THE ARTHUR YOUNG ACCOUNTING COLLECTION Graduate School of Business Administration Librar)^ of the University of CaUfomia Los Angeles This book is Pt^t?. on ♦h*' last date stamped b^ SOUTHERN BRANCH, UNIVERSITY Q5 CALIFORNIA, LIBR7\RY, pJp^/NGELES, CALIF. Library G^raduate School of Business Admlftlsstr&tiOBf University of California Los Angeles 24, California COST ACCOUNTING TO AID PRODUCTION A PRACTICAL STUDY OF SCIENTIFIC COST ACCOUNTING BY G. CHARTER HARRISON Associate-member of the American Society of Mechanical Engineers, Associate of the Institute of Chartered Accountants, Consulting Accountant NEW YORK THE ENGINEERING MAGAZINE COMPANY 1921 400 74 Copyright 1921, by THE ENGINEERING MAGAZINE COMPANY PRESS OF BRAUNWORTH & CO. BOOK MANUFACTURERS BROOKLYN, N. Y. Bua. Admint Library FOREWORD T' HINKING, as a power to achieve actual results, was never more strikingly forced upon the attention of peoples than f during the past years of war. The care with which military ? commanders fostered the morale of their men, and the great efforts made by political leaders to mold and direct public «* opinion, will always be remembered by those who watched and S studied the progress of that great conflict. In contrast, enemy t) nations sought to implant their own ideas, wishes, and points of view, as one of the potent weapons of warfare. The process thus used in attempting to influence men's minds, and thus their _ actions, we call propagandizing, and the letters, articles, ^ pamphlets, books, and posters propaganda. Unfortunately how- ever a sinister meaning has come to be attached to these terms, y but nevertheless men of progressive thinking have always tried ^ to tell and show to others their ideas and convictions and so ^ exert an influence over their actions. All of this is normal ^ and commendable. It is the abuse of this process, its perversion V) to ignoble or wrong purposes, that should be condemned, and it is therefore, sincere commendation to refer to the work of Mr. G. Charter Harrison as propaganda in the great field of productive industry. Many of the early efforts at industrial management were inspired by the needs of the accounting function of a manu- facturing business. It was realized that a knowledge of costs was essential in meeting competition and in making sure that the business was stable. So, many of the attempts at bettering industrial organization and management sprang out of an effort to secure accurate costs. But. generally speaking, professional accountants seem to have failed to fit their own work into the broad scheme of productive industry. And this has been per- mitted in spite of the teachings of many of the engineers who first entered the industrial field and who were compelled to develop cost accounting as one branch of their own work. iii IV Notably, Frederick W. Taylor and Harrington Emerson developed cost work, and wrote emphasizing the place of im- portance that costs occupy in the general scheme of management in industry. During the past decade there has been a gradual widening of the divergence of viewpoint between many of the leaders in management and engineering and cost accounting. The engineers have been working under tremendous pressure. Pro- duction has been the keynote of all their efforts and the demand for goods has been insistent and insatiable. Under these cir- cumstances it has been quite natural to reach out for every possible help to increase and improve the productive process. So engineers have wanted cost accounting methods that would aid in reaching toward the great objective of industry. In contrast, the cost accountants have seemed to be solely interested in securing accurate, refined cost history of what has actually taken place in the processes and operations of produc- tion. In the midst of this separation of viewpoints, this lack of harmony between men with objective and subjective minds, came the writing and work of a chartered accountant, with some twenty years of professional experience of which some fourteen years have been spent in the United States and who boldly supports the point of view of the engineers. Mr. Harrison recognized that the objective of industry is the production of goods, that everything that hampered the productive process should be eliminated, that impatience with a factory system or detail that hindered, or at least did not help, production was natural, and that cost accounting, instead of being static in accumulating history, should be an active part of the great process of production. Fearlessly thinking and writing, he con- demned the attitude of many of his fellow accountants, telling them that their practice was twenty-five years behind the times, that they were making themselves slavishly subservient to a financial condition in industry that m.ust pass away, and declared to them that if cost accounting was to hold its own among the business professions, it must turn over a new leaf and prepare to serve in "The New Industrial Day." Looking through the form and semblance of things he declared, further, that cost accounting was unworthy of any place in industry if it did not contribute to production, and, not content with stopping at this point, he re-enforced his challenge by pointing out better and improved methods, by showing the way in which cost accounting could become an aid to production. In all this work he has endeavored to stimulate and arouse the thinking of men, realizing that as the years pass greater progress can be secured by this means than by working for the adoption of any particular accounting scheme or plan. In a series of articles published in Industrial Management in 1918 and 19 19, he developed the advantages, in fact the neces- sity, of predetermined costs. Then he showed how to establish cost standards and use them to control costs in the making. And, he developed the theory of standardized cost formulas and presented a number of these arranged in such a manner that the little skilled office employee would be able to w^ork out accurate results in carrying forward a cost accounting system based on the determination of standard costs and the comparison of actual costs with these standards. All of this work has the touch of stern reality, for jMr. Har- rison has applied these methods in his own consulting practice and in widely different Industries, so far apart as the tonnage production of steel and the building of complex, agricultural machinery. From this fearless thinking, from this willingness to write boldly of the truth as he sees it, from this earnest desire to advance his own profession of cost accounting and to assist in the up-building of productive industry, Mr. Harrison has written his book, "Cost Accounting to Aid Production." Its purpose is avowedly to provoke the thinking of others, in this respect differing from practically all of the preceding literature on cost accounting. Two features of the method of treatment add interest and charm. Generous credit is given to engineers who have written on cost-accounting topics, even although they may have condemned much that is looked upon as accepted in cost- accounting practice. The other attractive feature is the frequent and generous references to philosophic writings, showing that the principles underlying cost accounting can be interpreted in terms of those things that we recognize as the very truths of life. Far too few technical and engineering authors permit themselves to depart from the narrow limits of their topics, and in exercising this restraint they fail to make their own work conform to the great concepts of truth that are the heritage of all. No reader will be able to lay down this book without feeling anew the essential responsibility of industry In present day human life, nor without a renewed realization that every part of the great professions, which are working for the carrying VI on of productive industry, is but a section of a great whole and must be united in the closest of harmonious cooperation with all the others, else much less than the best will be achieved. It is easy to suspect that it was one of Mr. Harrison's wishes to leave some such impression upon the minds of those who are fortunate enough to pick up and read through what he has written. L. P. Alford. New York, N. Y., August, 1920. INTRODUCTION TN a number of articles appearing in Industrial Management -*- between October, 1918 and March, 1920, which have been revised and elaborated to form the present volume, the author presented a serious and far-reaching indictment of the com- monly accepted methods of cost accounting. In these articles he claimed that the methods of cost accounting, which are taught in what are regarded as the standard works on this subject, are incorrect in principle, unscientific, inaccurate, and inadequate, in brief, absolutely unsuitable to meet the needs of modern business. The author does not claim however to be the first to disclose the fundamental defects underlying the established methods of cost accounting. Ten years ago in the pages of Industrial Management Mr. Harrington Emerson presented a clear and convincing indictment of the usual retrospective cost accounting methods and other writers since that time, notably the late Mr. H. L. Gantt, have forcibly demonstrated the shortcomings of the average cost system to meet the needs of industry. Such criticisms as have been made however have emanated from the engineering and not the accounting profession and while the critics have generally displayed a very complete understanding of the defects in cost accounting methods, practical advice as to the solution of the accounting problems involved in the cor- rection of these defects has been notably lacking. In his efforts towards the bringing of cost methods into line with modern industrial thought the author had the distinct advantage of possessing an extensive experience in professional accounting work combined with a fairly intimate acquaintance with the problems of manufacturing, the latter being gained in part through his activities as comptroller of a large manufac- turing business, as the head of the system division of one of the leading firms of professional accountants, and for a number of years as a consulting accountant. vii Vlll The methods formulated by the author and described in the following pages represent an absolute revolution in the basic conception of the functions of a cost system — whereas the com- mon idea of costs is confined to the compilation of information as to past events, under the author's methods all costs are pre- determined. These methods represent the application of the scientific management idea in cost accounting — not the restricted and far too common idea of scientific management which con- siders this as being merely a system of shop management but the broader conception which regards scientific management as representing the fundamental change in the viewpoint of indus- try from that of retrospection to prospection. In the opening chapter the author states that "it is probable that the average cost system, taking into account all factors, is not more than 50 per cent efficient, so that the annual loss from this cause may well be regarded as a matter of consider- able importance." That this statement is a highly conserva- tive one will hardly be disputed by those best in a position to judge and, surely, if one half of the money annually spent in cost accounting is to be regarded as a preventable waste, the amount involved represents a serious drain upon industrial life. But this direct loss is trifling compared with the indirect one resulting from the fact that the average cost system does not disclose inefficiencies which therefore remain uncorrected owing to ignorance of their existence. Cost accounting at the present time occupies an anomalous position. On the one hand there is the engineering profession, which knows what is required but does not understand account- ing technique, claiming that cost accounting is out of tune with industrial effort, and on the other hand there is the accounting profession, trained in the development of accounting mechanism, but apparently indifferent to the fact that in clinging to obsolete ideas it is a brake on the wheels of industry. One has only to read the cost accounting literature of the last few years to realize that most of it is merely a rehash of old ideas, and that the writers have not appreciated that revolutionary changes in industrial methods demand corresponding changes in cost accounting. Useful in many ways as are the habits of thought resulting from the training of professional men along standard- ized lines, there is the danger that thinking will become more or less stereotyped and a condition of mental inertia result. History is full of instances of the positive refusal of the human mind to travel along a different line to that in which IX it has been accustomed to follow. About a century and a half before the birth of Christ, Ptolemy expounded his theory of the order of the universe. According to this theory the earth was the center of the universe, around which the sphere of the heavens revolved from east to west, carrying all celestial objects with it once every twenty-four hours. This was regarded as an eminently satisfactory doctrine, for obviously the idea that they were situated at the very hub of the universe, so to speak, was pleasing to the people of those days and further was not the theory proven by the evidence of their own eyes? Did not they see the sun every morning make its appearance in the east and slowly travel towards the west? About 1500 years after Ptolemy's time, however, there came into the world one of those inquiring souls who do not take things for granted. Copernicus, the father of modern astron- omy, announced to an unbelieving world that the ideas advanced by Ptolemy were all wrong; that the world was not the center of the universe ; that the sun did not revolve around it and that the apparent movement of this luminary across the horizon was due to the revolution of the world upon its own axis. This discovery did not receive an enthusiastic reception for obviously, it was not easy to eradicate an idea which had been fixed for 1500 years, and for nearly 150 years after Copernicus published his great work on the revolution of the celestial bodies it was kept on the index of prohibited books of a great church as being subversive of the truth. It is easy, of course, to understand how the rank and file of mankind would find it difficult not only to totally reverse a conception current for centuries but also to accept a theory which was contrary to what their own observations would lead them to believe, but the significant fact is that those who should have been in a position to fully appreciate the arguments of Copernicus held so tenaciously to their old ideas that over seventy years after Copernicus advanced his theories they were pronounced by a body of learned men as being ''absurd in philosophy." As a matter of fact, however, it is not surprising that the strongest opposition to the acceptance of any revolutionary idea should often come from the ranks of specialists in the particular field of thought affected. The learned men who denounced the theories of Copernicus doubtless honestly believed that they had given these theories impartial consideration, but so firmly were the old ideas intrenched in their minds, so deep the grooves worn by the habitual trend of their thoughts in the matter under review that they were not really capable of passing an unbiased judgment. It is no easy matter to abandon the old mental tracks along which the accustomed trains of thought run so easily and smoothly, and if even scientists whose religion is the pursuit of knowledge for its own sake find it difficult to embrace the new merely because it is unfamiliar, how much harder must it be for those whose selection of their vocation has been prompted more by utilitarian motives than by an insatiable thirst for knowledge. In such a case, as is to be expected, there is a natural reluctance to changes which will disturb the existing order of things and it is not therefore at all surprising that professional men are often ultraconservative when it comes to embracing new truths and casting out the errors and half-truths of yesterday. As the author sees it, the solution of the problem is largely in the hands of the manufacturing executive. If he demands certain results from the professional accounting advisers he employs to formulate methods of cost accounting and refuses to be satisfied with anything short of these demands the self- interest of the accounting profession will force a readjustment of its ideas in connection with cost accounting. If, on the other hand, the manufacturer is satisfied with systems of cost account- ing designed without any real appreciation of the requirements of modern industry, the development of cost accounting will be the result of a slow process of evolution. The question of paramount importance is Avhether the American business man can afford to wait for a leisurely solution of so vital a problem. SYNOPSIS OF BOOK Foreword iii Introduction vii Accepted methods of cost accounting unsuitable to meet needs of modern business— Defects in established methods disclosed by engineers — Methods submitted represent application of scientific management idea in cost accounting and change viewpoint from retrospection to pros- pection — Average cost system not over 50 per cent efficient— Great loss due to systems not disclosing inefficiencies which therefore remain uncorrected owing to ignorance of their existence — Engineers have proper viewpoint but lack knowledge of accounting technique whereas accountants cling to obsolete ideas — Illustration of difficulty of chang- ing established ideas — Correction of defects in cost accounting methods largely dependent upon the manufacturing executive. Chapter I — The Application of Scientific Management I While all other branches of industrial management have shown marked advance in recent years no material improvement has been made in cost accounting methods — Continuance of this condition largely due to ignorance of its existence by manufacturers — Professional accountants have failed to read the "writing on the wall" — Engineers in endeavor- ing to replace the accountant have failed through lack of knowledge of accounting technique — Extreme simplicity of design a fallacy- — Similarity of a "Sistem and a machine — Importance of diagrams — Seven reasonable requirements of a cost system — (i) Accurate costs of specific articles ; no matter how complicated a product its current cost should be obtained very promptly — (2) Manufacturing Efficiency Data; the cost of idleness must be distinguished from the cost of production — Variations in material, labor, power and tool costs — (3) Promptness i:i furnishing information prime requisite — Information which should be obtained daily, weekly and monthly — (4) Reports for the Executive — Possible to furnish essential facts in a cost statement on a single sheet of paper — Principles of exceptions as applied to cost reports — Example of summarized manufacturing statement — This state- ment should be supported by complete detailed statements — (5) Sales Statistics — System 'should show profits realized (a) by salesmen, (b) by lines, (c) by territories, (d) by classes of customers and for any combination of these — Estimated profits on orders received — (6) Cost of operating system — should be economical as regards time of (a) Executives, (b) Clerks, (c) Shop employees — Economy of system xi Xll depends on proper design — Futility of recording time on detailed operations — Unnecessary weighing and elaborate stores systems — (7) Standard Practice Instructions — Importance of these — Proper design increases efficiency of lower grade office employees — Speed and accu- racy obtained by eliminating personal element — Typical plan of cost accounting — confined to obtaining historical data which are limited in value — Difficulty of shifting costs of labor and material — the effort to trace causes of cost increases — The fallacy of low non-productive labor percentage — the injustice of per pound and per piece factors — Inelastic methods of compiling information — The effect of lack of focus — The importance of sales statistics — Lack of coordination. Chapter II — Standards and Standard Costs 33 Forward march of civilization rendered possible only by use of stand- ards — False ideals and standards — Division of responsibilities of operating and accounting divisions — The function of the oper- ating division — The function of the accounting division — Illus- trations of standards without records, and records without stand- ards — Average office illustration of absence of both standards and records — Can costs be predetermined? — Cost-plus systems — Standard costs the fundamental improvement — Five purposes served by stand- ard costs — Cost accounting and labor — Low average of efficiency — ■ Profit sharing — Mr. Perkins' views — Mr. Leitch's plan — Sound psy- chology underlying this — Doubt as to it being essentially just or of universal application — Defective in basing rewards on past results — Only means of making equitable distribution is a system of cost accounting which is based on standards and provides for distinguishing variations over which the worker has control from those which are beyond his control— The influence of scientific methods on industrial progress — Unfortunate tendency to make comparisons with past re- sults rather than with full possibilities — Importance of records which will show comparison of actual results with results possible — The first step towards correcting an error is knowledge of its existence — - The principles of a cost system based on standards illustrated by a simple example showing method of determining manufacturing efficiencies — Current costs and cost of sales — Discussion of principles of burden distribution — Illustration of error when departmental burden rate employed — Effect of decreased production on burden element in costs. Chapter III — The Universal Law of System 68 Prosperity of a business depends as much upon its intangible assets as upon its material possessions — Andrew Carnegie's views — The breaking-in process — Some organizations never properly "run in"— Importance of system — Principles not devices — Efficiency "experts" — Definition of system — Unity underlying systems — Comparison of sj-s- tem of human body with that of a business — Importance of good habits — Bad business habits — Why business methods fall short — Pro- cedure in planning routine work — Special qualification needed to design a cost accounting sjstem — Basic principles of simple cost system— XIU Plan illustrated especially suitable for concern desirous of obtaining essential information with least possible disturbance and expense — Absurdity of figuring detailed time on individual operations — The sum- marized manufacturing statement — Cost of sales and profit and loss statement — Current cost of machine — Figuring standard costs of material— Figuring standard costs of labor and burden— Often path of wisdom to take advantage of data already compiled and set stand- ards on basis of past results replacing these later by more scientifically determined standards — Even if standards incorrect they enable com- parisons from month to month to show trend of costs — The use of assays or tests in combination with past results in setting standards — Illustration of figuring standard cost in case of complex piece of silverware. Chapter IV — The Principles of Burden Distribution 92 The right system invariably a compromise — Illustration of a plan where advantages of simplicity in design deliberately sacrificed to obtain more important benefits — Methods of burden distribution a matter of judg- ment — Fallacy underlying usual methods of making burden distribu- tion — Illustration of elaborate "wheel-within-w^heel" methods of burden distribution — Disadvantages of such methods — Necessity of introduc- ing considerable refinements in complex situations — Underlying prin- ciples of machine rates illustrated by diagram show'ing method of compilation of machine rate, also showing how by means of the machine rate it is possible to obtain very complete data relative to operating efficiencies. Chapter V — Cooperation and Coordination no Strong individualism marked characteristics of the American business man — Advantages and disadvantages — Efficiency in business largely dependent upon two factors : cooperation and coordination — Ex- amples of lack of cooperation — Cooperation and the average office — The importance of cooperation in accounting — The trend toward cooperation and coordination — The balancing of industrial initiative and organizational needs — The advantages of coordinating methods — Manufacturers apt to believe systems simpler than is actually the case — Why complex businesses demand complex systems — Diagram of a coordinated cost, planning and production system — Disadvantages of written production records — Transcribing written data to graphic charts marked step in advance but combination of written and graphic record as described still greater improvement. Chapter VI — The Importance of Deliberation in Introducing Changes 124 Desire for immediate showing often results in hasty and unwise action — Correct methods can only be determined after careful and deliberate thought — Improperly designed routine methods cause continued loss — Carefully planned changes build morale — The general plan of a system should be drawn first and the details developed after but the reverse procedure is often adopted with disastrous results — Importance of bringing manufacturing data to a focus — Description of machine group XIV planning and control board — Variety of information obtained by use of punched cards. Chapter VII— The Principles of Scientific Management 130 The development of the scientific management idea was inevitable com- ing as it did as a direct response to the need for some improvement over the old-time haphazard methods of management — Scientific man- agement a natural trend — Illustrations of delay in realizing full sig- nificance o£ scientific management not realized — Scientific management more than shop management — It is not merely a system of shop man- agement but is more akin to a mental attitude — In its essential features it represents the use of the trained imagination in industrial life — Elements of successful operation — Illustrated by treasurers' budgets — Crop Statistics — Salesmen's quotas — The experimental method — Appli- cation of principles of scientific management by modern purchasing agent — Change of viewpoint of entrepreneur from retrospection to prospection — All problems are more or less intra-departmental — The accounting department is the one department which should be in a position to coordinate the efforts of all departments — Unfortunately it does not fill this function in most cases — The two problems of opera- tion — The first that of the accountant, the second that of the executive ■ — Necessity for revision of plans no argument in favor of not making plans but rather the reverse — Illustration of the principle of prede- termination in case of a concern manufacturing motor trucks and where sales, costs and profits are predetermined. Chapter VIII — Cost Accounting and the Sales Manager 145 Defective methods of cost accounting weaken the whole fabric of busi- ness — In the shortcomings of its competitors lies the salvation of the average business — Greatest handicap to efficient business operation is incomplete, inadequate and inaccurate information relative to costs and profits — Where careless figuring brings loss — "Where have our profits gone"? — Tendency to "shade" costs — Rough and ready method of determining monthly profits — Its advantages and disadvantages — Information as to profits realized — The use of punched cards in obtaining sales statistical data — Limitation of usual methods which are confined to furnishing information as to sales but not as to profits made on sales — Bad effect of such methods on selling organization — Fixing responsibility for poor showings — Selling and distribution costs - — Impossible under usual detailed methods of cost accounting to obtain requisite information with permissible expenditure — Figuring the cost of sales — Illustrated by simple example — Figuring the cost of sales of complex machinery — Immense volume of clerical work required to figure cost of sales under usual methods responsible for failure of many manufacturers to obtain this information — Figuring the cost of sales for an exceedingly varied product — The economy of this plan as compared with the usual method of figuring cost of sales — Obtain- ing profits and losses by salesmen, classes of customers, etc. — Special problems in connection with figuring cost of sales by list and standard cost method — An illustration of the method of ascertaining profits and XV losses made by individual salesmen in the agricultural implement industry. Chapter IX — Cost Accounting axd Scientific Method 178 "The business of science is to predict" — Science involves an investigation into "causes" — The value of prediction— Scientific management is truly scientific — Briefly stated it is foresight, the predetermination of methods and results — Difference in viewpoints of engineer and account- ant — Postmortem cost accounting — Views of Mr. Emerson and Mr. Gantt — The manufacturer's need of knowledge — The difliculty of com- parison — Cost statements do not distinguish between the elements of time and rate or quantity and price — Serious defect in usual methods of cost accounting that these do not distinguish between the cost of idleness and the cost of production — Engineers' criticisms of profes- sional accountants — The need of the superintendent for adequate cost information — The value and limitations of experience — A humiliating situation — The larger significance of double-entry bookkeeping — The figuring of standardized operations — The use and abuse of time clocks — The method of distributing labor costs — Science is the description of the course of events b}- the aid of the fewest and simplest general formulas — In cost accounting there are plenty of forms but few for- mulas — Engineering science largely founded on formulas — Tendency of accountants to quibble over non-essentials — No way of avoiding considerable complexity in the design of systems to efficiently handle complex business — The complexity should however be confined to the design and should not extend to the operation of the system — Com- plexity in design and simplicity in operation obtained by the use of cost formulas — Illustration of the use of cost formulas in the pickling department of a steel mill — Use of cost variation sheet. Chapter X — Establishing a Scientific Basis for Cost Accounting. . . 202 Dangers of specialism — Characteristics of the scientific mind — The narrow specialism of scientific management — The value of cost accounting formulas — Two tables of formulas the use of which is illustrated by several examples — The purpose of dual comparisons — Changes in standards and the author's method of handling these. Chapter XI — The Future of Cost Accounting 221 Accountants cannot claim that their attention has not been drawn to the defects in the established methods of cost accounting as these have been emphasized by engineers — The first step towards correcting an in- efficiency is determining its existence — Our lack of accounting methods — The impossibility of providing reliable current information by retro- spective systems — The coordination of accounting and planning — The advantages of standard costs — The coming revolution in cost account- ing—The opportunity before accountants. THE APPLICATION OF SCIENTIFIC MANAGEMENT Chapter I SHOULD a manufacturer be told by a competent adviser that one of his machines performing an important operation was grossly defective in design, and while expensive to operate was turning out a relatively low production of a poor grade of product, he would not be satisfied until he had learned full details of where the trouble was and had taken the necessary steps to correct it. One of the most important and expensive machines of the average manufacturer, however, is in just the condition indicated — it is costing more, often far more than it should, to produce very much less than he is entitled to expect from it. The machine referred to is the cost system — the mechanism for producing vital information relative to the operation of the business. Curiously enough, while all other branches of indus- trial management have made marked progress in the last few years, cost accounting methods in general have made no material advance. It would be futile to estimate the total loss involved in inefficient methods of cost accounting, but it is probable that the average cost system, taking into account all factors, is not more than 50 per cent, efficient, so that the annual loss from this cause may well be regarded as a matter of considerable importance. If the same economic loss involved in inefficient methods of cost accounting were found to result from defective technical practice, a large proportion of the engineering profes- sion would undoubtedly be exercised in finding some means of eliminating this unnecessary tax upon industry. The continuance of this condition of inefficiency has ap- parently been due to the fact that the manufacturer has not recognized its existence and though in some cases he has reaHzed in a vague way that he was spending a lot of money for the information his cost system has furnished, he has accepted the assurance of his cost accountant that the methods adopted con- formed to the commonly accepted standards. A manufacturing business cannot be safely operated without some information relative to costs. This fact is generally realized by manufac- turers and the existing methods have doubtless been retained in many cases on the assumption that any cost system is better than none at all. Professional accountants, who should obviously be the leaders in the development of cost accounting methods, have failed in a marked degree to read the "writing on the wall," and in spite of the fundamental changes in manufacturing methods intro- duced in recent years have made few contributions of importance toward the revision of cost accounting methods to conform to these industrial developments. It is true that there is an endless amount of literature on the subject of cost accounting, but it follows the beaten trail and though some improvements have been made in the methods for distributing burden, it is claimed that the present generally accepted methods of cost accounting are in as retarded a state of development as w^ere those of manufacturing previous to the introduction by Frederick W. Taylor of the idea of scientific management. In this connection reference may be made to a recent book on accounting, written by a recognized leader of the accounting profession, a chapter of which is devoted to the problems of cost accounting, but neither in this nor the rest of the book is any reference made to the important changes in manufacturing methods which have resulted from the adoption of scientific management principles, and to the steps which should be taken to bring cost accounting methods generally into line with these developments. Occasionally there will be found professional accountants who seem to fully appreciate the fact that the cost accounting methods of to-day represent little if any advance over those current ten years ago. Practically all other branches of industrial manage- ment have experienced radical changes in recent years but it does not seem to have occurred to accountants that cost account- ing also recjuires to be revolutionized in order to con- form to the new order of things and in commenting on the slow advance which cost accounting methods in general have made they have apparently assumed that progress in this science must necessarily be a process of exceedingly slow development whereas what is required and urgently so is not a gradual evolu- tion in methods but a complete and speedy revolution in principle. This viewpoint of professional accountants as regards the status and future of cost accounting is well reflected in the fol- lowing somewhat plaintive remarks taken from a recent review in a leading accounting journal: To a reviewer of books on accounting, however, there soon comes a sense of shght weariness so aptly termed in trench-slang as "fed-uppedness" as book after book proves to be an old friend with a new face. He is almost tempted to exclaim with the preacher : "There is nothing new under the sun." In the nature of things connected with an art based upon a few faxed principles this is to be expected. All that one can do is to bear in mind that improvements in accounting methods are always possible but evolve by almost imperceptible degrees. The engineering profession, however, has very clearly per- ceived .many of the defects and absurdities of the established methods of cost accounting, and in no case have these been better demonstrated than by J\Ir. Harrington Emerson in his work entitled "Efficiency as a Basis for Operation and Wages.'" In the numerous volumes on scientific management and cost accounting which have appeared since that book was published it is surprising to find so little information along constructive lines as to the methods to be followed in order to put into prac- tical operation the ideas advanced by Mr. Emerson. As to whether the efficiency engineer ignored the accounting profession, or called upon it in vain for assistance in solving the accounting problems associated with his work of introducing the principles of scientific management, is a Cjuestion that the author is not in a position to answer. In endeavoring, however, to solve these problems without the assistance of skilled ac- countants, as many engineers have done, they have apparently overlooked the fact that though accounting is an art based upon a few simple principles, the effective application of these prin- ciples calls for years of study and practical experience. In fact, when the engineer wanders into the domain of accounting he is apt to present as diverting a spectacle as would the accountant in the field of engineering. The Engineer's Failure to Appreciate Cost Accounting That engineers do not fully appreciate the fact that cost accounting is a complex science necessitating specialized knowl- edge for its application is evidenced by their writings. It was a distinct shock to the author after having spent a number of years of very hard work in developing Mr. Emerson's ideas along accounting lines to find, in re-reading one of his books, the somewhat airy statement that cost accounting can be very simply and easily developed from the cost formula he gives. Another engineering writer even states that "the employment of an expert accountant to devise and install a cost system in a manufacturing and repairing plant is an absurdity." And further that "an expert on shop management can learn the simple accounting required in a short time. In fact he cannot be an expert without this knowledge." The above quotations are somew^iat illuminating as illustrating the tendency for an expert in one line to underrate the knowl- edge and experience required to qualify as an expert in another. The old proverb "a little knowledge is a dangerous thing" applies to accounting as well as to other things. That the primary purpose to be aimed at in any system of accounts is extreme simplicity of design is a fallacy that will undoubtedly die hard. A cost accounting system is merely a machine for the production of specialized information and, like any other complicated piece of mechanism, should be judged not so much from the standpoint of simplicity of design as from that of the results obtained from its use and the facility and economy with which it can be operated. To condemn any system of accounting on the sole ground of its complex design would be as absurd as to complain that the modern automobile is far more elaborate in its design than was Trevethick's steam carriage which astounded and alarmed the pedestrian in 1802. Both represent means of transportation, the earlier machine being absurdly simple in design, but no one would claim that it was a superior article to the later invention. Undoubtedly all possible simplicity in design consistent with efficient operation should be aimed at, but the term is a purely relative one and the cjuestion is not so much whether a system is simple or not but whether, taking all factors into consideration, it is as little complex as the conditions warrant. It is believed that the methods which will be submitted later in the present work will demonstrate that accounting plans must be quite complex in design, though not necessarily difficult in operation, if the multiplicity of results desired are to be obtained with a minimum of expense and without duplication of effort. The designing of such plans demands a high degree of account- ing technique and a fundamental grounding in accounting prin- ciples which can only be obtained by years of practical accounting experience which obviously the engineer is not often in a position to obtain. The Similarity of a System and a Process or Machine The author has visited a number of plants where extensive reorganization work has been undertaken by efficiency engineers, but in no case which has come to his attention has there been any complete layout of the plan to be followed. A manufacturer, employing the services of an engineer to design a machine to meet some special requirement of his business, would certainly feel entitled to call for complete working drawings of the pro- posed machine before he approved the spending of possibly several thousand dollars for its construction, particularly so if he were better acquainted with the manufacturing processes involved than the engineer he employed. It would also seem reasonable for a manufacturer, employing the services of effi- ciency engineers to undertake the introduction of improved methods in his plant, to require similar complete drawings illus- trating the results contemplated under the plan and the steps proposed to realize these results. For, though the manufacturer is calling upon outside assistance in the solution of his problems, it is obvious that there must necessarily be many details of the business with which he is better acquainted than the experts he employs, and his careful consideration of the details of a plan before its installation is attempted may often obviate the neces- sity of changing methods once installed. The first step toward the solution of any problem is a proper classification of all of the factors entering therein, and the most efifective method to use in designing a plan to meet the needs of a complex industrial situation is to clearly show on paper the various elements and interrelationships involved, and then to follow a similar method in formulating and presenting plans to meet the conditions existing. From the standpoint of the engineer engaged in the work of applying scientific manage- ment principles, and in the introduction of improved routine methods, such a method of procedure presents marked advan- tages. Not only does it aid in chirifying the problems of the engineer but it also provides for all effort expended being directed toward a clearly defined end and reduces the amount of super- vision required. In the event of any change of organization it enables the work to proceed without embarrassment. In the course of his professional work the author has in- vestigated the cost systems operated in approximately a hundred different factories but he cannot recall one case in which he found that any systematic attempt had been made to diagram the cost methods employed. This is a remarkable fact when it is considered that in some of the factories hundreds of dif- ferent accounting forms had been introduced piece-meal and hap- hazardly without any comprehensive general plan, whereas the superintendents of these plants would not think for even a moment of constructing a one-car garage without first having complete detailed drawings submitted to them. One marked disadvantage of not having complete plans for a cost system before the attempt is made to install it is the necessity which arises as a result of this negligence for the perpetual changing of forms. The author recalls one instance where a professional accountant changed a time card three times in one month. Emplovees soon lose confidence in a system which is always being changed and they very naturally reach the conclusion that the designers of the system do not really know what they want the result being that the work of introduc- ing the system is rendered more difficult than necessary. Owing to the almost invariable custom of introducing cost methods without first making comprehensive drawings showing the ultimate results to be accomplished and every intermediate step involved in obtaining these results there is no very clear idea in the minds of those introducing the cost methods as to exactly what results they are endeavoring to accomplish, with the result that the systems start out ambitiously enough with elaborate detailed forms but get nowhere and in fact are remark- ably like the western roads referred to by Ralph Waldo Emer- son which "opened stately enough with planted trees on either side, to tempt the traveler, but soon became narrower and nar- rower, and ended in a squirrel track, and ran up a tree." In Figure i is produced a section of a drawing illustrating this idea of showing the operation of a plan in considerable detail and in diagram form. MOVE MAN NAME OF BUNDLE PART LIST AND SEQUENCE OF OPERATIONS ■> ' STORES RECORD 1 ttept. 5.H^ ytojs.... 1 name: SECTION SIN ^/^e/r^ ., /6S- lO SI n EQUIPMENT STORES • OPERATION LABOR CHARSES s; OPERATION ii OPtRATION OPERATION ii RollandCuioff flf WtlJ SiiRSES SMMOCOSI. awoiioaw. — iiABomomsr — nmuraaoT. — S \i I i % i S ¥ % 1 Ii s ¥ % t i \¥ i i 5 1 5 f>. !i.,^«si fl Uf *« SIO »>) ^m « ■■ w 7/« w SI9 1 _J - _ . . _ , _ 1-^ J The Reasonable Requirements of a Cost System Though it is obviously somewhat difficult to submit any definite standards for cost accounting methods generally, as these will greatly depend upon the character of the business and to some degree upon the ability of the organization and the extent to which it can make good use of the information which would be obtained, certain more or less general require- ments can be stated. As an illustration of the extended scope of a properly designed cost system, the following list is given of demands which should reasonably be made of such a system for a concern manufac- turing a varied line of metal parts, some standard and some special, the manufacture of which involves the use of a consider- able variety of machines. 1 Accurate Cost of Specific Articles 2 Manufacturing Efficiency Data 3 Promptness in Furnishing Information 4 Reports for the Executive 5 Sales Statistics 6 Cost of Operating the System 7 Standard Practice Instructions I Accurate Cost of Specific Articles The system should provide for the tabulation of cost data in such form that accurate and prompt information can be obtained as to costs by operations and in total of parts, part- assemblies and final assemblies. Not only should the system furnish information as to costs actually realized but, more im- portant still, it should provide prompt and accurate data as to what costs should be under current conditions. In fact, in the business of to-day a cost system that does not provide for a predetermination of costs cannot be regarded as in any way meeting requirements. In many cases an article is placed on the market before it has been manufactured in sufficient quanti- ties to render the detailed actual cost data obtained a reliable guide as to w^hat the cost should be in manufacturing on a com- mercial scale and, unless some reliable method of predetermin- ing costs is followed, fixed the sales price of the article is largely a matter of an intelligent guess. The need for a means of properly predetermining costs is felt by most manufacturers but such work as is done along these lines is generally undertaken independently of the regular cost system and not being subject to the checks and balances pro- vided by a correctly designed cost system these estimated costs are often seriously incorrect. The author recalls one instance where a predetermined cost of a tractor had been made which on investigation was found to have omitted the cost of the wheels ! The feasibility and importance of predetermining costs has been enlarged upon by several writers on cost accounting, but as far as the author knows there is no book on cost accounting which illustrates how a cost system can be designed so that this function of cost predetermination will form an integral part of the general plan. The importance of cost predetermination is emphasized by Benjamin A. Franklin, who in his stimulating and interesting book "Cost Reports for Executives" writes as follows: This variation of the cost of the same article at different times con- stitutes the important point, not only in the proper understanding, but in the appreciation of costs. The abilitj- to master this point and to figure estimates or prediction of cost from a standard under varying conditions gauges the comprehension or the meaning and value of practical costs. Another writer who has dealt with the cost predetermination function of a cost system is William B. M. Ferguson, who in "Estimating the Cost of Work" makes the following remarks: In the art of estimating, it is only in determining what costs should be, if we eliminate preventable waste (or using Mr. Emerson's term, it is only in predetermining costs) that we establish a standard which is "a criterion of excellence." In estimating what costs will actually be we use for a standard of comparison the type or example of past performance which represents the average cost of work, under standard conditions. By thus using a standard estimate for each unit (whether the unit chosen be an object or operation), based on the cost of a standard number of units under certain conditions taken as standards the estimator can proceed methodically to classify and study all cost data and estimates with reference to such standards. In concerns manufacturing a standard product, no matter how complicated, a system of cost accounting if properly designed should enable accurate information of the current costs of manu- facture to be obtained very promptly. For instance, in a busi- ness such as the manufacture of agricultural implements, where many different kinds of machines are manufactured, it should be possible for the cost accountant to furnish an approximately accurate cost of any machine under current conditions in less than half an hour after the information is called for, and this should be so even if the machine in question comprises several hundred parts and necessitates the performance of five times as many operations. 2 Manufacturixg Efficiency Data Cost of Idleness. No system of cost accounting can be con- sidered as in any way suitable to meet the needs of the manu- facturer which does not distinguish between the cost of produc- tion and the cost of idleness. Under the usual methods it is necessary to distribute the total expenditures for the month over the total product for the month regardless of whether the factory is operating at full capacity or not with the result that the effect of what is probably the most important single cost factor, namely that of idleness, is merged in the general costs. Every manufacturer knows that when operating at less than full capacity his costs will increase owing to certain of his expense remaining whether he operates at full capacity or not but there is all the difference in the world between knowing this fact in a general way and having cost statements showing monthly the total amount costs have been increased owing to the failure of the factory to realize its full production possi- bilities. Variations in fixed charges owing to the production being less than lOO per cent of capacity should be analyzed as due to: (a) Actual idleness of the department or the plant as a whole (b) Shortage of operators (c) The average production per operator being less than standard Labor. The cost system should furnish complete data relative to manufacturing efficiencies and in particular information re- garding the efficiency of: (a) The individual operator daily, weekly or at longer periods (6) A class of workers (c) A department (d) A plant as a whole 10 Furthermore, increases or decreases in cost should be analyzed into those resulting from changes in: (a) The rate of wages paid (b) The time consumed in the performance of manufac- turing operations. Material. The system should provide for showing daily, weekly or monthly, as desired, increases or decreases in cost resulting from variations in: (a) The purchase price of material (b) The efficiency of the use of material, this being analyzed as to : individual operators, classes of operators, a department and a plant as a whole. Manufacturing Expenses. The increases or decreases in cost resulting from variations in expense should be shown in the completest form, and in particular the following information should be provided : Handling and Transporting Expense. Increases or decreases in cost should be shown for the various main classes of material and for miscellaneous stores and supplies. Pozver. Records should show increases or decreases in power cost analyzed as to those resulting from variations in: {a) The cost of power. (6) The efficiency of use of power. In the former case cost fluctuations should be analyzed as to cost of coal, unloading and handling, power purchased, labor, repairs and supplies. Miscellaneous Stores and Supplies. Increases or decreases in cost should be shown divided by departments, and, if desired, by individual operators. These increases or decreases should be analyzed as to those resulting from variations in: (a) The purchase price of supplies (b) The efficiency of use of supplies Tool Costs. Information should be provided showing the daily, weekly or monthly variations in the cost of tools divided as to: II (a) Classes of machines, or individual machines when desired (b) Departments (c) A plant as a whole In addition, such variations should be analyzed to show in- creases or decreases resulting from fluctuations in the purchase price of tools or in the cost of making them, and variations in the efficiency of the use of tools. Machine Costs. Very complete information should be pro- vided as to machine efficiencies, this showing increases or de- creases in cost resulting from variations in: (a) The number of hours a machine is operating (b) The production efficiency of the machine when operating (c) The cost of maintaining and operating the machine Spoilt JJ^ork. Increases or decreases in cost resulting from fluctuations in the loss from spoilt work should be shown daily, weekly or monthly divided as to: individual operatcjrs, classes of operators, classes of product, departments and a plant as a whole. Miscellaneous Works Expense. Full information should be provided as to increases or decreases in costs resulting from varia- tions in actual expense, compared with standard, these data being arranged under the account classification most suitable for the business. 3 Promptness in Furnishing Information The value of information relative to the cost of manufac- turing operations is generally in direct ratio to the promptness with which such information is furnished. Though it is not usually feasible to provide complete statements covering all of the operations of the business at very short inter\^als, owing to the expense which would be involved, at the same time there are certain very necessary reports which should be furnished to the shop executive every day. The following is indicative of the character of the information which should be provided daily: 12 Summarized Manufacturing Report: Goods ordered, manufactured and shipped to-day and to date, divided as to classes and by any further sub-division desired. Summarized Payroll Report by Departments: Number of employees on roll. Number of employees absent or working short hours and total hours so lost. Actual hours worked by operators. Standard hours of work produced by operators. Percentage of efficiency realized. Payroll of operators. Average rate per hour of operators. Hours worked other than by operators. Payroll of employees other than operators. Average rate per hour of such employees. Total hours worked by all employees. Average rate per hour earned by all employees. Summarized Machine Report for Each Machine and Class of Machine: Standard hours. Actual hours worked. Employment efficiency. Standard production. Actual production. Operating efficiency. End efficiency. In addition to providing for information being furnished daily to the shop executive in the form of summarized reports as described above, provision should be made in the design of the cost system for all data relative to costs and operations being so compiled as to render it possible at any time to obtain very promptly any arrangement of such data required. Owing to the very considerable amount of clerical work involved in the compilation of complete cost statements covering all of the activities of a factory it has become an almost universal custom for these statements to be prepared monthly, the number of days elapsing between the end of the month and the issuing of these statements varying from five days to a month or more. Even under the best conditions, however, it will be obvious that some of the information presented in these statements must be 13 in regard to events which are over a month old and by the time the cost statements have been examined sufficiently to enable the superintendent to determine where conditions appear to be unsatisfactory the time which has elapsed between the event and the investigation will often render the latter of little value. Complete information relative to costs cannot in the nature of things be economically presented to the operating executive daily, but much of the information incorporated in the monthly statements, and in fact most of the really essential information can and should be made up weekly and in view of the fact that payrolls are generally made up on a weekly basis it would seem obvious that as regards labor costs at least it is the logical procedure to furnish the superintendent with complete informa- tion relative to this class of expense and not to hold up informa- tion which can be so readily obtained until the end of the month because it is not feasible to make burden distributions until that time. 4 Reports for the Executive It is by no means unusual for the executive of a large manu- facturing company to be presented at the close of the month with cost statements in such voluminous form as to render these a substantial volume and the amount of time which the con- scientious executive is compelled to devote to the study of such statements is a serious form of avoidable industrial waste. The idea that an executive should be compelled to \vade through dozens of detailed statements involving hundreds and often thousands of figures is an absurdity which it would seem would be self-evident but the condition is so general that the average executive apparently accepts the situation as being an inevitable one. As a matter of fact it is perfectly possible to furnish the executive of a large manufacturing plant with a summarized cost statement on a single sheet of paper of ordinary letter size from which in a few minutes he can learn more about the essential facts of his business than would be possible from spending hours in grappling with the usual detailed cost state- ments. Monthly cost statements in general are confined to a tabula- tion of expenditures which are shown without relation to standards so that the executive is compelled to rely for his information as to the trend of costs on making comparisons 14 of the cost of each item of expense for this month with that for the month previous and so on, a laborious and everlasting procedure which consumes a great deal of time and produces little results. George Horace Lorimer in his "More Letters from a Self- Made Merchant to his Son" strikes the keynote of the con- servation of the time of executives when he writes: In the first place, you don't need to bother very much about the things that are going all right, except to try to make them go a little better; but you want to spend your time smelling out the things that are going all wrong and laboring with them till you've persuaded them to lead a better life. For this reason, one of the most important duties of your job is to keep track of everything that's out of the usual. If anything unusually good happens, there's an unusually good man behind it, and he ought to be earmarked for promotion; and if anything unusually bad happens, there's apt to be an unusually bad man behind that, and he's a candidate for a job with another house. In the above quotation George Horace Lorimer is describing the application in industrial life of the "principle of exceptions" that is, the concentration of attention to the abnormal and unfavorable condition and the spending of no more time on the normal than is necessary to establish the fact of its being normal. If it is desired to eliminate the shocking loss of time of industrial leaders due to the lack of focus in thie accounting statements with which they are furnished it is necessary that this principle of exceptions he applied to cost accounting methods and this involves firstly the comparisons of all expenses with standards and secondly the analysis of variations from standard as to the causes underlying such variations. The summarized cost statement which should be furnished the executive of a manufacturing company should not recjuire more than fifty figures at the most to furnish him with a view in proper perspective of the trend of his manufacturing costs and the following taken from an actual form used by the author clearly illustrates the principles involved: Summarized Manufacturing Statement Month of Total Actual Cost for Month ^ooo.oo Total Standard Cost for Month $000.00 Net Increase or Decrease Comparing Actual witli Standard* $000.00 *Increases always shown in red and Decreases in black. 15 ANALYSIS OF ABOVE VARIATION EY CAUSES Variations in Fixed Charges Due to Fluctuations in Production Caused By : 1 Calendar variations $000.00 2 Idle time $000.00 3 Variation in number of operators $000.00 4 Variations in efficiency of operators $000.00 $000.00 Variations in Direct Labor Costs Due To : 1 Rates $000.00 2 Efficiency of operators $000.00 $000.00 Variations in Indirect Labor Costs Due To : 1 Rates $000.00 2 Hours $000.00 3 Extra pay for overtime $000.00 $000.00 Variations in Back-Work Labor Costs Due To : 1 Rates $000.00 2 Hours $000.00 $000.00 Variations in Stores and Supplies Due To : 1 Price $000.00 2 Consumption $000.00 $000.00 Variations in Power Cost Due To : 1 Cost of producing power $000.00 2 Efficiency of use of power $000.00 $000.00 Variations in Salaries Due To : 1 Rates $000.00 2 Number of salaried persons employed $000.00 $000.00 Variation in ^liscellaneous Expense $000.00 Net Increase or Decrease as above $000.00 Supporting the summarized statement should be detailed statements providing the executive with the fullest details as to the inefficiencies disclosed in total on the statement. For instance, if an increase in the salary expense attracts his atten- tion he should be able to turn instantly to a detailed statement which will show him exactly in which departments and positions such increase occurred. The essential idea underlving reports to executives should be the presentation of statements in such form that the unfavorable condition stands out prominently on the i6 summarized statement (for this reason cost increases under the author's methods are invariably shown in red ink) and the time is rapidly approaching when no executive worthy of the name will be satisfied to spend time in analyzing detailed cost state- ments in an effort to locate essential information which under a properly designed system should automatically and unmistak- ably be drawn to his attention. The system should of course show monthly the net profit realized from operations, gross profits being shown as to lines, specific articles, or under such classification as is best suited to meet the needs of the particular business. Furthermore, the statements should clearly indicate the extent to which fluctua- tions in profits have resulted from variations in the prices realized for the product and from variations in the cost of manufacture. 5 Sales Statistics The system should be designed to enable any reasonable refine- ment of selling efficiency data to be obtained. In particular, information should be provided showing the profits realized: (a) By salesmen (b) On different lines (c) By territories (d) By different classes of customers In addition, it should be possible to obtain expeditiously any combination of the above information, as for instance profits realized by salesmen on each line, or profits realized on different lines by territories, etc. In addition to providing for very complete data relative to profits and losses realized from actual deliveries to customers, the system should render it possible to obtain at least ap- proximately correct information relative to the profits which should be realized on orders accepted but not filled. The pre- determination of profits is a corollary to the predetermination of costs and though figures as to the former will be accepted by the wise executive with due reservation, properly used they should prove of the greatest assistance in his direction of the policies of the business. Furthermore, with a properly designed system the executive is furnished each month with full informa- tion as to where the actual results have varied from the estimates. 17 and as to the causes for such variations, so that he is enabled to adjust his plans to conform to fluctuating con- ditions. Whereas in the past executives were satisfied with receiving annual statements of profit and loss, and in the present are in many cases content to obtain monthly information as to profit actually realized, in the near future they will demand the predetermination in large measure of costs and profits. In place of working to a more or less nebulous end, each member of the organization will have definite standards to strive for, the extent to which such standards have been realized being reflected in the cost accounts and in the reports to the executive. Business men are gradually emerging from the retrospective to the prospective attitude and in the author's opinion, the accountant of the future will spend more time in making intel- ligent forecasts than in recording past events. 6 Cost of Operating the System The cost system should be economical as regards: (a) Executives, whose time in many organizations is wasted to an appalling degree in the endeavor to extract vital information from the mass of undi- gested cost data presented to them (6) Clerks (c) Shop employees, in particular as regards time spent in making out detailed time distributions, weighing material, etc. The importance of a system of cost accounting being designed with a view to conserving the time of executives has already been dealt with in preceding paragraphs. For a system to be economical as regards the number of clerks necessary to carry it along depends in large measure upon the judgment, ingenuity, and experience possessed by its designer and in this connection it may be mentioned that many manufacturers adopt a penny- wise and pound-foolish policy in entrusting the design of their cost systems to the men they expect to operate them afterwards. Such a policy is equivalent to expecting the designer of a steam engine to spend the balance of his life operating it, for it would seem to be obvious, if the matter is given any consideration, that an accountant possessing the imagination, training, and ability to successfully design cost accounting plans to meet com- plex conditions and to get the desired results with minimum operating expense will nut generally be open to a proposition to abandon the fascinating sphere of design for the useful but certainly less stimulating field of routine cost work. An important point to be considered in the drawing up of cost accounting plans is the proper coordination of the work of the cost department with that of the production and planning department, and in later chapters illustrations are given of coordinated cost, planning and production systems where this important recjuirement is given full consideration. Systems of cost accounting which demand the keeping by or for each workman of a record of the time spent on each stand- ardized operation he performs during the day result in the waste of a great deal of time of producers and in idleness of equip- ment in order to compile data v/hich in the majority of cases are of exceedingly limited value. The author has seen operators working on as many as twenty to thirty short-time operations in a day being compelled to walk fifty feet or more to a time clock every time they finished a job, and to this wasted time should be added that spent by the cost clerks in making minute distributions and postings of time to detailed cost-of-part cards to which reference was hardly ever made. There may be situa- tions where it is necessary to figure the elapsed time on every job a workman does, but if there are these are the exceptions rather than the rule. Much unnecessary work Is often called for in the operation of a cost system owing to the performance of needless weighing operations. Such superfluous work not only involves the direct expense of weighing but also the indirect loss resulting from the slowing up of manufacturing operations and in the cost of clerical work involved in recording this unnecessary weighing. It is hardly necessary to remark that complete and proper con- trol should be exercised over material but it will often be found that by the exercise of a little intelligent planning just as effect- ive control can be maintained by performing half as many weighing operations as were previously considered necessary. Very often considerable unnecessary expense is involved In the operation of stores systems particularly those In which stores accounts are carried both In quantities and money values for every Item of stock carried. The author recalls one Instance where an express bill for fifty cents was distributed over twenty different stores accounts. The case was exceptional, of course, 19 but there is no doubt that many stores systems cost at least twice as much as they should owing to this lack of a sense of relative values on the part of their designers. Manufacturers are apt to consider the cost of their cost departments to be confined to the pa}Toll of the cost department but this is practically never the case and the indirect expense resulting from an improperly designed cost system can very easily amount to a serious drain on a business. 7 Standard Practice Instructions The plan of the system and the details of its operaticm should be clearly laid down in diagram form so that employees can easily understand the routine involved and the relation of their work to the general scheme. There should be no possibility of things being done wrong owing to the absence of the clearest possible instructions as to the right way in which to do them. Under this head will come the provision for a complete descrip- tive card of accounts that will leave nothing to the imagination, for this, though a faculty of great value in certain conditions, is distinctly out of place in account distribution. The author has previously drawn attention to the fact that cost accounting plans suitable to meet the complex conditions presented by the modern large industrial establishment and cap- able of furnishing the multiplicity of results demanded, with a minimum of expense and without duplication of effort, must necessarily be complex in design but this in itself is not a serious matter provided the systems can be so drawn up as to render their operation comparatively simple. This result can be realized with the assistance of diagrams such as the author uses, numer- ous illustrations of which appear in this book, and through the aid of the formulas given in later chapters which render it pos- sible for the ordinary grade of office help to perform the most complex cost calculations speedily, accurately, and mechanically. It is naturally to be expected that the application of the prin- ciples of machine design in the field of cost accounting would develop results in the production of cost information similar to those realized from the development of machinery in factory production. In the latter case as the complexity of the machine increased the producing capacity of the lower grades of labor also increased ; bv the aid of modern automatic machinery a semi-skilled workman now producing better and infinitely more 20 work than could the skilled workman of an earlier period. In a similar manner the complex accounting structures developed by the author enable a lower grade of office help to produce more and better information than is possible under the simpler but less efficient forms of cost accounting. Speed and accuracy in cost accounting work can only be obtained by eliminating the personal element in the greatest pos- sible degree by rendering the routine work as nearly mechanical as possible. This principle is not only applicable to cost account- ing work — it touches all branches of human effort, for as A. N. Whitehead in his "Introduction to Mathematics" states: It is a profoundly erroneous truism, repeated by all copybooks and by eminent people when they are making speeches, that we should cultivate the habit of thinking of what we are doing. The precise opposite is the case. Civilization advances by extending the number of important opera- tions which we can perform without thinking about them. Operations of thought are like cavalry charges in a battle — they are strictly limited in number, they require fresh horses, and must only be made at decisive moments. The basic underlying defect in systems which are unduly expensive to operate will generally be found to be faulty design and the absence of adequate standard practice instructions. A cost system which everlastingly demands the making of decisions as to how this problem should be met and how that is like a faulty designed machine which is always breaking down and calling for minor adjustments. In the average cost department 95 per cent or more of the time of the chief cost accountant is consumed in supervising the routine work of getting out figures and only 5 per cent in making use of the figures after they have been compiled whereas the situation should be reversed and 95 per cent of his time should be spent in the interpretation of the figures and only 5 per cent in supervising their compilation. A Typical Plan of Cost Accounting In considering the more usual cost accounting methods in relation to the above requirements, it is necessary for the sake of clearness to take some specific case as a means of illustration and therefore in Figure 2 are shown the underlying principles of a cost system employed by a concern manufacturing a varied line of standard machinery, many of the parts of which are common to several machines and where accordingly parts are 21 (labor] (material (burden) 0PERAT0R5TIMECARD SORTED BY ORDER NUMBERS AND POSTED TO PART COST RECORD MONTHLY MATERIAL REQUISITION PRICED AT A VERA 6E COS T OF MATERIAL AND POSTED TO PART COST RECOnO PART COST RECORD BURDEN DISTRIBUTION ANALYZEDAND POSTED MONTHLY TO PART COST RECORD CHARGED MONTHL Y WITH LA50R MATERIAL AND BURDEN CREDITED WITH PARTS USED ON M AVERAGE COST BASIS PRICED ATAVEPA6E PR ICE ON PART COST RECORD AND POSTED MONTHL Y TO ASSEMSi Y COST RECORD PRICED AT AVERASE COST OF MATERIAL AND POSTED TO ASSEMBLY COST RECORD SORTED BY ORDER NUMBERS AND POSTED MONTHL Y TO ASSEMBLY COST RECORD ANALYZED AND POSTED MONTHLY TO ASSEMBLY COST RECORD ASSEf^SLY COST RECORD CHARGED MONTHLY WITH PARTS, MATERIAL LABOR AND BURDEN CREDITED WITH ASSEMBLIES WITHDRAWN AT AVERAGE PRICE (labor ] SORTED EY O^DER NUMBERS AND POSTED MONTHLY TO FINAL ASSEMBLY COST RECORD PRICED AT AVERASE COST OF MATERIAL AND POSTED TO FINAL ASSEMBLY RECORD ANALYZEDAND POSTED MONTHLY TO FINAL ASSEMBLY COST RECORD PR.'CEOATAVERAGE PRICE CN ASSEMBLY COST RECORD AND POSTED TO FINAL ASSEMBLY COST RNAL ASSEMBLY COST RECORD | CHARSED MONTHLY CREDITED WITHASSEHBLIES MONTHL Y WITH RAW MATERIALS SHIPMENTS LABOR AND AT AVERAGE BURDEN PRICE Fig. 2. — Diagram show-ing essential features of typical old style cost system for standard line of machinery'. S2 manufactured for stock and issued on assembly requisitions, this being a condition common to manufacturers of standardized machinery. It may be mentioned that the plan illustrated is still somewhat generally regarded as an efficient method of cost accounting. In considering this plan no attention is given to questions of burden distribution, etc., but merely to the basic method used in the determination of costs. Considered from the standpoint of the first of the require- ments enumerated above, namely, the obtaining of information relative to the cost of specific articles, it will be seen that under the plan illustrated a detailed account is maintained for the cost of each batch of parts manufactured. To the cost of these parts is charged the actual labor cost of the work performed thereon and the cost of the material used. Burden is distributed monthly to the cost of parts, part assemblies and final assemblies. Parts used in assemblies are charged to the assembly cost card on the basis of the average cost of such parts as shown by the parts' cost card. The cost of the assemblies includes also the cost of assembling material used and assembling labor and burden. The final assembly includes the average cost of part assemblies as shown by the assembly cost cards, assembling labor, material, and burden. The system now being considered is a typical example of what may be termed historical cost accounting the scope of which is confined to the ascertainment of information relative to costs actually realized. This being the primary purpose of this sys- tem, data obtained therefrom as to operating efficiencies being merely incidental, as explained later, the question naturally arises as to what is the value and what are the limitations of cost records compiled after the event. In a business such as that for which the system being described was designed, it is contended that information relative to past costs is of very limited value. The manufacture of parts being for stock, these parts being withdrawn as required for assem- bling, it will be understood that it is not only possible but highly probable that the parts included in any machine represent the result of manufacturing operations extending over a consider- able period of time, so that the final cost of a machine will represent a conglomeration of data involving material, labor and burden figured at the various prices extending over the period covered by the operations involved in the manufacture of the machine. Such a cost will in itself afford very limited informa- tion relative to the current cost of building a machine and with 23 fluctuating material prices and labor and burden rates a manu- facturer would certainly not feel justified in accepting a cost so compiled as the basis for making a selling price. Even if all of the parts required are actually on hand it would seem that the correct basis on which to figure selling prices would be that of replacement cost, not actual cost, for in the event of a falling market purchasers would expect to be given the benefit of the reduced material prices and correspondingly the manufacturer should be entitled to realize the profit resulting from purchasing material before the rise in price. The whole conception of a cost system which concentrates solely on the obtaining of data relative to past results is unsound and belongs to the days when the manufacturer was satisfied if some time after the end of the year his accountant presented him with a statement showing the annual net profits realized. To be able to operate a business with the maximum degree of safety and profit, before any work is undertaken there should be an intelligent estimate of what its cost will be, this estimate providing a standard of attainment and a definite incentive to economical manufacture. Under the plan described, in order to obtain reliable informa- tion as to current costs it is necessary to refigure the costs already compiled, on the basis of current conditions — a makeshift method for which the system is not adapted and one involving a great expenditure of time and considerable delay. The Difficulty of Shifting Costs of Labor and Material A system such as is being discussed may give fairly useful information as to costs during periods of a more or less constant condition of the material and labor markets, but in times of flux, as at present, such a system is liable to prove a danger in giving misleading information, which if accepted as correct may result in serious loss. Generally speaking, it would appear that this system gives little available cost data except for the purpose of valuing inven- tories and, even here, it may be questioned whether the costs so obtained should invariably be used for inventory purposes. Public accountants have adopted the principle of valuing raw material in inventories at current market price or actual cost, whichever is the lower, but it will be readily seen how difficult it would be under the plan described to refigure the material 24 included in work-in-progress and finished machines on a market basis, so that in the majority of cases the auditor, while adjusting the raw material inventory to take care of a fall in the price of raw material, will be inclined to accept the work-in-progress and finished work at their cost as shown on the records, owing to the difficulty of ascertaining the difference between the actual cost of the material included therein and the market value thereof. Considered from the standpoint of the second reasonable requirement of a cost system, namely, the furnishing of com- plete data relative to manufacturing efficiencies, it must be ad- mitted that the plan described fails totally to meet the demands. Hardly any other result could be expected when it is considered that the plan concentrates almost exclusively on obtaining costs and ignores the equally if not more important question of causes. The cost accounting methods generally followed are directed to a single purpose. As C. U. Carpenter states: "The possibility of ascertaining the cost of an article is often the only thought in the manufacturer's mind when the Cost System is mentioned, and is accordingly the only function that is developed." The Effort to Trace Causes of Cost Increases In a business such as has been described, a certain machine or batch of machines completed this month may show an increase in cost as compared with a previous batch, and the manufac- turing executive will call for information as to the cause under- lying this increase. This will result in an interminable and unsatisfactory investigation — comparisons of the costs of the individual parts will be made — this part is charged to this ma- chine at five cents more than the previous charge. Why? In any one part increases or decreases may be due to the combina- tion of a number of causes. For instance, in the month when the part was made the forge shop was not very busy so the burden rate of that department was increased. Or the work was done on a machine not suited to it, owing to the regular machine not being available. The machine used was more expen- sive to operate than the regular machine. Or again there was a heavy spoilage on that batch of parts owing to an incompetent operator or due to a defect in the material. The investigation of the increased cost of the machine being considered will call for a complete analysis of the costs of all 25 parts showing increases and it may be readily imagined how impossible it would be to bring to a focus informati(Mi so obtained as to increases in the cost of several hundred parts and probably five times as many operations. Furthermore, under this plan of only considering increases in costs, serious inefficien- cies may be overlooked owing to these being offset by the elimination of previous inefficiencies and consecjuently the total cost of a part remains approximately the same as before. In addition, it may be urged that comparisons with past costs though having their place and being of value when nothing better is obtainable are of minor importance contrasted with comparisons with standards based upon what the cost should be rather than what it was. After a few unsatisfactory investigations of this kind an executive will soon lose interest in obtaining efficiency data from an analysis of detailed costs, and the work of the cost depart- ment will become more or less perfunctory and resolve itself into the somewhat usual state of affairs where a mass of in- formation is compiled of which little use is made. It seems strange that this method of comparison should be regarded as being at all adequate to meet modern rec|uirements, but in a recent well-regarded book on cost accounting, discuss- ing the value of a detailed system of cost accounting to show the reason for not making a profit on an order for a machine, we find the following: But supposing that after all, it was found that we had not made a profit, but a loss instead. What should be done to discover the reason for this loss? The need for a comprehensive and detailed system of production orders, enabling us to ascertain the cost of each part or component of the machine would be forced upon us. And probably we should not be satisfied even with this. We should also require to know the separate cost of each process or operation on each dissimilar piece. Thus, if the baseplate were in question we should want to know the cost of the metal contained in it, the cost of molding, the total foundry cost; the cost of planing, drilling and hole slotting and scraping the sides, and whatever other opera- tions were performed on the baseplate separately. Only by doing so, and by being in a position to contrast such detail costs with the costs of similar pieces done on a previous occasion could we conduct our business intel- ligently and safely. It should be noted that the author cjuoted assumes that the above investigation and cost comparison will be undertaken after it is discovered that a machine has been sold at a loss when it should have realized a profit. There are those who may question 26 the value of such post mortems, especially when it is remembered that in many factories hundreds of different parts, involving thousands of separate operations, may be worked on in a month. Some information as to efficiencies is demanded by every progressive works manager, so the method of obtaining efficiency data by analyzing detailed costs proving ineffective, there soon develops a subsidiary system from which statements are pre- pared comparing the results obtained with more or less arbitrary standards. Among these we may mention our old friend the ratio of so-called non-productive labor to productive labor, which when used as a standard, results in every foreman scheming to include all labor under the head of productive, regardless of its real character. The Fallacy of Low Non-Productive Labor Percentage This brings to mind a case which came to the attention of the author where one factory was for years held up as an ex- ample to the rest of the factories operated by the same company because of its low percentage of non-productive labor. An in- vestigation, however, disclosed the fact that in this particular factory all employees working in the shop, including the fore- men, were reported as productive labor, whereas in the other factories foremen were reported as non-productive labor. A curious feature of such a method of comparison is that it entirely ignores the actual efficiency of operators so that all that is required to enable a foreman to make a most excellent showing, according to this standard, is to increase the productive payroll without increasing the production. In an actual case a foreman introduced an improvement in a machine which resulted in one man being able to do the work which formerly required two. The natural result in the month when this improvement went into effect was an increase in the ratio of non-productive labor to productive, for while the non-productive payroll remained constant the productive labor was reduced and as a consequence the foreman in question was sent for and solemnly reprimanded for his poor showing! Another favorite fetish of works managers is the ratio of piece work to day work. Where this false ideal is most con- sistently regarded it will be found that practically all jobs are piece work, and many cases have come to the attention of the author where the foreman did not have the remotest idea of 27 the time a job should take and issued it to a workman on an hourly rate basis. After the completion of the \vt)rk he wouKl divide the man's earnings by the production, reporting the result as the piece-work rate and the man's earnings as piece work instead of day work. The Injustice of Per Pound or Per Piece Factors A very usual form of presenting efficiency data is to show the departmental cost per pound or per piece of the product manufactured, whereas in many cases the variations in size and complexity of work cause legitimate fluctuations in cost amount- ing to five times as much as any possible variation in efficiency. Statements prepared on this basis are more often a source of irritation than a spur to efficiency. A foreman is sent for around about the end of the month and told that in the previous month his labor or tool expense per pound or per piece was so many per cent over the month previous. He immediately begins to rack his brain for some reason why this condition arose and probably remembers some particular order which gave him trouble and hopefully advances this as a reason for the poor showing. Of course, the cost system does not provide any specific information as to the causes underlying variations in costs so that the argument is more or less ineffective and the foreman leaves the cost department with a poor opinion of the cost system and with little faith in any information emanating therefrom. The author was partly responsible many years ago for the introduction of a system under which foremen were paid a bonus based upon the decreases in costs per pound or per piece in their departments. Undoubtedly, this plan had a good moral effect but the author now blushes to think how the system must often have rewarded the inefficient and penalized the competent. Primarily it was wrong, for it based its rew^ards on comparisons with results previously attained so that the worst organized department where savings could most easily be effected was the one where the greatest rewards were possible. In fact, given a department lOO per cent efficient at the start it would be theoretically impossible under this plan for any bonus to be earned at all. Again, any change in the character of work done in the department might quite easily result in legitimate cost variations per pound or per piece many times offsetting anv 28 possible variations resulting from fluctuations in efficiency. Furthermore, no distinction was made in the case of such items as stores or tools between increases and decreases in cost result- ing from variations in the price paid for stores and tools and those which were due to fluctuations in the efficiency of their use. Under this plan it would have been perfectly possible for a foreman to have earned a bonus because of a tool saving in his department, whereas more than the total of such saving might have represented a decreased cost resulting from a reduc- tion in the price of tool steel, the actual consumption of tools per unit of product having increased. The method described of showing information as to the cost of operating the departments of a factory in relation to standards is, of course, based on a perfectly correct idea, and the absurdi- ties referred to were only due to the absence of proper standards and of an adequate accounting mechanism for providing com- parisons of actual costs therewith. The almost universal at- tempts which are made to supplement the information produced by the detailed cost accounting methods are, in fact, excellent proof that the average works manager realizes the shortcomings of the detailed cost system In force and appreciates the fact that unless costs are shown in relation to some standard they are of little value as a means of increasing the efficiency of a factory. A criticism which is commonly made of the average cost system is the delay which is experienced in furnishing informa- tion to those for whose benefit it is compiled. Promptness in furnishing information is the third of the reasonable require- ments of a cost system, and in the system which is being criti- cized it would be difficult to provide data as to costs until some time after the close of the month, as it is inevitable under the plan employed for the bulk of the cost accounting work to be concentrated in the period immediately following the end of the month. The more promptly a system discloses inefficiencies the more cjuickly can the unfavorable conditions be corrected, and unless a system provides for daily reports covering the more important phases of the manufacturing operations it can hardly be considered suitable to meet modern requirements. The Inelastic Methods of Compiling Information A fundamental defect of most cost accounting systems is the inelastic method employed in compiling information. 29 Original data, are tabulated in such a manner that any rearrange- ment to meet any other need than the specific one for which the tabulation was made necessitates a complete, laborious retabulation by hand of the original data. By the employment of modern accounting machinery in conjunction with a plan scientifically drawn up to take advantage of the opportunities afforded thereby it is possible to arrange for any combination of original data to be obtained promptly, accurately and at little expense. The Defect of Lack of Focus An outstanding defect of the system being discussed and in fact of practically all detailed cost systems is in relation to the fourth requirement enumerated, namely, the necessity of a sys- tem of cost accounting being so designed as to render it possible to bring cost information to a focus for the benefit of the manu- facturing executive. From the comments already made on the particular plan described it will be evident that under such a method it would not be possible to compile a comprehensive statement which in a few figures would provide the executive with a bird's-eye view of the salient features of the month's manu- facturing operations. Executives who endeavor to make use of the information prepared for them by their cost department are engaged in a constant struggle to extract the essential facts necessary for their guidance in the operation of the business from the mass of detailed data presented to them, and it is hardly strange that they sometimes wonder whether the time and money expended in maintaining a cost department is really worth while. Reports to executives should be based on the principle of exceptions and in place of providing a mass of detailed and undigested information should be drawn up to indicate clearly and unmistakably w^here exceptional or abnormal conditions exist. The manufacturing executive should primarily be in- terested in information showing the trend of efficiencies and the reasons underlying fluctuations therein. An exactly opposite ideal is aimed at by the recognized detailed cost system for the basic purpose underlying this plan is to merge all expenses as far as possible into the detailed costs, so that the more nearly such a plan reaches its logical conclusion and the more complete and elaborate the methods of distribution the more inextricably 30 are inefficiencies buried in the detailed costs. In many manu- facturing concerns a serious cause of loss is due to spoilt work and the total loss from this cause is certainly information re- quired by the manufacturing executive, but the author has examined numerous detailed cost systems where such losses only showed on the cost records as affecting the cost per piece of the parts spoiled. The Importance of Sales Statistics When its importance is considered, it is a matter of surprise that so little attention relatively has been given to the ciuestion of sales statistics, the fifth caption in the list of recjuirements of a cost system. It is true that a great deal of data is compiled in many institutions covering, some phases of the activities of the selling organization and there are in fact few concerns of any size that do not possess records showing the gross sales made by each salesman and in each territory. It is rarely, how- ever, that reliable information is obtained as to the actual net pFofits earned by a salesman except in those cases where the product is a simple one and the figuring of the profits corre- spondingly easy. The direct result of this lack of information is that even salesmen who are not paid on commission strive more toward obtaining a large volume of sales than the realiza- tion of net profits. In a business handling a varied and complex product it is not feasible, of course, to obtain the somewhat extensive line of information specified in the list of requirements unless the system of cost accounting has been skillfully designed with this object in mind, and original data are compiled in such form as to render it possible by the use of accounting machinery to obtain expeditiously and inexpensively any combination of in- formation required. The actual money expended in maintaining any cost sys- tem has little significance unless considered in relation to the results obtained from the operation of the system. When both factors of actual outlay and benefits received are taken into account it will be found that the average cost system is unduly expensive. Not only is the actual cost con- siderable but the results obtained are of limited value. A detailed system of cost accounting such as has been described involves a great amount of clerical work not only in the cost department 31 but on the part of the workmen making out detailed time reports. In connection with the latter, as will be explained later, it is often possible to eliminate a great proportion of the clerical work performed in the shops and at the same time very much increase the utility of the information obtained. The relatively high cost of the average detailed cost system is largely due to the immense volume of comparatively useless information which is compiled and also to defects in the design of the system, for as previously stated a common fault of many cost systems is that basic information is tabulated in such a manner as to render it necessary to retabulate this by hand before any rearrangement of these data can be obtained. The Lack of Coordination Another cause of unnecessary expense in the operation of a system of cost accounting is the lack of coordination between departments closely allied. This applies particularly to the rela- tions between the cost and production departments which gener- ally operate independently in the use of the same basic informa- tion and where there is often found to be considerable duplication of effort. As will be demonstrated in later chapters the work of these two departments is so closely related that it should be considered as a single proposition and the two departments combined. There are few organizations where some loss is not experienced as a result of a lack of proper coordination between departments which should logically be intimately connected. An extreme instance of this kind was a case which came to the attention of the author where the general accounting and cost accounting departments of a large business were so far divorced from one another that each of these departments issued entirely distinct cards of account, this necessitating the analyzing of all shop expenses twice, once for the general books and once for the cost records. As regards the cost of obtaining the very complete line of information detailed in the list of reasonable requirements of a cost system previously given, it may be stated that in the majority of cases it is perfectly possible to operate a system under which these results can be obtained at an expense no greater, and probably less than, that required to maintain the recognized detailed cost systems. In some cases the author has been enabled to obtain the results desired at a verv great saving 32 over the expense previously incurred, but in any event it may be stated that the expense involved in operating an accounting plan properly designed to apply the principles of scientific man- agement is comparatively small considered in relation to the scope and value of the information obtained. Dealing with the last of the requirements enumerated, namely, the importance of complete standard practice instructions cover- ing the operation of a system of cost accounting, it has been found by the author that even in large undertakings there is a lamentable lack of such instructions. In fact, it is only occa- sionally that a case is found where the methods employed have been seriously and systematically analyzed and studied with a view to eliminating duplication of work and improving the methods generally. The lack of comprehensive instructions and detailed plans covering the operation of a system in its entirety is a source of considerable weakness to the average organization. This condition renders a business entirely too dependent upon the specialized knowledge of individuals and further holds back the development of the junior members of the organization by limiting their horizon to the performance of their specific duties. With complete standard practice instructions, however, not only is the danger of having work done incorrectly owing to the absence of definite written instructions eliminated, but further- more, when the plan of a system in its entirety is properly presented each member of the organization is assisted in seeing his particular work in its correct perspective. To an ambitious employee diagrams illustrating the routine work of the organi- zation can be of great value — not only do they render it possible for him to perform his immediate duties with a more intelligent understanding of their significance, but they also enable him to study the work of other members of the organization so that when the day of opportunity comes he is ready to take advantage of it. The Importance of standard practice Instructions Is being increasingly recognized in the field of shop practice, but in the sphere of cost accounting this and other principles of scientific management have been in a large measure neglected. In the author's opinion, however, the day is fast approaching when as much attention will be given to the application of these principles in the cost department as in the shop. Chapter II STANDARDS AND STANDARD COSTS THE use of standards by the human race dates back to the early dawn of civilization. The sparks made by a stone- age savage in chipping a flint arrow-head falhng upon some dry grass and setting fire to it resulted in the adoption of a standard method of producing fire, which was very little changed until the lucifer match was substituted for the flint and tinder of our forefathers' time. The savage who tiring of the effort involved in killing fish by means of a spear and who using guile in place of force took advantage of the greediness of his prey and made a primitive hook by lashing a piece of curved shell with fibre to a piece of bone or wood, introduced a standard method of catching fish, the principle of which is identical to that followed by the modern angler. The forward march of civilization has only been rendered possible by the adoption of standards. Standards passed on from father to son and from generation to generation represent the ratchets on the wheels of progress, and have enabled each forward step painfully and slowly made, to be maintained. Without the privilege of drawing on the accumulated experience of the race as represented by its standards, each individual would be compelled to start at the beginning and progress would have been impossible. Whereas the savage had very few and simple standards, as civilization developed standards increased in tremendous degree both as regards number and complexity, and in modern life the standards covering the multitudinous activities of human kind are of incalculable number. In dealing with the subject of cost accounting we are in- terested only in standards so far as they concern industrial life and here at the outset we are confronted with the fact that it is possible to have many standard ways of doing the same thing. Until recent years the standards followed by the various trades were largely rule-of-thumb or traditional knowl- edge and as Mr. Taylor stated in "The Principles of Scientific 33 34 Management" "Instead of having only one way which is generally accepted as a standard, there are in daily use, say, fifty or a hundred different ways of doing each element of the work." False Ideals and Standards In the management end of industry we also find a variety of standards or ideals, many of which are wholly false or at most only partly true. In some concerns the main standard appears to be a large tonnage and where this idea is most ram- pant, time and time again it will be found that at the close of the month light but highly profitable work will be relentlessly side-tracked, no matter how urgently recjuired by the customer, in order to manufacture some relatively unprofitable but heavy material for which there is no immediate demand but which will enable the month's tonnage production to appear in a favorable light to the directors. We are all familiar with the wild scramble in many shipping rooms at the close of the month to get out as many goods as possible in order to swell the month's ship- ments and it would be difficult to estimate the number of mis- takes which are a result of this somewhat misguided enthusiasm, due to the setting up of a false or at least an inadecjuate ideal or standard. Reference has previously been made to other false ideals or standards common to manufacturing institutions, such as at- tempting to realize as high a percentage as possible of piece work, or of so-called productive labor, but while such standards are to some extent founded upon knowledge gained from practical experience they present a dangerous tendency to grasp at the shadow and lose the substance. This is particularly so as regards the introduction of piecework rates on a large scale without proper consideration. The fundamental idea underlying scientific management is the substitution of definite, scientifically determined standards for all these nebulous ideals, and clearly defined methods of reaching these standards instead of haphazard and rule-of-thumb methods. This obviously applies to all phases of scientific man- agement such as time and motion study, standard practice in- structions and planning and dispatching methods. It is the province of the engineer to determine the standards for use in the shops and to provide for proper methods to be adopted for the realization of these standards. 35 In view of the complexity and number of standards employed, it is obvious that some means must be provided for showing the extent to which the results actually obtained conform to the standards set up, and this demands the maintenance of records. It is the province of the accountant to provide and carr}' along such records. The Division of Responsibilities of Operating and Accounting Divisions It would seem well at this point to emphasize the importance of a correct division between the responsibilities of the operating and cost divisions as regards the design and operation of the cost system, for there is probably no problem of organi- zation concerning which such varied views are held as this. Some accountants take the extreme view that the factory organ- ization should have nothing to say as regards the cost system and should be absolutely dependent upon the judgment of the cost accountant as to the extent and character of the cost information to be furnished the factory. On the other hand there are factory executives who regard the compilation of cost information as being purely a shop proposition and who operate cost systems which are entirely independent of the gen- eral accounting system. It would not be difficult to prove that the standpoint of each of these classes of extremists is an incorrect one — there can be no justification for the attitude of those accountants who regard the cost system as being merely an appendage of the financial department and it is this restricted viewpoint of many accountants which has done more to dis- credit cost methods generally in the shops than probably any other factor and has called forth such criticisms as the following made by the late ]\Ir. Gantt when he said: Most of the cost sj-stems in use and the theories on which thej' are based have been devised bj' accountants for the benefit of financiers whose aim has been to criticize the factorj^ and make it responsible for the shortcomings of the business. In this they have succeeded admirably — largely because the methods used are not so devised as to enable the superintendent to present his side of the case. It is doubtless this arbitrar\- and narrow-minded attitude of many accountants that has caused some factory executives to swing to the other extreme and regard the cost system as coming solely within the province of the operating division. As J\lr. Franklin states: 36 While the accuracy of unit order of article cost may not be absolute, the cost of total product can and should be proved absolute. This can be done only by connecting it with the accounting or bookkeeping methods. . . . Any plant without such connection has clearly not understood the cost problem. No factory superintendent of real calibre would wish however to be bothered with the responsibility of a cost system if while being relieved of this he could be assured that all reasonable requirements which he might make of the accounting division for information would be satisfactorily met, and accountants have only themselves to thank in most cases for encroachments on their territory. The function of the cost department is purely that of service to the administration, selling, financial, and manu- facturing divisions of the business, and no system of cost ac- counting can be considered as completely meeting the require- ments of modern industry unless it meets all reasonable demands of these divisions as regards furnishing prompt, accurate, and comprehensive information as to the operation of the business. Fortunately it is possible to draw a clear and logical line of demarcation between the functions of the operating and account- ing divisions in connection with a system of standard cost ac- counting, their relations to the system and to one another in connection therewith being definable as outlined in the following paragraphs. The Function of the Operating Division It is the function of the operating division to set the standards which will be used as the basis of the cost system, to determine for instance the capacity of the different producing departments, to furnish information relative to the standard routings followed by the product, to set time standards for the performance of manufacturing operations, to determine the number of pounds of steam which should be produced from a pound of coal, etc., and in brief to set standards for all manufacturing operations. It is also the function of the operating division to fully advise the accounting division of its requirements in connection with cost information. The operating division should likewise furnish such reports and information as are necessary for the operation of the system. It is not liowcver the function of the operating division to design accounting systems or forms independently of the accounting division. 37 The Function of the Accounting Division It is the function of the accounting division to cooperate with the operating division in connection with the compilation of standard data to the extent of furnishing information obtainable from the records of the cost department. It is further the duty of the accounting division to perform such purely clerical work in connection with standards as, for instance, classifying the standard data furnished by the operating division in such form as to meet the reciuirements of the accounting division. It is furthermore the duty of the accounting division to compile schedules fully covering the information it desires the operating division to furnish. The actual designing of the cost system and the drawing up of forms and standard practice instructions in connection there- with is solely and absolutely a function of the accounting division and of its professional advisers. It is the function of the accounting division, as far as is con- sistent with sound accounting and business principles, to meet the desires of the operating division as regards the character of the cost information to be furnished and the form in which such information is to be presented. It is/the function of the accounting division to maintain com- plete records covering the cost of all operations — to carry such records both at actual cost and in relation to the standards determined by the operating division, and also to analyze the differences between actual and standard cost by causes and to render periodical statements to the operating division in the form agreed upon and at the times set. For instance, it is the function of the accounting division to advise the operating division as to the extent of an increase in cost owing to less than the standard number of pounds of steam per pound of coal being produced, to an increase in the purchase price of coal or in the time consumed in manufacturing operations — in brief to advise the operating division of all divergences from standard and the cause of such variations as disclosed by the cost records. It is not, however, tJie function of the accounting division to set operating standards. The above remarks relative to the respective authorities and responsibilities of the accounting and operating divisions do not represent merely arbitrary, personal rulings. The division there made is based upon fundamental principles. To take for in- 38 stance the statement as regards the design hig of cost systems and forms being purely the function of the accounting division. A system of cost accounting is analogous to a machine, in fact, it is a machine for the production of cost information. A machine represents an arrangement of parts coordinated to give the results required with the minimum expenditure of power and loss of friction. Obviously, in the design of a machine the designer must have in mind not only the individual functions of the respective parts but also the relation between these parts and the machine or system as a whole. To attempt to have some parts designed by one individual with a viewpoint largely restricted to the function of these particular parts without refer- ence to the machine as a whole, and other parts designed by some other person similarly situated cannot but result in the system being lacking in coordination and proving less satisfac- tory in operation than would be the case if the basic principles of designing had been followed. Failure to conform to these principles invariably results in the operating and accounting divi- sions duplicating information, in unnecessary expense and con- stant irritation. The statement that it is not part of the functions of the accounting division to determine standards also calls for little argument in its support. Such standards as the accounting divi- sion would be in a position to set must necessarily be largely based upon records of past experiences, and though data as to past performances are of interest and of value in determining the trend of costs, such data are not suitable for use as standards in the sense in which this term is used in this book. The setting of cost standards calls for engineering and operating experience which the accountant per se is not often in a position to obtain, but in any event if he should possess such experience in any degree this is merely incidental and does not bring the setting of standards within the domain of the functions of the account- ing division. In large manufacturing businesses, the author has found that most satisfactory results can be obtained by placing in the cost department a representative of the operating department who forms a link between the accounting and operating divisions and whose main functions are to supervise the compilation of stand- ards and to ensure that cost and efficiency information produced by the cost department is given proper attention by the operating division. He also acts as an interpreter of the cost figures. 39 The Relatiox of Standards and Records Standards and records are as inseparable ideas as latitude and longitude, debit and credit, east and west. Standards with- out records are as ineffective as firing at a target would be if the marksman had no means of determining whether he was making hits or not, and, vice-versa, records withinit standards would be equivalent to carefully recording the result of every shot but giving the marksman no definite target at which to aim. With standards and no records we are in the position of a traveller with a time table and no watch, while conversely with records without standards we are in the position he would be with a watch but no time table. A very common illustration of standards without records is presented by the concerns who issue many rules and instructions but proAide no systematic method of ascertaining whether such instructions are followed, with the inevitable result that they are "more honor'd in the breach than the observance," and in the innumerable systems which are operated in a way far dif- ferent from that originally intended. As INIr. Gantt states: !Many shops have a very nice schedule system ; they plan their work beautifully — at least, it looks very pretty on paper, but they have no means of finding out whether those schedules are lived up to or not. Usually they are not. The majority of cost accounting systems are representative of records without standards with the result that a great pro- portion of the information compiled is meaningless and value- less, as the data obtained not being shown in relation to any standard of attainment are largely without significance. A further illustration of the use of records without standards is that of the riian who keeps the most minutely detailed account of his personal expenditures, but has no budget. The result is that having no definite scheme of saving, his accounts do not materially aid him in this connection, but merely provide him with the sad history of where his money went. Numerous illustrations of standards combined with records present themselves among which may be mentioned: taximeters which show the actual amount earned figured at a standard rate for a certain distance; the time book on which a red line is ruled at the opening hour, all persons signing above the red line being on time and all under late ; or the recording time clock 40 which shows in printed red ink figures all cases of tardy arrivals, or variations from standard. The budget systems of finance when properly carried out are perfect examples of the effective- ness of combining standards and records, the standards being the appropriations made for the various purposes and the records showing the extent to which the actual payments made conform to these standards. The average office affords an illuminating illustration of operations being performed with neither standards nor records. In many offices those in charge have but the vaguest idea of the volume of work which should be performed in a day and maintain no records showing the work done by individuals, with the result that office help generally is notoriously inefficient. The average office employee adjusts his pace to meet the immediate demands upon him as represented by the work ahead. The author calls to mind a case which came to his experience where in a seasonal business the sales in three months of the year aggregated as much as in the remaining nine months, yet in spite of the very small amount of work requiring to be per- formed by the bookkeepers during the slack months they ap- peared just as busy as during the heavy shipping season. The application of the principles of standards to cost account- ing necessitates the predetermination of costs — that nothing should be undertaken without its cost having been calculated in advance. It changes the whole viewpoint of cost accounting from retrospection to prospection. Can Costs Be Predetermined? The argument may be advanced that it is not possible to predetermine costs, particularly in jobbing shops and industries manufacturing a non-standardized product, but any doubts that the reader may have in this connection should be dispelled by the testimony of Mr. W. B. Ferguson, who in his valuable book "Estimating the Cost of Work" demonstrates the feasibility of predetermining costs in so difficult a class of work in this respect as that of ship repairing. In an article appearing in Tlic Journal of The American Society of Mechanical Engineers on the relation between produc- tion and costs the late Mr. Gantt made the following statement relative to the feasibility of predetermining costs: ... it should be possible for a manufacturer to calculate just what 41 plant and equipment he ought to have, and what the staff of officers and workmen should be to turn out a given product. If this can be correctly done, the exact cost of a product can be predicted. Such a problem cannot be solved by an accountant of the usual type, but is primarily a problem for an engineer, whose knowledge of materials and processes is essential for its solution. Having made an attempt to solve a problem of this type, one of the most important functions we need a cost system to perform is to keep the superintendent continually advised as to how nearly he is realizing the ideal set, and to point out where the shortcomings are. The strongest objection to this method of cost accounting will probably come from cost accountants lacking the practical experience necessary to estimate the cost of work, but as sug- gested in the quotation just given it is not the province of the accountant to set up standards, it is primarily that of an engineer or an experienced shop man working in conjunction with the accountant. Even though there may be cases where sometimes it is difficult to obtain a very accurate estimate of the cost of doing any work it is contended that any estimate carefully made is far better than none at all. It at least gives some incentive to work to. In cases where bids are made for contracts, there is no argument as to the necessity for predetermining costs, and this rule applies in any case where the price is made in advance. It is of course a well-known fact that the cost-plus method of remunerating contractors was extensively employed by the gov- ernment in the construction of war camps and war plants. In a recent article in the New York Tribune it was stated that this system was adopted ''because of the necessity for haste in the construction of war establishments and because of fluctuating cost of materials and labor, which would have made contractors reluctant to assume obligations involving millions of dollars on their own accoinit. . . . By this system the government furnished everything and paid all costs, depending upon the contractor to do the work efficiently and expeditiously and with as much economy as possible." It would be difficult to conceive of any system more perfectly adapted to defeat the purposes enumerated than the cost-plus plan which in offering a premium for incompetency and waste is obviously fundamentally unsound. That the system would result in appalling waste was inevitable and that it did so is now a matter of history. In this connection the following from the article alreadv mentioned is illuminating: "Army training camps cost the government $1,200,000,000. 42 Contractors net profits were about $22,000,000. Sworn testi- mony after the armistice elicited, for example, at Camp Grant, that there was reckless 'cost-plus' construction. Four thousand carpenters were hired where 2,000 would have sufficed and would have completed the work possibly in less time at less cost. Labor- ers were paid 60 cents an hour, and when discharged as ineffi- cient were rehired as carpenters at $9.60 a day. Cement and nails were ruined in great quantity by weather. Workmen loafed and at the end of the day would throw their tools in the mud, receiving new tools upon request. "At Camp Sherman, Chillicothe, Ohio, evidence elicited that hospital plumbers loafed and gambled through weather 28 de- grees below zero, while soldiers contracted pneumonia and died in great numbers. Joseph E. Poole, who had been employed at Camp Sherman, testified that nurses and doctors clad in sheep- skin and fur coats attended sick soldiers lying in frigid buildings because the steamfitters refused to work on the heating system, and loafed in order to make the job last longer and the pay greater." The cost-plus plan was the line of least resistance and was in some measure rendered necessary by the fundamental defects underlying the common conception of cost accounting principles. The argument advanced above that it was necessary to adopt this plan "because of fluctuating cost of materials and labor" is absurdly inadequate when we consider that "the government furnished everything." The price of nails may fluctuate but not the number of pounds of nails necessary to construct a building according to specifications — the hourly rate for carpenters may vary but the number of nails a carpenter should be expected to drive in a day is not dependent upon the price of labor. If instead of being rewarded in direct ratio to their inefficiency the contractors had been paid a fixed amount for their services plus a substantial bonus for speed and economy in the use of material and labor the country would have been saved untold millions. Any engineer will testify that it would have been pos- sible to have very closely figured the labor and material recjuired to construct the camps and certainly no very great difficulty would have been experienced in instituting systems of cost accounting which would have clearly shown how closely the contractor adhered to the standards set and how much bonus he was entitled to for handling the work economically. Of course, to some extent predetermined costs are used in all manufacturing concerns of any magnitude, this applying 43 particularly to plant improvement work where it is the usual practice to make an appropriation Ijasecl upon the estimate of the man in charge of the work. Any plant manager can testify as to the difference in the manner in which construction work will be handled when there is a definite cost figured in advance and the engineer in charge held accountable for keeping to the figure of the appropriation, and where there is no standard fixed and no incentive to keep the cost to any definite figure. This principle applied to all work performed will have the same effect as regards economical manufacturing. In a concern where standard costs are used, instead of working haphazardly toward more or less nebulous ends, every member of the organ- ization is provided with definite incentives, responsibilities, and records of accomplishment. In the majority of standardized industries such as that of the manufacture of automobiles, the price of the article to be sold is often set long before it is manufactured in sufficient quantities to enable compiled detailed costs to be a guide to the cost under quantity production conditions. Often the price of an article is set immediately the experimental model has been approved. Standard Costs the Fundamental Improvement The author joins issue with Benjamin A. Franklin's statement that the installation of adequate methods of cost accounting is the basic and fundamental factory improvement. The in- troduction of a system of standard or predetermined costs should, in the author's opinion, precede the introduction of scientific management in the shop, such as in the installation of methods of planning and dispatching. This particularly applies to those organizations where the will to be efficient is not fully developed, for the operation of a cost system along the lines mentioned will to a large extent of itself force upon such an organization the necessity for adopting the correct view- point and scientific management methods. Once such a system of accounting is installed, the work of the efficiency engineer is greatly facilitated, and he can then introduce his changes gradually and with the full knowledge that the accounting system will at all times enable him to determine the extent to which his work is successful. The substitution of the scientificallv calculated standards of the engineer for the 44 more or less arbitrary standards previously in force will present no particular problem. Just as electricity is a standard form of power the uses of which are universal and far-reaching, so are scientific standards of operation of manifold usefulness. In brief, standard costs serve the following: 1 The foundation for setting selling prices 2 The incentive to manufacture for the price set 3 A gage of efficiency in manufacturing 4 A gage of selling efficiency 5 A common unit of measurement so that all cost informa- tion can be brought to a focus By their scientific employment standard costs can be made to give results not possible in systems where they are not used. For instance, in a concern manufacturing a line of standard machines it is possible to adjust a standard cost to the basis of actual conditions with great facility. The advantage of having some common unit of comparison for cost purposes will be evident to any manufacturer who has endeavored to bring to a focus the information presented to him by his cost department. This ideal is easily realized, of course, in the case of the manufacturer of a simple product, such as cement, where all cost data are naturally given in rela- tion to the number of barrels of cement manufactured — labor so much a barrel, repairs so much, power so much and material so much. By the use of standard costs, however, the cost state- ment of a manufacturer of a line comprising several hundred machines, thousands of parts and tens of thousands of opera- tions can be expressed as simply as those of the cement manu- facturer, all costs being shown in relation to a common unit of measurement, namely, the dollar of standard cost. Cost Accounting and Labor Though it obviously does not come within the province of a treatise on cost accounting to deal exhaustively with the ques- tion of the relations between capital and labor, cost accounting methods are so intimately bound up with the conduct of indus- trial affairs that no v/ork treating of cost accounting as a con- structive force can be considered in any way complete which 45 does not give some attention to the bearing of cost accounting on the future relations between capital and labor. Students of industrial progress are agreed that we are prob- ably on the threshold of an era of material prosperity such as the world has never before seen. Within our reach are veins of wealth which when tapped will produce a flow of riches which will place the world in an economic position compared with which our present state must be regarded as one of com- parative poverty. W'e have in our possession the means of doubling our present production of wealth, and of raising our standard of living; before us lies a clearly marked road, which, if we elect to follow it will bring us to a modern Utopia where men will work less hours and reap greater profits, and the human race at last come into its full inheritance. Frederick Taylor in "The Principles of Scientific ]\Ianage- ment" makes the following statement: The general adoption of scientific management would readily in the future double the productivity of the average man engaged in industrial work. Think of what this means to the whole countrj-. Think of the increase, both in the necessities and luxuries of life, which becomes avail- able for the whole country, of the possibility of shortening the hours of labor when this is desirable, and of the increased opportunities for education, culture and recreation which this implies. And there w^as probably no one better qualified to speak with authority in this matter than the late Mr. Gantt, to whom Charles W. Wood in "The Great Change" attributed the following: If our industrial machine were made to run at top-speed and maximum capacity, according to the laws of production which have already been discovered, America could win the war, pay for it out of hand, live in comparative opulence while we are doing so and be immensely richer at the close than we were ever before. On the whole only about 50 per cent of our industrial machines are actually operating during the time they are expected to operate ; and on the whole these machines, during the time they are being operated, are producing only about 50 per cent of what they are expected to produce. This brings our productive result down to about one-fourth of what it might be if the machines were run all the time at their highest capacity. This conclusion is not a guess, but is based upon reliable data. Unfor- tunately there are many other elements of unnecessary waste in our productive processes which cannot be so accurately calculated but which reduce our effectiveness certainly to 20 and very probably to 15 per cent. In "Man to Alan," John Leitch writes as follows: My own opinion is that, considering the country as a whole, we have not during the past ten or fifteen years, secured more than 40 per cent 46 of our labor efficienc}'; that is we have wasted probably 60 per cent of our manufacturing capacity. This is a stupendous waste — far greater than the wastage of war and it acts and reacts through our whole national organization. It prevents a just measurement of wages, lengthens hours unduly, and makes production costs and consequently sales prices unreasonable. The average commodity going through no particularly minute fabrication doubles in price from the raw material to the consumers, so this deplorable state of affairs hits everj'body. And Frank A. Vanderlip, President of the National City Bank, states: There is good reason to believe that if in every department of production the efiiciency of all labor were raised to the standard of the best present practice, the industrial output of this country would be doubled. Experi- enced industrial managers of wide observation go so far as to say it could be quadrupled, but if it should be increased 25 per cent, or even ID per cent, by simply doing our work by better methods, all the cost of the war would soon be made up. In the light of the above statements it does not seem far fetched to compare the old attitude of capital and labor toward each other to that of two dogs fighting over a bone and leaving untouched a large juicy steak lying just under their noses. Entirely aside from the ethics of the matter, however, it is obvious that unless a fair distribution of the benefits derived therefrom is guaranteed to labor, capital can never obtain its cooperation in the adoption of the necessary steps towards in- creasing efficiency. These are days when momentous changes are in the air, as the late George W. Perkins wrote : . . . we are entering a new period of relationship between capital and labor. In the long ago this relationship was that of owner and slave; then came the period of master and man ; then the period of emplo3'er and employee, each period being a decided step forward. I believe that we are just now entering a period of co-partnership, when the tool user will be part tool owner and when capital and labor will share more equitably in the profits of the business in which they are jointly engaged. Mr. Perkins, as is well known, was a strong advocate of profit sharing in its true sense, which he defined as follows : By profit sharing I do not mean bonus giving. I mean actual profit sharing based on the earnings of the business, with a fair percentage to capital and a fair percentage to labor after ordinary wages and interest have been earned. Profit sharing can be practiced satisfactorily only when the business concern makes its transactions public, so that the laborer 47 and the stockholder can know as much about the business as the manager himself. In the adjustment of difficulties between capital and labor I am confident that open books will accomplish much more than open shops. But much as he respects Mr. Perkins' judgment in other matters the author must confess that in his opinion Mr. Perkins overrates the capacity of the average working man to perceive the relationship between causes and their uUimate effects. The ordinary human being is so constituted that to call forth his best efforts demands that there should be some clearly shown direct relationship between these efforts and their reward, and it calls for no little powers of imagination for a worker at the bench to see any direct relationship between his personal effi- ciency to-day and the annual profits of the huge corporation which employs him. For the laborer to "know as much about the business as the manager himself," to use Mr. Perkins own words, calls for a higher calibre of mentality in laborers than they usually possess. Uncjuestionably, a policy of profit sharing creates a community of interest between employer and employee which is of tremendous value in the establishment and maintenance of harmonious relationship, but if the object in view is the raising of the efficiency of an organization to a lOO per cent basis in the author's opinion at least, this cannot be accomplished by any general distribution of profits. In one respect, however, profit sharing presents an advantage over a plan under which there is a more direct relationship between the personal efforts and reward of the employees. The introduction of a system of profit sharing is a comparatively simple matter — the directors decide, for instance, that all profits over 5 per cent on the capital stock shall be divided between the stockholders and the employees on a 70-30 basis or in any other proportions that may be decided upon — a notice is then sent to the employees advising of the action taken by the directors and the matter then resolves itself into a simple matter of book- keeping. On the other hand, the introduction of a system whereby the employees are to be rewarded in accordance with their efficiency calls for the determination of standards for all activities and the installation of methods of accounting which will furnish reliable information relative to variations from these standards and which will distinguish between cost variations over which the employees can properly exercise control and those which are dependent upon causes outside of their sphere of influence. 48 In the author's opinion, John Leitch more nearly approaches the solution of the problem in his "Industrial Democracy" plan, in any event there is a more direct relation between the worker's effort and his reward under this plan than there is under the general profit sharing plans which Mr. Leitch criticizes as follows : After a long investigation of many systems I have concluded that it is unfair to permit the compensation of the worker to depend upon any factor which he does not control ; he may do his work well and find that there are no profits because the company did not sell at a proper price, or granted improper credits, or did any one of the thousand things which lose money. If under profit sharing he does his work and gets no dividend he is very properly dissatisfied. Mr. Leitch's plan for giving the worker a direct interest in the business is to share with him the savings resulting from economies. This plan in his own words is as follows: Here is how it works in practice. I take the cost of a unit of production in the period preceding the introduction of Industrial Democracy and compare that cost with the results after democracy has gone into effect. If there is a saving, then one-half that aggregate saving is the amount of the economy dividend for the period and is paid to the men as an added percentage to wages. This is a dividend upon service. It should be paid at intervals not longer than two weeks, to preserve it as a matter of current every-day interest. There is sound psychology underlying Mr. Leitch's plan — consider for a moment the stimulus of a two-weekly distribution based upon the actual results realized by the workers compared with that resulting from an annual dividend based largely upon a showing over which the worker may have little control. In a factory where Mr. Leitch's plan was operating, there would be little need of close supervision by the management of the individual worker, for this would be undertaken by the workers themselves. The author once visited a small factory where the proprietor saved the expense of checking the employee's piece work earnings by letting the workers calculate these themselves and post them on a board in a conspicuous place in the shop, relying on the fact that any worker who overstated his earnings would be called to account by his fellow workers. If this plan worked successfully, and the manufacturer who used it claimed that it did, how much stronger would be the moral effect of a plan like Mr. Leitch's where an employee to get more than was due him would be robbing his fellow em- 49 ployees! As to this feature of his plan, Mr. Leitch has the following to say: The man who came into that shop and acted as if he were working for and not with the boss soon got his awakening. The men held a slacker as no better than a thief for he was stealing from them by helping to cut down dividends. Now it will be obvious to students of accounting that the ordinary systems of cost accounting are totally unsuitable to meet the accounting demands which would be made by Mr. Leitch's or any similar plan. The great majority of cost systems are designed with one purpose only in view, namely, the ascer- taining of the cost of the articles manufactured, and are so absolutely inelastic that it is a hopeless matter in most cases to apply them successfully for any other purpose than the narrow one for which they were created. There is something almost sublime in the lofty manner in which engineering and other non-accounting writers dispose of the complex accounting problems which touch upon their own undertakings. Mr. Leitch is no exception to this rule — he devotes a single brief paragraph to explaining how the trifling detail of the accounts is handled and then hurries on to matters of greater moment. What he has to say on the subject of accounts is as follows: Now for the first question — the calculation of the dividends when costs are rising. Economy is a relative term. I calculate the relative saving in cost of production. Suppose wages, materials, etc., have risen 50 per cent over a former period but production costs have gone up only 30 per cent — then have not the production costs relatively decreased? I take it that they have and award dividends upon this basis. Simple, is it not? First we "take the cost of a unit of produc- tion in the period preceding the introduction of Industrial Democracy" and then we "calculate the relative saving in cost of production" and that is all there is to it! Obviously, the whole question of justice to the management and the worker depends upon the accuracy of the method of figuring the saving, and if Mr. Leitch wished to be really helpful to those who desired to put his plan into effect it would seem as if a little more practical information on this subject would have been distinctly to the point. A test of the soundness of any general theory is whether it is capable of universal application and in the final analysis so Mr. Leitch's method of figuring "economy dividends" will be tried in this crucible. Taking the case of one simple product, for instance that of cement, no particular difficulty should be experienced in figuring the "cost of a unit of production" and the "relative saving in cost of production" along the lines Mr. Leitch suggests, but how does he propose to figure those things in the class of undertaking with which the author is most familiar, where a single factory will manufacture thousands of different articles involving tens of thousands of different opera- tions and at the end of a two-weeks' period the factory floors will be loaded with work in process in various stages of manu- facture? Is it then a simple matter to figure the cost of all the different units of production and the "relative saving in cost of production" every two weeks? Another question, and that is whether Mr. Leitch's methods are intrinsically just. Assume, for instance, that there are two factories which previous to the introduction of "Industrial Democracy" are respectively 25 and 50 per cent efficient and that after "Industrial Democracy" is in full blast they both reach an efficiency of 80 per cent. That is to say, productive operations which on a basis of 100 per cent efficiency should cost $100 before the introduction of "Industrial Democracy" cost $400 and $200 respectively, and that afterwards the cost in both factories is reduced to $125. In the first case, for every hundred dollars' worth of production, figured on a 100 per cent efficiency basis, the workers will receive one-half of the saving of $275 or $137.50, while in the second case they will only receive one-half of the saving of $75 or $37.50. The example may be an extreme one, but the principle applies, and considered from this viewpoint ]\Ir. Leitch's plan, though providing a reward for ultimate competency, also furnishes a premium in proportion to the original incompetency. Imagine ]Mr. Leitch's plan in more or less universal operation and it is reasonable to suspect that there would be difficulty in getting workers for a factory which was operated with a fair degree of efficiency previous to the introduction of "Industrial Democracy," for obviously it would be far more profitable to work for the concerns which were most hopelessly inefficient previous to the adoption of Mr. Leitch's methods. In using past results as his basis of comparison, Mr. Leitch's methods cannot but be considered as a step backwards. The whole conception of modern industrial thought as represented by scientific management is based on the setting of standards of SI possible attainment and Mr. Leitch's plan of making his com- parisons with past results is in line with the fundamental defect in cost accounting methods generally which are confined to recording and comparing past accomplishments expressed with- out relation to standards. A really equitable plan for the sharing of savings resulting from increased efficiency demands first the determination of standards for all operations — standards of time, of material con- sumption, and of quality of product, and second a really scien- tific system of cost accounting which in addition to showing the actual efficiency realized will enable a clear distinction to be made between the effect of factors over which the workers have control and those which are beyond their power to influence. Furthermore, the cost system should have constructive value in pointing out the causes contributing to a failure to realize the standard set. In addition, the plan should be such as to enable comprehensive statements to be furnished the workers in such form as to be intelligible to them. As Mr. Perkins states, "open books will accomplish much more than open shops" and it is easy to believe that we are approaching a time when manufac- turers will realize that it is a good policy to take their workers to a greater extent than before into the councils of management. It is hardly consistent to keep workers entirely in the dark as to the fundamental facts of business and then to complain that through ignorance of these facts they sometimes make absurd and unjust claims. The ignorance of the average worker of fundamental economic facts, if somewhat appalling, is not sur- prising when one considers how little opportunity he has to become acquainted with these facts, and how distorted is the information which is often handed him by his leaders. The essential features which a cost system should possess in order to furnish the means for ecjuitably figuring savings in costs for distribution to workers, which were enumerated above, are also those which a manufacturer should demand of a cost system to meet his own requirements in connection with the management of his business. These requirements ^re met by the scientific methods of standard or predetermined cost account- ing described in this volume. 52 The Influence of Scientific Methods on Industrial Progress Our present civilization differs from all previous civilizations in one fundamental respect. Ancient civilizations rose to a certain point and then having failed to find the key to con- tinued progress advanced no further and ultimately crumbled to ruin. Excavations made on the site of ancient Nineveh revealed great libraries of books consisting of bricks and cylinders of various sizes with inscriptions transcribed on them while in the state of clay and rendered indelible by subsequent baking, some of the tablets discovered dating as far back as 4500 B.C., while Assyriologists in general are inclined to believe that a high state of civilization had been attained in Mesopotamia at least 9000 years ago. The significance of these discoveries was well described by the historian William Gates when he wrote : We may note at once how these new figures disturb the historical balance. If our forerunners of eight or nine thousand years ago were in a noonday glare of civilization, where shall we look for the much talked of "dawnings of history" ? By this new standard the Romans seem our contemporaries in latter day civilization; the "Golden Age" of Greece is but yesterday; the pyramid-builders are only relatively remote. The men who built the temple of Bel at Nippur in the year (say) 5000 B.C., must have felt themselves at a pinnacle of civilization and culture. The "open sesame" to the door of progress, which the ancients lacked, and the factor which rendered possible the remarkable advance in knowledge of recent centuries was the development of the scientific method — that process of trial and error under which each tentative theory advanced is submitted to the check of experiment and accepted or rejected on this basis. The Greek philosophers failed to develop scientific method, owing to their tendency to formulate broad, general theories without submitting these to the acid test of experiment, so that they would, build up an elaborate structure on a foundation of false premise, a classical instance of this being Aristotle's doc- trine that of two weights dropped from a height the heavier would fall the faster. Observing probably that pebbles dropped to the ground quicker than feathers the philosopher rashly as- sumed that the heavier the thing was the quicker it would fall, and overlooking the factor of air resistance concluded that "bodies fall with velocities proportional to their weights," a S3 doctrine that was universally accepted for over nineteen hundred years and which formed the basis of many a learned discussion. It remained fur Galileo in 1590 to apply scientific methods in the testing of the correctness of Aristotle's doctrine which as is well known he did by dropping weights from the leaning tower of Pisa and establishing the fact that bodies do not fall with velocities proportional to their weights and that except for the resistance of the air all bodies would fall through the same space in uniform time. It was due to the diffusion of the scientific spirit and scientific methods that in the space of two brief centuries man made a greater advance in his control over natural forces than in the thousands of years previous. What a staggering advance was made between the years 1700 and 1900! In 1700 the first practical steam engine had not been constructed and over a hundred years were to elapse before George Stephenson's "Puffing Billy" ushered in the era of steam locomotion, and Robert Fulton's Clcniiont demonstrated that steam navigation was a practical commercial possibility. Probably if one of the inhabitants of Nineveh in the good old days seven thousand years B.C. could have returned to this earth about a.d. 1700 he would have found less to astonish him than would the Pil- grim fathers if they could to-day revisit the country in which they found refuge from religious persecution. It is hardly necessary to enlarge upon the tremendous develop- ment of industry in the last few decades due to the introduction of scientific methods in business, but owing to our unfortunate habit of making comparisons of current achievements mainly with past results and without reference to what we could attain if we realized our full possibilities, we fail to perceive that remarkable as our achievements may have been through the adoption of scientific methods they fall lamentably short of what lies within our powers. As William C. Redfield says in "The New Industrial Day": So splendid have been the results of our industrial growth, so brilliant the victories of our manufacturers at home and abroad, so astonishing the inventive skill with which by special tools and new appliances we have reduced the cost of our production, so matchless has been the courage with which some of us have forsaken the old and taken up the new, that we are apt to lose sight of the fact that these achievements and this brilliancy and fine courage have been the characteristics of the few rather than of the many, and that most of our industries are still laggards in the race. 54 The desire to excel is inherent in human nature — we do not Hke to feel that we are less efficient than our neighbors and even the slackest of farmers will generally keep the weeds out of the fields that adjoin the travelled road. Business men as a whole are ambitious to achieve the best results and no manu- facturer worthy of the name would be satisfied to have his business continue in a state of marked inefficiency if he could be convinced that this condition really existed. The problem, therefore, resolves itself largely into one of education in provid- ing means for furnishing every manufacturer with correct in- formation as to how closely he realizes the inherent possibilities of his business, and further as to where and why he has failed. Provide a manufacturer with periodical statements showing how many thousands of dollars he is throwing away each month because through lack of proper methods of planning his work his machines are operating at a fraction of their potential capacity and it will not be long before he has taken the necessary steps to properly operate his plant. Furnish a sales manager with statements showing that through lack of orders resulting in the factory being operated at less than full capacity $20,000 a month is being added to the cost of the goods which are being produced, and the chances are that with this information before him he will figure out some way to obtain enough business at a reduced price to eliminate that $20,000 from subsequent state- ments. The first step towards correcting an error is determining its existence. As Sir Francis Bacon wrote: "Truth to emerge sooner from error than from confusion" and the first step on the road towards efficiency is to know definitely not how our methods of to-day compare with yesterday, but how they stack up in comparison with what industrial science has proved to be possible; to quote once more from ]\Ir. Gantt, who saw so clearly and spoke so fearlessly: We claim to be an industrial nation. I feel we are only just beginning to be an industrial nation, and shall not be fully entitled to that name until we have a complete knowledge of the principles on which successful industry is based. Too man}' of our enterprises are still founded on what has been done rather than on what can be done. The real industrial leader must he guided by future possibilities rather than past performances. The author has italicized the last sentence for in these few words he feels that Mr. Gantt strikes the kev-note of this volume. C06T or SALIS Qie aaat prlaelpla la employed In figurine eoet of i^l^t •« is folloved In the case of &*oert«lnin« current oost* the ararege ratio* of aotwl to statxiBrd ^terlal, labor and burden being applied to the standard costs of the goods shipped. In the c&se shorn the increase of acttal otsY the standard cost of the goods shipped due to the causes analyzed In detail »* the Suooarized Kaaufacturing Kfflcieocy Stiiteitent, was as follows: Increased actual cost oo^ared vith standard Reducing the Btendard profit of To an actual profit of Total $1,936.55 3,842.00 $1,905.45 Per 10.000 bolts $ 9.68 19.21 COSTOFSALE5 STATEMENT OF COST OF SALES No. of Pieces Shipped 2,000,000 >^ SUH_ »R.iEi> H.-re ^ i~&»E«Se o« oec«e>se c "^ „..»u ,..„ s ^^ r.n .«...T TOT.L WUNDS r^yj;; "o'"*^"'"! ol;ci , •"•""««•' xm«^.'iB.poe]L9o ..^ !^ ««« g l^9W.0S '^7 /yzJlAW "7 '•''<" 'X""" '^x^"'' ^— -— .^^ =v.%--^3!"m s?. ^ -""'"'■"• KZ r ET' E « MM rav 120*7 '-^ 1 l! o Fig, 3.— Diagram illustrating principles underlying system of standard or pfedetennined ( 55 The Principles of a Cost System Based on Standards The underlying principles of a system of cost accounting based upon the use of standards may best be understood by considering an exceedingly simple illustration. Accordingly, in Figure 3 is shown in diagram form the essential features of a system of cost accounting to meet the requirements of a hypothetical case, in which it is assumed that a manufacturing concern has accepted a contract for the manufacture of several million machine bolts at a price of $13 a thousand. It is further assumed for the sake of simplicity that the business in c^uestion is confined to the performance of this contract. Before making a bid for this work the cost department has been instructed to make a careful estimate of the cost of making this bolt and in the standard cost card shown in Form I it will be seen that the estimated or standard cost of the bolts is $11,079 V^^ thousand and, therefore, the estimated or standard profit on the contract is $1,921 a thousand. This diagram illustrates the following important information obtained by the use of standard costs: 1 Manufacturing efficiencies 2 Current costs 3 Cost of sales I Manufacturing Efficiencies The executive of a concern engaged in the carrying out of a contract such as has been described is primarily interested in knowing the extent to which the actual costs vary from the standard and the causes underlying these variations. All of his plans are based upon the assumption that he is going to realize his standard profit of $1,921 per thousand and, the selling prices of the bolts being fixed, his activities will be solely directed to keeping the manufacturing cost to the standard or below it. The variations from standard are brought to a focus on the summarized manufacturing efficiency statement (Form A) which shows the actual and standard expense of material, labor and burden, and the increases or decreases comparing actual cost with standard, the former being shown in red and ndard costs would be followed in actual practice. The standard cost, for instance, miglit be 92 SCRAP • CLEARANCE ACCOUNT Sfqndard Volua _£!. 93 figured on the assumption that a special cut shape would be used whereas if such a shape were not available a metal sheet might be used in place thereof. Regarding this problem solely from the standpoint of sim- plicity of design, it is obvious that the plan to adopt would be to maintain records showing for each part manufactured the gross material used and the scrap produced in the various opera- tions involved. Such a plan, however, would necessitate very numerous weighings of material and scrap and the material used being somewhat expensive these weighings, to get accurate results, would have to be made very carefully. In addition, a very great deal of clerical work would be necessary both in the office and the shop. By the adoption of a plan exceedingly complicated in design (though simple enough in actual operation) it was rendered possible to obtain all results desired without necessitating the weighing of scrap from individual pieces. In such a case the complexity of design is of small moment if the adoption of a simple plan requires an immense amount of work on the part of the shop and office employees. Far too often unneces- sary weighing operations are called for by cost accountants which result not only in retaining needless weighmasters on the payroll but are also a handicap to the business in slowing up production. Some weighing operations are worse than useless, an example of which is the weighing of such scrap as turnings loaded with oil and dirt. Some thought given to devising methods of obtaining the results desired with one or more less weighing operations will often prove a profitable investment and as the plan illustrated in Figure 7 is applicable to meet a by no means uncommon situation a study of this diagram and the following description of the plan is recommended to those who are not entirely satisfied that their weighing expense is not un- necessarily high. The ]\Iethod of Obtaixixg Actual and Standard Material by Lines Material will be divided into a few main classes arranged according to the general description of the material concerned. Each main class will Ije sub-divided according to a more detailed description covering gauge, size and shape. Two sets of accounts will be maintained, viz. : the controlling accounts which will 94 relate to the main classes only, and be carried in both standard and actual figures, and the detail or material accounts which will be carried in Cjuantities only, the latter being maintained by the storekeeper for his own guidance and to prove controls. The purchase records of the general books will be designed in such a manner as to provide an analysis of material purchases by main classes and the periodical totals of these analyses W'ill be recorded in the material controlling accounts (Form B) under the main caption of received, and sub-captions of quantity and actual cost. The standard value under the main caption of received will be obtained by multiplying the cpantity received by the cost. Standard material values will be established at a figure which will include freight and in compiling the purchase records in the general books the freight will be extended to the column of the analysis relating to the particular class of material in respect to which it was incurred. The material recjuisition card (Form C) has been designed to provide the following information: 1 Material account number which indicates both class and account numbers 2 Actual weight issued 3 Standard cost of material issued 4 Standard cost of material in product 5 Line of product 6 Class of scrap 7 Standard value of scrap in production As material is issued by the storekeeper the weight issued will be recorded on the material recjuisition card (Form C), the issues thereon being extended at the standard material cost per unit of weight. The units of product will be extended at the unit material and scrap values as shown on the standard cost of parts card (Form A). Monthly, or as often as may be desired, the cards will be sorted by class of material and the issues credited to the material controlling account at standard material cost, adjustment to actual being made by using the ratio between actual and standard shown on the received side of the record. The cards will be re-sorted by line of product and tabulation made of the standard cost of material issued and the standard cost of material in product. These figures will be posted to the debit of the work-in-process accounts for each line and the standard material costs adjusted to actual by using the ratio shown on the material controlling account. The 95 above process will provide the ratio between the standard cost of material in [)rodiict and the actual value of the material used in manufacture. Under the accounting plan here described, which is based upon the use of standards of material, quantity, and price, it is necessary, in order to be able to determine the eflk-iency realized in the use of material as also the material cost by lines, for the records to show the extent of the variations between standard and actual material cost. This problem is rendered particularly difficult as it by no means follows that the form of the material used as a basis for figuring standard costs will be followed in actual practice. For instance, the standard cost may be figured on the assumption that a cut shape will be used, whereas when a shape is not available a sheet may be used in place thereof. The Method of Obtaining Actual and Standard Scrap BY Line No particular problem presents itself as regards recording the variation between standard and actual in the material issued but the difficulty which exists is as regards ascertaining the effect of the resultant variation in scrap comparing actual with standard as obviously it would not be possible except at great expense to figure the scrap produced on each order. In the plan here presented a solution has been arrived at based upon the fact that an increase in material, owing to the material used being in different form to that contemplated in standard, will tend to result in a corresponding increase in the scrap which should be produced and vice versa. Accordingly the general plan here presented is as follows: The material requisition card (Form C) is designed to show: I. The standard cost of material issued (that is the actual weight issued extended at the standard price) 2 The standard cost of the standard material in the product (that is the standard weight extended at the standard price) 3 The standard value of the standard scrap to be salvaged from the product Now obviously the difference between (i) and (2) represents the difference between the actual and standard weight of material 96 used extended at the standard price and is a direct index of the fluctuation in the cjuantity of material issued as compared with standard. Reverting to the statement above to the effect that an increase in material issue owing to a variation in the form of the material used as compared with standard will tend towards a corresponding increase in scrap production, it would follow that if the variations in scrap of each class are obtained in total an approximately correct distribution of this variation by lines of product can be made by distributing the variation to lines proportionately to the total variations of material quan- tities as obtained from (i) and (2) above. Though this plan considered from the standpoint of the design of the system may be regarded as complex, it presents an exceedingly valuable feature as regards economy of operation of the system, for under this method scrap does not require to be weighed on the individual order, all that is necessary being to obtain the total production of each class of scrap periodically. This production can be figured either by periodically weighing the scrap produced or if preferred it can be obtained by taking into account the sales of scrap and figuring the inventory of scrap on hand at the close of the month. The standard value of scrap in production will be obtained by sorting the material requisition cards (Form C) by scrap class numbers and tabulating the standard scrap production column. The total for each class of standard scrap will be charged to the "standard scrap in product" column of the appro- priate scrap clearance account (Form H). As previously stated, the actual scrap production will be ob- tained by weighing the production of each class of scrap pro- duced periodically. Scrap produced will be valued on the basis of the amount realized from scrap sales. Standard scrap production will be distributed to classes of product by sorting the material recjuisition cards by line numbers and tabulating the standard scrap production column. Varia- tions between standard and actual scrap, as previously explained, will be distributed to product lines proportionately to the varia- tions between the actual and standard quantities of material chargeable to the lines. By the method here described for handling scrap transactions, calculations of scrap production are made on the basis of prices realized during the current period. Unsold balances of scrap will be carried to the scrap inventory account (Form K) and then sold, any profit or loss occasioned by the ultimate price 97 realized being under or over the price current at the time of the vakiation of the production being carried direct to the profit and loss account. Before it is possible to ascertain the amount of scrap that is to be transferred to the scrap inventory account, it will be necessary to credit the scrap clearance account witli the actual and standard values of scrap used in production. The current price of scrap so used will be charged to the scrap reclamation account (Form J) where labor on reclamation will also be charged, thus making a total of scrap metal and labor on reclama- tion which represents the cost of producing blanks from scrap. In as much as nearly all blanks are bought from the outside, it is proper to credit the scrap reclamation account with the value of such blanks at the price for which they are purchased on the outside, carrying any balance to the credit or debit of profit and loss account, as representing additional profit or loss to the profit or loss made in the regular course of operation. The credit to scrap reclamation account for blanks made will be ofTset by a corresponding debit to the appropriate material account: in the latter account the entry in the actual column being the amount credited to scrap reclamation, the entry in the standard column being the regular standard cost of the blank. Burden Distribution a Matter of Judgment The exercise of the faculty of judgment is of particular im- portance when determining methods to be employed in connec- tion with burden distribution. There is no one plan of distribu- tion applicable to all classes of business, and refinements of distribution which in one case would be of the utmost impor- tance in another would be absurd. For instance, in a business such as that of the manufacture of bolts and nuts where the cost of tools is very great and where high efficiency of operation depends very largely upon the wearing quality of tools, it is necessary that the system of cost accounting should provide com- plete data relative to tool costs and tool efficiencies. In some other lines of business tool cost is relatively unimportant. It can sometimes be safely merged in the machine rates and even as part of the departmental or general burden. Probably more has been written on the subject of the treat- ment of burden in accounts than on any other phase of account- ing, but with very few exceptions writers on this subject have 98 labored under the fundamental misconception of cost accounting which regards the province of a cost system to be absokitely Hm- ited to furnishing the means of distributing the expenses of a business as equitably as possible over its product. The result has been what might have been expected — like travelers on the wrong road, the more energetically they have proceeded along the line they have elected to follow the farther away they have strayed from their true destination. In view of the fact that the primary and often the sole pur- pose of the usual elaborate systems of burden distribution is to enable correct information to be obtained as to the cost of the different products manufactured it is pertinent to inquire whether even this limited demand is really met by such systems. The author claims that wdien the system of burden distribution does not provide for distinguishing between the cost of produc- tion and the cost of idleness, which condition applies in the great majority of cases, however elaborate the refinements of burden distribution may be the results obtained are absolutely incorrect and misleading. The absurdities of the usual methods of burden distribution are most evident, however, when the results obtained are con- sidered from the standpoint of their value to the operating man. Under the wheel-within-wheel methods of burden distribution generally followed expenses are distributed and redistributed innumerable times — the result being that the final figures pre- sented have no real significance and only by the most detailed and elaborate analysis can the elements of which any figure is comprised be determined. The elaborate systems of distribution defeat the purpose for which they were introduced — instead of clarifying the situation the farther they are carried to their logical conclusion the more they befog the issue so that finally a single figure on the cost statement represents an inextricable conglomeration of more or less irrelevant factors, and the figures mean little or nothing to anyone but the man who compiled them and even to him have little significance unless he first tears down into their component elements the figures which he has so painstakingly built up. To take a concrete illustration, one of the hundreds of items on the cost sheet of a steel company would be the cost of locomo- tives in the open hearth and assuming that the usual methods of burden distribution are followed and that an increase in this item results in a demand for its analysis, it will be found that there are a great number of factors which may contribute to 99 the apparent increase shown which are in no way directly related to tlie work of the open hearth department or even the actual cost of operating the locomotives, the expense of which is in eluded in the charge on the open hearth cost sheet. Some of the typical items which would contribute to the charge on the open hearth cost sheet would be the following: Proportion of expense of mechanical department office Overhead of shops doing repair work on tracks and locomo- tives which overheads would include such distributed factors as: Drinking water Light Electric power Mechanical department office expense Taxes Insurance Depreciation Now each of the above items would be the result of other elaborate distributions and redistributions, as for instance; Drinking Water : This in addition to the direct charge for labor and repairs to pumps and wells, pipes, buildings, etc., would include such indirect charges as the cost of high-pressure steam (less low-pressure steam) electric power, taxes, deprecia- tion, and shops overhead. Taking one of these sub- divisions of the cost of drinking water — steam, for in- stance, and we would find that this also will have been afTected by a multitude of factors, of which the following are examples : Shops overhead, which of course has also been affected In- the cost of the steam and of hundreds of other factors The cost of locomotives, which account we are con- sidering The mechanical maintenance office, etc., etc. Under such a system a simple, direct expense such as salaries paid to the clerks in the mechanical maintenance office would be distributed and redistributed a thousand times a month and it would be difficult to determine how much investigation would be required to enable an accurate statement to be made of the final disposition on the cost sheets of this item. Particularly unfortunate features of a method of cost dis- tribution such as has been described above, which it may be incidentally mentioned is entirely in accordance with the prin- ciples laid down in standard works on cost accounting, are that it hides the true significance of really valuable information which has been compiled, involves considerable expense to perform and in addition delays the preparation of reports. The usual complaint of the cost accountant is that the operating men do not sufficiently analyze the monthly statements which are prepared for their guidance, but when it is considered that no one other than the cost accountant himself is in a position to determine exactly how any particular item is made up and further that even for him this procedure involves a long and tedious process of analysis, it is difficult to understand how an operating man could be expected to make much headway in this direction even if he had the time available, which generally very properly he has not. Even more serious however is the fact that the cost figures are not shown in relation to standards, so that the operating man is compelled to compare the figures for this month with those of previous months, but even these comparisons are of little value for under such methods of dis- tribution as have been described the fluctuations in any given item of cost may be dependent upon numerous factors having little or no relation to the item being considered. The interpretation of cost statements would often be amusing if it were not so tragic, and in this connection the author calls to mind one case where a corporation with a large plant producing a main product with many by-products employed a firm of profes- sional accountants to install a system of cost accounting involving the elaborate wheel-within-wheel methods of burden distribution such as have been described, and under which it is necessary to distribute some of the burden of the machine shop to the tool room and vice versa, and where the expenses of cleaning the office are carefully distributed to the operating departments, etc. The final result of these efforts was a series of cost sheets with thousands of items, each of which was reduced to varying unit costs taken to four places of decimals for this month, last month, this year to date and last year to date. To achieve this demanded the entire time and efforts of an experienced chief clerk and a considerable force of machine calculators and plant data gatherers, and the completed volume was seldom presented ■^NDAvRD MKCHINE EKRNINeS Month of DA^T^v ST^NOKRD MACHINE EARMINGS 6(>>RN1NS5 . ^^^f'' ^ lOI to the officials of the company until well into the course of the next month and then was presented in person l)y the chief clerk who remained in the capacity of interpreter. He was quite resourceful at this and could explain, for example, to the perplexed official that the increase in the cost of operating the locomotive crane last month included an increase in the wages of the coal-handling gang, overtime in the machine shop, mis- haps to the auto truck, severe breakage in the laboratory and an increase in the clerical force of the shop offices. The example given is exaggerated little if any and illustrates the danger of carrying refinements of burden distribution to a point where the results obtained become ridiculous. In many cases, of course, in order to obtain correct cost information it is necessary to introduce very considerable refine- ments of burden distribution particularly in cases where the product is of a varied character and the work performed on a variety of machines. An illustration of the grossly inaccurate results sometimes obtained under the plan of distributing burden on a departmental basis was given in a previous chapter in which it was shown that under this method of distribution one class of work would be charged with ten and a half times as much burden as it should properly bear. In such cases, accurate costs can only be obtained by the use of machine rates and in Figure 8 are illustrated the underlying principles involved in such a plan of distribution. The Underlying Principles of Machine Rates A section of this diagram is devoted to illustrating the method of building up machine rates, and in the example given it is assumed that the rates taken are made up on the basis of past results, though obviously where an organization has developed to a point where standards of possible attainment can be figured in place of past performances such standards would be used. The method of building up the machine rates, however, would be similar to that shown. Reference to the diagram will show that in the simple case taken as an example a machine rate comprises the following: 1 A standard rate per hour for machine repairs and main- tenance 2 A standard rate per hour for power I02 3 A standard rate per hour for departmental burden (over and above machine maintenance and power) 4 A standard rate per hour for general factory expenses The first two of these factors are common to the machines in a machine group (by which term is meant all machines in a department of identical character). The third is common to all machines in a department, and the last is common to all machines in the plant. The portion of the machine rate for machine repairs and maintenance represents the cost per hour of maintaining the machines during the period taken as a basis. For instance, taking the second group of machines in Department A as an example, the machine hours in the period totalled to 4000 and involved an upkeep expense of $600, representing a rate per machine hour of $0.15, which figure is accordingly incorporated in the machine rate for that group of machines. The units of power produced during the period taken as a basis totalled to 300,000, the cost of producing these being $30,000 or a cost per unit of $0.10. It is assumed that the consumption of power by the machines in group 2 of Depart- ment A is four units per hour, so that $0.40 is added to the machine rate in respect to this expense. The burden (over and above productive labor, machine main- tenance and powder) of Department A in the period taken as a basis totalled to $5000, and the total of the machine hours in the department in this period was 20,000, representing a cost per machine hour of $0.25, this amount also being added to the machine rate. General factory expenses, which are distributed over all the machines in the plant, totalled to $38,000, the total of the machine hours for the whole plant in the period being 200,000, or a cost per machine hour of $0.19. The machine rate for group 2 in Department A totals there- fore to $0.99, made up as follows: Machine repairs and maintenance $0.15 Power 0.40 Department A, departmental burden 0.25 General factory expenses 0.19 Total 0.99 I03 In the standard cost sheet (Form A) is ilkistrated the method of using the machine rate in the compilation of a cost. In the operation shown as an example the standard time on a machine group per hundred pieces is taken as lo hours, the machine cost being figured at lo times the machine rate of $0.99 or $9.90 per hundred pieces. The balance of the diagram illustrates the use of machine rates in connection with the compilation of efficiency data, this, as also the labor efficiency data illustrated, being obtained through the medium of punched cards and machine equipment for sorting and tabulating. This use of punched cards for statistical purposes is probably well known to most of the readers of this volume, the method first being used in connection with the compilation of the census in Washington, and now very largely in industrial accounting. The principle involved is very simple, information being recorded on cards by punching holes in the manner illustrated in Form B on the diagram, information being obtained from the cards by the use of two machines, a sorting machine and a tabulating machine. The function of the sorting machine, as its name indicates, is to sort the cards in any arrangement desired. For instance, taking the card shown in Form B as an illustration and assuming that it is desired to arrange the cards by departments, the machine would be adjusted to sort the column headed c and the cards run through the sorter which would automatically (either mechanically or electrically, depend- ing upon the system of machines employed) sort them by depart- ments. The tabulating machine, as its name also suggests, is used in obtaining totals from the cards and is, in reaUty, an adding machine, the cards being run through the machine which registers the totals of the columns which it is desired to tabulate. For instance, continuing the illustration just given, after the cards were sorted by departments, by placing these cards in the tabulator the machine would automatically provide the totals of the following columns: actual hours worked; standard hours; standard machine earnings; standard labor; actual labor; actual hours at standard rate. The outstanding advantage of the punched card method of compiling information is its extreme flexibility, for whereas in the case of compilation of written data any rearrangement of the information requires an entirely new written tabulation, by the use of punched cards any desired combination of information can be obtained merely bv resorting and retabulating the cards. I04 The use of the punched card (Form B) In obtaining data relative to labor efficiencies is illustrated in Form C (analysis of standard labor earnings) this form showing the following for each group of machines: 1 Standard labor earned 2 Actual labor 3 Net increase or decrease 4 Actual hours figured at standard rate 5 Actual hours figured at actual rate (same as 2 duplicated on form in order to facilitate calculation of items in column 6, which represent difference between columns 4 and 5 as explained later) 6 Increase or decrease due to rate fluctuations 7 Increase due to variations in efficiency The method of obtaining the information required in this form would be as follows : 1 Sort operation cards (Form B) by departments (column c) 2 Sort operation cards by machine groups (Column D) 3 Tabulate cards for each group as shown in Table 13 Table 13. Standard Labor Earnings Labor Earnings Column on Operation Card (Form B) Column on Analysis of Standard Labor Earnings (Form C) Standard labor earned Actual labor Actual hours figured at standard rate On Form C obviously the difference between the standard labor earned (column i) and the actual labor (column 2) is the increase or decrease comparing actual with standard, and represents the index of the efficiency of labor as a whole, this difference being entered in column 3, increases being entered I05 in red and decreases in black, as indicated on tlie illustration. The difference between the actual hours figured at the standard rate (column 4) and the actual hours at the actual rate (column 5) represents the increases or decreases owing to changes from the standard rates, these dift'erences being entered in column 6. The balance of the net increases or decreases that is the difference between columns 3 and 6, represents the increases or decreases resulting from variations in efficiency these differences being entered in the column so headed (column 7). The operation card (Form B) also forms the medium through which the information required on the analysis of standard machine earnings (Form D) is obtained, the cards still arranged by machine groups being tabulated as shown by Table 14 : Table 14. Standard Machine Earnings Machine Earnings Columns on Operation Cards (Form B) Columns on Analysis of Standard Machine Earnings (Form D) Actual hours worked Standard hours earned F G H 2 4 8 Total standard machine earnings The employment efficiency percentages in column 3 are obtained by dividing the standard working hours in period (column i) by the actual hours worked (column 2). The operating efficiency percentages (column 5) are obtained by dividing the actual hours involved (column 2) into the standard hours earned (column 4) and the end efficiency (column 6) by dividing the standard hours earned (column 4) by the standard working hours in period (column i). The analysis of the total standard machine earnings (column 8) into standard repairs and maintenance of machines, power, departmental burden, and general factory expenses (columns 10, 12, 14, and 16) is obtained by using the components of the machine rates given in the section of the diagram illustrating the method of building up the machine rates; for example, tak- ing the case of machine group 2 already referred to, the distribu- io6 tion of the total standard machine earnings of $370.26 is made up as shown in Table 15: Table 15. Distribution of Total Standard Machine Earnings Item Standard Machine Rates Per Hour Total Repairs and maintenance $0.15 0.40 0.25 0. 19 $0.99 $ 56.10 14Q.60 Power Departmental burden 93 50 71.06 $370.26 General factory expense Total The information obtained relative to standard machine repairs and maintenance, power, and departmental burden is carried to the departmental efficiency statement (Form G), where the total expenses are also shown, the latter being obtained from the distribution of store requisitions and indirect labor cards, as indicated on the diagram. The analysis of standard depart- mental miscellaneous expense and general factory expense is made in a similar manner to the analysis of machine repairs and maintenance and power, detailed data relative to this being shown in Forms E and F. Information relative to efficiencies is brought to a focus in the summarized manufacturing cost and efficiency statement (Form H) this showing a comparison between the actual and standard costs of material, labor and burden of the whole plant. No details are shown in the diagram of the method employed for obtaining comparison between actual and standard material costs, this matter having been dealt with somewhat completely in the foregoing chapters. There is nothing new in the use of machine rates as a medium of burden distribution but it is a somewhat remarkable fact that apparently the leading exponents of their use have not realized that in machine rates they have in their grasp the means of bringing cost accounting into line with modern industrial thought as expressed in scientific man- I07 agement methods. So completely has the accoiintin.c;' mind been obsessed by the idea that the sole object tjf cost accountin^^ is to distribute expenses in such a manner as to ol)tain correct information as to the costs of manufacture that the fact that in machine rates we have the ideal vehicle for furnishing operating efficiency data does not seem to have been realized. A machine rate is a standard cost and a comparison of the machine earnings and the cost of operating the machines as illustrated in Figure 8 provides the simplest and most effective means of furnishing efficiency data. The advantage gained from the use of machine rates as a medium of expense distribu- tion though important is not to be compared with that resulting from their use as a means of comparing the actual expense w'ith standard. Combining Standard Labor With Machine Rate In the illustration given in Figure 8 the standard labor cost is figured independently of the machine cost but the ideal plan to follow when machine rates are used is to combine the standard labor with the machine rate. Once the machine rate is figured the work of compiling standard labor and burden costs is con- fined to determining the machines on which the various opera- tions are performed and the standard production per hour for such work on the different machines. Assume, for instance, that the standard labor and machine rate per hour on a certain class of bolt header is $i.6o (labor $0.60, machine rate $1.00) and the standard production per hour for different classes of work on this machine to be as follows: Countersunk machine bolts — ^^2 inch diameter — 2000 per hour Plow bolts — 7/16 inch diameter — 2500 per hour then the standard labor and liurden cost per 1,000 of heading the two classes of product shown would be: ^T 1 • ,1 1. 60X1000 _ Machme bolts =0.80 2000 „ , , 1. 60X1000 , Plow bolts —=0.64 2500 io8 In order to determine the machine earnings all that is neces- sary would be to figure the production at the rates shown by Table i6: Table i6. Total Machine Earnings Class of Product Production Rate per i ,000 Total Machine Earnings Machine bolts 50,000 75,000 $0.80 0.64 $40 . 00 48.00 Plow bolts Total $88.00 Assuming that the machine rate of $1.00 per hour was made up as follows: Power $0.20 Tools 0.30 Repairs 0.15 Departmental burden 0.20 General burden 0.15 $1.00 .The distribution of the machine earnings would be made as shown in Table 17: Table 17. Distribution of Machine Earnings Item Standard Rate per Hour Per Cent of Total Machine Rate Proportion of Machine Earnings Producing labor $0.60 0.20 0.30 0-15 0.20 0.15 37-5 12.5 18.75 9-375 12-5 9-375 $3^.00 Power Tools Repairs Departmental burden General burden II .00 16.50 8.25 II .00 8.25 Total $1.60 100.00 $88.00 lop Combining this information with the actual expense of operating the machine and a profit and loss statement is obtained for the machine as shown by Table i8 which has real sig- Table 1 8. Machine Profit or Loss Item Machine Earnings Cost Profit Loss Producing labor Power $33 • oo II .00 16.50 8.25 II .00 8.25 $35 00 10.00 15.00 12.00 12.00 7.00 $1 00 1.50 1-25 $2.00 Tools Repairs 3-75 1 .00 Departmental burden . . General burden Total $88.00 $91 .00 $3-75 $6.75 Net loss $3 00 nificance for the operating man. If the cost accountant can fur- nish the operating department with statements like this which do not demand laborious analysis and comparisons with previous months but show where costs have exceeded standard he will not have to complain that the operating men do not take sufficient interest in the figures which are submitted to them. In addition to showing the extent of variations from standard the plan should be expanded to show the "cause" of these variations, but this feature of the methods developed by the author is reserved for a later chapter. Chapter V COOPERATION AND COORDINATION THE predominant characteristics of the American people are extreme individuaHty, openness to new ideas, impulsive- ness, energy, restlessness, and ambition. When the magnificent story of the material concjuest of this land of opportunity is reviewed, the possession of these traits seems not only fitting but inevitable, for both ancestry and environment have joined in making the American of to-day what he is. The inhabitants of the United States are the descendants of the most progressive and adventurous of the Europeans, of the Spanish, French, Dutch, British, Italians, Germans, Scandina- vians, and Russians, who, breaking away from their own en- vironment, embarked upon an adventurous journey to the land of promise. None but the competent, the strong and the self-reliant could survive the hardships undergone by the early settlers ; in the first terrible winter which the Pilgrims suffered nearly one-half of the entire number was cut off. As William Bradford, after- ward Governor of New England writes : But it pleased God to visit us then, with death dayh', and with so general a disease that the living were scarce able to burie the dead, and the well not in any measure sufficient to tend the sick. In 1607 George Percy, speaking of the colonists in Virginia writes that. Burning fevers destroyed them, some departed suddenly, but for the most part they died of mere famine. . . . Sufferers were groaning in every corner of the fort, most pitiful to hear, and if there were any conscience in men it would make their hearts to bleed to hear the pitiful murmurings and outcrys . . . some departing out of the world sometimes three and four in a night ; in the morning their bodies trailed out of the cabins like dogs to be buried. The hardships suffered by the early settlers — famine, fever, and the fierce, unrelenting struggle with land and forest and Ill the Indicin foe, the tremendous tasks involved in the develop- ment in three centuries of a country not far short in point of area of the whole of Europe, have developed a race of people untrammelled by tradition, fearless, and tireless in endeavor and self-reliant in the extreme. In the business world of to-day, we find in a marked degree the strong individualism which the American inherits from his hardv and self-reliant forefathers. It is a magnificent in- heritance, this trait, and one which has made the American race leaders in the fields of invention and of business, but like all other human attributes there is a point where excess of devel- opment is a detriment rather than an advantage, and this applies particularly as regards individualism in the modern business organization where a large number of persons require to work together for a common end and for the common good, and where unless the interests of the individual are subordinated to those of the business organization as a whole there will be working at cross-purposes and consecjuent friction and waste. Efficiency in the operation of a business is largely dependent upon two factors : cooperation, or the working together of the organization towards a common end ; in other words team work, and coordination, or the arrangement of methods and instru- ments of production and distribution in such a manner that the business machine forms a harmonious whole, operating smoothly, continuously and effectively. American business how- ever does not yet fully appreciate the importance of either cooperation or coordination, and the evidences of this are every- where apparent. There is often too much of a tendency on the part of department heads to surround their departments with an imaginary line, outside of which they have little interest, and within which they resent intrusion. In an earlier chapter the author mentioned an instance where the heads of the general accounting and cost accounting departments were so jealous of their authority that they issued separate cards of account, this procedure rendering it necessary for two entirely distinct expense and payroll distributions to be made — one for the general books and one for the cost records. Similar instances mav be recited, and the reader can doubtless think of many more. Tremendous sums of money are lost owing to a lack of cooperation and coordination between the sales and distribution divisions of business. Some years ago, a certain automobile device was advertised extensively, and most expensively, but little provision was made to meet the demand resulting from the advertising campaign, so that the money spent was in large measure wasted. An Example of Cross Purposes A leading publishing house some time ago in a full page advertisement in a magazine having a circulation among the particularly well-to-do offered an expensive set of books to be sent on approval to readers of that magazine. A friend of the author, a man of considerable means and extensive credit, wrote for these books to be sent him on approval. Some time after- ward he received a printed postal card acknowledgment stating that the books would shortly be shipped. About three weeks later the books had not arrived and as he wished to give these to a member of his family as a birthday present, and as there was very little time left, he telegraphed at his own expense asking when the books would be shipped, stating that he wished to make a present of them and would appreciate prompt action. Several days afterward this concern wrote him advising that if he would furnish references they would be pleased to ship the books. When he wrote reviewing the history of the transac- tion and criticising the manner in which the affair had been conducted, particularly stating that he would have been glad to have furnished references had the necessity for this been men- tioned in the advertisement or in the acknowledgment of his original request, his letter was never answered. Here is a case where the efforts and money expended by the advertising depart- ment were worse than wasted, owing to the incompetence and stupidity of other departments of the business. In many manufacturing concerns the salesman makes the promises, having full authority to do so, but being without information relative to conditions in the factory, he leaves to the operating division the duty of explaining to the customer why the promises are not kept. The relation between the average selling and operating or- ganizations is one somewhat approximating a state of armed neutrality. Not being fully acquainted with one another's prob- lems the members of one division are apt to attribute all troubles experienced to the deficiencies of the other. A particular source of irritation is the tendency of salesmen to accept orders for special product, when by the exercise of a little salesmanship it would be possible to supply the customer's wants with a 113 standard article and by this means save t/oiible for the operating division and expense to the customer. Cooperation and the Average Office The average office offers an excellent illustraticjn of lack of cooperation. When the limited amount of assistance they offer one another is considered, one might imagine that the em- ployees in adjoining departments were v\^orking for competing concerns instead of for the same institution. In all departments there are certain times when there is a peak load of work, in the payioll department, for instance, at the end of the week and in the accounting department at the beginning of the month, and there are also times when the work ahead is naturally very unequally distributed, for instance, when orders are few but ship- ments many, with resultant slackness in the order department and pressure in the billing and accounting departments. In many businesses, however, no attempt or very little is made to relieve pressure at one point by transfer of clerical help from a department where the work at the time is light. The argument that the employees in one department do not know the work of another department is simply evidence of a lack of training and planning, for the greater part of the work of all office departments is routine of such a character that if clear in- structions were available any intelligent clerk could handle it with moderate supervision. The author happens to be well acciuainted with the methods of one large office in the middle west where several hundred clerks are employed and this concern has been able to very greatly reduce its clerical expenses by a centralization or coordination of the control of its office force, so that temporary pressure on one department can be equalized by transferring help from another department. Such a plan of handling work affords a further advantage in furnishing greater possibilities for the advancement and development of members of the office organization. One of the most difficult problems confronting the manager of a large office is to find some way of enabling ambitious and capable subordinates to increase the value of their services both to their employers and themselves. In many cases there is no oppor- tunity for advancement in the near future — the w(^rk (if the immediate superior is satisfactory and other channels of promo- 114 tion are not available. By coordinating the work of the office employees, however, the versatile and capable employee can become very valuable and his capabilities along the lines of being able to handle a number of different jobs coupled with an elastic plan, so that advantage can be taken of this versatility, render it possible to pay larger salaries to the exceptional man than would otherwise be the case. In addition, the broader acquaintance which the employee obtains of the business generally enables him to handle the problems which he meets in his daily work more intelligently and with greater interest. The Importance of Coordination in Accounting The importance of coordination between the cost and general accounting systems has always been realized by professional accountants, but it is by no means unusual to find cost systems operated entirely independently of the general books and not controlled in any way by the latter, and the author calls to mind one instance when the dangers attending such a condition were somewhat vividly exemplified. In this case it was the custom to prepare a monthly statement of profit and loss. This statement was made up in two sections, it being the duty of the general accountant to set a valuation on the production of the factory for the month and of the cost accountant to make up a statement showing the cost of this production. These two sections of the statement were made up entirely independently, the excess of the value of the product over the cost of produc- tion representing the estimated profit for the month. The operations of the business in question involved the production of an important by-product, the value of which repre- sented a considerable proportion of the company's income and this by-product was treated by the cost accountant as a reduction of the cost of production and added by the general accountant to his valuation of the product, with the result that the profits as shown by the statement were inflated to the extent of this by-product, this being taken into account twice. Very serious troubles have been caused by lack of coordina- tion in accounting systems. The author knows of one case where an important company went into a receiver's hands, even though it was essentially in a sound condition, owing to having greatly overestimated its profits and declared a dividend which in fact had not been earned ; in another case an important com.- 115 pany made a similar error which might also have resulted disastrously. The accounting system of a large concern manufacturing a varied and extensive product is necessarily complex, and unless the multitudinous records required are properly controlled and coordinated the most dangerous misinformation may be given out. The Trend Toward CoorERATiox axd Coordixation We are entering an era of cooperation and coordination, not only as regards the internal economy of the individual business but also as regards the relations between competitors in the same line and industry in general. This spirit is evidenced by the efforts which are being made in the different industries to establish uniform methods of accounting which will better conditions in the trade generally by eliminating indiscriminate price cutting, owing to a lack of knowledge as to costs of manu- facture and distribution, and by encouraging the adoption of better business methods. It is beginning to be realized that busi- ness failures result not only in loss to the individual manu- facturer, his employees, stockholders and creditors, but to his competitors in the loss of prestige sustained by the industry, and to the community in general, for in the long run it is the ultimate consumer who pays for everything. It is an under- standing of this fact that prompted the Associated Advertising Clubs of the \\Vjrld to institute the valuable work undertaken by this organization in educating the retailer to keep proper records and adopt better methods of management. Not onlv is there an increasing tendency toward cooperation between manufacturers in the same line, and between business men in general, but w^e may also look forward to an increasing degree of cooperation between the business interests of the country and the Government. The sound common sense of the people of this country will undoubtedly rebel against the exten- sion of the paternalistic attitude so dear to a certain type of statesman and expressed in a desire to super\-ise, direct, and govern all of the activities of industry. Public service corporations are beginning to realize that in the long run the wa^■ to profits lies al(mg the line of cooperation with the consumer. The old ''public be damned" policy is fast losing its adherents and though it is too much to hope that this ii6 change of viewpoint has been entirely due to a change of heart, in recent years the majority of pubhc service corporations have shown an almost pathetic desire to earn the good will of their customers. The Balancing of Industrial Initiative and Organiza- tion Needs One of the important problems in business is to determine the policy to be followed in order to encourage the exercise of individual initiative, and at the same time subordinate the individual to the interests of the organization and the business as a whole. In modern business, with the necessity which exists for the employment of specialists of many kinds, the mainte- nance of such a balance is an undertaking calling for skill and judgment. By the introduction, however, of properly designed routine methods the problem is greatly simplified, the work of all individuals being coordinated and part of a harmonious whole. Even professional organizers often fall far short of fully applying this principle in management. This is particularly the case as regards the methods introduced in the planning and cost departments, in many cases the work of the former being entirely disconnected from that of the latter. Even in those cases where the methods of the planning department are founded upon the use of standards of time and production, the cost department will be operated along the lines of detailed cost accounting absolutely divorced and independent of the standards used by the planning department. Such a situation is obviously an ab- surdity. If the work of the shop can be predetermined and laid out according to standards of time and material, obviously the same standards can be employed in the cost department, the records of which will then reflect results in terms which are also common to those employed in the planning department. The author, however, cannot recall having seen any book or article on scientific management or accounting where a really complete coordinated planning and cost system is described. As was previously stated, it is the province of the engineering department to determine standards and to provide the means of accomplishing them, while it is the function of the accounting department to furnish records showing the extent to which the standards are being realized and where the efforts of the en- gineering department have been successful and where not. 117 The Advantages of Coordinating Methods The advantages of coordination in methods are many. Primarily, under such an arrangerient the accounting and plan- ning departments are speaking the same language which under the usual methods employed they certainly are not. Further- more, coordination of these departments reduces very greatly the work in connection with the compilation of the basic data underlying costs and planning and also the cost of the routine work in connection with the operation of the system. W^ith this and the chapter folhnving, there is given a series of diagrams which illustrate the principles underlying the opera- tion of a coordinated planning, production, and cost system, a study of which it is believed will demonstrate the very material advantages accruing from the coordination of the work of the planning and cost departments. This plan is drawn up to meet the conditions existing in a concern manufacturing an extensive line of standard machinery — about as complex a condition as will ordinarily be met. Obviously, the plan is complicated and here again the author wishes to emphasize his contention that any really efficient plan to meet complex conditions must neces- sarily be complicated also. As a matter of fact, most manufacturers who believe that the system they employ is a very simple one are under a delusion. The author calls to mind an instance when he presented to a department head a plan covering a suggested routine for handling a certain important division of the work of the latter's department. He was by no means prejudiced against the in- troduction of improvements, but he firmly but courteously rejected the plan when it was presented to him. Upon being asked the reason, he stated that it was "too complicated." Whereupon he was presented with another diagram with about twice as many forms as the other and three times as many opera- tions and asked whether that looked any better. After he had emphatically stated that this second plan was far worse than the first presented the news was gently broken to him that the second plan was that which he was then operating, and from this point no difficulty was experienced in obtaining his enthu- siastic support of the introduction of the new plan. Some time ago, one of the author's assistants made a careful analysis in diagram form of the system employed by a progres- sive manufacturing concern, and in order to ensure that the ii8 chart correctly illustrated the routine followed this was sub- mitted to one of the officers of the company for his criticisms. This gentleman, after satisfying himself of the accuracy of the chart, stated that before this was drawn up he was under the impression that the system in force was an exceedingly simple one and that when he actually saw it on paper and realized how complex and elaborate it really was he nearly had heart failure. To manufacturers who also believe that their methods are very simple the suggestion is made that they select some bright young man in their organization and instruct him to carefully chart the routine followed in connection with handling a cus- tomer's order from its receipt in the mail up to the billing and shipping of the goods and the determination of the profit or loss realized on the order. Make it clearly understood that every step must be illustrated. If the resultant chart is not quite elaborate and complex, either the business is abnormally simple, the bright young man a master in the skilful elimination of facts or the system far more efficient than any which it has been the author's privilege to pass upon. It is somewhat surprising that in connection with one of the most complex things which the world has ever known, namely the modern business, manufacturers and business men generally should expect, or even hope, to attain extreme simplicity in methods. All simplicity possible, assuredly, but not simplicity obtained at the expense of inadequate results and unduly costly methods. The practical man realizes that he cannot expect to get simplicity beyond a certain point in the design of a high- grade automobile, an aeroplane, a locomotive, a battleship, or a submarine, and further that the design of these calls for ability and extensive training and yet he will believe it possible for his own highly complex business to be handled efficiently in some remarkably simple manner, which he leaves the members of his organization, who have had no special training in the formula- tion of efficient routine methods, to find out. Why Complex Business Demands Complex Systems There is no way of avoiding considerable complexity in the design of systems to efficiently handle a complex business, but as was previously stated the complexity should stop right there for a system which is unduly difficult to operate is to that extent ^ 'L4 STANDARD PART LIST Et SEQUENCE OF OPERATION ■nbly M?i^J'^-''f^"l'. Ctossof Produef,,!...--- 5hee>s Sheef r ^HfH r I^J^ ■ — M SECTION I ■' SUMMARY OFSTANPARD COST AND REVISED CURRENT COST STATEMENT MACHINE COST aSounV «JSn" «ATER,*L^(B4C(a.ses) V. Nalltable Irvn w- Nufsand mishtrs f^ eimvjro/} Casttnos Springs esw LABOB:(euD9pti) // Carpen/trS^p IZ dladamifh Q/fh/ra J5 8/iKtemrffi fbrqt 'ilODICAL REVISIONS OF f4 8otf Dtparfrrrenf STANDARD COSTS TVOmiN ThE APPROXIMATELY TOTAL LABOR rsoo BURDEH.f&jMacherouD) ih s.oo rh TOTAI 3.S0 XD— ; •O Blacksmith Fbrgt s. / Bulldo^trs 1 oo \ 3 Bnidlet4 Mammrrs yS floor Grinder etc TOTAL IS.OO TOTAL BURDEN TOTAL COST 120. oo \ sJ =i — SECTION n Figs, 9 and 10.— Diap-am illustrating coordinated cost, planning and production system. Sections I and 2. Illustrating method of compilation of standard cost and planning datt. \To face page itf. GRAPHIC MATERIAL^^o PRODUCTION CONTROL RECORD Nameof Assemblij No.3l P.'anferFrarm " Ho. 1357 Section No.ii2__ No.of Assemblies _iZg— f^citefaComp|gl4 fekSM. ♦ PART PRODUCTION DA.TE SCALE Jan. 7 B 9 10 II I2 14 15 16 17 le STANDARD PART LIST NnrnfrtfA-^cpmhlu '^ i: Pra'rftrFrane CLASS OF PRODUCT 7, r^^T CR. 1 ^L_ ^ fvTTOw WhtilSpi^Cax 3/3 Malleabla SfS PC. UadinsLe*erQt,f> 6*9 1 " ^9 P£- fUjsfKrOek'AOj. Wasfier 9*9 'I €C TIOMOf SW !tD*RD PMfT ^ ^t€dConfroSer5prim 10* '1 F <»e/UnOfrS (5££ SECTION I) T^ LrfiiiKiU^rLakh Bxi I09 ' i'rZSi CR l?3l Pc. i^RLg^ eJ M^ ~""^- . 1 ^ GRAPHIC MATERIAL^No PRODUCTION CONTROL RECORJ) FOaOWUPOFHXTEfflAUEQUlREMEHlS BYPRODUCT CUSS S' MWI«D S.O«T I4Q d Iff 153} 3 600 *■ SECTION W Figs, li and iz.— Diagram illustrating coordinated cost, planning and production system. Section 3. Illustrating routine in connection with machine group planning and control. Section 4. Illustrating routine in connection with material and production control. \To face fage tip. c 119 defective in design. Some of the most complex pieces of machinery in common use are simple enough to operate; if they were not they would not be in common use. What proportion of telephone users have any real conception of the means by which the sound of their voices is carried over the telephone wires, yet ignorance in this respect does not in any way detract from the value of the service they receive from their telephone. Take, as an example, the magnificent twin-six automobile which we often see skillfully driven by women. The design of that machine represents the crystallized experience of a multitude of skilled engineers, electricians, and others. But do many women know about all of its manifold parts and complications? The reader knows perfectly well that the chances are that they do not, in fact, it is quite possible that they do not know the dif- ference between the differential and the carburetor, and if they have given any thought to the matter at all, which is to be doubted, it is more than possible that reasoning by analogy and bearing in mind the heating system in their own homes they believe that the function of the radiator is to keep the engine warm ! In the previous chapters of this volume the diagrams illus- trated were confined to the work of the cost department and to the compilation of cost and efficiency data. As was stated, however, one of the essential requirements of a cost system is that it should be coordinated with the work of the production and allied departments, so that duplication of work and over- lapping of authority can be avoided. The coordination of sys- tems of cost predetermination with the factory planning systems along the lines of those described in this volume is a logical and inevitable development of the predetermined cost idea and until such coordination is realized both the cost and planning systems must necessarily fall far short of the ideal. The Diagrams of a Coordixated System The diagram illustrating the coordinated cost, planning and production system to be described, is divided into eight related sections. These are as follows: 1-2 jMethod of compilation of standard cost and planning data (Figures 9 and 10) 3 Routine in connection with machine-group planning and control (Figure 11) I20 4 Routine in connection with material and production control (Figure 12) 5-6 Routine in connection with planning and dispatching control (Figures 13 and 14) 7-8 Routine in connection with cost and efficiency control (Figures 15 and 16) In the plan illustrated full advantage is taken of the increased facility in planning and recording production, afforded by the use of graphic charts, two such charts being illustrated, the machine group planning and control board (Form 3 A, Figure 11) and the graphic material and production control record (Form 4A, Figure 12). The Development of the Graphic Idea The modern development of the picture or graphic idea in connection with records of production, etc., has been in response to the demand for some plan which would furnish immediate information relative to the progress of work in the shops, ex- pressed in such form as instantly to draw attention to the salient features of the situation. Under the older method of production accounting, this information would be buried in books of record involving a regular mining operation to bring to the surface. For instance, in the case of a concern manufacturing a standard line of machinery involving the manufacture of thou- sands of parts many of which would be common to several machines, in the older method of production accounting a record would be maintained in book form of the manufacture and use of each part, a sheet in the book being provided for each part. To determine what the manufacturing situation at any time was as regards these parts it would be necessary to abstract the balances of the part record and apply these against the require- ments of the various machines to be manufactured, taking into account the fact that this assembly might reciuire four of a given part, while another would only use two of that part. The compilation of this information being a laborious undertaking it would only be done at considerable intervals and even then would not be up-to-date, so that when information was required relative to the manufacturing position the usual procedure would be to visit the bins or shelves. In factories where such methods are employed it will be found -R" BOA R D. WH I I CAJ I OH I KOI iach: OPERATION TRACER Pai-t»lcr --Sl3 Furrow Wheat Sprinp Case Ho. of Pieces Requirea t SIO Lot N o. 450 - OPERATION loePTC^J'J^'IpiECES Grind Sloittng 4-50 «JOB NOW .BEIN<3 , WORKED ON >TB<(i ^ [too HUk-rtRlilL MOVED EQUlPHEKTMOveO .Ml NEXT UOE> M/\TERIM_ A.ND EQUIPMENT MOVED TO MACHINE.. RKF! ^ MAd i CAfl i> 1,500,000 o o 1,200,000 " 900,000 ■ 600,000 300,000- Jar Feb Mar - Apr Maij June July Auc . Sept Oct Nov Dec / / / / / / ^ y K ^y '^ ( • V U 50^ V r A / A^ / /y y .^ ^ ; /ne c n^^ r7C?/ed =>-of'^ ■ ' ^ y — -"^ Fig. 17. — Method of charting forecast of profits. chart so that a comparison of these with those of the estimates would show the extent to which the business ship has deviated from the course laid down. Now under the form of accounting here illustrated all results require to be shown in relation to the estimates. It is assumed that the manufacturing costs have been predetermined according to the methods previously explained in these articles and that the administrative and selling costs, based upon sales of 250 trucks a month, have also been carefully predetermined. All efforts are concentrated toward the realization of $50,000 a month profit — responsibilities are apportioned between the sell- ing and manufacturing departments, the former to dispose of 138 250 trucks a month at a price of $1000 and at a selling expense of $100 a truck and the latter to deliver these trucks at a factory cost of $650, Detailed statements showing the variations from estimates for three months are given in Tables 19, 20, and 21, the informa- OOO'Oi^ qsj tion appearing on these statements being charted on the form illustrated in Figure 18. All figures on these statements are expressed in relation to their effect upon the estimated profits, the results shown on the statements being summarized as shown in Table 22. 130 Table 22. Increases or Decreases in Comparison with Estimated Profits January February March Total Due to variations in volume of sales . Due to variations in price *$5,ooo *5,ooo 2,500 500 *i,5oo *I,250 *i,500 $10,000 *i5,ooo *i,ooo 500 5,000 1,000 1,500 $20,000 *i7,50o 3,000 1,000 12,500 3,500 8,000 $25,000 *37,500 4,500 2,000 Due to variations in cost of sales: Cost of material Labor Factorv burden 16,000 Administration expense Selling expense 3.000 8,250 Total *$i 1,250 $2 ,000 $30,500 $21,250 Asterisk (*) denotes decrease. A consideration of the first month's statement (Table 19) will show that the market conditions were not properly prede- termined. The price of the truck was too high to meet com- petition and in spite of the fact that 50 trucks were sold at a reduced price of $900 ($100 less than the standard) the volume of sales was 25 trucks less than the estimate. This condition resulted in a loss of the $200 profit on the 25 trucks not sold, making a total of $5000 and a loss of $100 apiece on the 50 trucks sold under the estimated selling price totalling $5000 more and making a total loss, as compared with estimate, of $10,000. The manufacturing department managed to keep their costs below standard but owing to the decreased volume of sales the selling and administrative expense per truck was above standard. Obviously a complete change in selling policy was necessary if the estimated profits were to be realized and it was decided to reduce the price of the trucks to $950, the effect of this policy being shown in the statements for February and March. In February, as a result of the change in selling price, the number of trucks sold was 50 in excess of the estimate, which would have resulted in an increased profit over standard of $10,000 had the price been maintained. Owing, however, to the reduced price there was a corresponding loss of $15,000 making a net loss, as compared with estimate, of $5000, but this was more than offset by the decrease in factory burden, selling, and ad- ministrative costs per truck, owing to the increased volume of business over standard. I40 In the month of March (Table 21) the number of trucks sold was 100 in excess of standard which would have resulted in an increased profit, as compared with the estimate, of $20,000 had the price of $1000 per truck been maintained. The reduc- tion in price of $50 resulted in a decrease in profits of $17,500, so that at this point the profit due to increased sales more than ofifset the loss due to decreased selling price, wath the result that the large savings in factory burden, sales and administrative expense due to the increased production were all velv^et, the net profits for the month being $80,500 or $30,500 in excess of the estimate. Obviously, under these conditions the original estimates require revision — instead of figuring on selling only 250 trucks a month the sales manager decides that if he still further reduces the price to $900 he ought to sell 400 and the factory manager advising that he can produce this number of trucks, the new plans are figured on this basis. It is figured that the March figures for factory burden, administrative and selling expense can be maintained and the revised forecast for the cost of a truck during the next 12 months is made up as follows: Material $300.00 Labor 100.00 Factory burden 187.50 Administrative 35-00 Selling expense 67.50 $690.00 These figures then give a revised forecast of profits as follows Revised estimated sales, 4800 trucks at $900 each $4,320,000 Revised estimated cost, 4800 trucks at $690 each 3,312,000 Revised estimated profits, $210 per truck. . $1,008,000 The new forecast of revised figures is shown in chart form in Figure 19 and until conditions change sufficiently to render it desirable to make a further revised forecast the accountant will show monthly the position of the business as regards costs 141 and profits in comparison with the revised course as laid down on this chart. Apr Mau June Julu km. Sept. Od. Nov. Dec Jdii. Feb. Mar, t ■ ■- ■ ■■ - - - 4,500,000 4,000,000 3,500,000 3,000,000 2,500,000 Z,000,000 1,500,000 1,000,000 500,000 y y y -^ ^ ./^ y ^ ^ .A ^ ^ bj^ ,/^ y^ ^ ^ /^ 2/?7-= 6000 lOOO ^^ ALL LINES ' *NOT£H LINEdt ABOVE REPRESENTSmYliOLLMATERIALAND BURDEN DISTRIBUTION {Z) ABWE REPRESENTS REFERENCEnSTANDARDCOST SHEET HOT ILLUSTRATED Fig. 20.— Diagram illustrating general principles involved in determining monthly profit and loss by the use of price lists combined with standard £ i6i every time they wished to pass the burden alon^ to the ultimate consumer they sometimes might have paused a httle longer before raising prices. The list less discount idea has proven to be remarkably work- able. The originators of some of the standard price lists prob- ably never anticipated the condition which has developed in some industries where the discounts gradually declined to the /vanish- ing point and then retired in favor of "list plus premium" but figuring prices from the list when premiums are used is a little more convenient even than figuring with discounts so that, like the principle of standard costs, the essential soundness of the list and discount idea is proven by the facility with which it can be adapted to meet varying and unexpected conditions. Many years before he developed the application of the standard idea in cost accounting with which this volume deals, the author pondered on the possibilities of using the standard price lists as a means of determining the profits and losses realized on sales of different lines, but without the assistance of standard costs he made little headway. There were many complications — for instance there was not necessarily any direct relation between the cost of different articles and their list prices. Also owing to improved methods of manufacture certain classes of goods or certain sizes of goods could be manufactured more cheaply than at the time the list was made while other classes or sizes of goods cost as much as before, but the list would not be changed, the alteration in conditions being merely reflected in the use of different discounts for the different classes of product or groups of sizes. In some industries different price lists were used for the various classes of customers — class A customers, for instance having a slightly lower price list than class B, and so on. By the use of standard costs, however, and the exercise of a certain amount of ingenuity the author found that it was possible to devise methods which would successfully meet alb of these problems. Some of these methods are described in this chapter. In Figure 20 is diagrammed a plan which illustrates the general principles involved in the determination of the cost of goods sold and the figuring of monthly profits and losses by lines by the use of price lists combined with the application of the standard cost idea. The particular plan illustrated is not suitable to meet all conditions, even when sales are made on a list less discount basis, but a thorough understanding of this plan should enable a skilful accountant to api>ly the principles l62 involved to meet other situations, and at this point it would seem well to mention that he who thinks he can successfully apply any system of accounting which he sees in a h(jok to meet other conditions without possessing a thorough understand- ing of the basic principles involved is headed for trouble. The author realizes that in making this statement he is probably going contrary to the views of the engineer quoted in the first chapter to the effect that an expert on shop management in a short time can learn all the accounting required to enable him to satisfactorily design systems of cost accounting and that the employment of an expert accountant for this purpose is an absurdity. Though an accountant by profession, the author holds no brief for expert accountants as designers of cost sys- tems and in fact in this volume has been frank to criticize the accounting profession for its shortcomings in this field, never- theless he considers that some of the claims which are made that engineers should be masters as well as jacks of all trades are not founded on common sense, nor are to the benefit of the engineering profession, and that the logical exponents of accounting methods are those who have devoted their lives to this work. Accounting is deceptively simple on the surface — like chess it is founded on a few simple principles but its com- binations are innumerable and there is as much difference between the cost systems which an engineer with a superficial smattering of accounting knowledge and a highly trained accountant would design as there would be between the chess game which would be played by a novice who merely knew the moves and the masterpieces of Paul Morphy. The information which a cost system should furnish should form a trinity of cost data, efficiency data, and cost of sales data. As a general rule the systems of cost accounting which are designed by professional accountants while meeting at least partially the first and third requirements ignore the second but they at least conform to established accounting principles and furnish proper control of the cost records through the general books. The cost systems as a rule drawn up by engineers furnish considerable information relative to manufacturing efficiencies but this information is rarely brought to a focus and neither this nor the cost data are properly controlled by the general books, with the result that it is difficult to prove or disprove the cor- rectness of the information submitted, and provision for accurately figuring cost of sales except in the simplest situations is generally entirely absent. These three major requirements 163 of a cost system are not three separate problems but merely different angles of the same problem and under a properly designed cost system the methods used to satisfy one of the requirements should enable the remaining two to be also met. A cost system should be a stone to kill three birds. The absence of means for determining the cost of sales and the profit and loss by lines monthly is so common and so serious a defect in the cost systems operated by manufacturers of a varied line of product that at the risk of being tedious the author considers it desirable to enter into a somewhat lengthy explana- tion of the plan diagrammed in Figure 20. In this diagram in order to facilitate exposition the forms are given distinguishing letters while the lines, depicting the various accounting operations involved in the plan are numbered, the descriptive comments to follow being arranged in the order of the forms. Form A — Making Work in Process Account At the outset it should be mentioned that the plan being described was designed to meet the requirements of a business manufacturing silver-plated goods of great variety, these goods being carried on the stock shelves in an unplated condition until required for shipment, whereupon the goods (known as "metal stock" and so referred to in the diagram) would be taken from the stock room, sent through the plating room, buffing and other finishing operations performed on them and the goods then boxed and shipped. The operations up to metal stock are known as "making operations" and from metal stock to ship- ment as "finishing operations." It was necessary for this system to show the profit and loss realized monthly on the sales of about twenty different lines and a condition which required to be considered was that articles in the earlier operations were not identifiable with the line of which they would ultimately form part, blanks in various stages being carried in stock which could be worked into articles belong- insf to several lines. Under these circumstances it was decided not to attempt to carry separate making work in process accounts by lines but to carry all making work in process in one main account, subdividing this into: 1 Metal 2 JMaking labor 3 Making burden 4 Merchandise 5 Die service _ 164 The making work in process account is charged with the cost, both actual and standard, of all making operations performed the method employed following the lines illustrated in earlier diagrams (see Chapter II — Figure 3, Chapter III — Figure 5 and Chapter IV — Figure 7) this in general resolving itself into posting the actual cost of metal, labor, burden, and die service to the "actual" column of the respective divisions of the making work in process account and figuring the production on a standard cost basis and posting the figures so obtained to the "standard" columns under the same divisions of the making work in process account. The making work in process account is credited with the actual and standard cost of the goods transferred to the metal stock shelves as ascertained from the summary of metal stock transfers (Form C), the standard cost of the goods transferred (divided as to metal, labor, burden, and die service) being obtained by sorting and tabulating the metal stock transfer cards (Form H). The actual cost of the goods transferred to metal stock is obtained by applying the ratios of actual to standard cost as appearing on the making work in process account (See line 4 — Form A). Form B — Finishing Work in Process Account This form serves the same purpose as regards the finishing operation as the making work in process does for the making operations. The credits to the finishing work in process account — representing the standard and actual cost of the finishing operations on work received into finished stock — are obtained through the medium of the summary of finished stock transfers (Form D), the standard cost of the finishing operations being obtained through the sorting and tabulating of the finished stock transfer cards (Form J), the actual cost of the finishing opera- tions on the goods transferred to finished stock being figured by applying the ratios of actual to standard cost as appearing on the finishing work in process account. (See Line 9 — Form B), Form C — Summary of Metal Stock Transfers The purpose of this form was explained above when dealing with the making work in process account. The operations in- i65 volved in the use of this form as ilhistrated by the hnes on the diagram are as follows: Line 3 — Sorting metal stock transfer cards by line number and tabulating for standard metal, labor, burden, merchandise, and die-service. Posting totals so ob- tained in the various standard columns Line 4 — Posting ratios of actual to standard cost from respective divisions of making work in process account (Form A) to head of columns Lines 5 and 6 — Applying these ratios to standard figures pre- viously obtained (see line 3, above) to obtain actual cost of transfers to metal stock and carrying actual and standard cost for the line in total to metal stock account (Form E) Table 23 should make the above operation entirely clear Line 7 — Obtaining total actual and standard cost of metal stock transfers for all lines and posting to credit of respective divisions of making work in process account. Form D — Summary of Finished Stock Transfers This form serves the same purpose for the finished stock transfers that the summary of metal stock transfers does for the metal stock transfers. The operations involved in the use of this form as illustrated by the lines on the diagram are as follows : Line 8 — Sorting finished stock transfer cards (Form J) by line number and tabulating for standard metal stock, finishing labor, finishing burden, gold, and silver used in plating, paper and box, and merchandise. Posting totals so obtained as well as list price of goods finished, also tabulated, to the various standard columns of the summary of finished stock transfers Line 9 — Posting ratios of actual to standard cost from the respective divisions of the finishing work in process account to the head of the columns of the summary of finished stock transfers Line 10 — Posting ratio of actual to standard cost of metal stock for line from metal stock account (Form E) to metal stock per cent column on summary of finished stock transfers 166 Line 1 1 — Applying ratio obtained in previous operation to standard cost of metal stock in finished stock transfers to obtain actual cost and posting- both actual and standard metal stock cost to credit of metal stock account (Form E) Lines 12 and 13 — Applying ratios of actual to standard cost of finishing operations as obtained in operation No. 9 above to standard cost of finishing operations to obtain actual cost. Obtaining total of actual cost of metal stock and finishing operations and posting this total together with the list value of the goods transferred to finished stock to the finished stock account (Form G) Line 14 — Obtaining total actual and standard cost of finishing operations in finished stock transfers for all lines and posting to credit of various divisions of finishing work in process account (Form B) Table 23. Metal Stock Transfers — Line 5000 Item Standard Cost as Obtained from Tabulation of Metal Stock Transfer Cards Ratio of Actual to Standard as Obtained from Making Work in Process Account, Per Cent Actual Cost of Metal Stock Transferred Obtained by Applying Ratio in Second Column to Figures in First Column Metal $1896.00 1763.00 2009 . 00 83.00 67.00 82.00 113. 17 115.27 105.18 104.70 123 -44 129. II $2146.00 Making labor 2032 . 00 Making burden Merchandise Assorted die service Pattern die service 2113.00 87.00 83.00 106.00 Total standard and actual cost carried to metal stock account 1 $5900 . 00 $6567.00 Form H — Metal Stock Transfer Card This card represents the metal stockkeeper's report of goods received in the metal stock room. The standard cost per gross for metal, making labor, making burden, merchandise, and die service would be posted from the standard cost sheet for the 167 article reported as received (Sec line 2 — Form H). This standard cost sheet is not illustrated in the diagram but follows along the lines of the standard cost sheets shown in earlier diagrams. The extensions \vould then be made and the cards punched. At this point it may be well to draw attention to the im- portance of designing cards to be punched in such a way as to render the punching operation an entirely mechanical one. In the author's opinion a dual card (so called because both the written and punched information appear on the same card) is not properly designed if an expe- rienced punch operator who has never seen the card before is not enabled to punch the card at full speed at the outset and without requiring any lengthy preliminary study of the arrange- ment. This can be easily accomplished if the matter to be punched is arranged in the same order as are the different fields and if the "shark's tooth" plan used in Forms H and J is fol- low^ed. Under this plan by each item of written information to be punched are printed as many sharks' teeth as there are punching fields provided on the card. For instance on Form H five fields are provided for punching the order number and correspondingly five sharks' teeth are printed in the space pro- vided on the card for writing the order number so that assuming for the sake of argument that the order number is 989 the operator knows immediately from the sharks' teeth that she will have to punch five fields and accordingly punches the order number as 00989. It will be noted that the arrangement of the written data on Forms H and J proceeds from left to right in conformity with the arrangement of the punching fields with the exception of the date and the line number which are shown on the extreme right. The reason for this arrangement is that it is not convenient to crowd all of the written matter to be punched to the left of the card as those who are familiar with the particular kind of punch used will readily realize. The line number was therefore placed to the extreme right and was the first item to be punched on the hand punch, the month and day in the case being dealt with being invariably punched on a gang punch. Form J — Finished Stock Transfer Card The operations involved in handling this card are practically identical to those required for the metal stock transfer card. i68 The standard costs per gross are obtained from the standard cost sheets which in addition to showing the standard cost carry the Hst price of the goods which is also posted to the finished stock transfer card. Form E — Metal Stock Account A separate metal stock account is carried for each line, the main purpose of this account being to furnish the ratio of actual to standard cost for figuring finished stock transfers. In addi- tion, of course, the account is of value as indicating the amount invested on the metal stock shelves in respect to the different lines. Form F — Sales Card This card does not differ from the usual form of sales sta- tistical card with the exception that in addition to the amount billed provision is also made for punching the list value of the goods sold. In most cases this information will be shown on the invoice so that the additional work involved in making up this card is trifling. Form G — Finished Stock Account Separate finished stock accounts are carried for each line. The main purpose of this account is to furnish the ratio of actual cost to list for each line so that this ratio can be applied to the list value of the goods sold in order to obtain their cost. In addition the account is of value in indicating the amount of finished stock carried for each line. Form K — Statement of Profit and Loss by Lines The information shown on this statement, namely the profit and loss made in the month on the sales of the various lines, is of course the ultimate purpose of the plan illustrated. The operations involved in making up this statement are as follows : Line i8 — Sorting sales cards (Form F) by lines and tabulating for total amount billed Line 15 — Posting list value of sales as obtained from tabulation of sales cards to credit of finished stock account and applying ratio of actual to list (as shown 169 on debit side of account) to list value of sales to obtain actual cost of goods sold Line 17 — Posting cost of sales as obtained in foregoing operation to column so headed on statement of profit and loss by lines The method of obtaining the net profit by lines should be rendered entirely clear by the following statement: Statciucnt of Profit and Loss on Sales of Line 3000 in Month of February Amount of Billing $14,206.00 List value of goods billed. . . . $19,263.00 Ratio of actual cost to list per finished stock account for line 5000. .47.9557 per cent Actual cost of goods billed 9,238.00 Gross Profit $4,968.00 Less Selling and Administration Expense 2,841.00 Net Profit $2,127.00 The Economy of the Plan Illustrated as Compared with Usual Method of Figuring Cost of Sales The advantage of the plan illustrated in Figure 20 as com- pared with a cost finding system under which in order to determine the cost of goods sold by lines it is necessary to carry detailed cost accounts for each article made will be apparent when it is considered that under such a plan it would be neces- sary to refer to the detailed cost records for every item on an invoice in order to ascertain the last cost per unit for the article in Cjuestion and then to extend at this cost figure the number of pieces billed, a procedure ecjuivalent to repricing and extend- ing the invoice and involving so much work as to be prohibitive in most cases on the ground of expense. L'^^nder the plan illus- trated in Figure 20 there is practically no additional work in connection with the invoice with the exception possibly of to- talling the list amounts but this in the majority of cases will already have been done. i7o Obtaining Profits and Losses by Salesmen, Classes of Customer, etc. Under the plan illustrated in Figure 20 any subdivision of the profit and loss data can be obtained with facility — for in- stance the procedure required to figure the profits and losses on the sales of each line by the different salesmen would be as follows: 1 Sort sales cards by salesmen and line 2 Tabulate list and billed amounts for each line for each salesman 3 Apply ratios of actual to list (as obtained from the finished stock account — Form C) to the list value of sales to obtain actual cost of sales by lines; figure gross profits, pro-rata selling and administration expense and deduct same from gross profits to obtain net profits Similar procedure would be followed to figure the profits and losses on the sales of the various lines to the different classes of customers or to obtain any other combination of profit and loss data. The method followed in making an analysis of profits by salesmen is illustrated in Table 24. Special Problems in Connection with Figuring Cost of Sales by List and Standard Cost Method It will be remembered that in the explanation of the plan illustrated in Figure 20 it was stated that the conditions to meet which this plan was designed did not render it feasible to carry the work in process accounts by lines owing to the fact that the articles manufactured could not often be identified with the line until several operations had been performed. In many cases, however, the goods will be identified with the line from the outset and under such conditions the work in process accounts should be carried by lines as this method will give more accurate results and will simplify the work in connection with the figuring of stock transfers. In some industries it is the custom to use different lists for the various classes of customers and this condition presents no particular difficulty as regards the figuring of the cost of sales if the relationship between the different lists is uniform as regards the different articles, as for instance when the B list is uniformly 5 per cent higher than the A list and the C list uniformly 15 per cent higher. On the cost records, of course, lyi 4) C "cl O 1 Selling Gross and Net Profit Adminis'n Profit 1 Expense O" I^X vC D lO o On « « (N UO O " t^oONOOOOO 00 "- O vD lO O lOOO HH l-l „ « -0 " O ID ON x" Total Billings O 0) O^fN 0^0^00 fCO ON - -+ CMOrO -f C -1-2C t^ C^ - fOOO \0 O X lO X Tl-vO Tj- M ON PD t^ O lOOvrOONX C» N POi-i „ w cj ^cO vC lOX o\ O •- ■* TfX O O >Oi-i >o CD t^fCM N M w w -2 S2 Op: 'd o 0) ^ l-H CQ (U •4-1 a O tn ■;3 M <4-l CU O <lce Number W$95 r Number 20627 bxnan J 6- Jonas i+ory Illinois >s Jobber Kic 21 —Diagram iUustraling use of slandird cosis in ascertaining profits and losses made by individual salesmen. [To /ace #o«e //«. 175 10 ]\Iachine number 1 1 Amount billed 12 Freight and is used as a basis for determining the profits and losses realized on machine sales under various arrangements, as for instance by: Salesmen Territories Classes of customers Branches, etc. The use of this card in the diagram, however, is confined to ascertaining the profits and losses realized by salesmen, dividing these into the various classes of machines sold, as for instance: Implements Wagons Carriages Grain drills Gas engines Tractors Lighting plants, etc. Reference to Forms A, C, and D will show that the following information on the machine invoice (Form A) is coded: Code Number Territory — Illinois i6 Salesman — J. G. Jones 13 Class of customer — Dealer i Branch — Springfield 2 Class of machine — Implement i These code numbers are noted on the invoice (Form A) the punch operator using these notations as a guide in the punching of the machine sales card (Form D). The machine cards are sorted by salesmen and class of ma- chine sold and are then tabulated as illustrated to give the fol- lowing information relative to the sales of the individual salesman: 1 The number of each kind of machine sold 2 The total amount billed for each kind of machine 3 The freight billed for each kind of machine 176 This Information is posted to the analysis of machine sales by salesman (Form H) and by reference to the standard cost cards (not illustrated but similar in form to Form C, Fig- ure 5, see Chapter III) the standard cost of machines sold is obtained, and totalled by classes, in the case illustrated, it being assumed that the standard cost of all machines of the implement class sold by J. G. Jones was $2000. In order to obtain the relation between the standard and actual cost of this class of machine an inventory account (Form F) is carried, this account following the lines previously described and show- ing in parallel columns the standard and actual cost of the machines manufactured. In the case taken as an example it appears that the actual cost of the machines of the implement class carried in the Springfield Branch represented 140 per cent of standard, so that the gross profit realized from J. G. Jones' sales of implements for the month works out as follows: Standard cost of implements sold $2000 Ratio of actual cost to standard per cent 140 Actual cost of implements sold $2800 Amount of implement billings $3010 Gross profit on J. G. Jones' implement sales. . . $210 The method shown of figuring machine sales individually is feasible in this case as these sales are comparatively small in number as compared with repair part sales, which in a large concern may total to several hundred thousand items in a year, and accordingly some other method recjuires to be adopted in order to be able to figure profits realized on sales of repair parts. The method adopted is illustrated in the following forms : Repair parts sales invoice Form B Repair parts sales card Form E Implement repair part inventory account Form G A consideration of these forms will show that these repair parts are billed to customers on a list "less discount basis and accordingly to eliminate the refiguring of invoices the implement repair part inventory account is carried on both list and actual cost bases, the ratio of actual cost to list being shown. The repair parts sales card provides for the punching of the repair parts class number, the list price of the repairs sold and the amount billed, and as illustrated these cards are sorted by class numbers and salesmen and tabulated to show as regards the sales for each class of repair part by each salesman: The total list price of all sales for the class. The total amount billed for all such sales. According to the implement repair parts inventory account for the Springfield branch (Form G) the actual cost of these parts represented 30 per cent of list and accordingly J. G. Jones' showing on sales of repair parts of the implement class is made up as follows: Total list value of implement repair parts sold by J. G. Jones in month $89.00 Ratio actual cost to list per cent 30 Actual cost of implement repair parts sold. . . . 26.70 Total billed sales of implement repair parts. . . 82.67 Gross profit 55-97 Reference was previously made to the facility with which under the standard or specification plan of cost accounting, a distinction can be made between the results obtained by the sales and manufacturing divisions and though not specifically shown on the diagram it will be easily understood that by using fixed ratios for the year in figuring salesmen's profits the element of fluctuating manufacturing costs could be eliminated from the salesmen's profit and loss statements. The difi'erence between the costs charged against the salesmen and the actual costs would then appear as a separate item on the branch profit and loss statement. For instance, assuming that the ratio of actual cost to list for implement repair parts was fixed as regards salesmen at 26 per cent while, as noted above, the actual cost was increased to 30 per cent, the profit on the implement repair parts sold by J. G. Jones would be shown as follows: List price of implement repair parts sold by J. G. Jones $89.00 Ratio of actual cost to list adopted for year per cent 26 Charge to J. G. Jones for cost of sales $23.14 Total billed $82.67 J. G. Jones' gross profit $59-53 Excess manufacturing cost 4 per cent of list value of sales of $89.00 $3-56 Actual gross profit on J. G. Jones' sales of im- plement repair parts $55-97 Chapter IX COST ACCOUNTING AND SCIENTIFIC METHOD THE practical value of any science lies in the power it gives of foretelling the results which will follow from a given combination of conditions, or, as Herbert Spencer stated, "the business of science is to predict." This power of science to predict lies in the fact that the universe is subject to the opera- tion of immutable physical laws so that if the presence of a certain combination of conditions at one time gives a certain result, the identical combination of conditions at any subsequent time will result in a recurrence of the result previously obtained. Science, therefore, involves an investigation into causes, the scientific conception of which is defined by J. A. Thomson as being, "the totality of the conditions in the presence of which an event occurs, and in the absence of any member of which it does not occur." Engineering science is founded on the knowledge of the results which will surely follow certain combinations of conditions so that the naval engineer from his tables can calculate the speed of a battleship before even its keel is laid, and the electrical engineer the power which will be produced from a generator, the work upon which has not proceeded beyond the blue print stage. The practical application of astronomical science in the art of navigation lies in the ability of the astronomer to predict the exact position of the sun or some other heavenly body in a given latitude and longitude at a given moment. The practical value of meteorology lies in the ability which it gives to predict weather conditions and of geology to predict the presence of mineral wealth before even the first stroke of the pick is made. The Value of Prediction The late Mr. H. L. Gantt shortly before his death indicted the science of economics for its failure to predict the tremendous catastrophe of the World War, and the resultant lack of pre- 178 179 paredness of the world outside of Germany to meet this cata- clysm. We are beginning to realize that it is by this standard of being able to predict correctly, to foresee, that we must in the future appraise our sciences and our professions. The value of a lawyer lies not so much in his ability to get us out of trouble but in his counsel in keeping us out of lawsuits, in his advice before the event rather than in his assistance after we are in deep water. The old-fashioned physician still regards his duty as being limited to curing us w'hen w^e have become sick, often waiting until it is too late to save his patient, whereas the modern medico makes periodical examinations of his patient's condition and brings to light unfavorable tendencies in the early stages so that steps can be taken to avert disease long before the patient is aware of any unpleasant symptoms. More American lives \vere sacrificed in the winter of 1918 through the influenza epidemic than were lost in the World War, yet it was stated by the proprietor of a gymnasium in New York City that of the large number of active members which comprised its clientele not a single one caught this disease. Probably more lives are needlessly lost and more property wasted through a lack of foresight than all other causes combined. The old proverb to the effect that prevention is better than cure still rings true, and whatever interest may be aroused by the result of a post-mortem is certainly not shared by the erstwhile patient. Considered from the standpoint of the dictum of Herbert Spencer, previously quoted, that "the business of science is to predict" scientific management ranks high, for as the author stated in a previous chapter : Scientific management is more than a system of shop management — it is akin to a state of mind — a mental attitude. Considered in its essential features scientific management represents the use of the trained imagination in industrial life — a looking forward rather than a looking backward — the doing of things mentally before the attempt is made to perform them on the physical plane. Briefly stated, scientific management is foresight, the pre- determination of methods and results. It represents the applica- tion of the same principle in the operation of machines as is employed in their design. Foresight is necessarily a habit with the engineer. Obviously, he cannot wait until a bridge is constructed in order to ascertain wdiether it will withstand the strain to w-hich it will require to be subjected. It is, therefore, not surprising that the engineer I So has readily embraced the Idea of scientific management; for has not his whole training and experience been along the lines of "doing things mentally before the attempt is made to perform them on the physical plane?" The Difference Between Accountant and Engineer The training and experience of the professional accountant, however, is along totally different lines to that of the engineer. By far the greater proportion of the work of a professional accountant's office is auditing and investigation and after many years of continuous and exacting training in this line of work, it is not surprising that his viewpoint as regards business transac- tions is mainly retrospective, and that the less he is gifted with the faculty of imagination the better. The professional accountant's viewpoint is, of course, ab- solutely proper as regards his work of certifying as to the accuracy of the accounts and statements recording past trans- actions, but unfortunately in his incursions into the field of cost accounting he has not realized that the problems here are of an entirely different order to those which are involved in the certification of the records of past transactions and has drawn up his accounting systems with the main purpose of meet- ing the requirements of the treasurer's department, totally neg- lecting to provide for the needs of the producing end of the business. Post-mortem Cost Accounting It is now many years since Mr. Harrington Emerson drew the attention of the industrial world to the unsuitability of post- mortem systems of cost accounting to meet the requirements of an industrial world which was gradually embracing the idea of scientific management. Since that time though he and other prominent engineers have repeated and emphasized this conten- tion, the professional accountant with few exceptions is still providing his clients with these post-mortem methods of account- ing, which though probably suitable to meet the requirements of the financial interests are hopelessly and absolutely out of harmony with the needs and viewpoint of the producing end of the business. Mr. H. L. Gantt even went so far as to state that the failure of manufacturers to repair the leak of non- production is primarily due to the fallacious methods of cost accounting approved by professional accountants, and engineers generally seem pretty well in accord that one of the most serious drags on the industrial wheel of progress is the failure of accountants generally to appreciate the urgent need of an ab- solute revision of their ideas on cost accounting. The practical value of history is the ability which it gives from a study of past events to determine what to expect in the future and the value of past records of accounting should be regarded from the standpoint of the extent to which they also enable us to exercise foresight in the conduct of our business affairs. Unfortunately, this function of cost accounting is rarely exer- cised, such use of cost records for this purpose as is made being more or less incidental. As soon, however, as we reverse the usual order of things, and instead of confining our accounting work to compilations of past happenings determine our costs in advance, we find that our viewpoint on the purpose of accounts is immediately and vitally changed, for we are not only interested in what things actually cost but even more in the differences between what we figured the goods should and did cost, and forthwith we call for an analysis of these variations into causes. Mr. Harrington Emerson in discussing the defects of post- mortem systems of cost accounting stated that such systems are "wholly and absolutely incorrect, mixing up with costs incidents that do not have the remotest direct connection with them, so that analysis of cost statements . . . does not lead to elimina- tion of wastes." When, however, costs require to be pre- determined and to be analyzed into causes of increases and decreases as compared with the estimates, it is obvious that if the cost accountant charges any cost account with an item of expense not properly belonging there, he will quickly be called upon to justify his action. Furthermore, cost predetermination does lead to the elimination of wastes. The average post-mortem cost system is more remarkable for its power of concealing essential facts than for disclosing them, and it seems to the author that manufacturers in these days must be asking themselves searching questions relative to the adequacy of their cost records. The IMaxufacturer's Need of Knowledge The hectic davs of the war period are over. As business settles down the manufacturer is beginning to take stock. As l82 a part of this process he is naturally desirous of ascertaining how he stands in comparison with the pre-war period. He is paying a great deal more for his labor, and this being a condition over which he has little if any control he accepts philosophically and charges to his customers but he does want to know whether he is getting as much work done per man hour as he was before. His repair bill is way up, which is inevitable owing to increases in the price of both material and labor, but is all of the increase in this cost of repairs due to this cause — may not some of it be due to more labor and more material being used than formerly? Conversely, is it not possible that the efficiency of his repair men may have increased, or that his machines are being handled more carefully and do not require so much repairing so that although his repair cost in total is increased, as a matter of fact, figured on the pre-war price scale his repair costs to-day are less than formerly? There is probably not one manufacturing institution in a hundred where statements of operating costs before the war can be intelligently compared with statements of current operating costs and this remark applies also to comparisons of statements from month to month and year to year. The reason for this con- dition is clear. The average cost system having been designed solely for the purpose of obtaining the cost of product in terms of dollars and cents, does not provide for a complete separation of cost data into elements and, therefore, in making comparisons of costs in different periods it is not possible, without an immense amount of detailed investigation, to determine to what extent increases and decreases in cost are due to general economic causes over which the manufacturer has no control, and to varia- tions in actual operating efficiency. The Difficulty of Comparison In the author's experience it is the exception rather than the rule to find any mention in a cost statement of hours of labor as distinguished from the amount paid for labor, so that in comparing a cost statement of to-day with one prepared before the war, we are not able to determine to wdiat extent an increase has resulted from a raise in the scale of wages nor to ascertain whether the present cost in terms of labor and machine hours is greater or less than before. As an example, we may take a comparison of the cost of machine repairs to-day with the i83 costs of several years ago. To compare such costs intelligently we must be able to separate these into their basic elements and to segregate those elements of cost over which we have ccmtrol from those which are the result of general business conditions. If we wish to interpret clearly the repair figures shown on two cost statements we must be able to determine to what extent increases or decreases are due to variations in: 1 The number of hours of work of different classes of workmen employed 2 The average rates of pay of such workmen 3 The quantities of repair material used 4 The prices paid for such material The above information would require to be shown not only in total but also in relation to the number of hours the machines were operating and to the work produced therefrom. In many cost statements, however, and in fact in the great majority, repair costs are simply stated in terms of dollars and cents, and though such information may meet the requirements of the accountant in the preparation of his balance sheet and profit and loss account, it is entirely inadequate to meet the needs of the plant superintendent in his efforts toward decreasing costs of manufacture. It is the usual complaint of the cost accountant that the operating men do not analyze the elaborate and detailed state- ments which he prepares for their guidance. In making this criticism he overlooks, first, that the data he presents are not sufficient to enable the right kind of analysis to be made and, second, that such analysis is the proper function of the cost accountant and not of the operating man. The Cost of Idleness vs. the Cost of Production The most serious defect, however, in the accepted systems of cost accounting is the failure to distinguish between the cost of production and the cost of idleness. The phenomenal growth of German industry before the war was largely due to her appreciation of the importance of keeping her factories operating at full capacity; as Henri Hauser in his illuminating book, "Ger- many's Commercial Grip on the World," states, Germany fully understood that: It is no longer the demand that regulates the stream of production, it is the plant; it is the furnace which must not be permitted to go out, i84 it is the machine which must continue to revolve, it is the dynamo which does not cease from transferring into electric power the energy created b}- coal or by water power. As a general rule, however, cost systems do not show the cost of non-production but ingeniously saddle the machine which works with the cost of the machine which is idle. As soon, however, as our cost statements show each month the big red figure which represents the cost of non-production our manufac- turers will realize that idleness is the one thing which they cannot afford. There is all the difference between realizing in a general way that reduced production means increased costs and having this fact brought to our attention each month by a definite statement of the thousands of dollars which have resulted from the idleness of men and equipment. When our accounting systems provide this information there will result a tremendous impetus to American export business, for as former Secretary Lane states : Our industries have so grown that their output when run continuously at full time is greater than our home market will take at its best, and when times are dull there is a large surplus of unsold goods. Out of this condition has grown first the wish and then the need to obtain foreign markets. . . . Some have known what it means to have a plant made for production lie idle, eating its head off. Sometimes it happens that there is a product one could cheaply make but which one's particular market did not want. Perhaps there is some by-product which could be made if we knew where it could be sold. For these and similar ills the door of opportunity lies open, affords a remedy. Out there beyond the wall are many men of many minds, some of whom v/ill like what we make if we could sell it, or who can use enough of our present product to add to the output of to-day that which shall make the whole cost less per unit. The merging of the cost of idleness with the cost of produc- tion absolutely kills the value of cost statements considered as indices of operating efficiency. Every open hearth superin- tendent knows that the cost standards when he is operating half of his furnaces are absolutely different to what they should be w^hen all of his furnaces are in operation. It is no fault of his that there are only sufficient orders to take half his capacity, but the result of this factor is not shown separately in the cost records, so that comparisons of costs from month to month mean little or nothing, for the difference in legitimate costs when the furnaces are running full capacity and when only half of them are operating is probably greater than could ever result from fluctuations in operating efficiency. i85 Mr. H. L. Gantt presented the case of the producing end of manufacturing against the professional accountant very suc- cinctly when he wrote: Most of the cost systems in use, and the theories on which they are based, have been devised by accountants for the benefit of financiers, whose aim has been to criticize the factory and to make it responsible for all the shortcomings of the business. In this they have succeeded admirably, largely because the methods used are not so devised as to enable the superintendent to present his side of the case. One of the prime functions of cost-keeping is to enable the superintendent to know whether or not he is doing the work he is responsible for as economically as possible, a function which is ignored in the majority of cost systems now in general use. It is quite obvious that for a cost system to ''enable the super- intendent to know whether or not he is doing the work he is responsible for as economically as possible" it is necessary for us to distinguish between expenses for which the superintendent is directly responsible and those over which he has no control, and further in order to be in a position to state whether he is producing as economically as possible it is obvious that we require standards for all expenses so that we can compare our actual expense with our standard. Little argument is necessary to establish the fact that the usual post-mortem system of cost accounting fails totally to measure up to these requirements. The author does not deny the use- fulness of the records of past experience which it is the purpose of these post-mortem cost accounting systems to furnish ; he does, however, deplore the restriction of cost methods to this single end. Ralph Waldo Emerson was alive to l)oth the value and limitations of experience when he wrote: Experience is hands and feet to every enterprise — yet he who should do his business on this understanding would be quickly bankrupt. A Humiliating Situation Illustrating the truth of this dictum the author calls to mind the case of a certain large manufacturing concern which for many years kept records showing the percentage of net profits realized on its sales and, as year after year this percentage showed no material variation, in the course of time it became the custom to use this percentage as the basis (^f figuring the profits from month to month. This procedure was adopted in i86 figuring the interim profits in a certain year and out of these supposed profits a substantial dividend was declared and paid without awaiting the final accounting based on the physical in- ventory at the close of the fiscal year. Unfortunately the directors in declaring this dividend had not taken into account the effect of important changes in conditions, with the result that instead of having realized a profit it transpired that a net loss had resulted from the year's operations and the dividend was actually paid out of capital. The dismay and humiliation of the directors of that company may better be imagined than described. The Larger Significance of Double-entry Bookkeeping All business transactions are dual in effect. If a trader pur- chases goods for cash his merchandise is increased and his cash correspondingly depleted ; if he sells these goods on credit his merchandise is decreased and his accounts receivable correspond- ingly augmented and it is on this principle that is founded the double-entry system of bookkeeping, which is believed to have been introduced in Venice about 700 years ago and which is now practically universal. It is held by accountants that no cost system can be considered complete unless it is operated on the double-entry plan, so that the mechanical accuracy of the figuring can be determined by means of a trial balance which is a list of the debit and credit balances at a given time, the totals of which if the figuring has been correct must balance in view of the fact that every debit entry on the books should be oft'set by a corresponding credit and z'icc versa. It is a somewhat extraordinary fact, however, that the larger significance of the double-entry principle has not been realized by accountants generally and that such application of this prin- ciple as has been made has been restricted in the main to the peculiarly technical feature represented by the trial balance. Considered in a broader sense the usual cost accounting methods are confined to showing one side of the account only — to record- ing how much was spent for labor and what it was spent for, but not whether a proper equivalent was received for the money expended — to advising as to the cost of material used, not whether it was used efficiently or the contrary. Such use as is made generally of cost data for the purpose of determining whether a proper return has been made for money expended is i87 merely incidental, haphazard, and incomplete. Tliat this is so is just what might be expected in view of the fact that the accounting machinery is designed to meet the recjuirements of a restricted ideal and when an attempt is made to use it for a purpose for which it was never intended it is about as clumsy and inefficient as makeshift appliances generally are. The Figuring of Standardized Operations An immense amount of energy and tremendous investment in expensive time keeping equipment is more or less uselessly dis- sipated in the so-called refinements of cost distribution which are the result of a lack of appreciation of the fundamental im- portance of bringing the factor of equivalency into cost calcula- tions. There seems to be a general idea that if we obtain a complete distribution of the time consumed by every workman our cost problems will be solved, whereas in many cases the more complete and elaborate such distribution is the farther away we get from the results desired owing to the impossibility under the methods employed of digesting the tremendous volume of detailed information compiled. The author has been in factories where an operator would work on as many as 30 short-time operations in one day, each change of work necessitating the stamping of the time on the card for the jol) just completed and the issuing and stamping of another card for the succeeding job. Under such conditions it may easily be imagined how little actual use can be made of the information recorded con- sidered from the standpoint of determining whether a proper return was realized from the money expended. The author is by no means prejudiced against the employment of time clocks and in fact would be loath to prescribe methods for a concern w-hich was opposed to their use, but he is em- phatically out of sympathy with the idea of figuring the cost of every performance of standardized operations on stand- ardized products when the same operations are being performed over and over again, generally on a piece-work basis. And yet there are innumerable cost systems where this idiotic procedure is continuously followed, resulting in the employment of an army of clerks producing information of practically no real value and to this end adding to the high cost of living. It is not only the expense and waste of time involved in such methods of cost accounting which are to be deplored, but the more serious thing is that such methods, in spite of their expense, do not give adequate results. The simple, sensible way to keep track of labor costs is to set time standards for each operation and instead of recording the time spent by an operator on every job he performs during the day to compare his total time for the day with his production figured in terms of standard time. Under such a method all that is required in the form of time clocks is a regular in-and-out clock recording the actual time spent on the premises, and a record of the work which the man produces. This method eliminates the temptation to the work- man to equalize the time spent on jobs by undercharging one at the expense of another and gives the real informaticjn re- c|uired, namely, his relative efficiency, this being expressed as follows : Actual time spent lo hours Work produced in terms of standard. ... 7 hours Efficiency 70 per cent It may be asked very pertinently how, under this method, labor costs can be distributed to the various articles manufactured. Before this is explained it will be well to dispose of the favorite fallacy that if John Jones, who is working on day work and not feeling w^ell this morning, spends twice as long on a job as he would if he had not been out late the night before this extra cost is a legitimate charge to the particular article on which he is working, and that extra pay for overtime should be charged to specific articles, even if the need for working overtime is a general one and the decision as to which work is to be done in the regular time and which in the overtime period more or less fortuitous. The author claims, and believes that in this he will be supported by most practical men, that such increases over the normal cost should be regarded as charges against the product in general and not against the un- fortunate article which happens to come along at the time when the cost increasing event occurs. More important still, even if such extra expense is ultimately merged in the product, w^iich generally results in its significance being entirely lost sight of, it should first show clearly on the records and cost state- ments as a special expense, for owing to the inducement of extra pay it is by no means unusual for overtime to be worked unnecessarilv. iJig The Method of Distributixg Labor Costs The air having hcen cleared as to the basic principles of labor distribution, the author will now proceed to explain the methods followed by him in distributing labor costs to the product manu- factured without adhering to the customary procedure of keep- ing careful track of the time spent by an operator on every job he performs and distributing this to the cost of the different articles manufactured. As to whether the distribution of labor costs to the product should be made by specific articles or classes of product depends upon the individual conditions, but the general principles will be made clear if the latter case is taken as an illustration, for instance that of a manufacturer of agricul- tural implements w^ho desires to ascertain the profits realized from the sales of the different classes of machines manufac- tured by him, such as corn planters, grain drills, cultivators, harrows, etc. For the purpose of obtaining costs of sales no distinction need be made on the cost accounts as regards how much labor was expended in the forge shop on the different classes of product, all forge shop productive labor being in total carried on a forge shop labor in process account which would appear as shown in Table 28. Table 28. Forge Shop Labor-in-Process Account Item Actual Standard Ratio Actual to vStandard Per Cent Si 820. 00 931.00 $1400.00 700.00 130 Charge for month 133 Total S2751.00 $2100.00 131 To obtain the cost of the corn planters shipped during the month (as regards the element of forge shop labor) necessitates determining the standard forge shop labor per corn planter, this multiplied by the number c^f machines shipped giving the total igo standard forge shop labor in these shipments. This standard labor is adjusted to an actual basis by the use of the ratio of actual to standard of 131 per cent as shown in Table 28. Assume for instance the standard forge shop labor cost per corn planter to be $1.00 and the number of corn planters shipped in the month 500, the calculations would be : Standard Ratio Actual Labor Labor Actual to Standard per cent in Shipments $500.00 131 $655.00 The forge shop labor-in-process account w^ould then show as in Table 29, the balance carried forward representing the forge shop labor cost of all goods remaining unshipped: Table 29. Forge Shop Labor-in-Process Revised Account Item Actual Standard Ratio Actual to Standard Per Cent Total as above (Table 28.) $2751.00 655.00 $2100.00 500 . 00 131 131 Shipments Balance carried forward $2096 . 00 $1600.00 131 Reverting to the major theme, namely, the fundamental im- portance of the factor of equivalency in cost accounting — the opening of the other side of the ledger and the rendering of cost accounting double-entry in the fullest and most vital sense — it may be stated, that it is only along these lines that cost accounting will ever fill its proper place in the economic structure, for records of actual costs without parallel statements of stand- ards are as Incomplete as a trial balance which shows only the debits and ignores the credits. Parallel statements of actual and standard costs demand an analysis of increases and decreases and when this is furnished the problem of increasing efficiency is more than half solved, for the difficulty in the average manu- facturing plant is not so much in the correcting inefficiencies after their existence has been disclosed as in ascertaining exactly where to start on the work of cutting costs. The author has already pointed out how completely the under- lying idea of scientihc management conforms to Herbert Spencer's dictum that "the business of science is to predict" and how far the usual methods of cost accounting fall short of being scientific considered from this standpoint. But the power to foresee is not the only aim of science, as one writer states: The ultimate ideal of science ... is simply the description of the course of events by the aid of the fewest and simplest general formulas. Cost accounting has not as yet realized this ideal. There are plenty of forms but few formulas, in fact the only cost account- ing formulas that the author remembers having seen in print were some simple formulas devised by Mr. Emerson and that given by the late Mr. Gantt in his book entitled "Organizing for Work" when he stated that: The indirect expense chargeable to the output of a factory should bear the same ratio to the indirect expense necessary to run the factor}- at normal capacity, as the output in question bears to the normal output of the factory. Formulas represent the boiled down experience of the ages, as Ralph Waldo Emerson wrote : The memory disburdens itself of its cumbrous catalogues of particulars, and carries centuries of observation in a single formula. Engineering is an exact science and the work of that profes- sion is largely founded on formulas so that when the engineer finds himself in the domain of cost accounting he is naturally surprised to discover so much opinion and so little in the nature of facts and to crave definite basic formulas like that given above. Accountants are too prone to quibble over non-essentials. The author remembers a discussion some years ago which was waged in a leading accounting journal, and which covered many pages which could have been devoted to better things, on the subject of whether it is more correct to head a profit and loss account "for the period ended December 31," or "for the period ending December 31," and he has never seen much point to the everlasting arguments as to whether interest should or should not be included in costs, probably mainly due to the fact that under the methods he employs costs can be easily stated both ways and those with pronounced views on the subject can take their choice and be happy. 192 Cost accounting at present has reached about the same stage as the process of photographic development had a few years ago when the approved practice for preforming this operation was to close oneself in a stuffy darkroom where in dim red light, the photographic enthusiast would mix equal parts of solutions one and two and wait anxiously for the appearance of the the photographic image. If this did not appear as quickly as he thought it ought to he would add an extra quantity of solution number two and by this and other methods endeavor to stimulate the development of the picture. After the image appeared he had to use his judgment when to stop developing, with the result that generally the picture was either over or underdeveloped, to say nothing of the damage to the film resulting from the various manipulations performed. The whole process was wasteful of time, temper, and chemicals, the results were generally far from satisfactory and the amateur had to be very enthusiastic indeed to wish more than once to undertake the development of pictures. Nowadays, by means of a tank, a thermometer and a time and temperature table a dozen exposures can be developed in less than 15 minutes without ever even going into a dark room and with practically perfect results. The author has previously dealt at some length with the com- mon fallacy "that the primary purpose to be aimed at in any system of accounts is extreme simplicity of design." As Mr. Benjamin A. Franklin suggests, however, a cost system should be "a panorama of the movement and groupings of shop events" and a cost system must necessarily be complex about in propor- tion to the complexity of the events which it attempts to portray. As the author stated in an earlier chapter: There is no way of avoiding considerable complexity in the design of systems to efficiently handle a complex business, but the complexity should stop right there, for a sjstem which is unduly difficult to operate is to that extent defective in design. When in addition to providing the data obtained under the usual cost methods, namely, costs of specific articles and costs of goods sold, a comparison of all expenditures with standard and an analysis of variations according to "causes" are also furnished by the methods developed by the author, extreme sim- plicity in design is a practical impossibility. If simplicity of design were the only ideal in locomotion, however, the world would still be using wheelbarrows in place of automobiles. 193 Complexity IN Design: Simplicity in Operation The author is hoping that at this point the attentive reader will ask the question that the above remarks have been leading up to, namely "How is it possible to combine complexity in the design of a system with extreme simplicity in its operation?" The answer has already been suggested. The result is obtain- able by the use of formulas. Under the methods developed by the author by the aid of formulas the most complex co3t analyses can be accurately and speedily made by any clerk who can read, write, add, and subtract, and without any fuller understanding of the principles underlying the methods followed than the average girl in a cost department who uses a slide rule has of logarithms. As an illustration of the use of formulas to render the making of complex cost analyses an exceedingly simple matter, the fol- lowing case has been taken : It is assumed that it is desired to ascertain the variations between actual and standard cost and to obtain a complete analysis of these variations in the pickling department of a steel mill. It is also assumed that the production of this department at full capacity is 10,000,000 pounds a month and that the standard cost of production on this basis is figured as follows: Producing labor, 8,000 hours at average rate of 0.60 $4,800 Steam, 100,000 b.hp. at 0.015 1,500 Electricity for Exhaust Fan, 10,000 kilowatt hours at 0.02 200 Acid, 1,000,000 pounds at 0.0 1 10,000 Labor in Repairs, 400 hours at average rate of 0.50 per hour 200 jMaterial in Repairs 100 Taxes, Insurance, etc 300 Total $17,100 The electricity for the exhaust fan, the cost of repairs, taxes, insurance, etc., not varying directly with the production are regarded as being in the nature of fixed charges, the otlier items of expense being assumed to vary directly with the production. By the term "fixed charges" as used here it is not to be under- 194 stood that the amount of the expense will not fluctuate, for obviously in the case of the electricity used for the exhaust fan both the quantity of electricity used and the cost of produc- ing electricity may fluctuate. For such an item of expense as this, however, if the production of the department is less than standard, even if the expense itself remains constant, there will be an increase in cost per unit of production as compared with standard, owing to the actual expense requiring to be spread over a smaller production. It is in this sense that the term "fixed charges" is used in the case of expense items coming under this head, it being necessary to show to what extent an increase in cost is due to idle time. The problem to be solved by the use of formulas is as follows: Given the actual production in the month and the actual ex- penditures, to provide comparisons of actual and standard ex- pense analyzing the variations between actual and standard as follows : Producing Labor fDue to variations between ac- J tual and standard time. Due to variations between ac- tual and standard rates. Steam 'Due to variations in the quan- tity of steam used as com- pared with standard. Due to variations in the cost of producing steam as com- pared with standard. Electricity for Exhaust Fan 'Due to reduced production as the fan is running continu- ously. .= Due to the quantity of elec- tricity used. Due to the cost of producing electricity. Acid 'Due to variations in the quan- tities of acid used as com- -{ pared with standard. Due to variations in the price paid for acid. 195 Labor in Repairs Material in Rcoairs Taxes, Insurance, etc. < 'Due to reduced production — • otherwise the idle time factor. Due to variations in the time spent in repair work. Due to variations in the rate paid repair men. 'Due to reduced production. Due to variations in the quan- tity of repair material used. Due to variations in the price paid for repair material. ' Due to decreased production as compared with standard. Due to variations in the actual expense for taxes, insurance, etc. All of the above items of information can be obtained by a proper combination of four factors: A — The actual expense for the month B — The actual expense figured at standard rates or prices. For instance, it will be seen by reference to Table 30 that the actual producing labor was assumed to be : 5800 hours at 0.65, making $3770, this being entered in col- umn A. But the standard rate per hour as previously shown was 0.60, so that the actual expense figured at standard rate would be: 5800 hours at $.60, making $3480 C — The standard cost for standard production, this being the standard cost on a 10,000,000 pounds a month basis as previously shown and totalling to $17,100 D — The standard cost for actual production, this being the standard cost for standard production (C) divided by the standard production and multiplied by the actual production. The actual production in the case taken as an illustration being 7,500,000 pounds, the standard cost for this production is figured as follows : 17,100.00 10,000,000 times 7,500,000, making $12,825.00 ig6 The formulas for obtaining the different items of information required are as follows: 1 Comparisons of actual and standard in total ; D-A 2 Variations in production: D-C 3 Time efficiency, expense varying directly with the pro- duction, D-B 3a Time efficiency when expense in nature of a fixed charge: C-B 4 Variations in labor rates: B-A 5 Variations in the quantities of material used when expense varies directly with production : D-B 5a Variations in the quantities of material used when expense is in nature of a fixed charge: C-B 6 Variations in the price of material: B-A 7 Variation in expense when expense varies directly with production: D-B 'ja Variation in expense when expense is in nature of a fixed charge : C-B 8 Variation in the consumption of service production (steam, electricity, etc.) when expense varies directly with production: D-B 8a Variation in consumption of service production when expense is in nature of a fixed charge: C-B 9 Variations in the price of service production: B-A The above may be boiled down as follows : D-A Comparisons in total D-C Variations in production D-B Variations in expenses not of a fixed charge character: Variations between actual and standard time. Variation between actual and standard quantities of material. Variations between actual and standard expense. Variations in the consumption of such service items as power, steam, electricity, etc. C-B Variations in expense in the nature of a fixed character: Variations between actual and standard time. Variations between actual and standard quantities of material. Variations between actual and standard expense. 197 Variations in the consumption of such service items as power, steam, electricity, etc. B-A Variations in rates of pay, price of material or of service So, all information required in the case chosen as an illustra- tion can be obtained by the use of five simple formulas. These items of information and formulas applying thereto can now be stated: Producing: Labor Steam Electricity for Exhaust Fan (fixed charge) Labor in Repairs (fixed charge) Materials in Repairs (fixed charge) Taxes, Insurance, (fixed charges) r Comparison in total . D-A I Time Efficiency .... D-B i Rate variations B-A f Comparison in total . D-A < Consumption D-B I Price B-A etc. Comparison in total. D-A Variations in production, D-C Consumption C-B Price B-A ' Comparison in total . D-A Variations in production, D-C Time efficiency C-B Rate variations B-A 'Comparison in total. D-A Variations in production, D-C Material consumption. C-B Price variations .... B-A ' Comparison in total . D-A Variations in production, D-C Expense C-B In actual practice as is shown in Table 30 the work of figuring cost variations and making an analysis thereof is therefore rendered an absolutely mechanical process as follows: 198 First. The list of the expense accounts and the figures of standard cost for standard production for each expense account are either printed or otherwise dupHcated to avoid rewriting each month (see column C). Second. The formulas for ascertaining each class of variation are shown at the head of the columns provided for figuring such variations — for instance, in the illustration it will be seen that the column headed ''Variations in Production" has the formula D-C printed at the head of it. Third. Each of these variation columns is given a number (corresponding to the numbers already given) as follows: 1 Comparison in total. 2 Variations in production. 3 Time efiiciency. 3a Time efiiciency for expense in the nature of fixed charge, etc. Fourth. For each account there is printed the numbers of the columns for the variations requiring to be figured — for in- stance, the item "Electricity for Exhaust Fan" has the following combination: i, 2, 8a, 9, meaning that for this item of expense variations have to be figured as follows: 1 Comparison in total. 2 Variations in production. 8a Service consumption — fixed charge item. 9 Price of service. The formulas being printed at the head of each column, the work of figuring variations is purely mechanical. To make it all entirely clear, the proceeding involved in figur- ing the variations in this one item of expense, "Electricity for Exhaust Fan," may be listed as follow^s: Standard cost of standard production of 10,000,000 pounds is $200.00 Standard cost of production of 7,500,000 pounds is 1 r 200 therefore times 7,i;oo,ooo= $1^0.00 10,000,000 This is entered in column D. 199 Actual consumption of electricity is assumed to be 9000 k.w. hours which figured at the actual rate of .ooiS* per k.w. hour is $162.00 This is entered in column A. Actual consumption of 9000 k.w. hours figured at stand- ard rate of .2 per k.w. hour is $180.00 This is entered in column B. Comparison of the actual and standard expense and the analysis of the variation by causes in accordance with the formula given above are then made as follows: Increase Dectease I Variation in Total: D-A $150.00 162.00 $12.00 analyzed as follows: 2. Variations in production : D-C $150.00 200.00 $50.00 8a Consumption: C-B $200.00 180.00 $20.00 9 Price : B-A $180.00 162.00 18.00 Net increase as above 12.00 $50.00 $50.00 200 Table 30. Cost Variation Sheet — Formula Com- bination A B C Account Actual Quantities at Actual Rates Actual Quanti- ties at Standard Rates Standard Cost of Standard Production Quantity Rate Amount Quantity Rate Amount Production 10,0 0,000 pou nds Producing labor. . . . 1-3-4 Hours 5800 0.6s 3.770 00 3.480 00 00 Hours 8,000 0.60 4,800 00 1-8-9 B.H.P. 80,000 0.016 1,280 00 1,200 B.H.P. 100,000 0.013 1,500 no Electricity for ex- haust fan i-2-8a-9 K.W. hrs. 9,000 0.018 162 00 180 00 K.W. hrs. 10,000 0.02 200 00 Acid i-S-6 Pounds 730,000 O.OII 8,030 00 7.300 00 Pounds 1,000,000 O.OI 10,000 00 Labor in repairs. . . . l-2-3a-4 Hours 250 0.60 150 00 125 00 Hours 400 0.50 200 00 Material in repairs. . 1-2-50-6 80 00 70 00 100 00 Taxes, insurance, etc. l-2-7a 310 00 310 00 300 00 Totals 13.782 GO 1 2,66s 00 17,100 00 Wherever asterisk appears in the above Pickling Department Month ok , D 1 I 2 3&3a 4 5&sa 6 7&70 8 &80 9 Com- parison in Total Varia- tions in Pro- duc- tion D—C Labor Variations Material Variations Expense 7 = D-B Service Standard Cost of Actual Production Time Rates Quant. Price B—A Quant. 8 = D—B Price 3 = D—B B—A 5 = D—B B—A Quantity Amount D—A 3a = C—B C—B na = C—B &a = C-B 7,500,000 pounds 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 1 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 Hours 6,000 3,6oo 00 00 00 00 00 00 00 00 3600 3770 3600 3480 3480 3770 *I70 120 *290 B.H.P. 7S.OOO 1,125 II2S 1280 II2S 1200 1200 1280 *8o 180 162 00 00 *ISS *7S 00 K.W. hrs. 7,500 ISO ISO 162 ISO 200 200 180 00 00 *I2 *So 20 18 00 Pounds 750,000 7.S00 7SOO 8030 7SOO 7300 7300 8030 *S30 200 *73o Hours 300 150 ISO ISO 150 200 200 I2S 125 ISO *So 75 *25 7S 75 80 7S 100 100 70 70 80 *S *2S 30 *IO 22s 225 310 225 300 195 •740 300 310 *85 *75 *IO 12,825 *957 *200 *3IS 230 *IO *SS *62 00 illustration, red figures are indicated. Chapter X ESTABLISHING A SCIENTIFIC BASIS FOR COST ACCOUNTING THE oft-quoted remark that, "a man should know something about everything and everything about something" ex- presses a fundamental truth. Adherence to the principle there enunciated will render it possible on the one hand to avoid the Scylla of dilettantism and on the other to steer clear of the Charybdis of narrow specialism and the horrors of the single- track mind. This is the age of the specialist and even with minds equipped with many tracks, the bulk of the traffic carried must be restricted to certain limited trains of thought peculiar to the line of work on which the mind is mainly occupied. Herein lurks the danger of specialism, for unless the specialist sees his calling in its proper relationship to things in general he is liable to develop the single-track mind — that form of monomania which has resulted in there being some dentists who attribute all human ills to diseased dental nerves, some physicians to germs, some osteopaths to crooked spines, some physical culture experts to lack of exercise, some dietitians to improper food and some enthusiasts to the twin demons of tobacco and rum. It is probable, for instance, that most people believe that prohibition, at least in the abstract, presents certain desirable features, but when the average sane individual reads letters in the newspapers urging that all fiction in public libraries which refers to the employment of alcoholic stimulants should be destroyed, and that all paintings in public galleries depicting depraved but apparently happy persons engaged in looking on the wine when it is red should be incinerated, the question which naturally arises in his mind is whether there must not be more insane persons at large than inside the asylums. It might be well to mention at this point, as explanatory of the motives prompting the foregoing remarks, that the author believes he may possibly have been criticized by some for not hewing sufficiently to the mark in his dissertations on cost ac- 202 203 counting, for using valuable space in gallivanting around the universe when the space might better have been devoted to describing such purely practical details appertaining to his sub- ject as the form which stores requisitions should take, or to discussing the merits of different methods of handling pay-rolls. Doubtless to some there is considerable charm in a work on cost accounting which wastes no time in preliminary frills, but in its opening paragraphs strikes at the roots of the matter by stating that "costs are divided into three parts — material, labor and burden," but the author ventures to question the advisability of this hurried and impetuous diving into a subject and to sug- gest that before thus launching himself so enthusiastically into the deep waters thereof the wise student should pause to get his bearings and then pause again. One of the prime characteristics of the scientific mind — and though the accepted methods of cost accounting are far from being scientific, cost accounting must be regarded as coming within the realm of science — is a sense of the inter-relationship of things. As Professor J. Arthur Thomson states: It regards Nature as a vibrating system most surely and subtly inter- connected. It discloses a world of interrelations, a long procession of causes, a web of life, infinite sequence bound by the iron chain of causality. Whatever the world owes to Dr. Frederick Taylor — and its obligation is great — it is to Mr. Harrington Emerson that we are indebted for our conception of the far-reaching importance of the scientific management idea. To Taylor, the pioneer, scientific management was essentially a system of shop manage- ment; to Emerson, the scientist, scientific management is infinitely more than this, for to his mind, as the author reads it from a study of Mr. Emerson's published works, scientific management represents a revolution in our attitude toward life in general as well as industrially, and a light on the path which mankind must follow if it is to realize its utmost possibilities. That great master of inductive science, Francis Bacon, wrote: For myself I found that I was fitted for nothing so well as for the study of Truth; as having a mind nimble and versatile enough to catch the resemblance of things (which is the chief point) and at the same time steady enough to fix and distinguish their subtle differences. And though there were some who failed to appreciate and even scoffed at the wealth of illustration in Mr. Emerson's 204 books, the tremendous educational value of these writings is largely due to the vivid pictures Mr. Emerson drew and his reputation as a scientist — in the words quoted above, to his having "a mind nimble and versatile enough to catch the re- semblance of things (which is the chief point)." The Narrow Specialism of Scientific Management It is largely due to narrow specialism that scientific manage- ment is still regarded by many of its exponents as being merely a system of shop management and that the accounting profes- sion as a whole is still oblivious of the importance of the scien- tific management idea as applied to cost accounting work. It seems in fact rather remarkable to the author that considering the immense amount of time which has been devoted to cost accounting by many intelligent men, that in a subject so obviously akin to mathematical science so little attempt has apparently been made to determine whether the accepted methods conform to the recognized standards of scientific work. In the previous chapter the author endeavored to show how in one respect, at least, cost accounting can be rendered truly scientific and cjuoting in part from the following remarks from the pen of J. Arthur Thomson demonstrated how the operation of the laws underlying cost phenomena could be expressed in simple formulas, and also showed how these formulas could be applied in the determination of cost variations and in the analysis of these variations according to certain underlying "causes": The ultimate ideal of science, or at any rate of physical science, is simply the description of the course of events by the aid of the fewest and simplest general formulae, iriiy things happen as they do, it is now said is no proper question for science ; its sole business is to enable us to calculate hozv they happen. Obviously, as Indicated in the quotation given above, the func- tion of cost accounting as regards the determination of the "causes" of cost variations must be confined to showing the effect of "efficient causes," or "caused causes," not "ultimate causes" ; to showing hour a thing happened, not why it happened. It is the function of cost accounting, for instance, to show the extent of a cost increase resulting from an increase in rates of pay, but it is obviously not within the province of the cost records per se to show why there was an increase in rates. When 205 the complexity of the causes underlying the present high cost of living (and incidentally the "cost of high living") is con- sidered it would seem as if the cost accountant were to be con- gratulated on the fact that there are distinct limitations to the scope of his specialty. The Value of Cost Accouxtixg Formulas In the previous chapter, the illustration of the use of formulas was limited to showing their application to meet a simple example. The author, however, has recently compiled tables of formulas covering a wide range of conditions and as he finds these tables of material assistance in his professional practice he believes that they may also prove helpful to others, and ac- cordingly with this end in view these tables are incorporated in this volume. Serious students of cost accounting, it is believed, will be amply repaid for time spent in a careful study of these tables. They bring to a focus the result of considerable investigation into the fundamental laws underlying cost phenomena and provide the means of solving many obscure cost problems. Even if the cost methods of a business are not drawn up along the lines recommended by the writer these formulas can be used in the solution of specific cost problems as shown in the examples given. The complete formulas are embodied in two tables — Tables 31 and 32 — which require to be used in conjunction with each other. The use of these tables also necessitates an understanding of the system of symbols employed, which is as follows: The capital letters A-H are used to indicate the different classes of accounting data which enter into the various formulas, as follows: A indicates the actual time or material expended figured at the actual rates of pay or actual price of the material. B indicates the actual time or material expended figured at the standard rates of pay or standard price of the material. C indicates the standard cost for a standard working month, say of 25 working days. D indicates the standard cost for the number of working days in the month — for instance, if there were 23 2o6 working days in the month D would equal 23/2 5ths of C. E indicates the standard cost for the days actually worked in the month ; for instance, if a plant or a department were closed down for two out of the 23 working days in the month assumed above, E would represent 2i/25ths of C or 2i/23rds of D. Note. — In the event that the base or original standard is being used for all com- parisons the term "standard cost" for C, D and E above refers to such base or original standard. In the event, however, that a revised standard is being used for the purpose of determining operating efficiencies, or an alternate standard is being used, or a revised alternate standard, then the term "standard cost" as used above in the explanation of the significance of C, D and E does not mean the basic standard but the revised, alternate or revised alternate standard, as the case may be. F indicates the alternate standard cost of the actual produc- tion in the month, which is obtained by dividing the alternate standard cost for a standard month by the standard production for such standard month and mul- tiplying the quotient so obtained by the actual produc- tion. By the term "alternate standard cost" is meant a standard varying from the base or original standard and set up as a gage of operating efficiency when there is some variation from the operating methods on which the base standard is formulated. For instance, the base standard may be founded on the use of coal in a furnace, the alternate standard being introduced to bring into account the change in operating standard when fuel oil is substituted for coal. G indicates the revised standard cost of the actual produc- tion in the month when a revised standard has been introduced for the purpose of bringing comparisons for the determination of operating efficiencies into line with current operating standards. This is figured by dividing C by the standard production in the standard working month and multiplying the quotient by the actual production for the month. H indicates the basic or original standard cost of the actual production in the month. In the previous chapter in order to simplify the presentation of the idea of using formulas in determining cost variations no ref- erence was made to the effect of using alternate or revised stand- ards, nor was any attempt made to distinguish between the basic causes underlying variations in production, namely: 207 (a) Due to the number of possible working days in the month varying from the standard working days in the standard month (b) Due to the idleness of a department or of the plant as a whole (c) Due to the production of the department or plant, when operating, varying from the standard produc- tion for the operating time The letters A, B, and C bear the same significance in both chapters. The letter D as used in the preceding chapter cor- responds to the use of the letter H in this chapter. The numbers i to Jj are used to indicate the various divisions of cost variation analysis as follows: / The variation in total 2 The variation due to the revision of the standard 5 The variation due to the use of an alternate standard 4 The variation in cost resulting from the number of working days in the month being more or less than the number of working days in the standard month used as a basis for figuring standard cost 5 The variation in cost owing to idle time 6 The variation due to the production per day or hour being more or less than standard 7 The variation due to fluctuations in rates of pay 8 The variation due to fluctuations in the hours worked as compared with standard p The variation due to differences between the actual and standard price paid for material 10 The variation in the quantity of material used 11 The variation in the price of service such as power, light, etc. 12 The variation in the quantity of service consumed 7J The variation in expense The small letters p, h, c, and d are used to indicate the char- acter of the expense being dealt with: p indicates an expense tending to vary directly with the production such as most forms of producing labor h indicates an expense which is in the nature of a monthly fixed charge such as tlie salary of a superintendent, or fire insurance premiums 208 c indicates an expense which is a fixed charge per working day as, for instance, a time-keeper paid on an hourly basis d indicates a fixed charge per day worked as, for instance, a cleaner paid an hourly rate while his department is working, but not paid if his department is not operating even though the rest of the plant is working. The small letters a and r indicate that some other than the basic standard is being used as a means of determining the cur- rent operating efficiency: a indicates that an alternate standard is being used r indicates that a revised standard is being used ra that a revised alternate standard is being used Table 3 1 gives the formulas for figuring the variations in total and due to the different causes. For instance, the formula given for figuring the amount of the increase or decrease in cost, owing to variations in the actual rates of pay (See Item 7, Table 31), or in the price of material (See Item 9, Table 31), as compared with standard is B — A. As explained previously, these letters indicate the actual time or material expended figured at the actual price and the actual time or material expended figured at the standard price, so that the formula B — A involves the following calculation: Actual expenditure at actual price less actual ex- penditure at standard price equals variation due to change in rate or price. In view of the fact that the total of the cost variations by causes must equal the total variation obtained by comparing the total actual cost with the value of the production figured at standard, it follows that the mathematical calculation involved is a simple equation. This can best be shown by giving an illus- tration as follows: The formula given in Table 32 for determining and analyzing the variations between actual and standard cost in the case of material in the nature of a fixed monthly charge and where an alternate standard is in force, is: I = 3 + 4 + 5 + 6a + 9 -^ loh Expressing the above in the complete form given in Table 31 gives the following: H-A=H-F+D-C+E-D+F-E+B-A+C-B 209 The arithmetical accuracy of the equation is proven by match- ing the various elements as follows: H-A = H-F+D-C-VE-D+F-E-{-B-A+C-B* The following example illustrates the actual method of using Tables 31 and 32: Character of Expense: Foreman paid for every working day in the month whether his department is operating or not. Class of Expense: Fixed charge per working day, Class (ci). Standard Used for Determining Operating Efficiency: Re- vised. Formula per Table 32: i = 2-\-^-\-6r + y-\-8c (see asterisk on this table). Formula Expanded to Terms of Table 31 : H-A=H-G+E-D^G-E+B-A-\-D-B Standard Data Standard working days in month 25 Standard pay per day .• . . $5.00 Standard pay per standard month $125.00 Standard production, tons 250 Standard cost per ton $0.50 Revised Standards Production per standard month, tons 312.50 Revised standard cost per ton $0.40 Assumed Actual Case Working days in the month 23 Days department worked 21 Foreman's pay (raised to) per day $6.00 Production, tons 260 Comparative Data A Actual at actual: 23 days at $6.00 $138.00 B Actual at standard: 23 days at $5.00 $115.00 C Standard cost for standard month as above $125.00 D Standard cost for actual working days in month: 23 days— 23/25ths of $125.00 (C) $115.00 •This equation should be written with a cancellation mark through each item. 2IO E Standard cost for days worked in depart- ment: 21 days — 2i/25ths of $125.00 (C) $105.00 G Revised standard: 260 tons at $0.40 $104.00 H Basic or accounting standard: 260 tons at $0.50 $130.00 Comparisoiis 1 Comparison in total {H-A) $130.00 $138.00 $8.00* 2 Variation due to revi- sion of standards {H-G) $130.00 $104.00 $26.00 5 Variation due to idle time (department was closed down during two working days) (E-D) $105.00 $115.00 $10.00* 6 Variation due to pro- duction per day ac- tually worked being less than standard {G-E) $104.00 $105.00 $1.00* 7 Variation due to change in rates of pay {B-A) $115.00 $138.00 $23.00* 10 Variation due to dif- ference between ac- tual hours per day worked and standard {D-B) $115.00 $115.00 Totals $8.00* $8.00* Item 2 above would be omitted on operating efficiency state- ments, the data on these being normally confined to showing variations between the actual cost- and the current operating standard, in this case the latter being the revised standard. The information which would appear on the r)pcrating efficiency statement in respect to the example heing dealt with would he as follows : Actual cost $138.00 Standard cost (revised) $104.00 $34.00* Analysis of above increase: Idle time $10.00* Production efficiency $1.00* Rates $23.00* $34.00* * Asterisk indicates red figures signifying increase. Further illustrations of the use of these tables are given later. The Purpose of Dual Comparisons From the illustration given above it will be noted that what- ever the current cost standard may be (whether alternate, revised basic or revised alternate) comparisons of actual costs under the plan followed are invariably made w?ith both this current standard and the basic standard. As the advantage of using both the basic and current standards may be questioned, a word of explanation as to this would seem in order. In mak- ing the dual comparison provided for, two purposes are served: 1 All costs being showai in relation to the base or original standard, it follows that statements that can be com- pared with the same thing can be compared with one another, so that however many changes in standards may have been made in the interim between two state- ments comparisons can readily be made between them. 2 From the standpoint of accounting technique it is highly desirable that the cost system in force should not demand the amendment of a multitude of detailed standard costs in order to reflect changes in standards introduced to conform with current operating condi- tions. All industrial engineers will appreciate the value of a plan which provides for systematically taking up in the accounts revisions in standards. As Mr. Emerson states: "Staff standards 212 are infinite and ever-changing. The best practice of yesterday is the laughing stocl< of to-day," and the author calls to mind a case in one industry where changes in design of the machinery manufactured were so numerous that the force of industrial engineers employed to figure the standards were just about able to hold their own with the force of designers figuring changes. Ultimately the latter won out and the industrial engineers with great cheerfulness transferred their efforts to a field of action of a more stabilized character. Changes in standards are the earmarks of progress. It is stated, for instance, that about the year 1500 soldiers who used guns stood in files 37 deep; the reloading of the weapons occu- pied so much time that when a man had fired he passed to the rear and was not ready to fire again until the 36 men in front of him had discharged their weapons. Allowing two seconds for getting out of one another's way and for aiming the weapons, we might estimate a hundred per cent efficiency of speed in firing in those days as 30 shots a minute. Comparing this with a modern machine gun firing 1200 rounds a minute, we have an increase in efficiency of 147,900 per cent! As an instance of slow continuous raising of standards there may be cited that of the gradual increase in the sugar contents of beet root, the pounds of beet root rec[uired to obtain a hundred pounds of sugar being recorded as follows: Year Pounds 1836 1800 1842 1600 1857 1200 1871 IIOO 1894 750 It is not necessary to give further illustrations; standards are being constantly raised by the improvement of equipment and methods, and a cost system based on the use of standards should most certainly provide the means for promptly amending the cost records to reflect such adjustments in standards. In spite of the apparent complexity of the formulas given, in actual practice by the methods formulated by the author their use in the determination and analysis of cost variations from month to month is an absolutely mechanical operation which can be quickly and accurately performed by the ordinary grade of office help. 213 The facility with which the anth(ir has hccn ahlc to apply these formulas to meet successfully widely varying conditions would seem to indicate their soundness and practicability, and he ven- tures to believe that in these and similar formulas will be found the key to the solution of most fundamental cost problems. Table 31. Formula to Apply in the Determination and Analysis of Cost Variations for the Different Classes of Expense (To be used in conjunction with Table 32) Charge Fixed Fixed Fixed Varying Charge Charge per Charge per Division of Cost with per Working Day Production Month Day Worked iP) {b) (c) (d) I Comparison in Total . . . Standard Variations H-A H-A H-A H-A 2 Revised standard .... H-G H-G H-G H-G (ar) F-G (ar) F-G (ar) F-G (ar) F-G 3 Alternate standard. . . Production Variations H-F H-F H-F H-F 4 Working days D-C 5 6 Idle time E-D H-E E-D H-E Daily production .... H-E (a) F-E (a) F-E (a) F-E (ar & r) G-E (ar & r) G-E (ar&r) G-E Labor Vari.vtions 7 Rates B-A B-A B-A B-A 8 Time Material Variations (p) H-B (a) F-B (ar 8z r) G-B (b) C-B (c) D-B (d) E-B Q Price B-A B-A B-A B-A JO Quantity Service Variations (p) H-B (a) F-B (ar & r) G-B (b) C-B (c) D-B (d) E-B ij Price B-A (p) H-B B-A (b) C-B B-A (c) D-B B-A 12 Quantity (d) E-B (a) F-B (ar & r) G-B Expense Variations 13 Amount (P) H-A (a) F-A (b) C-A (c) D-A (d) E-A (ar & r) G-A 214 o O Q <: o > J g; o tn O > Pi m o "^ (^ ^ >< o ►o ++++ ++++ ?^ V. S^ V a a e 13 , — 1 1— < >— I Ti-'^rt-Th If-. \n m ir> \0 vO vo vo <; + + + + ++++ ++++ + + + + ^d rO rO rO (~0 rCcOrOrO rOtOrOtO to to tn tr> tM + + + + f + + + + + + + + + + + •r-i ^. K V. V. ^-?~.?^^. v>^s^>> >» ^. >^ *^ > e o a a acaci oeea a e « e fS (N 0< 0) ^ ^. (U r^ W HH '^Tt-'+-t- iniciriu-j vO O vO MD H + + + + + + + + + + + + + + + + 4-> N 0) 0) 0) M M M M MMMM MMMM P^ II II II II II II 11 11 II II II II II 11 II 11 '^ ..„„„ „„„„ „„„„ a rCj -C> -JS .9 00 O M o -H 1 1 T o "^3 -a tj 00 O M CO O N a M w « a « e WW VO^vDO + + + + + + + -« J^ Os >-i to tn rt g % + + e m m tr> iTi ^ ^ ^ '^ ++++ ++++ + + + + a e « a S cu t^ hi HH ■^'*-t)-'^ UOIOIOIO vo vo NO ^ 4J + + + + ++++ ++++ + + + + ^ rO rO fO fO mromro to tr> tr> tr> to to to to g II II II II II II II II II 11 II II II II II II „ „ ^ „ „„„^ „„„„ 1 o •J5 -a .^ Si o CO O M Q 13 Q -1 1 1- ,n "^ <-i ^ « O r^ On >-< fo !?; w -H o 'U) ^ -a 'a "a '-^ 00 O M < + + + -^ LJ t^ as i-i to 13 ^+ + + + ^+ + + + C ^ 00 HH _|_ (J + + W fO ►fl lomiou-j vo^NOvO '^ « w 0+ + + + g+ + + + g+ + + + C/3 2 t^ O " « K, ■^■^tJ-'^ p^ lOiDUOirj ol NO VO \0 NO O '55 03 r; II II 11 II J 11 11 II II H 11 !l II II td il 11 II 1 jj „ w 1-1 1-1 pq :5 'rt K .2 oj tn HI .2 q; 00 Oh hJ S CO W ^ J S CO W w fc fe fo O Si t« s ■^ i-i r^ tn ^ '-^w M rOT}',_^i-i rs CO^ ,— V w M to 't :5 a ^ki.11. ^ — '^ ^Ci -d -Jii ^^ ^i u lo ^ s^-i^^-i o w 215 Additional Illustrations of Uses of Tables 31 and 32 Illustration 2 Class h Expense; Fixed Monthly Charge; Revised Standard Character of expense, foreman paid fixed monthly salary. Class of expense, fixed monthly charge (Class b-i). Standard used for determining operating efficiency (revised). Formula per Table 32: i =2 +4 +5 +($;' + / +56 Above formula expanded to terms of Table 31: H-A =H-G+D-C+E-D^-G-E-\-B-A +C-B Standard Data Standard working days in month 25 Standard pay per month $125.00 Standard production, tons 250 Standard cost per ton $0.50 Revised Standard Production, tons 312.5 Standard cost per ton $0.40 Assumed Actual Case Working days in month 23 Days actually worked 21 Foreman's salary raised to $150 Production, tons 260 Coniparatire Data A Actual at actual $150.00 B Actual at standard $125.00 C Standard cost for standard month as above $125.00 D Standard cost for actual working days 23 — times 125.00 $115.00 25 E Standard cost for days actually worked 21 — times 125.00 $105.00 25 2l6 Standard Cost for Actual Production G Revised standard 260 tons at $0.40 $104.00 H Basic or accounting standard 260 tons at $0.50 $130.00 Comparisons 1 Total, H-A 130.00-150.00 $20.00* 2 Standard revision, H-G 130.00-104.00... $26.00 4 Working days, D-C 1 15.00-125.00 $10.00* 5 Idle time, E-D 105.00-1 15.00 $10.00* 6 Production efficiency, G-E 104.00-105.00. . $1.00* 7 Rate variations, B-A 125.00-150.00 $25.00* 8 Time, C-B 125.00-125.00 *Indicates red figure signifying increase. Illustration 3 Class d Expense; Fixed charge per day zvorked; Revised Standard Character of expense, foreman paid by the day for every day his department is working. Class of expense, fixed charge per day worked, labor (d-i). Standard used for determining operating efficiency (revised). Formula per Table 32: i =2-]-6r-\-'/-\-8d. Above formula expanded to terms of Table 31: H-A =H-G-^G-E-{-B-A-\-E-B. Standard Data Standard working days in month 25 Standard pay per day $5-00 Standard pay per standard month $125.00 Standard production, tons 250 Standard cost per ton $0.50 Revised Standards Production, tons 312.5 Standard cost per ton $0.40 Assumed Actual Case Working days in month 23 Days department worked 21 Foreman's wages raised to $6.00 Production, tons 260 217 Comparative Data A Actual at actual $126.00 B Actual at standard 21 days at $5.00 $105.00 C Standard cost for standard month $125.00 D Standard cost for actual working days... $115.00 E Standard cost for days worked in depart- ment $105.00 Standard Cost for Actual Production G Revised standard 260 tons at $0.40 $104.00 H Basic or accounting standard 260 tons at $0.50 $130.00 Comparisons 1 Total {H-A) $130.00 $126.00 $4.00 2 Standard revision (H-G) $130.00 $104.00 $26.00 6 Production efficiency (G-E) $104.00 $105.00 $1.00* 7 Rates (B-A) $105.00 $126.00 $21.00* 8 Time (E-B) $105.00 $105.00 Totals $4.00 $4.00 ^Indicates red figure signifying increase. Illustration 4 Class b Expense; Fixed Monthly Charge; Alternate Standard Character of expense, material used in repairs of equipment. Class of expense, fixed monthly charge (b-2). Standard used for determining operating efficiency (alternate). Formula per Table 32: i =j-{-4+j-{-6a+Q + iob. Above formula expanded to terms of Table 31: H-A =H-F-\-D-C+E-D+F-E-\-B-A +C-B Standard Data Standard material per month of 25 days $250.00 Standard production, tons 5'°^° Standard material cost per ton $0.05 Alternate Standard Standard material per month of 25 days $400.00 Standard production, tons 4,000 Standard material cost per ton $0.10 2l8 Assumed Actual Case Working days in month 23 Plant operating, days 20 Material used at standard price $300.00 Material used at actual price $350.00 Production, tons 2,800 Comparative Data A Actual at actual $350-00 B Actual at standard $300.00 C Alternate standard for standard month . . . $400.00 D Alternate standard for working days 23 — X 400 $368.00 25 E Alternate standard for days worked 20 — X 400 $320.00 25 F Alternate standard cost — actual production 2,800 tons at $0.10 $280.00 H Basic standard cost — actual production 2,800 tons at $0.05 $140.00 Comparisons I In total (H-A) $140.00 350.00 $210.00* J Variation in standards (H-F) 140.00 (difference between 280.00 $140.00* basic and alternate standard) 4 Working days (D-C) 368.00 400.00 32.00* 5 Idle time (E-D) 320.00 368.00 48.00* 6 Production efficiency (F-E) 280.00 320.00 40.00* p Price (B-A) 300.00 350.00 50.00* 10 Quantity {(^-B) 400.00 300.00 100.00 Totals $210.00* $210.00* *Indicates red figure signifying increase. 219 Illustration 5 Class b Expense; Fixed Monthly Charge; Revised Alternate Standard Character of expense, material used in repairs of equipment. Class of expense; fixed monthly charge {b-2). Standard used for determining operating efficiency (revised alternate standard). Formula per Table 32: i =2ar-\-3-\-4-{-j-{-6ar-\-g + iob. Above formula expanded to terms of Table 31 : H-A =-F-G+H-F+D-C+E-D+G-E+B-A+C-B Standard Data Standard material per month of 25 days. . . . $250.00 Standard production, tons 5,000 Standard material cost per ton $0.05 Alternate Standard Standard material per month of 25 days $400.00 Standard production, tons 4,000 Standard material cost per ton $0.10 Revised Alternate Standard Standard material per month of 25 days. . . . $360.00 Standard production, tons 3,000 Standard material cost per ton $0.1 :r Assumed Actual Case Same as previous illustration, i.e.: Working days in month 23 Plant operating, days 20 jMaterial used at standard price $300.00 Material used at actual price $350.00 Production, tons 2,800 Comparative Data A Actual at actual $350.00 B Actual at standard $300.00 C Revised alternate standard cost for stand- ard month $360.00 D Revised alternate standard cost for work- ing days in month — X 360,00 (C above) $331.20 25 220 E Revised alternate standard cost for days worked 20 — X 360.00 (C above) $288.00 25 F Alternate standard cost of month's produc- tion 2,800 tons at $0.10 $280.00 G Revised alternate standard cost of month's production 2,800 tons at $0.12 $336.00 H Basic standard cost of month's production 2,800 tons at $0.05 $140.00 Comparisons 1 In total {H-A) $140.00 350.00 $210.00* 2 Variation in standards (F-G) 280.00 (difference between 336.00 $56.00* alternate and revised alternate standards) 5 Variation in standards (H-F) 140.00 (difference between 280.00 140.00* basic and alternate standards) '4 Working days (D-C) 331.20 360.00 28.80* 5 Idle time (E-D) 288.00 331.20 43.20* 6 Production efficiency (G-E) 336.00 288.00 48.00 p Material price {B-A) 300.00 350.00 50.00* 10 Material quantity 360.00 (C-B) 300.00 60.00 Totals $210.00* $210.00* *Indicates red figure signifying increase. Chapter XI THE FUTURE OF COST ACCOUNTING WHATEVER other reasons accountants may have to offer for their faihire to bring cost accounting methods into Hne with modern developments in the industrial field generally, they certainly cannot claim that attention has not been drawn to the shortcomings and absurdities of what must still be re- garded as the established methods. Ten years ago Mr. Harrington Emerson presented a clear and convincing indictment of retrospective cost accounting methods. At that time he wrote as follows: There are two radically different methods of ascertaining costs : the first method, to ascertain them after the work is completed; the second method, to ascertain them before the work is undertaken. The first method is the old one, still used in most manufacturing and maintenance under- takings, the second method is the new one, beginning to be used in some very large plants, where its feasibility and practical value have already been demonstrated. The objections to the old method are not only that it delays information until little value is left in it, but that it is wholly and absolutely incorrect, mixing up with costs incidents that do not have the remotest direct connection with them, so that analysis of cost statements, as, for instance, repair costs per locomotive mile, does not lead to elimination of wastes. The advantages of the second method are not only that the costs must be ascertained before the work is begun, but that costs as finally tabulated are the real costs divided as to each unit, whether a single element or aggregated out of a million separate elements (i) into standard expense and (2) into avoidable loss. An analysis of costs so stated facilitates an almost inexorable elimination of inefficient conditions of all kinds, standard expenses being constantly standardized at new levels — wastes, the excess above standard costs, being constantly removed. Another engineer who has drawn attention to the falsity of the usual methods of cost accounting was the late ]\Ir. H. L. Gantt. In criticizing the common methods under which no dis- tinction is made between legitimate costs of production and those due to inefficiency and idleness he states: Few of our business men have ever known what it costs to produce an article. They are the victims generally of a false cost-keeping system. 221 \\'hen an accountant wants to figure the cost of an article one of the first things he does is to throw in all the "overhead." Even though ninc- tenths of the plant is absolutely idle loo per cent of the whole investment is charged to the "cost of production." This is altogether misleading. If I rent two apartments in New York City at $ioo a month each, then live in one and keep the other closed, I cannot honestly claim that it costs me $200 a month for a place to sleep. All our accounting systems should contain another column, one showing the losses incurred through shutdowns, strikes, the idleness of any part of the plant, experiments that do not work, failure to get supplies, anj-thing and everything which is not rightfully chargeable to the actual process of production. In one column, then, the actual cost of production would appear; in the other the manufacturer could see at a glance the tremendous cost of non-production and would be anxious to repair the leak. The reason he doesn't repair it oftener to-day is that his accountants have covered it up with pretty figures. As Mr. Gantt suggests, the first step toward correcting an inefficiency is to determine its existence — in fact, as ]\Ir. Walter H. Polokav states: An accurate knowledge of the excess of expenses over the necessary cost of production leads almost inevitably to the discovery of means for eliminating this waste. Our Lack of Accounting Methods Though Mr. Emerson and other engineers liave reaUzed very fully the defects in the usual cost accounting methods and have clearly foreseen the direction which cost accounting in the future must surely follow, it must be admitted that they have given very little detailed information as to the methods to be adopted to realize the results demanded. Apparently they have not fully realized that the application of their principles involves a com- plete revolution iti accounting thought and technic^ue and re- cpires a drastic readjustment of ideas on the part of accountants as to the fundamental principles of cost accounting. It is to be greatly regretted that the engineering and accounting professions have delayed so long in combining forces toward the elimination of what is probably the most serious defect in the industrial machine of to-day. The author ventures to believe that in this volume he has described methods which represent the practical application of the ideas advanced in the quotations given, and these methods indicate at least in a measure the path to be followed in order 223 to release the industrial world from the shackles of the cumber- some and inefficient methods of cost accounting which are still inflicted on the long suffering manufacturer. A consideration of the methods illustrated in preceding chapters will clearly demonstrate how closely the results obtained by tlieir use parallel those called for by Mr. Emerson when he wrote: When a simple system of stating all costs — whether for a single task for man or machine, or for all a man's work for any period, or for all the work of a gang or department, or for a whole plant — is available; when this system permits parallel statement of actual and standard costs — then the whole problem is well-nigh solved, patience, persistence, fidclit}^ and high ideals accomplishing the results, through the use of staff specialists. Mr. Gantt's desire for a system of cost accounting which will show in one column actual costs of production and in another costs of non-production is also met in the plans described, for in the manufacturing efficiency statements illustrated the effect of non-production is clearly and unmistakably shown by the red figures which indicate increases in costs as compared with standard. In addition, however, to meeting the demands of the operating division by furnishing complete information relative to costs and efficiencies, a properly designed system of predetermined costs is of inestimable value to other divisions of the business, particularly that of sales. The Impossibility of Providing Reliable Current Information by Retrospective System It is hardly an exaggeration to say that in concerns manufac- turing a complex product and operating retrospective systems of cost accounting the sales manager is rarely ever provided with reliable information relative to current costs of manu- facture. In the case of a concern manufacturing machinery where the operations involved in the manufacture of the parts incorporated in the machines finished in any month have ex- tended over many months previous, the costs submitted by the cost department represent not the current cost of building these machines but a composite of several months' costs, and in times of fluctuating prices of material and labor such costs are likely to be distinctly misleading, to say the least. Under the methods described by the author, however, it is possible to furnish on 224 demand at any time a closely approximate current cost of any machine, even though it may consist of a thousand or more parts and involve ten thousand detail operations, and this with- out requiring revision of the detailed cost figures. A further valuable feature presented by properly developed systems of predetermined or standard costs is the means afforded by their use of obtaining the most complete information relative to profits made on sales, and some illustrations have been given in earlier chapters in connection with this. The manufacturer of a varied product whose cost department provides him with reliable and comprehensive information as to his profits by lines, by salesmen, by territories and by classes of customers is the rare exception and not the rule, and it needs no very special gift of prophecy to foresee that the time is fast approaching when sales executives will demand that their cost departments furnish them with information which will enable them to con- duct their business on the foundation of accurate information in place of guesswork or the judgment of competitors equally in the dark as to actual facts. The Coordination of Accounting and Planning An additional and valuable feature of standard costs is in connection with their coordination with the scientific planning and dispatching of work through the shops, a properly designed system of standard or predetermined costs not only enabling the cost department records to reflect the results obtained by the planning department but also rendering it possible for both departments to coordinate their routine work to their mutual benefit. In Figures 9 to 12 (Chapter V) and Figures 13 to 16 (Chapter VI) there was illustrated a coordinated cost, plan- ning, and production system to meet complex conditions, under which the scientific planning and dispatching of work is ab- solutely coordinated with the scientific determination of costs, with the result that duplication of work is eliminated and the cost and planning records so dovetailed and harmonized that reference can be made from one to the other with facility. Under such a coordinated system the planning records provide an inter- pretation of the causes underlying inefficiencies disclosed by the cost records, and the latter being expressed in terms common to both cost and planning departments are of material assistance to the planning supervisor in adding significance to the informa- 225 tion appearing on his own records by expressing these in terms of dollars and cents. An outstanding defect of the average planning and production system introduced by engineers is the disregard of the importance of coordinating the planning and costing functions and the entire separation from the cost system of many otherwise admirable planning systems when these should logically be combined can- not fail to reduce the effectiveness of both systems as well as to involve duplication of effort and excessive expense. A system of predetermined costs involves the use of standards of material quantities and of time, both of men and machines, and these standards should also be common to those used by the planning department. Unless this is so, unnecessary expense will be in- volved in maintaining separate records of standards and in addi- tion there will be confusion between the cost and planning records owing to their lack of uniformity. The time for establishing coordination between the cost and planning methods is at their inception, for unless the designers of the planning system have in mind the ultimate coordination of this system with the costs and provide for this in their plans, to obtain the full benefits which should be derived from such coordination w'ill demand extensive revision of established methods, this involving the dual task of first forgetting the old, and second, learning the new. Elasticity in Cost Accounting Reference has previously been made to the lack of elasticity in the average cost system, information on the cost records being so compiled as to render it of little use except to meet the par- ticular need for which it was originally compiled. The author in his work of substituting methods of cost predetermination for systems of retrospective cost accounting frecjuently finds cases where cost information over a few wrecks old is practically value- less. He recently inspected a cost system of a company where tens of thousands of cost cards w^ere on file, but as these did not state the date on which the costs were compiled it was not possible to ascertain whether they were figured when wages w^ere on a pre-war basis or during the period of abnormal labor costs. In this case only the total labor was shown, as for in- stance, "planing $1.75," no hours being given. In another case where the product manufactured w-as of a 226 complex character, a finished article comprising a dozen or more parts, not only were the quantities and prices of the material omitted, but material costs were shown in total for all of the parts comprising the article, a similar method being followed in connection with labor costs. It is a fundamental principle in the methods employed by the author that all costs should be so compiled that they can be adjusted to the basis of current conditions with facility. Under these methods it is not necessary to refigure the detailed costs of the thousand or more parts entering into the standard cost of a machine in order to adjust this cost to the basis of current material, labor and burden rates. When a change in methods of manufacture results in the substituting of parts or the elimina- tion or changing of operations it is necessary to revise the standard costs to conform to this change, but this is a different matter to requiring the refiguring of some ten thousand detailed costs owing to a change in the wage scale or an increase in the price of grey-iron castings. The Advantages of Standard Costs A number of illustrations have been given in the preceding chapters of the value of standard costs in bringing cost informa- tion to a focus — of showing in one figure how the costs of the whole plant for a period compare with standard. A further advantage previously referred to is in connection with bring- ing to a uniform basis efficiency statements compiled at different times and in comparison with varying standards. Obviously, standards are constantly changing. As Mr. Emer- son states: "Staff standards are infinite and ever-changing. The best practice of yesterday is the laughing stock of to-day." But a great proportion of the value of efficiency information com- piled is lost if there is no way of showing the costs of to-day in comparison with the standards of yesterday. Under the method illustrated in Figure 22 in addition to showing actual costs in relation to adjusted standards these are also shown in relation to a base standard, so that efficiency data compiled at any time is always comparable with that compiled at any other time. It is a well-known fact that specialists are in a degree apt to lose their sense of relative values and to lay undue emphasis on the importance of the sphere in whioii their interests are in DEPARTMENTAL ETnCIENCY 5TAT£MfNT PREVIOUS TO 1 REVISION OF STANDARDS "zr usicswt amn\iTmm ss JKHtM^KCnWE 1000 X ItCO X - Ap«er Svnervtsron soo \x TOTAL moo X mW U 350101? 50? 00 FISST REVISION OF STANOARK ^llWMSlC S(/pp/fts Superfisiorf >zoi OEPARinENT HEAD tUMIKATlNG COMPARISONS k™l smm »»« Dnns sm to i; 5mV*s WC ,W : L'y ^ ^fermiaa ifit? l,V TOTAL «siio \