invoice should be entered on the invoice record for summary pur- poses and the details of the invoice posted to the debit of 33 Principles of Cost Accounting the appropriate ledger accounts. Requisitions should have the number of the units actually issued noted thereon, with prices of the units issued, should be extended and entered on the summary and the details posted to the credit of the ap- propriate ledger accounts. A trial balance of the ledger should be taken monthly or oftener. The continuous posting of details of invoices and requisitions and the continuous balancing of the units of stock as well as the money values, proves valuable as a per- petual or running inventory. The balance of a given kind of stock as shown by the ledger may be verified by checking with the physical inventory, at regular periods or at such times as the stock is at a minimum. One report only is necessary from the stores department so far as the cost clerk is concerned and this should take the form of a summary showing particularly the cost of the ma- terials and supplies issued against the numbers of the various jobs in process. The report may be made monthly, bi- weekly, or as much oftener as judgment indicates or the cost department desires. A specimen report is given on page 35. In connection with the general discussion of materials and supplies a few words should be said regarding freight and cartage and labor in the stores department. While they will be discussed here from a strictly technical standpoint and such items added to direct cost, experience teaches that while perhaps not so accurate it is more practicable to in- clude them in the overhead. Inward freight may be added to the price per unit on a percentage basis ascertained by finding the ratio which the freight on the invoices bears to the cost thereof. Cartage unless it can be applied to specific invoices is more difficult of distribution. It is possible, however, to ascertain the ratio 34 Materials and Supplies of cartage to the total cost of goods and subsequently dis- tribute same over the invoices. A similar ratio of the cart- age to the cost of the individual invoices may be ascertained and the cartage then applied to the units. This method is w U! U ! s & g W d OO 1O OOOOOOdO^dOoo MO O *^" ""^ CO O 1/5 O^ 1-1 cOOO 1/5 t>. O 00 d . t> 1/5 M t^ 1/5 1/5 O ON t^ O 1/5 CO NO vO . M 10 cOMOcO^OMdOcO i-i -co *n **'-' w "- 1 ^t-- d oo d oo * M~ M M & M O t>. O >/500 O O OO d covo N CO OO O SO ON ** *^}" 1/500 PN 1O C< 1/5 Cs) vO O C4 CO O s BUTION. Lot No. 2 OO ON t- M \O t^O !> CO CO O OO \O * t>-OO O SO vO l"^ 1/5 >^ W M 1/5 CO d ON 04 ON d MM 1 o" M 00 : s SvS^^^^^a^^g^ 8.8 oo Q d 2 s t^ O O O CO CO ^)-OO O N l^. OO Tj- d O M O COOO IO ON M O M 1/5 t^O OO * o T3 ^ ' ' ^ 5 sj S o MO*-* t^* t^* ONOO d ^^ O NO d ON d ^^OO O ON O NO O O M rf-O O 1-1 M 5 CM^iOi-OOO ONt>-O ON 00 3 OO t>. t>" t^O O M ON 1/5 t^ i-i ON O*O O ^" t>*OO NO M i-i JN, i^ vO NO I s * co O OO O ^^"NO CO cO r^* ^^ 1/5 O CO ^^NO i/5 *^ d CONO cOOO 10 \O cOvO CO M M M d M cioT d d" w 1 IFICATION. : o -.2 : i ; i i i i % O T3 ''en H . '^'O & !S 2c/3"*S ^ -rt^o ' C3 o Sj O p; ,0 g 5 ^ | | ! T3 DpQCQOOOcj^'oPHf-GC o v -oT3 c5 S 1 c U 35 Principles of Cost Accounting largely based on theory and the work involved frequently precludes its adoption in practice. Labor in the stores department is of two kinds : Manual. Clerical. Manual labor covers : (a) Receiving and putting goods in stock. (b) Taking goods out of stock and preparing them for issue. It will be seen that from a theoretical standpoint the manual labor involved may be divided between the two pro- cesses just mentioned, and that it, along with clerical labor, may be distributed over the invoices. In such cases, how- ever, the invoices would have to be held until the end of the week and the payroll ascertained, unless the labor were to be distributed daily. An arbitrary percentage is some- times added to cover this and other factors, but the objection to this plan is that it involves an adjustment at the end of the week or month in order to bring the books into agreement with the actual figures which the payroll shows. The prac- tice now commonly in use, is to throw this item, like inward freight and cartage, into the overhead for general distribu- tion. CHAPTER VIII LABOR The subject of labor can best be discussed by looking at it from the standpoint of the foreman or head of a depart- ment and ascertaining the nature and extent of the informa- tion he requires. Labor may be defined as services performed for which compensation is paid. The compensation may take the form either of wages or salary, and labor may be divided into two kinds, clerical and manual. Clerical, or administrative labor, is that performed with the head. Manual labor is that per- formed with the hands. Manual labor, in turn, so far as its application in manufacturing is concerned, may be divided into direct and indirect labor. The direct labor is frequently referred to as productive labor, and the indirect as non- productive labor. A choice of terms in this matter is of slight importance, except that the terms direct and indirect appear to be slightly more correct from a descriptive stand- point. It is usually easier to determine whether or not an operative is directly or indirectly engaged upon the product than whether or not he is producing anything. The direct labor may be applied either to the work performed at the hands of the operatives or through the medium of machines. Such labor is always expended in connection with, but not specifically applied upon, the product. It is reasonable to suppose, looking at the subject from the standpoint of the foreman, that with regard to the work of the individual the 37 Principles of Cost Accounting information required would be something of the following nature : 1. What the operative does; the nature of the work in which he is engaged, and the particular job upon which he is working; 2. The unit of compensation, whether it be on a time or a piece or job basis; if on the time basis, whether he is work- ing by the hour, day, week or month ; if on a piece basis, the number of units produced; if on a job basis, the amount of time employed on a job; 3. The rate of compensation; 4. The amount earned. What applies to the individual applies to departments, and in order to obtain the same information with regard to the departments that has been obtained with regard to in- dividuals it is only necessary to multiply the information per individual by the number of individuals in the depart- ment. What applies to the departments applies to the plant as a whole, and in order to obtain this information with regard to the plant as a whole it is only necessary to multiply the departmental information by the number of departments. It is apparent from the above that it would be advisable to have a summary of the entire plant, showing 1. The amount earned by each individual; 2. The amount of work of the operatives, taken collec- tively, which applies to each lot or job or class of work in process. 3. The total amount earned by all operatives. As to the reasons for recording these three points of in- formation, it may be said that with regard to the first it is necessary to ascertain the amount of the payroll liability at 38 Labor the end of each period, in order that the accounting depart- ment, or more properly speaking, the paymaster, may be informed as to the amount necessary to meet the payroll; second, the liability to each individual, or the amount which he is entitled to receive at the hands of the paymaster on pay day; third, for the purpose of distribution, in order that the amount applicable to each job or lot may be ascertained. Having determined the information necessary, the matter of records may now be considered. These will, of course, comprise three kinds; those pertaining to the individual; those pertaining to the department; those pertaining to the plant as a whole. With regard to those of the department and plant as a whole, it is unnecessary to say scarcely any- thing more than that they are either partial or complete summaries of the individual records. The record of the individual, as above indicated, should show 1. His name or number; 2. The nature of the work upon which he is engaged; 3. The number of units produced, or amount of work performed; 4. The rate of compensation; 5. The amount earned. The origin of the individual record will depend largely upon 1. The nature of the work; 2. The intelligence of the operative ; 3. The basis of compensation. The members of a railroad construction gang would not, as a rule, keep their own records. Laborers in a foundry, on account of the low order of intelligence sometimes obtain- ing, would probably not keep their own records, whereas operatives on clothing, being of a higher grade and em- 39 Principles of Cost Accounting ployed upon piece work, might, in some cases, record their own work. The form to be employed in keeping such records would depend upon the type of production, whether single or mul- tiple unit, and the basis of compensation, whether time or piece. If the time basis were in use, a time book kept by the foreman or some delegated employee might be used for recording day labor. If the hour were the unit of time, it is more probable that the time would be recorded upon a card, which might be kept by the operative or by some employee designated for this work. In cases where the piece basis is employed for the re- cording of work, labor tickets are commonly used. These are either given out to employees upon the completion of work, or they may be in the form of coupons attached to an order, which are detached by the employee when the job is completed. Labor tickets may also be arranged so that they may be punched by the foreman or some designated employee when occasion requires. In the first of the two instances above cited, they are re- tained by the operatives until the end of the week or wage period, when they are turned in as vouchers and made the basis upon which the payroll is constructed. The labor at- tendant upon the counting of coupons is sometimes over- come by issuing them in strips or having them pasted in books something on the same order as those issued by several well-known concerns who give trading stamps with pur- chases. Rough outlines, indicating in a general way the scheme of time books, cards, and labor tickets follow. 40 Labor TIME BOOK SINGLE UNIT PRODUCTION AND DAY LABOR Name M. T. W. T. F. S. Total Rate Amount TIME CLOC TIME CARD MULTIPLE UNIT AND HOUR BASIS NAME OR No. Job No. In Out No. Hours Rate Amount LABOR TICKET Name or No. Job No. Total Rate Amount Principles of Cost Accounting In connection with the use of the above forms, and labor in general, calculating machines and mechanical devices of all kinds are invaluable in making extensions or in checking same where made by employees or foremen. No matter what form of individual record is used, the information therefrom should always be summarized, on the labor reports, so as to show, first, by departments, and Zo MOOOO COfO 8O O rO M IO fO N M 42 O Labor second, by a subsequent summary of these, for the entire plant 1. The amount of the pay roll; 2. The liability to each operative; 3. The distribution of labor. The latter information should be so arranged that the total amount applicable to each job may be seen at a glance. The summary serves two purposes; first, that of supply- ing the payroll figures to the accounting department; second, the distribution of the labor to the cost department. A speci- men labor report is given on page 42. CHAPTER IX OVERHEAD In connection with this topic, the question may well be asked, what is meant by overhead? The term in itself is somewhat difficult to define, but it should convey to the mind the idea of indirect expense, or everything above prime cost; the expense of operating the business, not only of the plant, but the entire business; the expense, not only of manufacturing, but selling, administra- tion, and carrying on the business in general. It is variously called "Loading," "Burden," "Indirect Expense," and (es- pecially by English authorities) "On Cost." Overhead divides into : Manufacturing; General. Manufacturing overhead begins with indirect labor and ends at the point of shipment from the factory. General overhead begins with the point of shipment and ends at Profit and Loss Surplus. It should be borne in mind that manufacturing overhead includes not only the miscellaneous expenses of a general nature incident to the manufacture, but in practice usually such items as indirect labor, Inward freight and cartage, and minor merchandise and supplies which are inadaptable to direct distribution. General overhead has nothing whatever to do with the manufacturing. It covers the expenses incident to the 44 Overhead conduct of the business from the point where the goods have been finished and are ready to be shipped, and includes such items as selling expenses, administrative expenses, deduc- tions from income, charges for reserves, and deductions from sales. It has just been said of overhead that it was indirect ex- pense. By that is meant expense which does not permit of direct distribution. It is impossible to measure the propor- tion of each class of expense which is applicable to each job or lot, and requires some kind of arbitrary division or basis of distribution. In connection with a discussion of bases, the following questions are pertinent: 1. Which is the most equitable? 2. Which is the most accurate? It is necessary to choose some basis which deals fairly with all the work in process ; one which will distribute over- head to all jobs in actual process, and avoid loading jobs which are in the factory, but not in process. A variety of bases is available from which to choose. They divide gen- erally into five classes, namely: 1. Time; 2. Cost; 3. Percentage; 4. Production; 5. Sales. Under the time basis there is the labor hour, the machine hour, and the overhead day. Under the cost basis there is the wage hour and prime cost. The labor hour may be defined as the unit of time whereby the work of one operative is measured; in other words, it is the labor of one operative one hour. 45 Principles of Cost Accounting The machine hour is the unit of time whereby the work of one machine is measured; it is the work of one machine one hour. The overhead day is the unit of time whereby the amount of overhead applicable to each unit of production is meas- ured; it is the amount of overhead applicable to one unit during the period of one day. As a concrete example, let it be supposed that in job No. i there are 200 units and in job No. 2, 500 units. The amount of overhead for the period to be distributed is $2,000. Let it be assumed that job No. I has been in pro- cess 10 days and that job No. 2 has been in process 4 days. It will be apparent that job No. i, consisting of 200 units in process 10 days, would be equivalent to 2,000 units in process one day, and that job No. 2, consisting of 500 units in pro- cess 4 days, would be equivalent to 2,000 units in process one day, or taking the work collectively, the same as if 4,000 units had been in process one day. If the amount of over- head for the period is divided by 4,000, the average length of time the units collectively have been in process, a rate of 50 cents will be obtained, which may be made the basis for distributing the overhead as between the two jobs, in accord- ance with the number of overhead days involved, which in this particular example happens to be 2,000 in each case. Having allocated the overhead to jobs, it is a simple opera- tion to reapportion it to units by dividing the overhead on each job by the number of units involved, respectively. The amount of overhead applicable to each job is $1,000. Job No. i involving 200 units will, therefore, bear a cost over- head of $5.00 per unit, while Job No. 2 with 500 units will cost with regard to overhead $2.00 per unit. As stated above, under the cost basis, there is the wage 46 Overhead hour and prime cost from which to select. Prime cost needs no discussion, except to refresh the reader's memory that it includes but two items, materials and supplies, and direct labor. The wage hour may be defined as the unit of cost, whereby the work of an operative is measured. It is the cost of the work of one operative for one hour. Of the other bases of distribution little needs to be said. Students of the subject of cost accounting generally are familiar with the percentage basis, and it is only necessary to make mention of the fact that the amount of overhead ap- plicable to each job is that proportion which the number of units in the job bears to the total number of units involved. In the case of the production basis the number of units involved would be the number produced, and in the case of sales the number sold. The sales basis is not so frequently used in manufactur- ing concerns as it is in wholesale and retail concerns organ- ized on a departmental basis, and where the distribution of general expense is thought to be more accurately made by using the volume of sales of the respective departments as a basis. It has not been thought necessary to give the formula for distributing the overhead under each basis, since it may be easily deduced from the illustration covering the over- head day. The bases in all cases depend upon circumstances. They will be governed many times by whether the employees are paid by the day or hour, or by the piece; they will be gov- erned by the nature of the business. A time basis would not ordinarily be employed in cases where goods are required to be invoiced before the records are completed, or the end Principles of Cost Accounting of the month is reached. A job printing establishment, for instance, usually does work on an estimated basis and bills the job as soon as completed, adding to the prime cost an arbitrary percentage to cover the overhead and profit. The basis to be employed may also depend upon the fa- cility or regularity with which the books can be closed. While it is impossible to make any hard and fast rule as to the basis to be employed, such a division being entirely governed by circumstances, there is this to be said: the time basis is the ideal, and always preferable. No other basis should be considered if a time basis can be used. The argu- ment in its favor is that practically all the items entering into the overhead are of such nature that they accrue over a period of time. Examples of these, which, upon an- alysis, will be found to bear out the above statement, are as follows : Heat, Traveling expenses, Light, Advertising, Power, Salaries of officers, Direct labor, Rent, Salaries, manager and clerks, Taxes, Depreciation of equipment, Insurance, Salaries of salesmen, Interest. Having selected the time basis, there is the choice of the labor hour, the machine hour, and the overhead day, depend- ing upon the payment of compensation, whether the unit be one of time or piece. The arguments against the wage hour, prime cost and percentage bases are as follows : It is claimed that where the wage hour is employed the burden falls on the high-priced labor, which is unjust. The 48 Overhead skilled workman is usually more rapid, turns out more and better work, and requires less supervision. In the case of prime cost the burden falls upon the expensive material, while, as a matter of fact, the expensive product takes no longer to go through the factory than the inexpensive one. The objection to the percentage basis is that at best it is only an estimate based on past experience. It is constantly changing and should be constantly revised. Irrespective of the basis selected, the overhead should be summarized on the overhead report in order that the cost department may make the distribution to the various jobs. A specimen report is given as follows : DISTRIBUTION OF MANUFACTURING AND GENERAL OVERHEAD FOR THE MONTH ENDED DECEMBER 31, 1908 . en c B, jj rt AVERAGE COST PER 6 2 H G Q Tl OVERHEAD DAY Total Manufac- Genera' o B E "3 S B Manutac- General Overhead turing > rt a d O turirg Overhead Overhead 274 2 74 148 .157248 .566481 $107.11 $23.27 $83.84 275 2 68 136 98.43 .21.39 77.04 276 2 50 100 72.37 15.72 56.65 277 2 55 110 79.62 17.30 62.32 278 5 873 4365 3,159.08 686,39 2,472.69 279 S 1437 11496 8,320.00 1,807.73 6,512.27 280 7 1224 8568 6,200.92 1,347.31 4,853.61 281 2 1464 2928 2,119.09 460.43 1,658.66 Total . 27851 $20,156.62 $4,379.54 $15,777.08 Total Over- head Total Over- head Days Average Cost per Overhead Day Manufacturing Overhead $ 4,379.54 27851 157248 General Overhead 15,777.08 27851 566481 Total $20,156.62 27851 .723729 49 CHAPTER X TYPES OF MANUFACTURING COST SYSTEMS Manufacturing cost systems differ as to type. Accord- ingly, they may be classified as simple, compound, and com- plex. The type depends upon such things as whether the goods are produced on special or stock order or whether the work is performed by hand or machine, and the peculiarities of the business, such as necessity for rendering invoices at the time of delivering work, for example. All types involve the same elements materials and sup- plies, labor and overhead. The first two, in so far as their relation to the type of system is concerned, do not vary. The last named should be classified for the reason that it is comprised of items of two different kinds ; those which per- mit of distribution to the operating departments and those which do not. A part of the overhead originates in the de- partments and must be applied to the product through such channels. Some of the overhead is foreign to the depart- ments both in its origin and application, and while it must be applied to the product, it never reaches it by way of the operating departments. Overhead in its relation to the oper- ating departments as affecting the different types of system is therefore classified as distributable and non-distributable. In the simple type all of the three elements go through the factory, without combination, direct to the product. The word "combination" is used here as referring to the elements from an accounting standpoint rather than a physical stand- Types of Manufacturing Cost Systems point. In the compound type, material may go direct, while the labor and distributable overhead become combined or material and labor may be combined while distributable over- head goes direct. In the complex type, material, labor and distributable overhead become combined, while the non-dis- tributable goes direct. These combinations may represent departments, proc- esses, machines, or centers of production. There is no great distinction between "department" and "process" as used herein, except that more than one process may be included in one physical department. In the accompanying illustrations, where an attempt is made to bring out more clearly the subject matter of the preceding paragraphs, departments are indicated by the let- ters A B C ; the elements of cost by the letters, M, L, O D, and O, N D; and the jobs by numbers. Words and graphics almost fail when an attempt is made to describe briefly and clearly, or to illustrate, the complex type of cost system. It may be referred to as a group of small cost systems wherein each operating department con- Principles of Cost Accounting stitutes a member. It might aid in the illustration if, in the diagram illustrating the complex type, one were able to im- agine the departments "A B C" as containing within their respective limits the diagram of the simple type sufficiently reduced in size to permit of such treatment. In the operation of the complex system, materials and labor may be combined within a given department and car- ried forward, or the combination may be extended to in- clude all of the three elements and similar treatment follow. The last named procedure is difficult of accomplishment, except where conditions have been standardized and an over- head rate can be ascertained. The difficulties in the way of success in the absence of such a rate are as follows : 1. The cost record must follow the product. 2. The distribution cannot be made until the end of the month or period. M Types of Manufacturing Cost Systems COMPLEX TYPE TO JOBS 3. The product must go forward when required for physical treatment, irrespective of the cost record. Whether or not the rate is correct cannot be determined until the end of the period, when the actual amount of over- head for the period has been ascertained and the true rate found. 53 CHAPTER XI WHEN DEPARTMENTAL DISTRIBUTION OF OVERHEAD is INDICATED Since the time when Adam Smith advanced and substan- tiated the theory that a division of labor increases produc- tion, the tendency on the part of the manufacturer toward a highly developed physical organization has been constantly increasing. Manufacturers have learned that by segregating and controlling their materials and supplies and dividing the operatives into departmental groups, increased production and greater efficiency result. Arranging the departments so that the course of the product is ever forward, results in a great saving of time and a corresponding increase in the amount of work of which the organization is capable. In the more modern plants special attention has been given to the physical arrangement of the various departments. The stores department where the incoming material is received is located as near as possible, not only to the department where the first operation of labor is performed, but to the means of transportation, whereby the material is received. The course of work is constantly forward, never doubling back or going twice over the same route, and finally reaching the shipping department which is located adjacent to the shipping facilities. The effect which such an organization has upon the elements of cost is decidedly simple except in the case of overhead. The materials and supplies present no particular problem, since in no matter which type of sys- 54 When Departmental Distribution of Overhead is Indicated tern is involved, they emanate either from the main stores, or what might be termed branches of the main stores located in the departments and known as department stores. The direct labor originates in the various departments and causes no particular trouble in its handling. The treatment of the overhead is the problem which is hardest to deal with. While the statement has been made heretofore that it was inadvisable in the simple type of system to distribute the overhead to departments, and subsequently apply it to the product, it must be borne in mind that in the compound and complex type the situation is entirely different. These types frequently have to provide for complex and diversified product, and in such instances a departmental distribution of the overhead is not only desirable for statistical purposes, but absolutely necessary in order to obtain results which most nearly approach correctness. In the case of diversified product certain units go through all departments, certain units go through a part only of the departments, and in either instance certain units may go into departments where the overhead varies from heavy to light. It would be manifestly unfair to charge the product with overhead of departments through which it has not passed, or to burden product going through departments wherein it is heavy. Where a variation of the overhead exists it is unquestionably more correct to localize and apply it to the product at points of contact. The justice of so doing is shown by the illustrations wherein the local and general methods are compared on page 56. In the following tabulation "light" is the item which has been selected for distribution. The total cost of the light for the period was $24, used in the various departments, designated A, B, C as indicated. It is assumed that job No. 55 Principles of Cost Accounting i was 34 hours, and job No. 2, u hours in going through the three departments as indicated in the tabulation. By dis- tributing the overhead to the respective jobs from depart- ments, it is apparent that job No. i would bear $18.40 and job No. 2, $5.60; as against the respective amounts $18.13 Departments Total B Light $24.00 $10.00 $8.00 $6.00 Job No. i 34 hours 8 hours 16 hours 10 hours " " 2 II " 2 " 4 " 5 " 45 hours 10 hours 20 hours 15 hours Departmental Distribution Job No. i Job No. t A $8 . oo $2 . oo B 6 . 40 i . 60 C 4.00 2.00 $18.40 $5.60 General Distribution No. i No. 2 ATT B C.. 45)$24.oo 5333 34 21332 15999 $18.1322 5333 II 5333 5533 $5-8663 and $5.87, were the overhead to be apportioned on the basis of total hours without regard to the amount of time spent in the respective departments. It has been previously stated that one of the principal 56 X When Departmental Distribution of Overhead is Indicated objects of departmental distribution was to secure statistical information. Such information is needed for administrative purposes and affords an opportunity for comparison which is invaluable. It may be made to serve as an index to effi- ciency. By distributing to the centers of production, such as departments, processes, or men, the items of expense or cost affecting such centers, and redistributing in turn to the units of product undergoing process the expense or cost thus con- nected, the establishment of a rate or amount per unit is made possible, which furnishes a ready means of comparison and indicates the capability of the operating center involved. In like manner items of cost may be grouped around ma- chines so as to produce similar results. The obtaining of rates has the effect of creating standards, while perhaps not standards in the scientific sense, at least temporary standards which measure capacity and ability for work and answer that purpose until replaced. In this way they serve as an index to efficiency. Through the means of such statistics it may become evident that the increased cost of a certain pro- cess is due to the idle time or inefficiency on the part of the operatives. This may have occurred on account of a falling off in the amount of work, some fault in the method of dis- tributing work, or delay on the part of the foreman in so doing. Proper statistics can be made to indicate such condi- tions promptly, thus paving the way to the application of remedies. Such remedies may be brought about, first, on the part of the foreman, by laying off a part of the force, or improving the method of distributing work; second, on the part of the superintendent in causing the foreman to become more efficient, either through the aid of advice, or such other measures as may suggest themselves in view of the circum- stances surrounding the case. 57 CHAPTER XII DEFECTIVE GOODS, WASTE, SHRINKAGE AND IDLE TIME Incident to the processes of production there frequently occur certain irregularities which complicate the problem of obtaining accurate costs. In the casting of soil pipe and fittings, air bubbles and failure of the molten metal to run evenly cause many defec- tive pieces. In the cutting of half-soles out of sides of leather there is waste. In the importation, roasting and packing of coffee there is loss through shrinkage. In the case of operatives paid by the hour there will be time be- tween jobs which will be lost. Hence, several somewhat knotty problems present themselves in the form of the treat- ment of defective goods, waste, shrinkage and idle time. With regard to defective goods there are three methods available. The first is to divide the cost of the job or lot by the number of perfect units, thereby buying, in the cost of the perfect units, the cost of the defective work. The second way is to divide the cost of the entire lot or job by the num- ber of the perfect units, after deducting the cost or scrap value of the defective work. The third way is to set up the defective work at its actual cost and carry it through as de- fective work, adding to the first cost any subsequent cost ap- plicable thereto. As an illustration of the first method, assuming the cost of producing 100 perfect units to be $500 it is evident that if only 98 perfect units result the cost will be $5.10 per unit. In the case of the second method, the 58 Detective Goods, Waste, Shrinkage and Idle Time cost will be $5.06, if it is assumed that $4, being the scrap value of the imperfect units, has been deducted from the cost of the lot, and the balance of $496 divided by 98 per- fect units. In the case of the third method, the cost per unit will be $5 98 being perfect and 2 imperfect. The second method is probably the most common. One of the collaborators on "a uniform method of cost- finding for steel foundries" has, in effect, this to say on the subj ect : "Defective castings fall naturally into two divisions. First, those discarded at the foundry as imperfect, and sec- ond, those returned by customers. The reason for discard at the foundry may be either on account of construction, due to the complication of pattern or thinness of section, or im- perfect practice. In such cases the job should be charged with the material, and labor credited with metal at scrap value, and the balance divided by the number of good cast- ings. As a prevention against the return of defective cast- ings by customers, the cost should be loaded with an arbi- trary percentage based on the cost less the scrap value which should be credited to the proper reserve." In the manufacture of hats, for example, the third method, while perhaps not most commonly used, is the most scientific. Defective hats are known as "knock-downs." The cost of "knock-downs" is of considerable importance. The question presented is, whether or not it pays to finish up for sale hats which are imperfect when formed. Is it good practice to load the cost of "knock-downs" up to the point of "stock bodies," on perfect hats, and finish up for sale a hat, the proceeds from the sale of which is considered as so much "velvet?" As a result of such practice "knock- downs" might very easily be sold at a considerable loss,. 59 Principles of Cost Accounting whereas, if the proper information were available, the super- intendent would be enabled to decide whether or not imper- fect bodies might be profitably completed. Waste and shrinkage seem to present similar characteris- tics and would seem to be subject to the same treatment if it were not for the fact that in the case of waste something may be recovered from the scrap, whereas shrinkage leaves nothing behind which may be realized upon. To illustrate by a theoretical example the treatment of waste, let it be assumed that a side of leather 2*4x3*4 ft square, containing 1053 square inches, costs $4.21. If a pair of soles averages 80 square inches and out of the side, allowing for the irregular edges, twelve pairs of soles rep- resenting 960 square inches can be cut, the remaining 93 square inches will be waste. Expressed in dollars and cents, the situation will be as follows: cost of 12 pairs of soles, $3.84, or 32 cents per pair; waste, 37 cents; total, $4.21. The waste may be treated in three ways, namely, charged to profit and loss ; given a scrap value and deducted from the cost of the side; or loaded onto the cost of the 12 pairs of soles. The first treatment is not desirable. The second is not practicable, since while the pieces will doubtless be used up it is not possible to assign a value to them. The third method seems preferable and will increase the cost per pair to 35 cents. Shrinkage involves no question of scrap value. It repre- sents the invisible disappearance of weight through evapo- ration. It may be treated in two ways, viz., charged to profit and loss or made to increase the cost of the product that remains. The latter is preferable. Suppose that a merchant were to purchase a bale of to- 60 X Defective Goods, Waste, Shrinkage and Idle Time bacco weighing 200 pounds for $194. The cost would be 97 cents per pound. If at the time of sale at $1.10 per pound the contents of the bale have shrunk to 194 the cost per pound will have increased to $1.00. The theoretical ques- tion now presented is "Has the merchant sold 194 pounds of tobacco at 97 cents per pound and made a profit of $31.82 or 194 pounds at $1.00 per pound and realized a profit of $26.00"? Obviously, the net result is the same in either case, since if the first method of handling the transaction is selected the gross profit of $31.82 will be offset in the profit and loss account by the loss on 6 pounds of shrinkage at 97 cents, or $5.82. While either method may be said to be correct, the second is to be preferred, under ordinary cir- cumstances, since it facilitates the work of the cost depart- ment and leaves no profit and loss adjustment to be taken into consideration. Idle time affects the costs in the same manner as shrink- age. If a man is paid $2.40 for an eight-hour day and works only 6 hours the result is a cost per hour of 40 cents per hour instead of 30 cents. If his time is being charged against a piece of work it is apparent that it must be charged at 40 cents instead of 30 cents unless it is desired to charge 2 hours of his time at 30 cents an hour to profit and loss. Loss of time between jobs has the same effect, although as a practical matter many concerns now employ time clocks where the finishing time on one job and the starting time on the succeeding job are simultaneously recorded. What is sometimes called "a profit on labor" is merely a percentage added to the hourly rate paid to the operative which experience shows to be necessary in order to provide for the idle time incident to break-downs and delays of one kind or another. 61 Principles of Cost Accounting Idle time will ordinarily be charged to cost of production, but where abnormally extended as in the case of certain op- eratives paid during a strike or other periods of enforced idleness the time should be charged to profit and loss. The same thing may be said of defective goods, waste and shrinkage, that while ordinarily the cost of production should be loaded to provide for such loss, under abnormal circumstances such, for example, as damage to raw material by water, the loss should be charged off. A general rule with regard to these items may therefore be formulated as follows: Where the loss is incident to the production it should be charged to cost. Where the loss is an extraordinary one and not connected with the production the loss should be charged to profit and loss. 62 CHAPTER XIII DISTRIBUTABLE OVERHEAD AND THE BASES OF DISTRIBUTION In making the distribution of such overhead as permits of distribution to the various departments, care should be taken that only such overhead be distributed to the respective departments as distinctly applies to them. Such overhead as applies must be analyzed and some consideration given to the departments as to their physical characteristics, the ca- pacity of their contents, and frequently the value of same. In this connection there must be considered the floor space, cubic contents, value of the machinery and the horse-power of same. It is probable that before proceeding to the discussion of the items to be distributed some thought should be given to certain of these items as to the economic and other theo- ries concerning them. Reference is made especially to rent, taxes, insurance, and interest on capital invested in machinery and tools. Under the economic theory, these items are not consid- ered as a part of the manufacturing overhead. Under cer- tain popular theories advanced by engineers and accountants, these items play a most important part. The economist, and the accountant who endeavors to base his accounting on a substantial economic foundation, argues that rent plays no part in the manufacturing cost. It is an item of general overhead, to be taken into consideration in fixing the selling 63 Principles of Cost Accounting price, but from the standpoint of the business, taken as a whole, is a deduction from income, and no part of manufac- turing costs. It is probable that before this question can be satisfactorily settled, considerable research on the part of men possessing the necessary qualifications will be necessary. It has in its favor, that its exclusion from manufacturing cost facilitates comparison where some concerns own their build- ings, while others are obliged from their lack of capital to share a portion of their income with the landlord. It will be pointed out by the opposers of this theory that a concern purporting to own its own plant may be, in fact, paying interest on capital borrowed for the purpose. It will further be pointed out by such persons that even though this were an investment of owned capital, taxes are paid on the property in lieu of rent and interest. This contention may be met by the supporters of the economic theory with the statement that there is not a sufficient similarity in amount as among these three items to permit of their being included in the manufacturing overhead and thus tend to obscure the true cost of manufacture and interfere with a comparison of costs composed of like items. There would appear to be no more reason for including interest on capital and taxes, than rent, in manufacturing costs, as on account of being similar to rent, they are more properly chargeable against income. The item of insurance also permits of some discussion. It is argued by the economists that insurance is not a true item of manufacturing cost. Insurance is a premium paid for the protection of capital, and being an expense of capital, considered from the standpoint of the business as a whole, is a deduction from income. Advancement of this theory is usually confronted with the query as to why the salary of 64 Distribution Overhead and the Bases of Distribution the watchman at the factory, who is engaged in protecting the capital of his employer, is not treated as a deduction from income rather than a part of manufacturing expense. Having disposed rather indefinitely of the various theo- ries covering certain of the items making up the overhead, they may now be considered with regard to those which fall within the control of the operating department, and with regard to certain of these, those which may be said to fall specifically within the control of the foreman, as well as those which do not fall within the control of the operating depart- ment. They may be listed and grouped as follows : Under control of Operating De- partment . . . x 1 Under control of. foreman rHeat, Light, Power, Repairs and mainte- nance, * . 4 Depreciation of ma- chinery and tools. -Superintendence (Rent, Not under control of Operating I Taxes, Department ] Insurance, Llnterest. It will now be necessary to consider with regard to the above items their distribution to the departments and the various bases upon which they may be distributed. There may be eliminated from this class, repairs and maintenance, and depreciation of machinery and tools, since such items are local in their origin and do not require distribution. Heat may be distributed on a basis of cubic yards, after first obtaining the cubic contents of all departments receiving heat. The cost of heat for all departments is divided by the number of cubic yards contained in same, and multiplying the rate thus obtained by the number of cubic yards in each department, to ascertain the cost of heat applicable to each. 65 Principles of Cost Accounting The distribution of light depends upon whether or not facilities for measuring same by meter are available. Where electricity is used, and meters are found, the unit of measure- ment is the kilowatt hour. Where gas is measured by meter, the unit of measurement is the cubic foot. Where meters are not available light is distributed on the basis of square feet of floor space. Power is apportioned on a basis of horse-power hours. This unit is obtained by multiplying the horse-power of the machines by the number of hours in operation. Superintendence may be distributed on a basis of direct labor hours; rent on a basis of square feet; taxes on a per- centage basis, the percentage being computed on the value which the contents of any given department bears to the total assessed value of all departments. Insurance may or may not permit of localization. It should be localized, if possible; if impossible, it should be distributed on the basis of value. Interest should likewise be apportioned on the basis of value. It has not been thought necessary to repeat in each in- stance the formula for distribution, on account of being practically the same in each instance and having been once given in connection with the distribution of heat. 66 CHAPTER XIV MACHINE RATES Distribution may not cease with departments. Having allocated the items of expense thus, we may go on further and redistribute within departments to processes, to ma- chines, or to individuals. The theory being in each case the same, but as applied to machines slightly more interesting, we may proceed with its application thereto, and to discuss the question of machine rates. The subject matter for distribution will depend upon the type of system, and may embody overhead alone, a combi- nation of labor and overhead, or a still further combination of material, labor and overhead. The rates are of two kinds the departmental, sometimes referred to as the "old" machine rate, and the allocated rate, sometimes known as the "new" machine rate. Either may be a fixed rate (de- veloped in a previous period) or a scientific rate (estimated) and either may involve one or two supplementaries. In order to find the departmental rate, it is necessary to divide the actual overhead of the department by the number of actual machine hours for the entire department. A rate is thus obtained which furnishes a basis for distributing the overhead to. the jobs, in accordance with the number of ma- chine hours shown by the respective jobs. This method is satisfactory, in case there is no bench work and the machines are of the same type, of the same value, occupy the same amount of floor space, and use the same amount of power. It should be noted that this method pro-rates the over- 67 Principles of Cost Accounting head. Objection to it is found in that it does not sufficiently localize the overhead, and the objection gives rise to a de- mand for a method which will permit of as much direct dis- tribution as is possible. To supply this demand, the allo- cated machine rate was evolved. The rate here is obtained by dividing the total cost of labor and overhead as allocated to individual machines by the number of hours the corre- sponding machines are in operation. The cost applicable to the jobs in question is obtained by multiplying the rate by the number of machine hours on the respective jobs. This method may be used to advantage where the majority of processes are machine. Bench work, of course, complicates matters, and attention to the physical arrangement should be given in order that machines of the same type may be in the same group. The fixed rate contemplates the use of one determined upon the basis of actual running time during the next pre- ceding month or period. The charge to the jobs is obtained by multiplying the number of operating hours per job by the rate and crediting to the overhead a corresponding amount. The amount so credited, which, it will be noted, is an estimate based on past experience, will be offset at the end of the current month or period by the actual cost during the period, and as usually happens a difference will result. This difference may mean that the fixed rate upon which the charges to jobs have been made was either too high or too low, and the difference must be distributed either as a debit or a credit to the cost of the jobs, in accordance with whether the fixed rate was too high or too low. It gives rise to what is known as a supplementary rate, and which is ob- tained by dividing the "difference" by the actual number of operating hours. The redistribution is brought about by 68 Machine Rates multiplying this supplementary rate by the number of actual operating hours shown by the respective jobs. The scientific rate is the most complicated, but produces the most satisfactory results. It contemplates the estimating, or predetermining, of certain items of overhead for the year or period. Among these are : Superintendence, Depreciation, Heat, Taxes, Light, Insurance, Power, Interest. The scientific rate also contemplates operation on the basis of maximum running time for each machine during the entire year or period. Items of overhead are first distributed to departments and subsequently to machines. The machine cost is then divided by the maximum operating hours in order to get a rate per hour. The charge to jobs is obtained by multiplying the number of actual operating hours devoted to the job, by the rate, and the crediting of a corresponding amount to the overhead. Idle time, as in the case of the fixed rate, gives rise to the necessity for further distribution and the obtaining of what is known as the first supplementary rate. This is ascer- tained by dividing the cost of the idle time by the total num- ber of actual operating hours, and the distribution by multi- plying the first supplementary by the number of hours on each job. As jobs are charged a corresponding credit is made to the overhead. It will be remembered that there are now two credits to the overhead, one arising at the time of applying the first supplementary. The process from this point is precisely the same as in the case of the fixed rate. Actual overhead for the month or period is now ascertained and charged to the overhead, thereby offsetting the credits 69 Principles of Cost Accounting just previously mentioned and usually resulting in a difference between the actual overhead and the predetermined over- head, plus the first supplementary rate. The manner of dis- posing of this difference gives rise to the second supplemen- tary rate, which is obtained by dividing this difference by the actual operating hours on all jobs and distributing to the jobs in accordance with the number of hours each shows. As this last supplementary is charged, overhead is credited, thus actually balancing the overhead account. In order to bring this out, reference to the following ledger account, as well as the succeeding illustration, may be found helpful : OVERHEAD ACCOUNT Actual $3,000 . oo $3,000.00 Machine rate $2,000 . oo ist Supplementary 400.00 2d " 600.00 $3,000.00 ILLUSTRATION Full Time 2,400 hours Actual time 2,000 " 400 hours 2,000 hours)$4OO . oo Estimated Overhead Machine Rate $2,400.00 $1.00 Idle hours X $1.00 = $400.00. . 20 = ist Supplementary. $3,000 . oo = Actual overhead. 2 ,400 . oo = Estimated overhead. 2,000) 600. 00 = Excess to be distributed . 30 = 2d Supplementary. 575 Hours 720 Hours Job No. I 575 X $1.00 =$575. oo 575 X .20= 115.00 575X .30= 172.50 $862.50 Job No. 2 72oX$r.oo= $720.00 720 X .20= 144.00 72oX .30= 216.00 $1,080.00 705 Hours. Job No. 3 7osX$i.oo= $705.00 705 X .20= 141.00 705X .30= 211.50 $1,057.50 $862.50 i ,080 . oo 1,057-50 $3,000.00 CHAPTER XV WAGE SYSTEMS Before entering into a discussion of this subject a few words should be said as to the relation of wage systems to cost accounting. The success of a professional accountant depends in a large measure upon his value to the client. His value is dem- onstrated by his ability to save the client money. One of the principal ways of saving money is reducing cost. An ac- countant should therefore be in a position to indicate to the client the manner in which costs may be reduced. Wage systems undoubtedly lower costs, and the accountant in order to act intelligently and be of most value to his client should be familiar with the subject and the relative advantages and disadvantages of the various systems. The prophecy may also be made, that in the settlement of the ever-increasing difficulties between capital and labor, wage systems will not be an insignificant force. The constant struggle of to-day is to effect the reduction of tosts. Why? It may be that competition requires it, or it may be due to a desire on the part of the manufacturer for increased profits. While it is quite evident that costs may be reduced by the reduction of any of the three elements composing same, it is probable that the item of labor presents greater possibilities of successful reduction than either of the two other elements. There are two ways in which labor cost may be reduced. Principles of Cost Accounting The first is through the reduction of wages. The second is through an increase in the production. The first method produces a strenuous objection on the part of the laboring man; a complaint that he is being ill-treated, or perhaps his refusal absolutely to continue at reduced rates. The second method is the more scientific and satisfactory to the wage earner, and given the demand for unlimited production, is to be preferred by the manufacturer. As an illustration, whereby the same result is accom- plished, reference may be had for a moment to the tabulation which appears below and shows the application of the two methods to the casting of pin trays. Workman Wage Production Trays Cost Per Unit 1 $2.40 120 .02 (1) 1 $1.80 120 .015 (2) 1 2.40 160 .015 Considering $2.40 per day as the normal wage of a man who produces 120 trays, it is evident that the cost per unit will be .02. If the manufacturer desires to reduce the cost to .015, he may accomplish this result by decreasing the wage to $1.80, assuming that the production remains constant, or he may allow the wage to remain at $2.40 and insist that the operative shall increase the production to 160 trays. The reduction of the wage to $1.80 brings a storm of protest from the operative. Insistence that he shall increase his production causes him to become sullen, and perhaps complain that he is being driven. In the instance where his wage is reduced, if the workman continues, it is probable that he will "soldier," with the result, perhaps, that the pro- duction per day will fall from 120 to 90, thus, based on the wage of $1.80, restoring the cost to .02. It becomes quite evident, then, that a reduction of the 72 Wage Systems wage is practically out of the question, and that in order that the cost may be reduced, the production must be increased, and the question before us now is how this increase shall be accomplished. The small boy who is paid for doing chores, does them more cheerfully than if he is compelled to do them without compensation. The schoolboy who receives a quarter from his father every time his report card shows 100% in arith- metic, usually does better work in arithmetic on account of the quarter awaiting him. The quarter acts as an incentive. Laboring men are not unlike schoolboys in this respect. They will do more work per day and they will do better work per day, if some incentive is offered, than if driven to the same result. Let us assume that the incentive offered to the operative is one-half of the saving brought about through a reduction of the costs. It is not unusual to find that men, if offered the proper incentive, are capable, with ease, of doubling the production. Under such a condition, with a normal daily wage of $2.40 it is evident that the cost per unit would be .01. The saving per unit will be .01 which if equally divided with the workman, on a basis of 240 units produced, will give as the workman's share $1.20. The workman's daily wage will then be $3.60, while the net cost of production per unit to the employer will be .015. The conclusion to be drawn from the above is that the wage system, which has as its basis the sharing of savings with the employees, has accomplished the desired result of reducing costs, increased the wage of the employee, and thereby proved entirely satisfactory to all concerned. The following tabulation may bring out more graphically the preceding statement: 73 Principles of Cost Accounting Wage Production Cost Normal $2.40 120 .02 Increased Production % Saving to work- man $2.40 i .20 240 2dO .OI .oos *t v ."" J Workman S^.6o 24.O QIC I *t v D 5 n c r W e c rC e a e o a g s e s a s t e Wage e System In discussing the above, the question is often asked, Why not as an alternative, introduce piece rates? Here is an in- centive indeed. The benefit, however, accrues largely to the workman. It is true, of course, that there will be a certain amount of saving in the overhead, due to increased produc- tion, but that no saving will be effected so far as the labor is concerned. One hundred and twenty units at .02 will cost $2.40, and 240 units at .02 will cost $4.80. To use an expression popular in connection with the discussion of piece rates, oper- atives "work their heads off." Piece rates ultimately prove unsatisfactory to the work- man, because of the fact that as soon as the wage becomes excessive it is sure to result in a cut. The workman thus becomes dissatisfied and unconsciously adopts a standard. Mr. George Frederick Stratton, writing on the subject in the March, 1910, number of "System," relates the fol- lowing incident: "A young man secured a job in the brass finishing depart- ment He was a green man and started at day rates to learn polishing. Specializing on such work, he advanced sufficient- 74 Wage Systems ly in three weeks to go on to piece work. In two months he jubilantly exhibited a pay check calling for $14.00 and was applauded by his family. 'It's pretty good now! but it's as much as I'll get if I work there ten years.' 'How's that?' inquired his father. 'You're on piece work and you'll surely get more expert as the time goes on.' 'Sure thing,' retorted the young man, 'but $14.00 is the limit. If any man runs over that in our room, he'll get his head punched and he'll get the rates cut, too.' ' Piece rates may be effectively employed, provided the in- centive is restricted. That is to say, an incentive may be offered to increase production, if the rate is reduced on the surplus; for example: 120 at .02 $2.40 120 at .01 1.20 240 ) $3.60 (.01 5 It will be noted from the foregoing that the same thing has been accomplished in the application of piece rates to the problem that resulted previously where the daily wage basis was in effect. The application of the broad principle in the first instance is frequently seen in connection with machine work. Here reduction in cost is effected through a saving in time, rather than an increase in production. If the average or normal time required for the accomplishment of a certain task is eight hours and the rate of compensation or machine cost is .60 an hour, the cost of the job will be $4.80. If by close attention to his work, and the intelligent application of all his faculties, a workman is able to reduce the time of opera- tion to six hours, it is quite apparent that at the same rate per hour, or machine cost of ;6o, he has effected a saving of $1.20. Even viewed from the standpoint of equity, there 75 Principles of Cost Accounting would appear no reason why, in the natural order of things, the workman should not receive some benefit accruing through the saving of $1.20 at his hands; why he should not receive some premium or bonus for having accomplished this saving. Whether or not he is entitled to it from an equitable stand- point, it is certainly good judgment on the part of the em- ployer to share the saving with him, to the end that he may have some incentive for continuing his efforts to lower the cost. If he receives half the saving, in the above mentioned instances it will amount to .60. It will be seen that his day's pay, assuming that he does no further work after accomplish- ing the task set, will be made up of two elements; one being the regular wage at a fixed sum per hour, and the other the premium or bonus for the saving in time, amounting re- spectively to $3.60 and .60, or a total of $4.20 for the day, as illustrated herewith : 8 hours at .60 =$4.80 6 " " .60 = 3-60 saving) 2 2)$i.2o premium i .60 cost 7 .60 =$4.20 This work taken in connection with an eight hour day, leaves the operative still two hours in which to work on an- other task and thereby further increase his daily wage. It should be borne in mind that increased speed and in- creased production give rise to an increase in the amount of defective work and a corresponding need for the establish- ment of an inspection department. Most wage systems are constructed on the principles out- lined above, and while some arc known as premium systems Wage Systems and some as bonus systems, there is only a very slight techni- cal difference between these two terms. The word "pre- mium" is usually employed to indicate a division in the saving in time, whereas, the term "bonus" implies an increased rate offered for speed and skill. Up to this point, the discussion has been confined entirely to the reduction of cost based on the saving of labor. We shall also have to consider a similar saving with regard to overhead, or to overhead in conjunction with labor. The most common type of system which takes into account both labor and overhead, has for its basis what is known as the differential rate. The rate per hour is arranged on a sliding scale which increases in proportion as the number of units produced increases. The workman who produces 12 units receives a proportionately higher rate per hour than the workman who produces only 10 units. The system operates to the advantage of the efficient workman and to the disad- vantage of the inefficient workman. It is said to "differenti- ate" between the good workman and the poor workman. On this account the rate is known as the "differential." While it will be seen from the tabulation herewith sub- mitted that the increase in the number of units produced carries with it an increase in the rate, and a consequent in- crease in the wage of the operative, a consideration of the units taken in connection with the overhead will show that as the units of production increase, the overhead decreases. DIFFERENTIAL RATE Overhead $13.20 Labor Cost Overhead Cost Cost per Unit 10 units at .30 = $3.00 $1.32 $1.62 10 " " .32= 3.52 1.20 1.52 12 " " .34= 4.08 1. 10 1.44 8 units at .26 =$2.08 $1.65 $1.91 77 Principles of Cost Accounting The advantages of the differential rate are that it offers an incentive to the workman and increases his wage if he takes advantage of it. From the standpoint of the employer it is equally advan- tageous, in that it decreases cost by increasing production, and in general raises the standard, by enabling the employer to distinguish between the efficient and inefficient workman. CHAPTER XVI THE FIXING OF WAGE RATES The success of all wage systems depends upon the fixing of rates. Before a rate may be fixed it is necessary to deter- mine, 1. Which are the best methods and tools to use. 2. What length of time is required by the workman of average capacity to perform a task without un- due exertion? The necessity for this sort of thing was first seen about thirty years ago, by Mr. Frederick W. Taylor, who was at that time connected with the Midvale Steel Co. Mr. Taylor went about the task of gathering statistics and classifying them in a scientific manner, so as to permit of their use in determining the best methods and tools to use, and the time required for the performance of specific tasks. In a paper on the subject of Shop Management, Mr. Taylor makes the statement that the two facts which appear most noteworthy in connection with the method of Shop Management are: "First What may be called the great unevenness or lack of uniformity shown even in our best run works, in the de- velopment of the several elements which together constitute what is called the management" "Second The lack of apparent relation between good shog management and the payment of dividends." "The art of management has been defined as knowing ex- actly what you want men to do and then seeing that they 79 Principles of Cost Accounting do it in the best and cheapest way. What the workmen want from their employers beyond anything else, is high wages, and what employers want from their workmen most of all, is a low cost of manufacture. The possibility of coupling high wages with a low labor cost rests mainly upon the enormous difference between the amount of work which a first-class workman can do under favorable circumstances, and the work which is actually done by the average man. First-class men are not only willing but glad to work at their maximum speed, provided that they are paid from 30% to 100% more than the average of their trade." Having in mind the above facts, Mr. Taylor made a careful study of the best methods and tools to use, and evolved a system for standardizing the time of operations which may be best described in his own words, as follows: "In 1883 while foreman of the machine shop of the Mid- vale Steel Company of Philadelphia, it occurred to the writer that it was simpler to time with a stop-watch each of vhe ele- ments of the various kinds of work done in the place, and then find the quickest time in which each job could be done, by summing up the total times of its component parts, than it was to search through the time records of former jobs and guess at the proper time and price. After practicing this method of time study improvements for about a year, as well as the circumstances would permit, it became evident that the system was a success. The writer then established a time study and rate fixing department, which has given out piece work prices in the place ever since." The Taylor system, while it imposes upon the manage- ment the burden of seeing that the work is done in the time and manner specified, also provides a higher rate for in- creased efficiency. 80 The Fixing of Wage Rates In 1886 Mr. Henry Towne originated a wage system which was improved and made practical by Mr. F. A. Hal- sey, who in 1891 described the system in a paper before the American Society of Mechanical Engineers. The Towne- Halsey system contemplates as a standard the quickest time in which a job has been done. The workman who does it in the shorter time receives the same wage per hour for the time he is engaged upon the job, and in addition a premium for having worked faster, which ranges from one-quarter to one-half of the saving in time. It may be stated here, that scarcely any system has yet been evolved to which there has been no objection raised. An objection was raised to the Halsey system in that the rate became excessive after $0% had been saved. In 1901 Mr. James Rowan read a paper before the me- chanical section of the International Engineering Congress, in which he advocated the allowance of a bonus based on such a percentage of the regular wage as the time saved bears to the standard time. For example, if the standard time for the operation were one hour, and the standard wage .30, a saving of six minutes would be equivalent to 10%, and 10% of .30, or .03, added to the standard wage would give as the wage per hour .33. Objection was found to this system, that the bonus was too great in proportion to the saving during the first hours saved. Among other systems which have gained both notice and popularity are: Cardullo, Searle & Nicholson, Gantt, Emerson. Under the Cardullo system the wage is arranged on a Principles of Cost Accounting sliding scale based on the percentage of time saved, but is limited by the maximum, no matter how much time is saved. Searle & Nicholson advocate a system whereby the work- man receives one-half the time saved until the saving reaches 50%, thereafter a percentage based on the ratio which the time saved bears to standard time. This is a combination of the Halsey & Rowan methods and would seem to over- come the objections found to both. The Gantt system does not differ materially in principle from the other systems, except that in addition to the reward for efficiency offered to the operative, and which Mr. Gantt specifies shall be liberal, the reward shall be extended to those who supply the operative with materials and appliances to enable him to maintain the efficiency specified. Before discussing the Emerson system, which serves as an introduction to the next topic, a few words may be said concerning the various profit-sharing and stock-distributing systems, which are coming largely into vogue. Rewards of this description are intended to promote co-operation and act as an incentive to the workman; to decrease cost by increas- ing production. They are not as a rule entirely successful. They fail usually, so far as the workmen are concerned, be- cause of the fact that the profits do not depend entirely upon the workman. A saving may be made by the manufacturing department through a reduction of cost whereby profits are insured, only to have such profits dwindle on account of the shortsightedness on the part of the selling organization, or through poor judgment on the part of an administrative officer. This objection may be overcome, however, by fixing a standard cost at which the product is credited to the manu- facturing department; any reduction in this cost being con- sidered as a saving attributed to the manufacturing depart- 82 The Fixing of Wage Rates ment and a part thereof set aside and distributed among the men as profits. Notwithstanding the fact that the general objection has been overcome, these systems are usually deemed to be unfair and inequitable, since it usually occurs that the men who contribute most to the profit get the smallest share thereof. Workmen as a rule prefer individual return for individual effort, which the wage system accomplishes. Mr. Harrington Emerson recognized this tendency of human nature when he originated the Individual Effort Sys- tem. The Emerson System became famous in connection with its adoption and use in the shops of the Santa Fe Railroad, to the extent that it is popularly known as the Santa Fe Sys- tem. The essentials of the Emerson System are: A. Standard time, or time in which the work should be done; B. A premium for efficiency. The premium begins at 66% efficiency and gradually in- creases until 1 00% efficiency is reached, in which case the premium equals 20%. Above 100% efficiency the premium increases rapidly, constituting an increase of i% premium for each increase of i% in the efficiency. CHAPTER XVII THE EFFICIENCY DEPARTMENT One of the most striking innovations of recent times is that of the so-called efficiency department. It is mentioned here, on account of the close relation which it bears to Cost Accounting. It is presided over by the efficiency engineer, whose duty it is to determine the measure of return which the employer shall receive for the money which he employs in manufacturing operations. The housewife who purchases in the market a bushel of potatoes for one dollar, expects to receive in return the stand- ard of quantity as well as the standard of quality. It is con- sidered equally appropriate that the entrepreneur who in- vests a dollar in manufacturing operations should expect to receive a standard return of quantity and quality. It is the duty of the efficiency engineer to endeavor to bring this about. His function is to fix standards of quantity and quality. Just as the mining engineer makes an assay of ore, so the efficiency engineer tests the quantity and quality of the material used as well as the quantity and quality of workmanship. He must have a broad knowledge of the four elements of organization, namely: Machinery, Men, Materials, Methods. He is the chief of staff, whose assistants are specialists in 84 The Efficiency Department the above mentioned lines. The staff determines what shall be done and prescribes the methods for accomplishing the work. The line organization performs the work in accord- ance with the methods prescribed, and has always at its com- mand highly specialized staff knowledge upon which it may call for assistance. Under such an organization, each branch of the work is in charge of one of the assistants. The man in charge of machinery has as his duty the standardization of all machinery and equipment. To him is assigned the task of securing the proper types of machines and tools which are the most efficient. He advises as to their care and decides upon the location of each, with a view to se- curing the most effectual progress of the work through the plant. One case is reported where a 40% increase in the out- put was secured by a rearrangement of machines. Another assistant chief of staff looks after men and con- ditions, which is one of the most interesting as well as the most difficult branches of the work. He supervises the stand- ardizing of conditions and requirements that fall within the scope of his duties. He plans, directs and advises as to the welfare of the employes. He sees to it that be- fore an employee is engaged, he submits to examination as to his moral, physical and professional qualifications. Emer- son goes to the extent of saying that "it ought to be as diffi- cult to enter the services of a great corporation as to pass the entrance examination to West Point; but once in, it ought to be a catastrophe for a man to be forced to leave ; because the company provides so much that he cannot provide him- self, for his physical, financial and professional welfare, and because it rewards individual efficiency." 85 Principles of Cost Accounting Great attention is being paid in these days to the welfare of employees. Great corporations as well as individual em- ployers are giving more attention to providing better light and better air. Many manufacturing plants are equipped with automatic exhausts for the removal of dangerous parti- cles of dust, which heretofore have been allowed to fill the atmosphere in which the employees worked. Overcrowding of work rooms is being avoided and operatives are provided with a place to wash and bathe, and in many instances com- fortable dining rooms in which to eat. Medical attention is furnished and ample means of escape from the buildings in case of fire provided. In order that ample opportunity for recreation may be had, club rooms and club houses, with billiards, pool, bowling and all other appurtenances thereto, are provided by the company free of charge. In some cases the club house contains an auditorium where entertainments are held and lectures are given. One Western company went so far as to provide and equip a first-class bar, on the theory that the men would have liquor and the company pre- ferred that they should have good liquor rather than poor. Materials are looked after by another assistant chief of staff, who controls both the purchasing agent and the stores department. He standardizes the material to be used and specifies the kind and quality to be purchased. He prescribes the methods necessary for its care, to the end that it may not deteriorate, be wasted or be used extravagantly. The man in charge of methods, prescribes the methods whereby standards may be attained. It is his duty to advise workmen as to the most efficient use of equipment, machines and tools. In short, he is called upon to provide methods which will result in doing the most work in the shortest time and better work with less effort. 86 The Efficiency Department The efficiency organization, of course, requires records and accounting. Records are needed of machines, as to their installation, operation and maintenance. It is especially necessary that breakdowns and repairs shall be recorded, with regard to materials, a record of the purchases, issues and amounts consumed; as to work performed, both the quantity and quality. An authority on this subject states that it is impossible to maintain either standards or records, unless they are tied into the cost accounting. Standards serve to develop a predetermined cost. Tak- ing into consideration the cost of material as determined by the standards of quantity and quality, the cost of labor as determined by the standard time of operation, the cost of the overhead as determined by the standard of the various elements composing it, it is possible to predetermine or ob- tain an estimated cost which may be used as a standard or basic cost and which provides for 100% efficiency. 87 CHAPTER XVIII RECONCILING PREDETERMINED AND ESTIMATED COSTS WITH ACTUAL COSTS As a matter of fact, experience shows that there is fre- quently a wide difference between the ideal or standard and the actual. What should be is one thing, and what has been is another. Broadly speaking, it may be said that standards cannot be maintained. Failure to maintain them is due to 1. Inefficient material material which is below the standard of quality and requires more than standard of quantity. 2. Inefficient labor, due to inefficient workmen, methods or conditions. Cost accounting is required because of inefficiency. It is the duty of the efficiency engineer to say what the cost should be. It is the duty of the cost accountant to say what the cost has been. At this point a solution of the problem as to how a reconciliation may be effected between predetermined costs or estimated costs on the one hand and actual costs on the other, presents itself. Predetermined costs should be technically distinguished from estimated costs, in that they are constructed from pre- determined standards scientifically obtained, whereas esti- mated costs are purely hypothetical and are founded on the assumption that the costs for the current period will be the same as those of the next preceding period. 88 Reconciling Predetermined With Actual Costs As an illustration of the reconciliation between estimated cost and actual cost, attention is invited to the facts contained in the following tabulation : Total Material Labor Overhead Joh No 1 $3 080 $1200 $1 600 $280 " 2 2 200 1 000 1000 200 $5,280 $2,200 $2,600 $480 The application of the principle to contract work, with which everyone is more or less familiar, will perhaps serve to make the illustration clearer. It should be noted that the accounts which we are about to reconcile are those contained in the general ledger, and the question before us is : how we may carry in the general ledger estimated or predetermined costs, without interfering with the actual costs as developed by the financial accounts, and at the same time bring them into agreement at the end of the period. This is accom- plished, so far as the estimated costs are concerned, through the medium of two accounts, namely: Cost of contracts; Reserve for cost of contracts. It is usually possible to obtain from a contract book, wherein the estimates of the jobs are listed, a total of the entire estimated cost for all jobs during the period. From these figures, which, in the case of the above tabulation, amount to $5,280, the following journal entry may be framed : Cost of contracts $5,280 To Reserve for cost of contracts . . $5,280 Let us assume that at the end of the period the actual cost of the two contracts above mentioned is $5,780. This 89 Principles of Cost Accounting amount will have been charged to "Reserve for cost of con- tracts" concurrently with the credits to material, labor and overhead. By reference to the following ledger accounts it will be seen that the account "Reserve for cost of contracts" would at this point show a debit of $5,780 and a credit of $5,280, and the difference between the two sides of the ac- count would indicate the extent to which the estimate was in- correct. Dr. Cost of Contracts Cr. Reserve for Cost of Contracts Estimated... $5,280 Reserve.. 500 $5,780 $5,280 500 In order to effect the reconciliation, which will close out the "Reserve for cost of contracts" and make the "Cost of con- tracts account" show the actual cost, a second journal entry in the amount of $500 is necessary. Cost of contracts $500 To Reserve for cost of contracts $500 The matter of reconciliation would be comparatively simple if the question of uncompleted contracts were not in-, volved. This difficulty may be overcome by treating the un- completed contracts as inventories in the case of both ac- counts involved, and proceeding as before. The above method of handling these accounts becomes more valuable when the principles applied to the cost in total are applied to the elements making up the cost. Under such circum- stances the journal entry for placing the estimated cost on the books would be as follows : Estimated cost of uncompleted contracts $5,280 To Reserve for material, uncompleted contracts 2,200 " " " labor, " " 2,600 " overhead, " " 480 9 Reconciling Predetermined With Actual Costs Assuming that at the end of the period job No. i is com- pleted and job No. 2 uncompleted, the proper steps are, first, to deduct the items involved in the above journal entry af- fecting job No. 2 and bring them down as inventories. As- suming further that the total actual cost of job No. I is $3,280, distributed as follows: Material $1,200 Labor 1,600 Overhead 480 the proper journal entry would be : Reserve for material, uncompleted contracts $1,200 " labor, " " 1,600 " overhead, " " 480 To Material labor and overhead $3,280 It will then be apparent that by posting the above journal entries to the proper ledger accounts that, as to the material and labor in job No. I, both have been correctly estimated, but that the overhead has been underestimated in the amount of $200. The proper journal entry for effecting the reconciliation is as follows: Cost of contracts $3,280 To estimated cost of uncompleted contracts $3,080 Reserve for overhead, uncompleted contracts.. . 200 A further illustration of the application of these principles will be found in the following tabulations and journal en- tries. The journal entries may be used in cases where, in the absence of a cost system, it is desired to point out to a client engaged in contracting the measure of inaccuracy on the part of his estimating department. 9* Principles of Cost Accounting No. 1 $10,000 ~| Estimated cost " 2 20,000 L of " 3 25,125 J various contracts. $55,125 FIGURES SHOWN BY GENERAL BOOKS 12/31/08 Purchases 12/31/09 Cost Inventory, material $3,000 $25,000 $2,000 $26,000 " uncompleted jobs .... 15,000 14,000 1,000 Labor 18,000 18,000 $45,000 Overhead, various items 13,500 Actual cost $58,500 Cost of contracts (estimated) $55,125 To Reserve for cost of contracts $55,125 Reserve for cost of contracts 58,500 To Material, labor, etc 58,500 Cost of contracts 3,375 To Reserve for cost of contracts. 3,375 CHAPTER XIX THE REPORT OF THE COST DEPARTMENT It will be remembered that at the beginning of the first chapter it was proposed to discuss three topics. These topics embraced the nature of the information being sought, the means of obtaining the information, and the use to which the information is to be put after it has been obtained. The first topic was covered by an inquiry into the objects in as- certaining costs and which, briefly summarized, are to make them serve as a basis for fixing selling prices and to furnish information to the proprietor or administrative officer which will be of help to him in deciding upon administrative poli- cies. Such policies may include determining which lines of production or merchandise are profitable, and which are un- profitable, and instituting methods which will reduce costs. A discussion of the means of obtaining the information would appear to have been covered by reference to the sys- tem employed for gathering the information, and there re- mains to be explained the use to which the information is to be put after it has been obtained. Obviously, the party in interest is the proprietor or ad- ministrative officer. The information which he seeks is that which will enable him to draw quickly a conclusion from cer- tain facts presented to him concerning the costs. As a rule he is not a man whose time and patience will permit of delv- ing through voluminous books and records for this informa- tion. It must be summarized and placed before him so that 93 Principles of Cost Accounting its full significance will be evident at a glance. The medium for presenting the information in such summary form is the cost sheet, or the report of the cost department. The con- struction of the cost sheet will depend largely upon the nature of the information desired by the proprietor. Regardless, however, of circumstances, it is always es- sentially a statistical report and is based on unit costs. The units will vary, in some cases dozens, in others tons, in others single units, and in still others the unit may be the contract or job. Depending upon the use to which the information is to be put, the cost sheet may be compiled on a production or on a sales basis. The amount of detail which it carries will depend upon the extent to which the administrative offi- cer uses it as an index to operating efficiency. Generally speaking, the cost sheet must show distinctly with regard to unit costs the material, labor, and the overhead. In order to show the relation of the various elements of the material cost to the total material cost, it may sometimes be neces- sary to present in classified form all the materials involved. Such an arrangement is admirably adapted to comparison. At times it may be interesting for administrative and com- parative purposes to show the various labor departments separately. The proprietor may also be interested in know- ing all the items which make up the overhead. For the purpose of fixing a selling price and the super- vision of operations, a cost sheet on a production basis, that is to say, one showing the unit cost of finished goods orders, is usually sufficient. If it is the desire of the manage- ment to ascertain the profit on various contracts, or various orders, a cost sheet showing this information is very much more difficult of accomplishment and much more complex. The difficulty lies in that a shipping order may comprise 94 The Report of the Cost Department various qualities, or classes of goods coming from various production or finished goods orders wherein the cost varies, and it becomes necessary to assemble the unit cost of the various finished goods orders in order that the total cost of the shipping order may be ascertained for comparison with the sales price to show the profit on the order in ques- tion. The general arrangement of the cost sheet is illustrated in a form to be found on page 96. It is presented in the simplest possible form in order that the principles under- lying its construction may be readily seen. J i H Q .5 f-' W H W [THE END] * ; Hook is DUE on the last date stampe^ RY -~-*-rr M A 000 179 159 9 of CALIFORNIA AT LOS ANGELES LIBRARY