UC-NRLF 
 
 $B 260 sm 
 
 FUNDAMENTAL^*^ 
 
 
 COST<7/9 prof™ 
 
 CALCULATION ^^M 
 
 
 DENHAM 
 
 
Digitized by the Internet Archive 
 
 in 2007 with funding from 
 
 IVIicrosoft Corporation 
 
 http://www.archive.org/details/fundamentalsofcoOOdenhrich 
 
FUNDAMENTALS OF 
 
 COST an5 profit 
 
 CALCULATION 
 
 By 
 
 Robert S. Denham 
 
 Chief Engineer, The Denham Costfinding Co, 
 
 Cost Engineers, Cleveland, Ohio 
 
 Author of 
 
 Practical Cost Engineering, 
 
 Manual of Cost Engineering and Estimating, 
 
 The Science of Costfinding^ The A-B-C 
 
 of Cost Engineering, Etc, Etc, 
 
 Revised Edition 
 
 
 CLEVELAND 
 
 Cost Engineer Publishing Co. 
 
 1919 
 
',6^^ 
 
 v^vV-aV^ "^^^ 
 
 Copyright 1918 
 
 Copyright 1919 
 
 By ROBERT S. DENHAM 
 
 International Copyright 
 
 All Rights Reserved 
 
 " • * • e c 
 
 Printed by 
 Gardner Printing Co. 
 
 Binding by 
 
 Forest City Bookbinding Co. 
 
 Cleveland 
 
PREFACE 
 
 Mr. Business Man: 
 
 This book is written for you. It is in- 
 tended to help you to throw the searchlight of 
 analysis into those recesses of your business 
 heretofore darkened by the cobwebbed tradi- 
 tions and formulas handed down from the 
 age of the tallow candle, the ox cart and the 
 quill pen. 
 
 The two most vital factors in business are 
 Cost and Profit, but few there are who can, in 
 any transaction, define the point where the 
 elements of Cost cease to accumulate, and 
 Profit becomes a reality. 
 
 It is extremely important, now more than 
 at any other time in the history of America, 
 that business men know the cost of doing 
 business, the cost of manufacture, the cost of 
 distribution, and the extent of the profits in 
 the business. 
 
 Thousands of concerns not profitably con- 
 ducted are forced to pay taxes on profits 
 which do not exist, because unthinking and 
 misinformed accountants have established 
 incorrect methods of calculation. For the 
 same reason others who should pay taxes will 
 go free. 
 
 Every business should be profitably con- 
 ducted. Every business should pay its fair 
 
 405503 
 
r »r' 
 
 " ' ' ' ' '' • * .. ' c 'Preface 
 
 share into the treasury of the nation and 
 state; but how shall there be certainty as to 
 profitableness when the ancient methods of 
 calculation in common use are misleading? 
 How shall fairness and justice be upheld 
 when costs and profit in modern business are 
 calculated by methods which have been obso- 
 lete for generations? 
 
 We are confronted today, in a time of seri- 
 ous concern, with the deplorable facts that 
 the accounting profession has clung too long 
 to its ancient formulas; that it has offered no 
 practical solution for many of the more im- 
 portant industrial and commercial problems; 
 and that there is no evidence that it is now 
 engaged in any recognizable effort to meet 
 the needs of the hour. 
 
 The author offers no apology for breaking 
 away from traditional methods. He is ham- 
 pered by no "professional ethics" which for- 
 bid departure from so-called "standard ac- 
 counting practice," thereby destroying initia- 
 tive and balking progressive development, 
 but discarding precedents, breaking the idols 
 of "authorities" whose theories date back to 
 other times when conditions were simpler 
 than now, he places every problem of Cost 
 under the test of logical analysis. 
 
 4 
 
PTeface 
 
 The crying need is for facts: the facts of 
 cost, the facts of profits, not the camouflage 
 of meaningless, mythical phrases such as cost 
 accounting offers in "prime cost," "factory 
 cost," "labor cost" and "gross profit," nor the 
 Stygian mystery of that cesspool of ignorance 
 "overhead expense." 
 
 Every element of expense is definite, in 
 amount, in purpose and in benefit. The line 
 between loss and profit in every transaction 
 can be known within a fraction of one per 
 cent. The profit on each sale and on the busi- 
 ness as a whole can be accurately determined, 
 if you know how. 
 
 But the ancient methods must be dis- 
 carded. The uncertainty of "overhead" and 
 "gross profit" must give way to the definite- 
 ness of practical Cost Engineering. Theories 
 and formulas must be replaced by analysis 
 and reason. There must be coordination be- 
 tween modern business and methods of calcu- 
 lation. 
 
 It is the purpose of the author to show 
 insofar as the limitations of this popular- 
 priced book will permit, what the elements 
 of cost are, the correct rules for calculation, 
 grouping and distribution of same, the cor- 
 rect methods of determining the cost of pro- 
 
 5 
 
Preface 
 
 duction in factories and the cost of merchan- 
 dising. 
 
 In view of the fact that practically all 
 school textbooks teach incorrect methods of 
 calculating profits, and not to exceed ten per 
 cent of those whose duties include the making 
 of selling prices know the correct method, a 
 chapter on that subject will be included. 
 
 The aim will be to make each statement as 
 clear as possible, to back up each recommen- 
 dation with the reason for its presentation, 
 and where truth and justice will be served by 
 digression from the traditional methods in 
 common use, to convince the reader that the 
 difference is not only justifiable but worthy of 
 acceptance. 
 
 Further, the author hopes to leave in the 
 mind of every reader the impression that the 
 information he has gained is not only worth 
 the expense and time required to obtain it, but 
 that it will in a practical manner serve as a 
 basis for more successful business methods in 
 the future, so that profits may be developed 
 from hitherto unprofitable sources, and per- 
 manent good will established. 
 
 Sincerely, 
 
 THE AUTHOR. 
 
 6 
 
CONTENTS 
 Preface 3 
 
 1. The Philosophy of Cost and Profit 9 
 
 2. Direct Expenses 19 
 
 3. Indirect Expenses 29 
 
 4. Economic Expenses 43 
 
 5. Determining Cost 59 
 
 6. Selling Prices and Profits 77 
 
 7. Making Cost and Profit Statements 95 
 
 8. The Terminology of Cost Engineering.. 105 
 
 Index of Terminology 116 
 
 General Index 117 
 
^^One of the first things that a 
 man has to learn in business is 
 how little he can do by himself. 
 When he finds that out he be- 
 gins to look around for people 
 to do what he can't!' — Henry 
 Ford. 
 
CHAPTER ONE 
 
 THE PHILOSOPHY OF COST 
 AND PROFIT 
 
 What is Cost? 
 
 Wc grow so accustomed to the use of com- 
 mon words that we rarely stop to consider 
 their definitions. In fact we consult the dic- 
 tionary, as a rule, only when we encounter 
 some word that is new, or that is used in an 
 unfamiliar sense. As a matter of fact there 
 are many words in common use by persons 
 who should know better, that are used with- 
 out thought of their true meaning. One of 
 these is "cost." 
 
 We hear the merchant speak of his "cost" 
 when he has reference to the amount charged 
 him in the invoice for the item, without re- 
 gard to the other expenses which have been 
 involved in carriage, warehousing, protecting 
 and handling the goods. 
 
 We hear the manufacturer use the term 
 "actual cost" when he has in mind only the 
 elements of material and wages paid the 
 workers who are directly engaged in the pro- 
 duction of the item under consideration. 
 
Fundamentals of Cost and Profit Calculation 
 
 We hear the accountant glibly talk of 
 "prime cost" when he has in mind the same 
 elements, and of "overhead cost" when he 
 refers to the other expenses involved in the 
 operation of the factory and the distribution 
 of its product. 
 
 It is possible to convey information clearly 
 and definitely from one mind to another only 
 when each speaks the same language and 
 understands the meaning or definitions of the 
 words used, therefore the author requests the 
 reader to follow carefully the definitions pre- 
 sented herewith, that he may fully understand 
 the viewpoints and methods presented. 
 
 The cost of an item of product is the sum 
 of the expenses involved in its production and 
 distribution up to the moment at which cost 
 is determined. 
 
 This is the first fundamental principle of 
 Cost Engineering. 
 
 Cost is the sum of certain expenses. Being 
 a sum it must be a definite amount. Two 
 methods, therefore, which produce different 
 results in the effort to determine cost, cannot 
 both be correct. Both may be wrong, or one 
 may be right and the other wrong. 
 
 Expenses are the elements of cost. Part 
 10 
 
The Philosophy of Cost and Profit 
 
 of the expenses cannot be cost. Cost is noth- 
 ing less than the sum of all of its elements. If 
 a cent is omitted, or a cent included that is not 
 involved in the production of the item under 
 consideration, cost has not been determined 
 correctly. 
 
 The expenses of a business, or of the 
 operation of a factory, are definite, and lim- 
 ited. It is possible to so analyze these ele- 
 ments that each may be exactly known. The 
 total is then easily ascertainable. 
 
 When the items of product of the factory 
 differ in size or character it is necessary to 
 know definitely the cost of each lot of like 
 items produced. If one lot or item has been 
 charged with expense which belongs on other 
 product, an overcharge exists, not only de- 
 stroying the accuracy of the result in connec- 
 tion with the item under consideration, but 
 preventing correct determination of cost on 
 the items which should have borne the amount 
 thus overcharged. The sum of the costs on 
 individual lots of product for a given period 
 should equal the total of the expenses involved 
 for the same period. 
 
 The problem presented by a factory 
 which manufactures a single commodity, as 
 cement, beer, etc., is simple compared with 
 
 11 
 
Fundamentals of Cost and Profit Calculation 
 
 the problem of cost determination in a factory 
 where every lot is different from every other 
 lot, as is the case in factories making goods to 
 order upon specifications provided by the cus- 
 tomers, as in the manufacture of metal parts, 
 stampings, printing, etc. 
 
 Every individual expense item is definite 
 (i) in amount, or it could not be recorded; 
 (2) in purpose, otherwise it would not be au- 
 thorized; and (3) in benefit, for it is to pro- 
 cure some definite thing, either a commodity 
 or service, more desirable than the amount of 
 money involved, that the expenditure is made. 
 
 Expenses may be classified into two pri- 
 mary groups: Direct expenses and Indirect 
 expenses. 
 
 Expense items which have but one bene- 
 ficiary, to which they are chargeable in total, 
 without distribution, are direct expenses. 
 
 Expense items which have two or more 
 beneficiaries, requiring distribution, are indi- 
 rect expenses. 
 
 These divisions have long bfeen recognized 
 by cost accountants, but someone, generations 
 ago, thoughtlessly assumed that more or less 
 of the direct expenses might safely be used as 
 a basis for charging the indirect expenses, and 
 
 12 
 
The Philosophy of Cost and Profit 
 
 later generations of accountants have, with- 
 out question, accepted the formulae as au- 
 thoritative. The slightest effort in the direc- 
 tion of analysis will prove that no expense is 
 basic, and that such methods have no founda- 
 tion in fact. 
 
 No accountant would think of adding to- 
 gether the direct items of material and direct 
 wages on a hundred orders and distributing 
 the total to the individual orders upon some 
 arbitrary and unrelated basis, because, being 
 direct expenses, he can make the charge to 
 each without necessity for distribution. Yet, 
 for many decades, since the introduction of 
 labor-saving and automatic machinery, the 
 standard practice of cost accounting has been 
 to mass the unrelated indirect expenses into an 
 "overhead" or "general expense" account and 
 distribute the total upon a purely arbitrary 
 and unrelated basis, as for example the direct 
 labor expense, or the total of material and 
 direct labor expenses. 
 
 As no expense item is basic, and no group 
 of expenses is basic, such methods are purely 
 arbitrary and have no relation to facts. 
 
 That men who are otherwise intelligent 
 will advocate and follow such practices is 
 prima facie evidence that the principle of ex- 
 
 13 
 
Fundamentals of Cost and Profit Calculation 
 
 pense distribution is unknown to them. 
 Further, it is proof of the power of precedent 
 to so enthrall its devotees that they will fol- 
 low established routine long after progressive 
 changes ih correlated factors have made such 
 methods ridiculous. 
 
 As the result of analysis it is found that 
 every element of cost is related directly to 
 certain definite processes or functions of the 
 business; that where division of benefits re- 
 quire distribution of the expense item, the 
 divided parts can be measured and propor- 
 tions determined, so that in every case the 
 charge can be made in such a manner that 
 the proportions of expense charged will be 
 identical with the proportions of benefits con- 
 ferred. 
 
 Cost accounting recognizes no principle 
 of expense distribution, but depends upon 
 purely arbitrary methods. It uses the only 
 method possible where an overhead expense 
 account is created. The creation of such a 
 mass of unrelated expenses in itself defeats the 
 possibility of correct distribution because it 
 combines elements requiring different kinds 
 of units for expressing volume, whereas the 
 practical distribution provided in cost engi- 
 neering requires that all of the factors of a 
 
 14 
 
The Philosophy of Cost and Profit 
 
 group should be measurable by a common 
 unit 
 
 Correct expense distribution, then, is ac- 
 complished by considering each element in 
 relation to the benefit conferred, combining 
 the elements in groups only when the factors 
 of the group consist of items providing iden- 
 tical proportions of benefits, all of which are 
 measurable by a common unit. 
 
 In succeeding chapters the various classi- 
 fications of expenses will be considered, the 
 principle of expense distribution presented 
 and explained, and methods of determining 
 the cost of articles or items outlined. 
 
 Hazy as is the definition of cost to the 
 average man, it is little if any less understood 
 than the word ^Trofit." 
 
 Profit is that part of the ^^price'^ for which 
 an article is sold which remains after the cost 
 has been deducted. 
 
 Percentages of profit are correctly ex- 
 pressed only when they relate to the selling 
 price as the base, or ioo%. 
 
 The profits of a period are expressed in 
 relation to the total of sales. 
 
 Statements, frequently seen in the public 
 prints, which assert that ioo% or 200% 
 
 15 
 
Fundamentals of Cost and Profit Calculation 
 
 profit, or other percentages above loo, were 
 or can be made on the sale of goods, simply 
 display the ignorance of the person responsi- 
 ble for the statement. 
 
 If an article costing one cent is sold for 
 one dollar the profit percentage would be 99. 
 It is inconceivable that 100% profit could be 
 made on a transaction, for such a condition 
 would exist only in case the goods sold cost 
 nothing, and no expense, even that of time, 
 was involved in the conduct of the business. 
 
 A very common but erroneous method of 
 calculation is to compare the profits with the 
 investment, expressing the relation by per- 
 centage. 
 
 Such errors and the consequent confusion 
 are due to the fact that the accounting pro- 
 fession has no definite terminology. An effort 
 to establish a correct terminology in connec- 
 tion with the science of Cost Engineering was 
 made by the author several years ago in "A 
 Catechism of Costfinding" now practically 
 out of print. A similar effort is included in 
 this book under "The Terminology of Cost 
 Engineering." 
 
 No scheme of figuring profits can be con- 
 sidered practical which does not include in 
 
 16 
 
The Philosophy of Cost and Profit 
 
 cost every element chargeable either immedi- 
 ately or eventually as an expense item. 
 
 Profit is always the net increase in tangi- 
 ble assets due to the active transactions, or 
 sales, of business. It has no relation to invest- 
 ment. 
 
 Interest on investment is not profit, but is 
 the wage of financial energy. It is a form of 
 fixed expense that has no relation to activity 
 
 or the transactions of business. 
 
 « 
 
 Increased value of merchandise, due to 
 fluctuations in price, is not a part of profits. 
 The actual sale of the goods at a higher price, 
 because of the market fluctuation, will un- 
 doubtedly yield a larger margin of profit, but 
 the profit cannot exist until the sale is actually 
 made. 
 
 The anticipation of profits, because of 
 market changes or the carrying of goods in a 
 warehouse at a valuation which is higher than 
 their cost, and thereby anticipating profits, is 
 never justifiable. 
 
 No profit exists until the transaction has 
 been carried forward at least to the point 
 where the recorded charge for the item sold 
 exceeds the total of the outlay for the item 
 and the expenses of conducting the business. 
 
 17 
 
Fundamentals of Cost and Profit Calculation 
 
 Gross profit is a myth. The term was origi- 
 nated and is used to designate a percentage 
 applied to part of the elements of cost for the 
 purpose of arriving at a<supposedly profitable 
 selling price in which neither the cost nor the 
 amount of profit is definitely known. It is a 
 makeshift term, practicable only as a means 
 of avoiding an admission of ignorance of true 
 cost. 
 
 Further discussion of "Profits" will be in- 
 cluded in the chapter entitled "Selling Prices 
 and Profits." 
 
 18 
 
CHAPTER TWO 
 
 DIRECT EXPENSES 
 
 Direct Expenses are few in number, com- 
 pared to Indirect Expenses, and present prac- 
 tically no problem to either the accountant or 
 the Cost Engineer. 
 
 A direct expense item is one expended 
 for the benefit of but one beneficiary. 
 
 It may be chargeable to an individual fac- 
 tory order, an individual manufacturing 
 process, a class of product, or, in the case of 
 an office or store, it may be chargeable to an 
 order, a department or a class of merchandise. 
 
 A direct expense item is always charge- 
 able in total to a single account or beneficiary. 
 It never presents a problem in expense dis- 
 tribution because its benefit is never divided. 
 
 The major direct expense items are the 
 material chargeable to a factory order and 
 the amount of wages paid to workers engaged 
 in production on individual factory orders. 
 
 The minor direct expenses are, repairs to 
 machinery, which should be charged directly 
 to the process for which the machine is re- 
 quired; the supplies required for processes; 
 
 19 
 
Fundamentals of Cost and Profit Calculation 
 
 indirect wages for service in connection with 
 an individual process; the cost of replacing 
 spoiled material or ^product; expense for 
 sharpening tools, or replacing points and 
 knives worn out or destroyed in the operation 
 of processes; freight or cartage on shipments 
 which require such expense in excess of the 
 usual cost of delivery; advertising used in 
 connection with special lines of product, etc. 
 
 Many items which are direct in relation 
 to a process are indirect in relation to the fac- 
 tory order. In determining classifications the 
 relationship must be considered. 
 
 Early in the history of the race each in- 
 dividual or family existed upon the product 
 of its own energy, but when the advantages of 
 specialization became apparent, men began 
 specializing in the things that they could do 
 best, and serving their neighbors, who in turn 
 selected other special work, so that exchange 
 of product took place, and there was devel- 
 oped what we now call ^^trade." 
 
 One man made shoes, another clothes, an- 
 other built houses, thus originated the shoe- 
 makers, the tailors and the building trades. 
 As the demand became greater than the indi- 
 vidual worker could supply he took on as 
 
 20 
 
Direct Expenses 
 
 helpers other individuals to whom he taught 
 the "trade," and thus he became an employer. 
 
 Rivalry sprang up between the workmen, 
 each striving to do his work more skillfully 
 than his fellows. Since the quality of the out- 
 put and speed of production depended largely 
 upon the condition of the tools used, the care- 
 ful workmen found it most practical to pro- 
 vide their own equipment, thus avoiding 
 exchanges with careless workmen which 
 might occur if the tools were owned by the 
 employer, and the rights of usage common 
 between them. 
 
 In those days there were no power-driven 
 machine tools requiring heavy investment on 
 the part of the employer. Neither power, 
 repairs nor machine supplies were necessary. 
 Consequently, the major items of expense 
 were for materials and the wages of the work- 
 men. 
 
 Product was comparatively uniform in 
 character. No such factory organizations 
 existed as are common today. It was both pos- 
 sible and practicable for the employer to de- 
 termine a selling price by calculating the 
 amount of the outlay for material and wages 
 applying a percentage margin sufficient to 
 
 21 
 
Fundamentals of Cost and Profit Calculation 
 
 cover his few other factory expenses, his liv- 
 ing, and a fair profit. 
 
 To make the employer's problem easier, 
 the absence of transportation facilities in 
 those days limited competition to his imme- 
 diate locality. No salesmen were calling on 
 his customers with similar goods at lower 
 prices as is the case today. In fact, if his was 
 the only shop in the neighborhood engaged 
 in his particular line he had a virtual mo- 
 nopoly, and the price obtainable was limited 
 only by the keenness of the demand and the 
 ability of his customers to pay. 
 
 Changes in methods took place gradually. 
 Labor-saving machines were introduced, mak- 
 ing it possible for one man to produce many 
 times as much product in a given time as for- 
 merly. Wage rates remained practically the 
 same per day as before, and the employer as- 
 sumed that he was getting several times as 
 much product as previously with the same 
 expense. 
 
 Expenses for power, repairs, supplies, etc., 
 were charged to general expense, or overhead. 
 Little or no consideration was given to depre- 
 ciation, or interest on investment. Everything 
 except material and direct wages was charged 
 to overhead, the total of which was distrib- 
 
 22 
 
Direct Expenses 
 
 uted to orders or lots on the basis of '^prime 
 cost," the total of material and direct wages 
 involved. 
 
 Gradually manufacturers learned that the 
 expenses of processes had no relation to the 
 cost of the materials; that it cost no more to 
 cut or sew goods costing $6.00 per yard than 
 to do the same work with goods that cost half 
 as much. The cost of operating a stamping 
 press was the same whether the material being 
 formed was iron or brass. By many manu- 
 facturers, material was dropped from con- 
 sideration as a basic item, and direct wages 
 alone adopted as the basis of distribution. 
 
 The automatic machine has all but elim- 
 inated the wage factor on many processes. In 
 many factories the variety of processes ranges 
 from hand work, done in the original way 
 with bench and hand tools, through varying 
 processes involving high wage rates and small 
 investments, low wage rates and large invest- 
 ment, to the extreme where one individual 
 attends several machines. Yet the traditional 
 practice of assuming that wages are basic re- 
 mains the most commonly used method of 
 distributing the indirectexpenses. 
 
 In hundreds of instances throughout the 
 country, both material and wages are so con- 
 
 23 
 
Fundamentals of Cost and Profit Calculation 
 
 sidered. Ridiculous though they are, prac- 
 tically all schools of post accounting still 
 teach these methods. Leading "authorities" 
 on cost accounting, in current publications, 
 cite them as having certain advantages, giving 
 simplicity precedence over accuracy. 
 
 Let us test their merit: 
 
 The most important of the indirect ex- 
 penses are for housing, or rent for the space 
 used; equipment, involving depreciation, 
 taxes, insurance, etc. ; power, and administra- 
 tion. 
 
 Suppose that in a given factory two men 
 are employed, one at a wage of 25 cents, and 
 the other at 50 cents per hour. 
 
 If there is a relation between the amount 
 of wages paid to the workman,, and the other 
 expenses, the amount of space used by the 50- 
 cent man must be double that used by the 25- 
 cent man. The same proportion should exist 
 in the equipment investment, in the amount of 
 power used, and it should require twice as 
 much effort to supervise, and keep the records 
 of the 50-cent man's time, as to do the same 
 work for the 25-cent man. 
 
 The facts are, that as between the wages 
 paid to the workers and the indirect expenses, 
 
 24 f 
 
Direct Expenses 
 
 no such relation exists. Careful analyses made 
 by competent and experienced cost engineers 
 of the individual expense items involved in 
 the operation of over six hundred factories 
 have failed to disclose a single instance where 
 any other expense was in the same proportion, 
 or had any discernible relation to the amount 
 of direct wages paid to the workers. 
 
 In fact it has been thoroughly demon- 
 strated that there is no single expense item 
 nor group of items which is ba^sic, or that can 
 be safely used as a basis for the distribution 
 of another expense item, or group of expenses. 
 
 The author has been told many times by 
 manufacturers that they had no problem of 
 costfinding because they paid their workers 
 by the "piece." Experience proves that the 
 piecework wage system complicates, rather 
 than simplifies, the work of the cost engineer. 
 
 The assumption of the majority of manu- 
 facturers who pay wages by pieces, is that 
 because the material cost is the same, and the 
 wages per piece the same, all like pieces cost 
 the same, regardless of the speed or skill of 
 the workers. Let us see. 
 
 Suppose two workers are engaged on the 
 same kind of process, using the same equip- 
 
 25 
 
Fundamentals of Cost and Profit Calculation 
 
 ment, supplies, power, etc., and supervised 
 by the same foreman. Ohe, however, pro- 
 duces loo pieces per day and receives as pay 
 therefor $1.50. The other produces 200 
 pieces per day and receives as pay $3.00. Such 
 cases are common in actual experience. 
 
 Assume also that the overhead percentage 
 as determined by the cost accountant is 100% 
 (a rate in common use regardless of the true 
 proportion of the "overhead burden" to the 
 total of the direct payroll). Adding 100% 
 to the wages paid we find that the result makes 
 it appear that the lOO-piece lot cost $3.00, the 
 200-piece lot cost $6.00, and the per piece cost 
 is the same in both lots. What are the facts? 
 
 The worker who earned $1.50 required 
 the same equipment investment as the other, 
 used the same amount of space, the same 
 amount of power, the same supervision. In 
 fact all the elements were identical, except 
 the wages ; so that the actual difference in 
 cost of the two lots was not $3.00, as the ac- 
 countant figured, but $1.50. Assuming now 
 that the total of the indirect expenses applied 
 was correct, an equal division would show 
 $2.25 applicable to each. The cost of the 
 loo-piece lot is now found to be $3.75, and 
 the 200-piece lot cost $5.25, or $2.62^ per hun- 
 
 26 
 
Direct Expenses 
 
 dred. The product of the low wages is found 
 to be the most expensive, while that of the 
 employe receiving higher wages because of 
 greater efficiency is nearly one-third less ex- 
 pensive per piece. 
 
 Experience and analysis prove that no ex- 
 pense is basic, that all efforts to use direct 
 wages or other direct expenses as a means of 
 apportioning the indirect expenses are mis- 
 leading. 
 
 We find that while methods of manufac- 
 ture have been constantly improved until me- 
 chanical processes have almost universally 
 displaced manual methods, the accounting 
 profession has failed to keep pace with the 
 improvements. Its ^^authorities" are still ad- 
 vocating and teaching methods rendered 
 obsolete by the introduction of the first labor- 
 saving machine tool, and are becoming more 
 and more inadequate and ridiculous with 
 every progressive step in mechanical processes 
 of production. 
 
 It is time that manufacturers everywhere 
 learned to think for themselves, to discard 
 obsolete and misleading methods, and demand 
 others which, in the light of modern scientific 
 analysis, can be depended upon to show the 
 
 27 
 
Fundamentals of Cost and Profit Calculation 
 
 true relation between cost and selling price 
 in every transaction. 
 
 Direct expenses are not basic cost factors. 
 They are simply expense factors which, hav- 
 ing but a single beneficiary, require no act of 
 distribution. 
 
 28 
 
CHAPTER THREE 
 
 INDIRECT EXPENSES 
 
 In all the history of trade, commerce, and 
 manufacture the indirect expenses of business 
 present the problem hardest of solution. 
 
 A brief statement of the early history of 
 this subject was included in the preceding 
 chapter. Only that phase of the subject was 
 covered, however, relating to the use of direct 
 expenses as a basis of distribution. 
 
 In a comparatively few instances, an effort 
 has been made in plants having a number of 
 departments doing different kinds of work, 
 to treat each department as though it were a 
 separate factory. Thus in a factory manu- 
 facturing agricultural implements depart- 
 mental divisions would be formed for foun- 
 dry, forging, machine shop, woodwork, paint- 
 ing, etc. 
 
 An effort was made thereby to charge 
 directly to the department as far as the ac- 
 countant was able, such expenses as seemed 
 to belong to each. The general expenses of 
 the business were then charged throughout 
 either upon the basis of the direct wage pay- 
 roll of departments or as in a few cases, in 
 the ratio of the totals of the expenses directly 
 charged. The total of these so called "depart- 
 
 29 
 
Fundamentals of Cost and Profit Calculation 
 
 4. 
 
 mental overheads" was distributed over the 
 factory orders in proportion to the direct 
 wages involved, or in proportion to the man 
 hours of the workmen engaged directly upon 
 the orders. 
 
 In simple factories, corresponding to the 
 individual departments of the composite fac- 
 tory, the man hour basis is sometimes used by 
 accountants. 
 
 Another method of distributing the in- 
 direct expenses in factories employing a vari- 
 ety of labor, as well as a wide range of invest- 
 ment in machinery for different processes, is 
 the "machine hour rate" plan. 
 
 This plan takes into consideration more or 
 less crudely the expenses involved on account 
 of the different amounts of investment, the 
 varying rates of depreciation, the power 
 required, the floor area occupied, etc., and 
 divides the total by the number of hours that 
 the management estimates the machine should 
 be operated normally during a given period, 
 usually a year. 
 
 The rate, thus determined, is added to the 
 direct wages of the workers on each process, 
 and to the sum of them is added the expenses 
 of administration on some arbitrary basis, 
 usually the total of the "prime cost" of the 
 order. 
 
 30 
 
Indirect Expenses 
 
 Early in the present century Mr. A. Ham- 
 ilton Church, an engineer, in his book ^^Dis- 
 tribution of the Expense Burden," offered a 
 progressive step by suggesting that a factory 
 be divided into units, each of which per- 
 formed a single type of operation. Each of 
 these divisions was to be treated as though it 
 was a separate factory, although under the 
 same roof, and no dividing partitions existed. 
 
 Under his plan every division should be 
 charged with its rent upon the basis of floor 
 area. Depreciation, insurance on equipment, 
 and taxes, should be charged upon the basis 
 of investment, while power was to be charged 
 on the basis of horsepower hours. An hourly 
 rate was then determined by dividing the total 
 by the actual productive hours. This imme- 
 diately appealed to practical men as being 
 a sound and logical method of handling these 
 expenses. 
 
 Thus far Church solved the problem of 
 expense distribution satisfactorily, but his 
 work was incomplete, for in the same book he 
 admitted that the problem of distributing the 
 administration expense or, as he termed them, 
 the ^'general establishment charges," baffled 
 him. He vigorously attacked the traditional 
 method of charging them on the basis of direct 
 wages, and doubted the practicability of pro- 
 
 31 
 
Fundamentals of Cost and Profit Calculation 
 
 ductive hours as a universal basis, therefore 
 admitting that he could offer no satisfactory 
 rule for their distribution, he put the problem 
 up to the reader, advising him to use his own 
 judgment as to the method most practical for 
 any individual case. 
 
 Church's effort should have recognition 
 as the first radical step away from the tra- 
 ditional formulas of cost accounting, and in 
 the direction of what is today known as Cost 
 Engineering. 
 
 All the definite suggestions made by him 
 conform to the fundamental principle of ex- 
 pense distribution, the very foundation of Cost 
 Engineering. Had he gone a little farther, 
 and analyzed his own methods, he would have 
 found that in each case the expense was 
 charged in proportion to the advantage it con- 
 ferred on the benefited divisions, and that 
 those proportions were always expressed in 
 the term of measure denoting the relative vol- 
 ume of the units. For example, the item of 
 rent being expended to secure usable floor area 
 benefited each division in the proportion of 
 the floor area used. Floor area is logically 
 measured by using the square foot as a unit; 
 therefore the relative number of square feet of 
 area used indicated the relative amount of 
 expense chargeable. 
 
 32 
 
Indirect Expenses 
 
 In like manner, since it is the dollars of 
 investment which must be protected against 
 loss through depreciation of machinery; and 
 against fire by insurance; and against which 
 taxes are levied; the dollars of investment in 
 the various divisions indicate the proportions 
 of depreciation, insurance and tax expenses 
 chargeable to each. 
 
 In 1908, when the author developed and 
 formulated the fundamental principle of ex- 
 pense distribution he had not heard of Mr. 
 Church, nor of his book, but he had come into 
 contact with the methods which he advocated, 
 and they seemed so logical that he immedi- 
 ately analyzed them to determine the princi- 
 ple behind them. 
 
 Through long experience, and by careful 
 analysis, it has been found that the principle, 
 as formulated, applies to every known indi- 
 rect expense, and is therefore accepted as 
 fundamental. This principle and its method 
 of application will be presented at length as 
 the author proceeds. 
 
 An indirect expense item is one which, 
 having two or more beneficiaries, requires 
 distribution. 
 
 The reason that distribution of indirect ex- 
 penses has baffled the accounting profession so 
 long is that in the absence of knowledge of the 
 
 33 
 
Fundamentals of Cost and Profit Calculation 
 
 fundamental principles of expense, they per- 
 sisted in grouping unrelated expenses into 
 masses, thereby destroying the possibility of 
 correct distribution. 
 
 Every expense item is originally definite 
 in amount, purpose or object, and benefit. 
 The difference between direct and indirect 
 expenses is that whereas the direct expense 
 item has a single beneficiary to which it may 
 be charged in total, the indirect expense has 
 two or more beneficiaries between which it 
 must be distributed, or charged, in propor- 
 tion to the benefits conferred. 
 
 The human mind cannot conceive of a 
 divisible thing that cannot be measured by 
 some unit of weight, measure or count. 
 Therefore it follows that if the benefit con- 
 ferred by a certain expense item is divisible, 
 it is also measurable. Being measurable, the 
 relative proportions are easily expressed and 
 may be used as a guide for charging the money 
 expended. 
 
 One of the weaknesses of the accountants' 
 efforts seems to be a penchant for expressing 
 all proportions in percentages. In the dis- 
 tribution of expenses of manufacture, percent- 
 ages are not only unnecessary but cumber- 
 some. Proportions and not percentages are 
 important. 
 
 34 
 
Indirect Expenses 
 
 While individual indirect expense items 
 are easily distributed, economy of time and 
 effort is desirable. Therefore it is advisable 
 to group expenses for simultaneous distribu- 
 tion wherever such grouping is practicable. 
 
 Indirect expenses may be grouped for 
 simultaneous distribution only when their 
 benefits are measurable by a common unit, and 
 their beneficiaries participate in identical 
 ratios. 
 
 The inclusion of two or more unrelated in- 
 direct expense items in a single account or 
 group, as "overhead," "burden," or "general 
 expense," obscures the purposes of the ex- 
 penditures and renders correct distribution 
 impossible. 
 
 Lacking knowledge of the principles of 
 expense grouping, accountants and others have 
 charged part of the expenses individually ac- 
 cording to the best information which they 
 had, and combined the remainder in an over- 
 head expense account for distribution upon 
 some more or less arbitrary basis. 
 
 Thus it will be seen that the extent of the 
 overhead or burden account in any cost sys- 
 tem reveals the extent to which the account- 
 ant is ignorant of the principles of expense 
 grouping and expense distribution. 
 
 Where these principles are understood and 
 35 
 
Fundamentals of Cost and Profit Calculation 
 
 intelligently applied, it will be found that 
 there is not left a single undistributed item to 
 apply arbitrarily. In fact, if there were a 
 single instance in experience where the prin- 
 ciple did not apply clearly, it would be posi- 
 tive proof that the statement of the principle 
 was wrong. Then we would immediately 
 have to search again for the fundamental truth 
 which would cover every requirement. 
 
 For ten years the author has discussed this 
 subject with thousands of manufacturers and 
 supervised the application of these principles 
 in hundreds of factories. Not a single instance 
 has he found where these principles, and the 
 others, which all together form the funda- 
 mental principles of Cost Engineering, did 
 not fully measure up to all requirements. 
 
 This experience, and the excellent results 
 attained through it, must convince the most 
 skeptical that Cost Engineering actually ac- 
 complishes all that cost accounting aimed to 
 do but failed; that Cost Engineering is a prac- 
 tical science, and that its principles are as 
 fundamental, teachable and universal in appli- 
 cation as the axioms of mathematics. 
 
 Fundamental principles are invariable. 
 Rules may be made for applying the princi- 
 ples, but whenever the facts in any case are 
 such that the strict application of the rule 
 
 36 
 
Indirect Expenses 
 
 will conflict with the principle, the principle 
 must govern and the rule be changed to meet 
 the condition. For example: 
 
 In a factory occupying a building by itself, 
 or a part of a building where the type of con- 
 struction is uniform throughout, the arrange- 
 ment of equipment purely arbitrary with the 
 management, and uniform temperature re- 
 quired throughout, the elements of rent and 
 heat can be combined. The total of this group 
 may then be distributed to the factory divi- 
 sions upon the basis of floor area. 
 
 But if certain processes require a special 
 type of construction, different from the rest, 
 so that the arrangement is dependent upon 
 such construction, or if the atmosphere of cer- 
 tain rooms must be maintained at different 
 temperatures because of the requirements of 
 the processes performed therein, then they 
 cannot be combined. Such conditions cause 
 the rule to conflict with the principle that the 
 beneficiaries must participate in identical 
 ratios. 
 
 Under such conditions the items of rent 
 and heat should be distributed separately in 
 order that due consideration may be given to 
 the variation in requirements, and each divi- 
 sion be charged with these elements in the 
 exact ratio of benefits conferred. 
 
 37 
 
Fundamentals of Cost and Profit Calculation 
 
 Indirect expenses are of two types and may 
 be classified as ^^mmediate," and "ultimate," 
 or economic. 
 
 Immediate indirect expenses are items 
 usually appearing on the books, as a matter of 
 record, immediately upon their being in- 
 curred. 
 
 These are represented by the following by 
 no means complete list: 
 
 Rent, fuel, current or gas for lighting, 
 power, insurance, supplies, salaries, repairs, 
 taxes, telephone, telegraph, postage, wages, 
 compensation insurance, etc. 
 
 Ultimate indirect expenses are items that 
 are not usually considered and recorded at 
 the time that they are incurred, but are very 
 generally left for consideration at the end of 
 the fiscal year, if at all. 
 
 Some managers hold that consideration of 
 these items is optional with them, and they 
 are all too frequently left entirely out of state- 
 ments. 
 
 Some accountants, fearful that they will 
 incur the displeasure of the client if they show 
 that the business is not profitable, omit at least 
 a part of the items, creating the impression 
 that the business is more profitable than is 
 really the case. 
 
Indirect Expenses 
 
 Some managers, especially those who have 
 no interest in a business beyond their "jobs," 
 insist that important items be omitted, in order 
 that the business may show a profitable result 
 when no real profit exists. 
 
 Some accountants and many managers for 
 selfish reasons assume that the inclusion of in- 
 terest on investment is a mooted question, and 
 argue against it because it is to their personal 
 interest to do so. 
 
 The accounting profession as a rule holds 
 out against the inclusion of interest except that 
 paid for borrowed money. Within recent 
 years, however, the number of accountants 
 who admit the justice of interest charges on all 
 of the investment has been on the increase. 
 
 One unfortunate phase of the situation is 
 that the profession has made no noticeable 
 effort to reach a just and final conclusion in 
 this matter. If it was taken up for formal 
 consideration, it is not likely that even though 
 convinced of the justice of including interest 
 charges, any considerable number of those 
 who have held out against it would admit a 
 change of viewpoint. 
 
 A typical instance of the attitude of the 
 older generation of accountants is shown in 
 the following incident in which the author 
 was a principal participant: A manufacturer 
 
 39 
 
Fundamentals of Cost and Profit Calculation 
 
 who had given an order for the installation of 
 a cost accounting system to an old friend who 
 was a C. P. A. called upon the author to clear 
 up some interesting points of difference be- 
 tween cost accounting and cost engineering 
 methods. The C. P. A. was present, and ad- 
 mitted the soundness of every contention 
 made, but would not yield the point that Cost 
 Enginering as a whole was more practical and 
 accurate than the so-called "standard account- 
 ing practice" represented in his system. He 
 gave as his reason his belief that he could not 
 afford to brave the criticisms of the profession 
 should it become known that he had made a 
 concession. 
 
 Such is the power of established precedent 
 to hinder progressive development. 
 
 The manufacturer, keenly appreciating the 
 value of the differences brought out in the dis- 
 cussion, and the narrowness of the account- 
 ant's viewpoint, placed his order at once for 
 the installation of a Cost Engineering System 
 to replace that only recently installed by the 
 C. P. A. 
 
 A discussion of the author's reasons for ad- 
 vocating the inclusion of interest on all invest- 
 ment, and other "ultimate expenses," will be 
 covered in the succeeding chapter, entitled 
 "Economic Expenses." 
 
 40 
 
CHAPTER FOUR 
 
 ECONOMIC EXPENSES 
 
 Comparatively few manufacturers and 
 merchants realize as they should the impor- 
 tant truth that assets naturally tend to shrink, 
 while liabilities always tend to increase under 
 indifference or neglect. 
 
 Wealth is not created by accident. It is 
 created by the expenditure of energy. Some 
 men may seem to, and a few actually do, grow 
 rich without expending personal energy, but 
 somewhere in the background unseen forces 
 are at work involving the application of a 
 form of energy. 
 
 Energy in industry is of three kinds: the 
 personal energy of the individual or the or- 
 ganization; the mechanical energy or power 
 applied to the mechanical equipment; and the 
 financial energy, without which the personal 
 energy and mechanical energy would be com- 
 paratively weak. 
 
 Finances are the lubricant of industry. 
 Without them the wheels of trade and com- 
 merce must cease to turn. The proof of this is 
 seen in the thousands of failures credited to 
 "lack of capital." It is demonstrated on a large 
 
 41 
 
Fundamentals of Cost and Profit Calculation 
 
 scale in the deep valleys of trade charts mark- 
 ing periods of financial panic. 
 
 When the purse strings of the nation 
 tighten, business slows down. At the points 
 where the greatest strain occurs it stops, and 
 failures occur in large numbers. 
 
 These three kinds of energy may be lik- 
 ened to the supports of a three-legged stool. 
 Remove either the personal, the mechanical 
 or the financial energy, and the structure of in- 
 dustry topples. 
 
 The expenses of personal energy are met 
 in salaries and wages paid to workers. The 
 expenses of mechanical energy are met in the 
 expenditures for power equipment and opera- 
 tion, but the expenses of financial energy, the 
 economic or "ultimate" expenses, being less 
 understood, and slower in exacting the penalty 
 for negligence, are most often neglected. 
 
 Economic expenses are the charges, or 
 elements, of cost which must be included to 
 preserve the economic balance, or equilibrium, 
 of capital. They counterbalance deprecia- 
 tion, waste, shrinkage, and other losses due to 
 the conditions and contingencies of business. 
 
 If they are neglected, no creditor persist- 
 ently requests their payment and no attorney 
 
 42 
 
Economic Expenses 
 
 calls attention to the fact that they are over- 
 due, demanding immediate settlement, yet in 
 the end they must be paid. 
 
 Because they are not payable with the cur- 
 rent bills they are easily, and all too fre- 
 quently, omitted entirely from the books and 
 financial statements. 
 
 Some men call them "intangible expenses." 
 Others jest about them, while still others act 
 on the assumption that their recognition is 
 purely optional and that they may be consid- 
 ered in prosperous years, and omitted in the 
 lean years of business. 
 
 They are sometimes looked upon in the 
 same light as voluntary contributions to char- 
 ity. Reference to them is almost entirely 
 omitted from the curriculums of commercial 
 schools. Even the accounting profession has 
 no "standard practice" with reference to them. 
 
 They, however, have been brought into 
 their proper important position in Cost Engi- 
 neering. For it is the business of the Cost 
 Engineer to analyze and present the facts of 
 business as they exist, not as the client would 
 like to have them appear, or as expediency 
 demands, in order that a financial statement 
 may reflect credit upon the management. 
 
 43 
 
Fundamentals of Cost and Profit Calculation 
 
 Accounts payable to other creditors may 
 be defaulted and no legal action follow; 
 business may seem to prosper in spite of the 
 neglect of these elements, but ultimate pay- 
 ment cannot be sidestepped. Time is the in- 
 exorable creditor, exacting payment in full or 
 foreclosing. 
 
 Just as surely as the natural laws govern- 
 ing health cannot be infringed without the 
 penalty of illness, violation of the natural law 
 of compensation in finance will result in loss, 
 if not in absolute failure. 
 
 Depreciation is not an expense. 
 
 Notwithstanding the fact that the account- 
 ing profession has generally advocated 
 "charging off" at the end of the year "for de- 
 preciation" a certain amount from the assets 
 of the business, depreciation is not an expense. 
 
 Depreciation is a contingency. 
 
 The custom in times past has been, and still 
 is, to think of depreciation in relation to "wear 
 and tear," the physical condition only being 
 considered in calculations as to the life of 
 equipment. 
 
 There are many causes of depreciation, but 
 three appear more prominently than others. 
 
 44 
 
Economic Expenses 
 
 They are obsolescence, inutility, and wear and 
 tear. The least of these is wear and tear. 
 
 A machine may be in first-class physical 
 condition and be actually a liability because 
 it is out of date and its operation so unprofit- 
 able in competition with modern equipment 
 as to create a loss. 
 
 A machine may be in perfect physical con- 
 dition, and up to date, but if the demand for 
 its product has ceased, so that it cannot be 
 profitably utilized, it becomes a liability 
 rather than an asset. 
 
 If the machine is actually worn out in 
 service, and its product has been intelligently 
 priced and sold, a reserve has been provided 
 thereby for its replacement, and neither loss 
 nor liability is created. 
 
 Depreciation is a contingency which the 
 intelligent manager will foresee and provide 
 for by creating a reserve for replacement (not 
 by the makeshift of a depreciation account) . 
 
 Replacement reserve is provided to take 
 care of the probability that it will be neces- 
 sary at the end of an estimated period to pur- 
 chase a new machine to replace the old. Even 
 though no machine is actually purchased, the 
 reserve should be provided that the stockhold- 
 
 45 
 
Fundamentals of Cost and Profit Calculation 
 
 ers may have their money returned to them 
 at the end of the term of usefulness of the 
 machine. Capital must be protected against 
 loss if financial equilibrium is to be main- 
 tained. 
 
 "Charging off" for depreciation is an im- 
 practical plan. It creates a constantly reduc- 
 ing basis for the charge, with the result of 
 lengthening the period during which the 
 charge must be continued to balance the orig- 
 inal investment. Calculations show that a ten 
 per cent per annum depreciation charge from 
 reduced bases will actually require ninety- 
 seven years to approximately balance the in- 
 vestment. 
 
 A ten per cent replacement reserve ^^ charge 
 on!' included in the expenses of operation will 
 provide the funds for replacement in ten 
 years. The "charge on" is the correct method. 
 
 The term of years or period established as 
 the probable efficient life of a machine is prac- 
 tically the only arbitrary factor in Cost Engi- 
 neering. 
 
 Reference has been made here only to de- 
 preciation of the machinery values. Prac- 
 tically all assets depreciate, and provision 
 must be made for maintaining economic equi- 
 
 46 
 
Economic Expenses 
 
 librium to avoid losses. The more important 
 items are: 
 
 Depreciation of buildings. 
 Depreciation of equipment. 
 Depreciation of raw material stocks. 
 
 Depreciation of merchandise and finished 
 
 product stocks. 
 Waste from cutting materials. 
 
 Spoilage due to the hazard of operations, 
 and inefficiency of workmen. 
 
 Losses from bad accounts and the expenses 
 of collections. 
 
 Depreciation of good will. In cases where 
 good will has been purchased outright, 
 a reserve should be provided which 
 will balance the investment within the 
 period where the influence of the pur- 
 chased good will is likely to be ex- 
 hausted. 
 
 Patents should be carefully appraised, and 
 provision made for royalties to be 
 charged against product, which will 
 yield their value, in addition to normal 
 profits, within the period of protection. 
 
 Interest on Investment is a subject on 
 which there has been almost endless discussion 
 
 47 
 
Fundamentals of Cost and Profit Calculation 
 
 for want of proper consideration of funda- 
 mental principles. 
 
 Interest on investment is a form of wages 
 for energy employed by the business and must 
 be provided for before profit exists. 
 
 The expenses of fuel, supplies, and main- 
 tenance, pay for the mechanical energy em- 
 ployed by the business. 
 
 The wages and salaries paid to individuals 
 pay for the personal energy of workers em- 
 ployed by the business. 
 
 Interest on investment is simply the wages 
 of the money employed by the business. 
 
 Just as there can be no profit until after 
 the expenses of operation, and of personal 
 service, have been paid, there can be no profit 
 until after the wages of the invested capital 
 are paid. 
 
 There are many valid arguments in favor 
 of interest on investment being charged as an 
 element of operating cost, rather than consid- 
 ering it as a part of profits. For example: 
 
 Assume that a man has $50,000 invested in 
 safe securities yielding the usual legal rate of 
 interest (or wage) of six cents per dollar per 
 year. 
 
 This man is holding a good salaried posi- 
 tion which pays $5,000 per year for his per- 
 
 48 
 
Economic Expenses 
 
 sonal energy, and has in addition the annual 
 income of $3,000 earned by his investment. 
 
 He decides to engage in business that his 
 money may earn for him a larger return under 
 his personal management. 
 
 He draws his money from the security of 
 investment and reinvests it in a business enter- 
 prise solely in the hope of increasing his in- 
 come. 
 
 He fixes his salary at the old figure of 
 $5,000 for his personal service, and does his 
 best. At the end of the year he finds that the 
 net earnings of the business amount to only 
 $1,500 or three per cent of his investment. 
 Has he made a profit of $1,500? 
 
 He has not. His business venture has cre- 
 ated a net loss of half of the normal and legal 
 wages of his financial energy. He has lost 
 $1,500 as surely as though in his old position 
 he had been unable to draw more than $3,500 
 of his $5,000 salary. 
 
 Suppose that during the next year he does 
 $100,000 in business and his net earnings aside 
 from his salary amount to $4,000. What profit 
 has he made? 
 
 He has made a profit of one per cent. The 
 legal wages of the money invested is six per 
 
 49 
 
Fundamentals of Cost and Profit Calculation 
 
 cent, or $3,000. His profit this year from his 
 business venture amounts to $1,000 on a turn- 
 over of $100,000, which is one per cent. 
 
 Interest and profit should never be con- 
 fused, because interest is considered in rela- 
 tion to investment, while profit is properly 
 considered only in relation to sales or turn- 
 over. 
 
 Accountants sometimes contend that if it 
 is desirable to consider interest on investment 
 separately from profits, it may be done at the 
 end of the year, by setting aside from the 
 profits an amount equal to the legal interest, 
 calling the remainder "net profit." 
 
 In view of the fact that the majority of 
 modern factories make up goods to the speci- 
 fications of the customer, with a price quoted 
 in advance of making, it is necessary to make 
 estimates. 
 
 No estimate is complete that does not take 
 into consideration every element of expense 
 that will immediately or eventually be con- 
 sidered in the cost. Otherwise, how could the 
 manufacturer regulate the matter of profit? 
 He must include in his quotations, in addition 
 to the estimated cost, an amount which will 
 provide for the anticipated percentage of 
 profit. 
 
 50 
 
Economic Expenses 
 
 Profit is related to turnover, and not to 
 investment; while interest is related to invest- 
 ment and not turnover, the two items cannot 
 be included in a single percentage. 
 
 Much of the confusion of thought in these 
 matters is due to the fact that neither public 
 nor commercial schools teach practical meth- 
 ods of calculating cost and profit. 
 
 Before leaving this subject, let us take an- 
 other example in which we will use the same 
 individual and the same capital as in the 
 preceding illustrations. 
 
 In this instance the investor requires the 
 use of $100,000, while his personal capital is 
 but $50,000. He borrows $50,000 at six per 
 cent, which he invests jointly with his own. 
 
 (Those of our accountant friends who 
 deny the man who uses his own capital the 
 right to charge interest on it as a part of the 
 cost of doing business, never question the pay- 
 ment of interest on borrowed money as a 
 legitimate expense.) 
 
 At the end of the year the business shows 
 a good margin of profit, after paying the in- 
 terest on the borrowed money. 
 
 Is there any difference in the status of the 
 borrowed money employed in the business, 
 
 51 
 
Fundamentals of Cost and Profit Calculation 
 
 and the money which is owned by the man- 
 ager? Absolutely not. 
 
 If he succeeds in earning enough to pay 
 back the borrowed money should he then fur- 
 nish the product or goods to his customers 
 cheaper because it is his money that is in- 
 vested, rather than borrowed money? Such a 
 theory is as ridiculous as the claim occasion- 
 ally advanced that a concern has no rental 
 expense because it owns the building it occu- 
 pies. 
 
 Fundamentally, all industrial activities 
 are conducted with private capital. Every 
 enterprise, corporate, public or private, must 
 secure its financial energy from private sav- 
 ings, the result of ability, energy and thrift 
 on the part of individuals. 
 
 Stocks, bonds and notes are simply forms 
 of loans. The actual ownership of the capi- 
 tal does not change. The bond or stock cer- 
 tificate is simply evidence that the individual 
 owns a certain amount of money that is used 
 in the enterprise which has arranged for the 
 issuance of the form of document received as 
 evidence of the loan. 
 
 That rate of wages (interest) is lower as 
 the form of security advances. Government 
 
 52 
 
Economic Expenses 
 
 bonds, the safest form of loans, pay the low- 
 est rate, because the risk is smallest. 
 
 Commercial loans command a higher rate 
 because the risk involved is greater. Com- 
 mercial paper is practically guaranteed by 
 the common stockholders of the concern issu- 
 ing it, to the extent of the stock investment. 
 
 The holders of common stock in an enter- 
 prise take the greatest risk, because all other 
 forms of loans come first. Therefore, since 
 they take the greater risk of loss in unprofit- 
 able years they are entitled to the larger re- 
 turn of the profitable years. 
 
 The chief difference between a common 
 stock certificate and a bond or note is that the 
 former provides no specified rate of wage or 
 term of contract. 
 
 However, cost, the point between loss and 
 profit, must in justice be determined by a 
 method of calculation which will place every 
 dollar employed in the business upon an 
 equal footing. Cost must include interest on 
 the invested capital at the normal rate, the 
 rate that the business must pay for loans made 
 by those who do not assume the same risk that 
 the stockholder takes. 
 
 Bookkeepers and accountants are accus- 
 tomed to charging as expense only the inter- 
 
 53 
 
Fundamentals of Cost and Profit Calculation 
 
 est paid on borrowed money. The Cost En- 
 gineer holds that interest should be charged 
 on every dollar employed in the business, re- 
 gardless of ownership. 
 
 The ordinary classifications on which in- 
 terest should be charged include the invest- 
 ment in : 
 
 Real estate used for the business. 
 
 Buildings used for the business. 
 
 Equipment, factory, office, store, etc. 
 
 Raw stocks carried to facilitate economi- 
 cal production. 
 
 Investment in work in process. 
 
 Merchandise carried to facilitate quick 
 service to customers. 
 
 Finished product or merchandise carried 
 for customers' accounts. 
 
 Accounts receivable. 
 
 Cash in bank for use of the business. 
 
 These items cannot be added together and 
 a blanket charge made of the mass. Each 
 must be considered in relation to its employ- 
 ment in service to the customers, so that the 
 man who buys the product of hand tools will 
 not pay the interest on investment in expen- 
 sive machine equipment. 
 
 54 
 
Economic Expenses 
 
 Good Will is another item that seems, 
 heretofore, to have escaped the consideration 
 of thinking men. The term, as commonly 
 used, seems to refer to the force of habit in 
 causing people with purchasing power to con- 
 tinue to patronize a concern after it has 
 changed ownership. 
 
 This type of so-called "good will" is of 
 doubtful value. Notwithstanding the fact 
 that the man who has a store or other business 
 for sale dilates largely on the value of the good 
 will that is included in the offer, it is rare in- 
 deed that the new owner profits much by rea- 
 son of "force of habit." 
 
 Genuine good will is rarely transferable 
 in total. The man who gains by it is the man 
 who joins an organization which has already 
 established a valuable good will. Complete 
 change of ownership, publicly announced, 
 carries with it little good will. 
 
 The term is sometimes applied to a legiti- 
 mate form of intangible investment, and in 
 such cases has real value if the business is to be 
 continued under the new management with- 
 out radical changes in character or policy. 
 
 Practically no business can be established 
 without going through an unprofitable period. 
 Often it requires a year or more to get the 
 
 55 
 
Fundamentals of Cost and Profit Calculation 
 
 business up to a point where its tangible assets 
 equal the amount of investment. 
 
 The time of the persons who promote the 
 organization, arrange for the preparation of 
 the building, and manage the affairs prior 
 to the date when business actually begins, re- 
 quires a form of investment that does not show 
 in the inventories. The expense of advertis- 
 ing, printed supplies, and other unsalable ne- 
 cessities adds to this investment. 
 
 These items should all be a matter of rec- 
 ord, and provision made for refunding to the 
 treasury all such items before profit is con- 
 sidered. If the business changes hands before 
 such refunding takes place, due consideration 
 should be given to such of these amounts as 
 have not been refunded. 
 
 Genuine good will, however, is another 
 matter. It is the very foundation of perma- 
 nent business. Not one man in ten can de- 
 fine it. 
 
 Good will is the margin of service deliv- 
 ered to the customers beyond what they are 
 asked to pay for. 
 
 If you sell an article to a customer at a 
 price which leaves him with the impression 
 that he paid all or more than it was worth you 
 
 56 
 
Economic Expenses 
 
 create no good will. But if you deliver an 
 article to a customer at the moment that he 
 needs it, and it is made so well that he never 
 has reason to make a complaint about it, and 
 the price is such that he feels that he got a 
 square deal, you have delivered a margin of 
 service which will come back to you in future 
 business and recommendations of your service 
 to others. 
 
 Good will is transitory in its nature. Bad 
 management can destroy it. Neglect of the 
 interests of the customers causes it to dissolve 
 like vapor. 
 
 Where good will is actually purchased a 
 reasonable estimate of the "period of influ- 
 ence" should be made and a reserve provided 
 for and established, that within the estimated 
 period will refund to the treasury the amount 
 paid for it. 
 
 In the chapter on "Determining Cost" an 
 outline will be submitted to cover as far as is 
 practicable all the items of "Economic or Ul- 
 timate" expenses and the methods by which 
 they are to be included in cost. 
 
 57 
 
Round numbers are the cloak of 
 ignorance; definite figures form the 
 basis of action. 
 
 Two and two make four — au- 
 thorities do not differ. Mathe- 
 matics do not compromise. 
 
 A few cents in a cost figure^ in a 
 job estimate^ in a profit percentage, 
 mark the line between solvency and 
 bankruptcy — success and failure. 
 
 Build your system and your facts 
 to give you not the approximate, the 
 probable, the perhaps — but the pre- 
 cise, the actual, the definite. 
 
 Be exact. — ^^System." 
 
 58 
 
CHAPTER FIVE 
 
 DETERMINING COST 
 
 There was a time in the history of Ameri- 
 can industries when exact information about 
 cost of production was of very little impor- 
 tance. That day has long since passed and 
 will never return. 
 
 At the moment when this is written the 
 American business man is confronted with 
 conditions and requirements, made acute by 
 war, demanding immediate and accurate facts 
 about the vital elements of his business. 
 
 Unfortunately, the opportunities, the am- 
 pleness of time, and the normal conditions of 
 business, which were his in the past, and 
 which afforded the most practicable basis for 
 gaining information, were neglected. He 
 stands today as unprepared from the economic 
 standpoint as was our country, from the mili- 
 tary standpoint, the day the Lusitania was tor- 
 pedoed. 
 
 He has no choice but to get into action. 
 He must meet the needs of the hour. Every 
 helpful idea serves to lessen the weakness of 
 his position and hasten, the time when he can 
 adequately fulfill the demands made upon 
 him. 
 
 S9 
 
Fundamentals of Cost and Profit Calculation 
 
 Business in times past has been conducted 
 in a wasteful manner by rule of thumb meth- 
 ods. American business men have presented 
 the most remarkable examples of rapid for- 
 tune building, but the methods have been 
 hazardous. While some have climbed the 
 ladders of riches quickly, thousands have 
 fallen by the wayside, until statistics show in 
 normal times a greater percentage of commer- 
 cial and industrial failures in this country 
 than in any other country in the world. 
 
 The American business man is a lover of 
 the game. He is apparently always ready to 
 take a chance. But the time has come when 
 he can no longer take chances. The require- 
 ments of the nation are such that he must have 
 at his finger tips, for immediate reference, 
 more complete and accurate records than he 
 ever dreamed that he would need. 
 
 He may, in the past, have been willing to 
 plunge, and for a time conduct his business 
 without profit. Today he needs profit that 
 he may not only survive but assist in the sup- 
 port of his Government in its fight for the lib- 
 erty without which his life and the lives of 
 those he loves would be blighted. 
 
 One of the greatest hindrances with which 
 he has to contend in his effort to meet the 
 
 60 
 
Determining Cost 
 
 emergency of the hour, is the deplorable fact 
 that the terminology of business is cluttered 
 with meaningless terms and phrases. Def- 
 inite information is difficult of conveyance be- 
 cause each individual places his own interpre- 
 tation upon the words that he hears or reads. 
 There is no established terminology. 
 
 Another hindrance is that methods of pro- 
 cedure are as chaotic and uncertain as the 
 words and phrases by which the effort of 
 transmitting information is rendered inef- 
 fective. 
 
 The business man is not the only one who 
 is embarrassed and baffled by the fact that 
 business has neither terminology, principles 
 nor practical outlines of procedure, to deter- 
 mine the cost or profit in any transaction of 
 business. 
 
 The Government officials upon whom has 
 been placed the task of collecting and analyz- 
 ing the essential information are in little, if 
 any, better position. 
 
 The crying need of the time is for definite 
 statements of the principles of cost and profit, 
 for practical methods of applying those prin- 
 ciples to business so that the problems may be 
 solved within the least possible time and in 
 such a nianner that there shall remain no op- 
 
 61 
 
Fundamentals of Cost and Profit Calculation 
 
 portunity for misunderstanding or contro- 
 versy. 
 
 Definiteness is the keynote of Cost Engi- 
 neering. 
 
 Every expense element is definite. It is 
 definite in amount or it could not be recorded. 
 It is definite in purpose or it would not be au- 
 thorized. Its purpose is always the procure- 
 ment of a definite service or commodity more 
 advantageous than the amount of money in- 
 volved, otherwise the exchange would not be 
 made. The advantage gained by the expen- 
 diture imparts a definite degree of benefit 
 wherever the purchased item is utilized. 
 
 Correct distribution of an expense item 
 demands that the charge shall always be made 
 against the product benefited, and if more 
 than one item or process be benefited the 
 charges must be in the ratio of benefit or ad- 
 vantage conferred. 
 
 In manufacture, product always consists 
 of definite materials, to which have been ?iip- 
 plitd definite amounts of the time of definite 
 formative processes. 
 
 Materials are measurable. 
 
 The expenses involved in the purchase, 
 transportation, storage, and handling of ma- 
 terials can be definitely determined. 
 
 62 
 
Determining Cost 
 
 With definite specifications for materials, 
 definite information as to expenses involved, 
 there should be no question about the possi- 
 bility of determining the cost of materials re- 
 quired for any given lot of product. 
 
 Processes are definite. 
 
 A capable engineer can in a short time 
 make a complete list of the processes which 
 any given factory is equipped to perform. 
 
 The expenses required for the operation 
 of processes are definite. 
 
 The purposes for which the expenditures 
 are made are definite. 
 
 None of the operating expenses have any 
 relation to, or are involved in, the ratio of 
 wages paid to workmen. 
 
 Practically every expense involved in the 
 operation of manufacturing processes has a 
 definite relation to the element of time. 
 
 Rent is paid on a time basis, or if the 
 building is owned the items of depreciation 
 and insurance on the building, and interest 
 and taxes on the investment in building and 
 land, are calculated on a time basis. 
 
 As between the processing divisions of a 
 factory the expenses of providing the housing 
 facilities are calculated by the use of the fac- 
 tors of area and time. 
 
 63 
 
Fundamentals of Cost and Profit Calculation 
 
 The expenses incident to the equipment 
 investment, e. g. depreciation, insurance, in- 
 terest and taxes, are all related to time. The 
 amount of investment and the element of time 
 are the important factors. 
 
 The expenses of the power plant, or for 
 purchased mechanical energy, are related to 
 time. Horsepower required for operating 
 the machines and the time of operation pro- 
 viding the means of determining the propor- 
 tions of power expense chargeable to process- 
 ing divisions. 
 
 The superintendent supervises the active 
 time of productive processes, while the fore- 
 men supervise the time of the individual em- 
 ployes whether classed as productive or non- 
 productive. 
 
 Water, soap, towels, and toilet facilities 
 are required for the convenience of every in- 
 dividual, during the time that he is in the fac- 
 tory or office. These items are related to per- 
 sonal time. 
 
 Supplies consumed in the operation of the 
 processes are required practically in propor- 
 tion to the active operating time. 
 
 Records of the activities of manufactur- 
 ing processes and individuals require the use 
 of supplies relatively in the proportions of 
 
 64 
 
Determining Cost 
 
 the active time of the processes. Activity, not 
 idleness, creates the necessity for the expenses 
 of such supplies and the services of time- 
 recording and cost-computing clerks. 
 
 The normal unit of time measurement is 
 the hour. 
 
 The logical unit of process measurement 
 is the process hour. 
 
 The cost of process hours w^ill vary with 
 the expense elements involved and the num- 
 ber of process hours over which the process 
 expenses must be averaged to get the average 
 cost of the process hour. 
 
 The cost of a process hour is a complete 
 cost. Every element involved in the process 
 having been included, there is nothing to add 
 or subtract. 
 
 The total of the expenses involved in a 
 given process during a given period of time, 
 divided by the chargeable (revenue produc- 
 ing) hours of that process actually charged 
 against the production orders during the same 
 period, determines the rate at which such 
 hours must be charged to determine the cost 
 of that process as applied to the order. 
 
 It follows that the total charges against all 
 production orders during a given period must 
 practically balance with the total of the ex- 
 
 65 
 
Fundamentals of Cost and Profit Calculation 
 
 penditures of the same period. (These totals 
 are almost invariably within one-quarter of 
 one per cent of an exact balance.) 
 
 Wages may or may not be included in the 
 process hour cost rate, at the choice of the en- 
 gineer. 
 
 Wages comprise simply one element in 
 cost. 
 
 Wages have no relation to the total of the 
 process hour cost. 
 
 Wages are always related to time. They 
 are computed on the basis of time worked or 
 pieces processed or assembled. Piecework 
 rates are set on a time basis. 
 
 Where no special reason exists for a sepa- 
 rate consideration of wages they should al- 
 ways be included as one of the elements of 
 the process hour cost. Inclusion within the 
 hour rate materially reduces the clerical ef- 
 fort required for the operation of the cost 
 system. 
 
 As a result of many years' study of the 
 problems of Cost Engineering the author has 
 formulated a schedule of fundamental prin- 
 ciples of the science of Cost Engineering 
 which he presents herewith. 
 
 These principles and the rules of appli- 
 cation covered in the various phases of the 
 
 66 
 
Determining Cost 
 
 subject, as discussed in this book, together 
 with the effort at establishing a definite term- 
 inology of Cost and Profit calculation, are of- 
 fered in all seriousness as a nucleus upon 
 which may be builded a recognized science of 
 Industrial and Commercial Procedure. 
 
 In presenting the following schedule of 
 fundamental principles of Cost Engineering 
 (Denham Methods) each formal statement 
 of principle is accompanied by a brief ex- 
 planatory statement which it is hoped will 
 make the principle more readily understood. 
 
 /. The cost of an item of product is the 
 sum of the expenses involved in its produc- 
 tion and distribution up to the moment at 
 which cost is determined. 
 
 (Cost is the price at which the item may 
 be sold without either loss or gain to the 
 seller.) 
 
 2. Every cost element (expense item) is 
 definite in amount and purpose, or object, and 
 anticipates a beneficial equivalent in service 
 or commodity. 
 
 (Expenses having a single beneficiary are 
 ^^direct" expenses; those having two or more 
 beneficiaries are "indirect," and require dis- 
 tribution.) 
 
 J. Indirect expenses may be grouped for 
 67 
 
Fundamentals of Cost and Profit Calculation 
 
 simultaneous distribution only when their 
 benefits are measurable by a common unit, and 
 their beneficiaries participate in identical 
 ratios. 
 
 (The inclusion of two or more unrelated 
 indirect expense items in a single account or 
 group, as "overhead," "burden," or "general 
 expense," obscures the purposes of the ex- 
 penditures and renders correct distribution 
 impossible.) 
 
 4. In the distribution of indirect ex- 
 penses, singly or grouped, the proportions of 
 benefit conferred indicate the proportions of 
 the expense, or expense group total, charge- 
 able to beneficiaries. 
 
 (Rules may be established for the distribu- 
 tion of certain common indirect expenses, as e. 
 g. Rent, on the basis of used floor area, but 
 exceptions to the rules may be found in every 
 factory. Whenever a rule and its principle 
 are in conflict the principle must govern.) 
 
 5. Operating units, or machines, may be 
 grouped and the cost per hour averaged only 
 when their principal expense factors are in 
 approximately uniform ratios, and the output 
 of such character that the work may be inter- 
 changed between the units, or machines, of 
 the group. 
 
 68 
 
Determining Cost 
 
 (Although two or more machines have 
 practically uniform proportions of the chief 
 expense elements, as rent, investment, power, 
 wages and supervision, if the character of the 
 output differs so that work is not interchange- 
 able, one may be operated continuously and 
 the other spasniodically. Under such condi- 
 tions injustice would result from averaging 
 cost of productive hours.) 
 
 6. Contingent expenses, such as repairs, 
 shrinkage, normal waste and loss on by-prod- 
 ucts, constitute legitimate charges against pro- 
 duction, 
 
 (The causes of such expenses and losses 
 serve to indicate the objectives of the indivi- 
 dual charges.) 
 
 The foregoing principles have been in 
 practical use for the past ten years by an or- 
 ganization of Cost Engineers, and have been 
 tested in hundreds of instances, so that the 
 reader need not feel that he is offered anything 
 experimental. 
 
 Cost Engineering is a practical science. 
 It is as simple and direct as mathematics. 
 However, it cannot be learned in a moment 
 as a formula may be. It requires conscientious 
 effort to study it until one can become profi- 
 cient in its application. 
 
 69 
 
Fundamentals of Cost and Profit Calculation 
 
 The author does not wish to convey the 
 impression that the reader of this book can 
 immediately install a Cost Engineering sys- 
 tem in his factory or store upon the informa- 
 tion contained herein. The subject is too deep 
 for that. 
 
 Treatises on various subjects broaden our 
 horizon, and give us a better grasp on the art 
 of living. Study of the principles of chemis- 
 try gives us a better understanding of chemi- 
 cal actions and reactions, but only the few 
 who specialize in the subject and take meas- 
 ures to get actual experience become chemists. 
 
 Not every man who studies Cost Engineer- 
 ing will become a Cost Engineer, but all who 
 will try to assimilate the principles and rules 
 of practice will be better business men because 
 of the information that the effort provides. 
 
 Few manufacturers realize the number or 
 variety of the expenses of their business. No 
 list that could be published would be either 
 complete or cover exactly the conditions of 
 any factory. 
 
 The following list of the more common 
 items of expense is offered simply as sugges- 
 tive of the various kinds of expenses and ex- 
 pense groups which must be considered in any 
 effort to determine cost of production, or the 
 cost of doing business. 
 
 70 
 
Determining Cost 
 
 Advertising 
 Advertising Postage 
 Automobile Expense 
 
 Bad Accounts 
 Belt Lacing 
 Belting 
 Bookkeeping 
 
 Clerical Help 
 Costkeeping 
 
 Deductions for Errors, etc. 
 
 Discounts to Customers 
 
 Donations 
 
 Drivers' Wages 
 
 Dues, Business Organizations 
 
 Electric Current for Lighting 
 Electric Current for Power 
 Errand Boys 
 Express Charges 
 
 Foreladies' Wages 
 Foremen's Wages 
 Freight 
 Fuel 
 
 Gas for Lights 
 Gas for Heating 
 
 Helpers' Wages 
 
 Insurance on Buildings 
 Inventory Clerk 
 
 71 
 
Fundamentals of Cost and Profit Calculation 
 
 Insurance on Equipment 
 Insurance on Finished Stock 
 Insurance on Raw Stock 
 Insurance on Work in Process 
 Insurance, Boiler 
 Insurance Liability 
 Interest on Accounts Receivable 
 Interest on Building Investment 
 Interest on Cash in Bank 
 Interest on Equipment Investment 
 Interest on Finished Stocks 
 Interest on Raw Stock 
 Interest on Real Estate Investment 
 Interest on Work in Process 
 
 Lubricating Oil 
 
 Manager's Salary 
 
 Officers' Traveling Expenses 
 Other Officers' Salaries 
 
 Porters' Wages 
 Postage — Commercial 
 
 Rent 
 
 Repairs to Building 
 
 Repairs to Equipment 
 
 Replacement Reserve for Building 
 
 Replacement Reserve for Equipment 
 
 Salesmen's Commissions 
 Salesmen's Salaries 
 
 72 
 
Determining Cost 
 
 Salesmen's Traveling Expenses 
 
 Shrinkage of Merchandise Stocks 
 
 Signs 
 
 Soap 
 
 Spoiled Work 
 
 Superintendent's Salary 
 
 Stenographers 
 
 Stockkeepers' Wages 
 
 Storage 
 
 Supplies for Commercial OfBce 
 
 Supplies for Factory Operations 
 
 Supplies for Factory Office 
 
 Supplies for Sales Office 
 
 Taxes, Corporation 
 
 Taxes, Income 
 
 Taxes, Personal Property 
 
 Taxes, Realty 
 
 Taxes on Profits 
 
 Telegrams 
 
 Telephones, City 
 
 Telephones, Interior 
 
 Telephones, Long Distance Messages 
 
 Towels 
 
 Waste, Cotton 
 
 Waste Paper Baling 
 
 Watchman 
 
 Watchman's Clock Supplies 
 
 Water Rent 
 
 Workmen's Wages 
 
 73 
 
Fundamentals of Cost and Profit Calculation 
 
 Modern Business is complicated, and to 
 be successfully conducted requires system. 
 System is the carefully planned and finished 
 highway upon which management may speed 
 to the goal of profitable endeavor. 
 
 Smart alecks are fond of making a jest of 
 system, but successful men know that they are 
 essential to economy of operation. A few are 
 unable to draw a distinction between system 
 and red tape. 
 
 System requires routine, but red tape is the 
 extreme in which the effort of systematizing 
 has shot over the mark and adopted or created 
 routine that is either without purpose or is 
 unprofitable. The author of the routine, 
 working from formula rather than guided by 
 fundamental principles, is unable to eliminate 
 nonessentials, and establishes useless opera- 
 tions, thereby defeating the purpose for which 
 he is striving. Men of narrow vision, assum- 
 ing that the application of these formulas rep- 
 resents system, condemn all efforts of estab- 
 lishing systems except those of their own de- 
 vising. 
 
 Practical systems must be built upon 
 74 
 
Determining Cost 
 
 sound fundamentals. Neither theories, for- 
 mulas, nor personal opinions will suffice. 
 
 It is not the purpose of this book to offer 
 any special form of system, but rather to pre- 
 sent the fundamentals of Cost and Profit cal- 
 culation in such a manner that the reader may 
 work out his own problems with a better un- 
 derstanding because of the information herein 
 offered. 
 
 In establishing any cost system it is essen- 
 tial that an effort must be made to simplify 
 the work as far as possible, keeping in mind 
 the factors of accuracy, comprehensiveness 
 and practicability. 
 
 It is a rule in Cost Engineering practice 
 to place accuracy in the first place among the 
 requisites of a system. However, there is a de- 
 gree of accuracy beyond which it is not prac- 
 tical to go. The limit is watched by keeping 
 in mind the further rule that ^When the cost 
 of the effort approximates the value of the re- 
 sult it is unprofitable to go further." In other 
 words, all effort. must yield a profit to be de- 
 sirable. 
 
 "Practical accuracy" is defined as a degree 
 of accuracy to go beyond which affects neither 
 
 75 
 
Fundamentals of Cost and Profit Calculation 
 
 the selling price of the product nor the profits. 
 Anything not affecting the profits is neutral 
 and may be done or omitted according to the 
 judgment of the Engineer as to the im- 
 portance of the result. 
 
 Simplicity is facilitated by grouping ex- 
 penses for distribution. 
 
 The simplest possible form of grouping is 
 that which conforms to the third principle in 
 the schedule. The indirect expenses in the 
 following list have been grouped as nearly as 
 possible according to that principle. How- 
 ever, in any factory the conditions may re- 
 quire changes from the plan presented here- 
 with. 
 \j 
 
 Building Expenses: 
 
 Rent, or. Replacement reserve and insur- 
 ance on building, and interest and taxes 
 on investment in building and realty. 
 Heat 
 
 Janitor Service 
 Building Repairs 
 
 Equipment Expenses: 
 
 Replacement Reserve 
 76 
 
Determining Cost 
 
 Interest on Investment 
 Insurance on Equipment 
 Taxes on Equipment 
 
 Power Expenses: 
 
 Total of Equipment Expense on power 
 equipment 
 
 Total of Building Expense chargeable to 
 power 
 Repairs 
 
 Wages, Supplies, etc., for power depart- 
 ment, including fuel 
 
 Current (if purchased from central sta- 
 tion) 
 
 Light and Toilet Expenses: 
 
 Current or Gas for Lighting 
 Lamps, Cords, Tips, Globes, etc. 
 Water for Lavatories, Soap, Towels, etc. 
 
 Factory Administration Expenses: 
 
 General Superintendent 
 
 Factory Clerks 
 
 Factory Office Expenses 
 
 Factory Phones, Telegraph and Postage 
 
 Factory Stationery and Office Supplies 
 
 Porters and Elevator Operators 
 
 77 
 
Fundamentals of Cost and Profit Calculation 
 
 Commercial Administration Expenses: 
 
 Executive Salaries 
 
 Office Salaries, except factory and sales 
 
 Telephones and Postage 
 
 Stationery and Office Supplies 
 
 Bad Accounts and Collection Expenses 
 
 Discounts and Deduction to Customers 
 
 Federal and Corporation Taxes 
 
 Interest on Work in Process 
 
 Interest on Accounts Receivable 
 
 Insurance on Work in Process 
 
 Craft Organization Dues and Traveling 
 
 Expenses 
 
 Selling Expenses: 
 
 Sales Manager 
 Sales Office Salaries 
 Salesmen's Salaries and Commissions 
 Sales Traveling Expense 
 Sales Phones and Telegraph 
 Stationery and Supplies 
 Advertising and Postage 
 Samples and Sample-making 
 Donations 
 
 Local Organization Dues, etc. 
 Finished Stockroom Expense (condi- 
 tional) 
 
 78 
 
Determining Cost 
 
 Packing and Local Delivery: 
 
 Rent, Packing and Shipping Dept 
 Equipment Expense, P. & S. Dept. 
 Supplies, P. & S. Dept. 
 Trucks, Stables, etc. 
 Wages 
 
 Stock or Merchandise Departments: (Raw 
 and Finished should be considered sepa- 
 rately) 
 Rent 
 
 Equipment Expense 
 Insurance on Mdse. Carried 
 Interest on Investment in Stocks 
 Taxes 
 Shrinkage 
 Light, etc. 
 
 Commercial (purchasing, etc.) 
 Transportation 
 Supplies 
 
 Selling Expenses 
 Wages 
 
 When attempting to distribute expenses 
 the reader should keep in mind the fact that 
 each division is chargeable only with such ex- 
 penses or proportion of expenses as have 
 actually been involved in the production of 
 the output of the division so charged. 
 
 79 
 
Fundamentals of Cost and Profit Calculation 
 
 The common bases of distribution follow: 
 
 Building Expenses — Area of used 
 space 
 
 Equipment Expenses — Replacement 
 value of equipment 
 
 Power Expenses — Horsepower hours 
 
 Light and Toilet Expenses — Personal 
 hours, or payroll hours 
 
 Factory Administration Expenses — 
 Chargeable hours 
 
 Commercial Administration Expenses 
 — Extended values at cost 
 
 Selling Expenses — Extended values at 
 cost, when sold 
 
 Packing and Local Delivery — ^To be 
 determined by circumstances 
 
 Raw Stock Expenses — Frequently ap- 
 plied on basis of cost of material but 
 requires special attention 
 
 Finished Stock Expenses — Applied by 
 percentage to stock carried for custom- 
 ers, or through selling expense, accord- 
 ing to conditions 
 
 Foremen's Wages — Payroll hours of 
 divisions supervised by each 
 
 80 
 
Determining Cost 
 
 Generally speaking, the use of the thing 
 purchased will indicate the proportions 
 chargeable to divisions. This is not always 
 just. 
 
 When all the expenses of the factory and 
 its business departments have been properly 
 analyzed, grouped and distributed in propor- 
 tion to the benefit conferred by each, the cost 
 per hour of each process is determined. This 
 is done by dividing the total of the divisional 
 expense by the number of chargeable or rev- 
 enue producing hours that have been charged 
 to the factory orders during the period cov- 
 ered by the expenses considered. 
 
 All product of factories consists of com- 
 binations of materials and the time of the nec- 
 essary formative processes. 
 
 Materials are to be charged to factory 
 orders at cost, which includes not only the 
 purchase price as shown on the invoices, but 
 all expenses of warehousing, protecting and 
 handling, not omitting interest on invest- 
 ment. 
 
 The cost of materials plus the cost of proc- 
 esses as determined by Cost Engineering con- 
 stitutes the cost of the order. All expenses 
 being included in the process hour rates, noth- 
 ing is to be added except net profit. 
 
 81 
 
Fundamentals of Cost and Profit Calculation 
 
 In factories where product is made for 
 stock, and sold later, the selling expense 
 should not be included in the process hour 
 rates, but should be applied to the order when 
 sold. In such instances the expenses of ware- 
 housing the finished product should be ap- 
 plied with the selling expenses. 
 
CHAPTER SIX 
 
 SELLING PRICES AND PROFITS 
 
 The object of all commercial and indus- 
 trial activity is profit. In fact it might be said 
 that the object of all human effort is profit. 
 The first statement refers to the reward of in- 
 dustry, money; while the second refers to 
 various types of reward, such as the comforts 
 of life, the good will and friendship of neigh- 
 bors, and self-respect as well as financial re- 
 ward. This chapter deals with the reward of 
 industry and commerce — profit, as expressed 
 in terms of money. 
 
 The legitimate reward of business is 
 profit. In fact, commercial activity that is un- 
 profitable is not business ; it is folly. The man 
 who is responsible for unprofitable conditions 
 of business is a menace to the community and 
 to the state. He places in jeopardy the capital 
 and income of the stockholder who has en- 
 trusted to him the profitable use of his money; 
 he destroys the basis of credit and adds to the 
 risk of the creditor whose confidence he 
 abuses ; he injures the business of his competi- 
 tor who is striving to conduct his business on 
 sound principles; he weakens the support of 
 
 83 
 
Fundamentals of Cost and Profit Calculation 
 
 the family that loves and depends upon him ; 
 he injures his Government by curtailing its 
 sources of revenue and nullifying its efforts 
 for welfare and prosperity of its people; but 
 most of all, he injures himself. 
 
 The fabric of humanity is so closely and 
 delicately interwoven that the failure of one 
 individual to recognize his responsibilities af- 
 fects adversely the welfare of hundreds and 
 often thousands of his fellows. 
 
 Business must yield profits or failures will 
 result. 
 
 All business is buying and selling. 
 
 The merchant buys goods and resells them 
 in the same form, but because he adds an ele- 
 ment of service he is entitled to a profit. 
 
 The manufacturer buys materials in one 
 form, changes them to another which his cus- 
 tomers desire, adding also the element of serv- 
 ice, and is entitled to profit. 
 
 Neither would put forth the effort to serve 
 his fellows were it not for his anticipation of 
 the reward, or profit. 
 
 Profit is the amount by which the selling 
 price of a sold item exceeds its cost. 
 
 This definition of profit covers several im- 
 portant points : (a) the determination of cost, 
 
 84 
 
Selling Prices and Profits 
 
 SO that there may be certainty that the selling 
 price is higher; (b) determination of a selling 
 price that will at once yield a profit and not be 
 so high that prospective customers will refuse 
 to buy; (c) the fact that the item must be sold 
 before there can be a profit. 
 
 It is an unfortunate fact that nine-tenths 
 of the men engaged in business do not know 
 how to determine correctly either the cost or 
 the selling price of the goods they sell. The 
 reader may doubt this but his skepticism will 
 not change the facts. He may be one of those 
 who are using wrong methods without know- 
 ing it. 
 
 The author has stated elsewhere that 
 neither the public schools nor the commercial 
 schools, generally, teach these subjects cor- 
 rectly. Fortunately, there are a few excep- 
 tions. If this book shall have the effect of 
 waking up a few more it will have accom- 
 plished enough to warrant its authorship and 
 publication. 
 
 The best dictionaries offer definitions of 
 cost and profit which are in accord with tra- 
 ditional methods but not practical for modern 
 business. 
 
 In thus antagonizing the so-called authori- 
 ties of schools and reference books the author 
 
 85 
 
Fundamentals of Cost and Profit Calculation 
 
 does not wish to be understood as setting him- 
 self up as a higher authority. He presents his 
 claims to the confidence of his readers solely 
 upon the basis of their practicability for use 
 with modern business methods. 
 
 These are not matters in which a common 
 agreement can govern. 
 
 The school teachers, college professors and 
 compilers of dictionaries may be eminently 
 capable from the standpoint of classical edu- 
 cation, but the author and the business men of 
 the day are dealing in the facts of trade as they 
 are, and as they are unknown to the eminent 
 authorities who prepare textbooks and dic- 
 tionaries. 
 
 When the compiler of the dictionary pre- 
 sents the definition of cost as "the price paid 
 for an item" it is evident that he has in mind 
 as the price the consumer pays for the article, 
 the price he paid for his last suit of clothes or 
 for a book. 
 
 When the educator refers to the diction- 
 ary and finds the definition just quoted, his 
 mind instantly accepts the statement as true 
 because his own experience is identical with 
 that of the lexicographer who wrote the defi- 
 nition. 
 
 86 
 
Selling Prices and Profits 
 
 However, when the merchant or the 
 manufacturer has occasion to use the term 
 "cost" it means something entirely different. 
 It means, not the purchase price alone, but the 
 purchase price plus all of the expenses in- 
 volved in manufacture and distribution up to 
 the moment at which the cost is determined. 
 
 Much has been said in previous chapters 
 about determining the cost of production in a 
 practical manner, and the weakness of the old 
 methods or traditions of cost accounting. 
 This chapter is intended to cover those ele- 
 ments of business having to do with the dis- 
 tribution of the product after it is made and 
 the cost of manufacture determined — ^with 
 "Selling Prices and Profits." 
 
 Merchandising, like manufacturing, is a 
 simple proposition if but one class of mer- 
 chandise is handled, but in the department 
 store where each class of goods is separated 
 from other classes by the limitations of de- 
 partments there is large opportunity for the 
 profitable application of Cost Engineering. 
 
 Sales are the source of revenue of business. 
 In merchandising, as in manufacturing. Cost 
 of Selling must necessarily be a charge against 
 sales. No expense can be charged against in- 
 
 87 
 
Fundamentals of Cost and Profit Calculation 
 
 active stocks of goods. Every expense must 
 be provided for from revenue. Goods that do 
 not move are a liability. 
 
 In the simple store, selling a single class 
 of goods, the cost of selling absorbs a part of 
 the margin, the remainder of which consti- 
 tutes profit. 
 
 Margin is the difference between the pur- 
 chase price and the selling price and consists 
 of the cost of selling and the profit. Margin 
 is sometimes erroneously miscalled ^^gross 
 profit," but since the nature of profit is such 
 that it is always net, the latter term is mis- 
 leading. 
 
 Under the textbook theory a margin, or 
 "gross profit," can be added to the purchase 
 price of the item to determine the price at 
 which it must be sold to yield a profit of the 
 desired percentage. 
 
 The same textbooks that teach that profit 
 is a percentage in addition to cost (the as- 
 sumption being that purchase price repre- 
 sents the base or cost) , teach that commission 
 paid for making the sale (a part of the selling 
 expense) is to be considered as a percentage of 
 the selling price. 
 
 88 
 
Selling Prices and Profits 
 
 These teachings are inconsistent and im- 
 practical, not only from the standpoint of 
 modern methods, but there never was a time 
 when they were practical. The effect of mod- 
 ern conditions has not increased their imprac- 
 ticability, but it has greatly increased the dan- 
 ger to the welfare of business men of continu- 
 ing their use. 
 
 The accountants long ago should have in- 
 sisted upon their correction. The only reason 
 apparent for their not doing so is the fact that 
 the nature of accounting, being purely rou- 
 tine, does not develop the reasoning faculties 
 and deadens the creative faculties. The ac- 
 countant must have no imagination. His busi- 
 ness is to record history. 
 
 Standard practices of accounting have the 
 same relation to the transactions of business 
 that the crafts of undertaking and monument 
 erecting have to the human race — they bury 
 them and preserve their memory by records. 
 
 Accounting might be quickened into a 
 thing which would serve to create profits if 
 the devotees were not so bound to traditional 
 ^^standard practices" and used their mentali- 
 ties instead of leaning upon the so-called au- 
 thorities. 
 
 89 
 
Fundamentals of Cost and Profit Calculation 
 
 Modern business is done on narrow mar- 
 gins. The facts of Cost and Profit must be 
 known. Traditional theories at variance with 
 the facts are dangerous and will not serve. 
 
 The modern store, of the better class, is a 
 complicated affair. It involves the sale of 
 many kinds of merchandise, each having a 
 different rate or percentage of turnover. 
 Each requires a different amount of space, 
 special equipment, and, in many lines, spe- 
 cially trained and experienced salesmen. 
 
 Payment for the service of salesmen may 
 be made either by salary or commission, some- 
 times both. In some instances the employer 
 pays the expenses of the salesman. In other 
 instances the salesman must pay his expenses 
 out of his earnings. The departmental clerk 
 within the store may have no item correspond- 
 ing to the traveling expense of the outside 
 salesman, but he may receive, as part of his 
 compensation, a bonus calculated upon any 
 one of numerous bases recently devised and 
 inaugurated. 
 
 In addition to the compensation of indi- 
 viduals the expenses of rental, fixtures, sup- 
 plies and administration correspond very 
 nearly to those of the manufacturer. 
 
 90 
 
Selling Prices and Profits 
 
 With margins narrowed by either the 
 keenness of intelligent competition, or the 
 blunders of ignorant competitors, the im- 
 portance of extra cost knowledge enlarges to 
 serious proportions. 
 
 The future of trade and commerce de- 
 mands that efforts be made at the earliest mo- 
 ment to get into practice a code of procedure 
 and a terminology easily comprehended and 
 practical in use. 
 
 As little change from present usages as is 
 necessary in such a movement to attain the re- 
 sult is desirable. This may be accomplished 
 if interest can be aroused to the extent neces- 
 sary to accelerate action. It may take a 
 decade to attain the result but the longer the 
 start is postponed the farther into the future 
 is pushed the time of attainment. How shall 
 it be done? 
 
 Contrary to traditional formula and prac- 
 tice. Cost Engineering proves that the opera- 
 tion of the department store and the composite 
 factory are identical in principle. 
 
 The costs of each department or division 
 are determined by very similar processes. 
 When the cost is known it remains to de- 
 termine the selling prices and the amount of 
 profit desired or obtained. 
 
 91 
 
Fundamentals of Cost and Profit Calculation 
 
 First — All percentages used in connection 
 with the handling and sale of product and 
 merchandise should relate to the same base. 
 The only logical base developed by analysis 
 of the facts is the selling price in the individ- 
 ual sale, and the total of sales, in the period- 
 ical calculation. 
 
 Selling price, the base, is always repre- 
 sented by loo per cent. 
 
 The following items must be recognized 
 as related to selling price, or sales, as the base: 
 
 Expenses of selling of every nature must 
 be calculated as percentages of the base — 
 selling price, not purchase price. 
 
 Profit must always be calculated as a per- 
 centage of the base — selling price, not pur- 
 chase price. 
 
 The more intelligent and advanced busi- 
 ness men are doing this at present, but their 
 number is less than ten per cent of the whole. 
 
 Many concerns have adopted a fixed per- 
 centage which they add to the purchase price 
 of goods to be sold, as a means of determining 
 the price at which they are to be sold, re- 
 gardless of classification of the items or the 
 amount of the turnover developed. They take 
 a chance on profits and do not know what rate 
 
 92 
 
Selling Prices and Profits 
 
 of profit is made on the whole of the turnover 
 until the end of the period or year. They 
 never know the rate of profit actually made 
 on the individual item or classification. 
 
 Notwithstanding that calculations for the 
 purpose of making selling prices of individual 
 items are usually made with the purchase 
 price as the base, the profits of a definite 
 period are almost universally based upon the 
 volume of sales. For example: A concern 
 having sales amounting to $100,000 for the 
 year, finding that they had developed net 
 profits amounting to $10,000, would unhesi- 
 tatingly aver that they had made a profit of 
 ten per cent. 
 
 As an example of the confusion of bases 
 on the part of business men the author will 
 cite an actual incident that came under his 
 personal observation: 
 
 While discussing this subject with a de- 
 partment manager in a store consisting of sev- 
 eral departments the statement was made that 
 it cost twenty-eight cents of expense on every 
 dollar of goods sold during the previous year. 
 
 The manager was asked how he deter- 
 mined the selling price on an article. He re- 
 plied that he took the purchase price and 
 added twenty-eight per cent to it to get the 
 
 93 
 
Fundamentals of Cost and Profit Calculation 
 
 cost, and then added an additional percentage 
 to the total for profit. 
 
 He was then requested to determine at 
 what price he would sell an article, the invoice 
 price of which was $6.20, if the desired profit 
 was ten per cent. His calculation showed the 
 following : 
 
 Purchase price of item $ 6.20 
 
 Expense of doing business 28% 
 
 of $6.20 1.74 
 
 Total cost, including ex- 
 penses 7.94 
 
 Add 10% of total for profit 80 
 
 Selling price $ 8.74 
 
 The author knew, and called attention to 
 the fact, that the store was being operated un- 
 der a receivership, prima facie evidence that 
 there was something wrong with its busi- 
 ness methods. 
 
 He then briefly demonstrated to the man- 
 ager the correct method of determining the 
 cost and selling price that will yield a certain 
 profit on the sale, as follows: 
 
 94 
 
Selling Prices and Profits 
 
 Selling price represented by ioo% 
 
 Expense of doing business 28% 
 Profit percentage desired 10%, 
 Total of percentage other than 
 purchase price 38% 
 
 Percentage representing pur- 
 chase price 62% 
 
 The invoice price of the item was $6.20. 
 This amount divided by 62 gives one per cent 
 of the selling price, or $10, which multiplied 
 by 100 produces 100 per cent, or the selling 
 price, in this instance $10.00. In practice the 
 selling price is found by moving the decimal 
 point two spaces to the right, thus changing 
 $.10 to $10. 
 
 28 per cent of $10.00 allows $2.80 for ex- 
 penses. 
 
 The profit being 10 per cent is $1.00. 
 The cost of sale is $9.00. 
 
 According to the old plan the price was 
 incorrectly determined and the article sold for 
 less than cost. This in itself accounts for the 
 receivership. 
 
 Round figures were used for purposes of 
 illustration. Had the invoice or purchase 
 price been $7.53, that amount divided by 62 
 
 95 
 
Fundamentals of Cost and Profit Calculation 
 
 would have yielded $.1215, or a selling price 
 of $12.15. The result in any case may be 
 proven by calculating the given percentages 
 of the total. 
 
 With the principles of Cost Engineering 
 applied to determine the amount of expenses 
 chargeable to each class of sales, it w^ill be 
 found that when the expenses of the depart- 
 ment are considered in relation to the amount 
 of turnover of that class of sales, a different 
 percentage of cost will be found for each. 
 
 The rate of profit should differ on differ- 
 ent classes of goods. It is ridiculous to assume 
 that one rate of expense and profit will be 
 practical for a great variety of lines of goods. 
 
 In any case, the percentage of expense and 
 the percentage of profit added together and 
 deducted from 100 will show the precentage 
 of the selling price represented by the pur- 
 chase price. The purchase price divided 
 by the number per cent which represents it 
 will yield one per cent of the selling price. 
 This multiplied by icmd determines the selling 
 price. 
 
 When the departmental or "line" percent- 
 age has been established for a period, all that 
 is necessary in determining the selling price of 
 
 96 
 
Selling Prices and Profits 
 
 any item is to divide its purchase price by the 
 percentage and set the decimal two points to 
 the right. 
 
 There have been published from time to 
 time schedules of percentages which could be 
 added to cost to produce certain percentages 
 of profit on the sales. For example: 
 
 To make a profit of 25 per cent add 33-1/3 
 per cent to cost. 
 
 To make a profit of 20 per cent add 25 per 
 cent to cost. 
 
 To make a profit of 16-2/3 P^^ ^^^t add 
 20 per cent to cost. 
 
 Although the basic principle of this type 
 of schedule is correct because the percentage 
 of profit is related to the selling price, it makes 
 no provision for the expense of doing busi- 
 ness, is necessarily limited to the percentages 
 included, and uses the cost, frequently an un- 
 known quantity, as a basis. 
 
 The following incident will serve to show 
 the result of using diflferent bases for percent- 
 ages and the confusion likely to occur where 
 correct methods are not understood. 
 
 One of the principals in this business spent 
 several years serving as bookkeeper for an- 
 other concern which had "failed for lack of 
 capital." 
 
 97 
 
Fundamentals of Cost and Profit Calculation 
 
 The author was told that the business was 
 one of the most profitable in the industry 
 which it represented. In fact they boasted a 
 25 per cent profit, which was extremely un- 
 usual for that class of manufacture. To prove 
 that this was true they stated that they had 
 paid a 25 per cent dividend a month previous 
 to the date of the interview. 
 
 In discussion the author was given the fol- 
 lowing data in connection with the business : 
 
 Capital Stock $100,000 
 
 Sales 360,000 
 
 Material used 99j590 
 
 Profits 27,280 
 
 Their plan of making prices was as fol- 
 lows: 
 
 Compute the cost of material used and add 
 33-1/3 per cent. 
 
 Compute the cost of manufacturing pro- 
 cesses and add 33-1/3 per cent. 
 
 The total of these two items was the 
 selling price, and should yield a profit of 
 25 per cent on the sale. 
 
 The fact that they were able to pay a 25 
 per cent dividend satisfied them that they had 
 succeeded in making 25 per cent profit for the 
 year. It had not been noticed that while they 
 
 98 
 
Selling Prices and Profits 
 
 calculated 25 per cent on sales they had suc- 
 ceeded in making only 25 per cent on the cap- 
 italization. They confused the percentage of 
 dividends on capital with the profits on sales. 
 
 When asked if they had included depre- 
 ciation in their calculations they stated that 
 they had charged off their customary 5 per 
 cent. Interest on investment had not en- 
 tered into their calculations of cost or income. 
 They admitted the justice of an 8 per cent re- 
 serve for replacement, to offset the deprecia- 
 tion on plant. Taking an additional 3 per cent 
 for depreciation, and allowing 6 per cent of 
 total investment as interest expense, their prof- 
 its dwindled to $18,940, or slightly over 5 per 
 cent of the sales. 
 
 It was easily shown that the addition of 
 one-third to the cost of the $99,590 of mate- 
 rials used should have yielded $33,177 net 
 profit on materials alone. The actual net 
 profit being $18,940, it was evident that the 
 factory had been operated at a loss absorbing 
 $14,237 of the profit which should have ac- 
 crued on the materials. 
 
 In closing this chapter it is advisable to 
 present a resume of the more salient points 
 of the relationship of the various financial 
 items encountered in connection with the cal- 
 culation of Costs, Selling Prices and Profits. 
 
 99 
 
Fundamentals of Cost and Profit Calculation 
 
 (a) Manufacturing Expenses: On ac- 
 count of the extreme variation in the amounts 
 of various items required by the different pro- 
 cesses, no distribution by percentage is possi- 
 ble. Each item must be charged proportion- 
 ately to its use, or its benefit to the individual 
 process, as expressed in units by which the 
 item itself, or its use, is measured. 
 
 (b) Merchandising Expenses: Advertis- 
 ing, selling commissions, rent of storerooms, 
 and all other expenses in connection with the 
 sale of the manufactured goods, or materials, 
 or articles bought for resale, may be charged 
 by percentage of selling price, it being under- 
 stood that where the proportions of such ex- 
 penses differ to any considerable degree on 
 different classes of merchandise, each class 
 shall be charged with such rate as will cause 
 the sales of that class to carry their just pro- 
 portion of the expenses involved. 
 
 (c) Interest and earnings always to be 
 considered at a rate per cent per annum of 
 the amount invested. 
 
 (d) Dividends are to be considered at a 
 rate per cent of capital stock entitled to parti- 
 cipate. 
 
 (e) Profits are always to be considered at 
 a rate per cent of the amount of sales. 
 
 100 
 
CHAPTER SEVEN 
 
 MAKING COST AND PROFIT 
 STATEMENTS 
 
 The Cost and Profit Statement is the pulse 
 of the business, the index of its vitality. 
 
 The executives of the healthy business have 
 no difficulty in the preparation, and no em- 
 barrassment to anticipate in the presentation, 
 of such statements. 
 
 The business that is weak at the heart is 
 the one in which the making of Cost and Profit 
 Statements gives cause for uneasiness and fear. 
 
 Statements are required for three pur- 
 poses: (a) that the management may be kept 
 in touch with the vital factors of the business; 
 (b) as a basis of credit; and (c) for purposes 
 of taxation. 
 
 Unfortunately, there are people who fail 
 to realize that nothing is ultimately profitable 
 except the truth. They are sorely puzzled in 
 their efforts to make one statement serve all 
 purposes with results to their liking. 
 
 If the profits do not show up well, the 
 statement reflects upon the ability of the man- 
 agement. If they show up in the statement 
 
 101 
 
Funjajnmta h of Cost and Profit Calculation 
 
 better than the facts warrant, it means that the 
 concern will be likely to both deplete its work- 
 ing capital by declaring excessive dividends 
 and pay taxes to the Government of fictitious 
 earnings. If camouflage is used with the 
 banker he may, and likely will, see through 
 it to the detriment of credits. 
 
 The honest manager will not try to fool 
 either himself or his directors, because if the 
 profits are not what they should be their best 
 interests are served by knowing it so that the 
 conditions may be corrected. 
 
 The Government wishes to be fair, and 
 will demand only its share, but will punish 
 efforts to evade just taxation wherever it finds 
 them. 
 
 The banker is inclined to be more generous 
 with the man who presents an honest state- 
 ment showing small assets than with him 
 whose statement, although showing large as- 
 sets, bears the earmarks of "doctoring." 
 
 In the long run statements at different 
 times can be and frequently are compared. 
 Dishonesty cannot long be consistent. 
 
 It is a misfortune that there are managers, 
 boards of directors, and even accountants who 
 will stoop to dishonesty in making statements. 
 
 102 
 
Making Cost and Profit Statements 
 
 Corporations have been known to pay div- 
 idends regularly up to the period wherein a 
 receiver took charge of their affairs to secure 
 the interests of the creditors. 
 
 Such conditions indicate that there is 
 something fundamentally wrong with meth- 
 ods of preparing statements. It should not be 
 possible for men to present information in 
 forms seemingly truthful, while as a matter of 
 fact they are widely at variance with the truth. 
 
 The author would be unfair if he created 
 the impression that all erroneous statements 
 were dishonest. 
 
 Many of them are made by men who sin- 
 cerely wish to present the truth about their 
 business, but they do not know how. They 
 either have been taught or have simply ab- 
 sorbed traditional methods. 
 
 Many statements made up by public ac- 
 countants are seriously erroneous, because the 
 accountant either does not know the facts, does 
 not know how to get the facts, or does not 
 know how to present the facts. 
 
 Another thing responsible for erroneous 
 statements where honest effort has been made 
 to present correct information is the uncertain 
 terminology of business. 
 
 103 
 
Fundamentals of Cost and Profit Calculation 
 
 How shall a man, be he accountant, busi- 
 ness man, or law maker, present information 
 correctly when he must do so in words that 
 are commonly used without knowledge of 
 their true meaning? 
 
 Take the word "capital" for example. The 
 average business man uses it in at least two 
 senses. Unless he qualifies it the hearer can- 
 not tell whether he uses it in the sense of cap- 
 ital stock, a liability, or capital investment, an 
 asset. 
 
 How many of the readers of this book can 
 correctly define "earnings," "income" and 
 "profits?" These words are commonly used 
 interchangeably, yet each has a distinct mean- 
 ing and should never be used in the same sense. 
 
 The author has yet to find a man who can 
 tell positively whether the new war tax on 
 "profits" is actually levied against "earnings," 
 "income" or "profits." It is evident that the 
 men who framed the law did not understand 
 the terminology of business. 
 
 At the present moment there is reason to be 
 generous in our criticisms. When the ac- 
 counting profession has no definite terminol- 
 ogy whereby the various factors of business 
 can be designated, how shall we blame either 
 the business man or the law maker? Our 
 
 104 
 
Making Cost and Profit Statements 
 
 generosity, however, should not extend beyond 
 the immediate present. There will be little 
 excuse for ignorance a year hence. 
 
 The mutual interests of both the Govern- 
 ment and business will be served by a better 
 understanding of commercial and industrial 
 terminology, and a more careful usage of the 
 terms. 
 
 Whether or not the terminology suggested 
 in the last chapter of this book is adopted is of 
 no moment, if a better suggestion can be of- 
 fered and accepted. A personal element should 
 not be permitted to appear in the matter. 
 
 The welfare of the country is being hamp- 
 ered today by innumerable discussions, misun- 
 derstandings, and differences of opinion as to 
 the interpretations of certain laws and rulings. 
 The need for better terminology is also appar- 
 ent in the confusion found in conventions and 
 other meetings of business men, because they 
 do not speak the same language of business. 
 
 The need of better terminology and defi- 
 nite fundamentals was recognized by, and evi- 
 dent in, the earnest effort of Mr. Edward N. 
 Hurley, while chairman of the Federal Trade 
 Commission, to persuade Associations of 
 Manufacturers to adopt uniform systems of 
 Cost Calculation. His efforts were intended 
 
 105 
 
Fundamentals of Cost and Profit Calculation 
 
 to promote an understandable language of 
 business, but his use of the word "system" was 
 interpreted by many as referring to some 
 specific form of records. This misunder- 
 standing nullified much of his effort. What 
 Mr. Hurley desired was not uniformity of 
 mechanism but uniformity in principles of 
 calculation and presentation, so that the busi- 
 ness men of the country and the Government 
 could all understand each other and present 
 confusion be eliminated. 
 
 The fundamentals required for making 
 Cost and Profit Statements are: 
 
 1. Definite knowledge of what is cost, and 
 
 how it is determined. 
 
 2. Definite knowledge of receipts. 
 
 3. Definite knowledge of what constitutes 
 
 income. 
 
 4. Definite knowledge of what constitutes 
 
 earnings. 
 
 5. Definite knowledge of what is profit, 
 and how it is determined. 
 
 6. Definite knowledge of what constitutes 
 
 assets. 
 
 7. Definite knowledge of what are liquid 
 
 assets. 
 
 8. Definite knowledge of liabilities. 
 
 106 
 
Making Cost and Profit Statements 
 
 9. Appreciation of the necessity for re- 
 serves to take care of replacements, 
 shrinkage, etc., as a means of protecting 
 ' the invested capital. 
 
 Any man not fully informed on these sub- 
 jects, or that does not know how to obtain the 
 information, is not competent to make up a 
 Cost and Profit Statement. 
 
 The fact that practically all the present in- 
 formation is based upon the use of traditional 
 theories, impractical for application to mod- 
 ern conditions, renders the problem of making 
 Cost and Profit Statements very difficult. 
 
 Competent Cost Engineers, having many 
 years' experience in the installation of Cost 
 Engineering Systems, are unanimous in their 
 statement that of the hundreds of factory or- 
 ganizations they have served, not one had, in 
 their accounting systems, provided for all 
 items of expense. 
 
 That being the case, it is safe to assume 
 that because of the traditions of accounting 
 practice, and not through any intent to mis- 
 represent facts, practically every financial 
 statement is more or less incorrect. 
 
 But a small percentage of factories have 
 cost systems designed upon modern analytical 
 
 107 
 
Fundamentals of Cost and Profit Calculation 
 
 or Cost Engineering principles. The remain- 
 der either have no cost system, or use what 
 purports to be a cost system, based upon the 
 impractical formulas discussed in the earlier 
 chapters of this book. Such systems fre- 
 quently vary from accuracy as much as twenty 
 and sometimes thirty per cent. 
 
 How shall a man be able to develop a 
 practical or true statement of earnings or 
 profits if he does not know how to correctly 
 determine the cost of production or the cost of 
 doing business? 
 
 How shall he render true statements if he 
 does not know how to distinguish between re- 
 ceipts and income? Or if he confuses the 
 terms "income," "earnings," and "profits?" 
 
 Nine-tenths of the men in business do not 
 know how to determine a selling price that 
 will yield a certain percentage of profit after 
 providing for the cost of doing business. How 
 then shall they be able to make correct state- 
 ments covering thousands of transactions with 
 varying proportions of cost and profit? 
 
 Bankers are familiar with the fact that a 
 large percentage of business men are ignorant 
 as to what constitutes the assets and liabilities 
 of a business. Nor can they readily distin- 
 guish the characteristics, important to the 
 
 108 
 
Making Cost and Profit Statements 
 
 banker, which cause some assets to be classed 
 as "liquid." 
 
 To a large majority of manufacturers the 
 idea that reserves should be set up in cash 
 seems unimportant. They have been accus- 
 tomed to handling depreciation, if at all, 
 through the profit and loss account. In a few 
 instances a reserve account is carried, but the 
 actual money it represents is used in the busi- 
 ness as working capital. 
 
 Rarely is it possible for concerns using 
 their reserves to avail themselves of the cash to 
 purchase new equipment to replace the old. 
 
 Where cash reserves are actually carried 
 there is a feeling of confidence engendered 
 similar to that of the man who realizes that he 
 has a good bank account, as contrasted to the 
 example of the man who is continually work- 
 ing on his last dollar. He is free to make 
 plans for betterments knowing that he will not 
 have to worry about the financial side of the 
 problem. His desire to hold that feeling of 
 independence keeps him at the same time 
 from foolishly overequipping his plant. 
 
 Doing business on a sound basis gives a 
 man confidence in himself, gives him a clear 
 head for progressive plans, makes it unneces- 
 sary for him to resort to misrepresentations 
 
 109 
 
Fundamentals of Cost and Profit Calculation 
 
 and subterfuges in his Cost and Profit Re- 
 ports. 
 
 The live business man of the hour will 
 study modern methods, discard traditions, do 
 business on a basis of known cost and profit, 
 study the elements of business so that he can 
 have intelligible records for his own use in 
 directing his own affairs, to furnish the banker 
 with the requisite information to sustain his 
 credit, and to give the Government a frank 
 but correct statement of his earnings. 
 
 He will attain such a degree of prosperity 
 that he will gladly pay his share of the burden 
 of tax and still have enough for his own re- 
 quirements. 
 
 Ignorance spells weakness. Knowledge 
 is power. 
 
 110 
 
CHAPTER EIGHT 
 
 THE TERMINOLOGY OF COST 
 ENGINEERING 
 
 The reader has found in the preceding 
 chapters a number of references to the deplor- 
 able fact that Commerce and Industry have 
 no definite and recognized terminology. 
 
 Several words are frequently used in the 
 same sense, while again the same word is used 
 in several senses. The result is a confusion of 
 terms not only preventing practical transfer 
 of .information between individuals who 
 should understand each other but unquestion- 
 ably causing a serious loss of money. 
 
 The term "Profit," for example, is fre- 
 quently confused with earnings, income, mar- 
 gin, and dividends, yet each of these words has 
 a different meaning. 
 
 An effort has been made in preparing this 
 suggested terminology to apply to each word 
 the definition that seems best adapted to con- 
 vey the information desired. Practicability 
 has been given preference over the common 
 definitions of the dictionaries. For example 
 the word "profit" is defined by the Century 
 Dictionary as the difference between the first 
 
 111 
 
Fundamentals of Cost and Profit Calculation 
 
 cost or purchase price and the price for which 
 the article is resold. No account is taken of 
 the expenses of selling, therefore such a defini- 
 tion, while meeting the popular conception of 
 profit, is not practical for use in the light of 
 modern analysis. 
 
 At the moment of writing, the business 
 men of the United States are laboring with a 
 serious condition due to confusion of terms. 
 Taxes on incomes and profits make it im- 
 portant that the persons affected by the taxa- 
 tion understand fully just what the laws mean. 
 
 The amount of discussion and the differ- 
 ences of opinion expressed, makes it very evi- 
 dent that grave misunderstandings exist, and 
 demonstrates the imperative need of a definite 
 terminology. 
 
 The words and phrases are not arranged 
 alphabetically in the appended list but so that 
 the definitions of those generally confused 
 with each other may be the more readily com- 
 pared. The list is not offered as a complete 
 terminology but contains the words most com- 
 monly misused. The author anticipates a 
 more exhaustive treatment of this subject at 
 some future time. 
 
 Receipts — The total of money or negoti- 
 able items representing money received dur- 
 
 112 
 
The Terminology of Cost Engineering 
 
 ing a period, without regard to either ex- 
 penses, earnings or profit. 
 
 Income — The remaining: receipts after de- 
 ducting the cost of sales and all other expenses 
 and reserves required by the business. It may 
 be in the form of profits, interest on invest- 
 ments, royalties, rentals, investments made 
 within the period, etc. In the case of an in- 
 dividual it may also include salary, commis- 
 sions, dividends, etc. Income should not in- 
 clude estimated increase in value of property 
 or increase in the market value of goods held 
 in stock. It relates only to receipts and may 
 include items received which were the earn- 
 ings or profits of previous periods. 
 
 Earnings — ^Total increase of assets due to 
 the activities and investments of the business 
 or individual whether received or not. Earn- 
 ings become a part of income only when the 
 money or its negotiable equivalent is actually 
 received. Earnings are related to investment. 
 
 Profit of Time Period — The amount by 
 which the total sales of the period exceed the 
 total cost (not purchase price) of the items 
 sold. Profit is always net, the percentage be- 
 ing correctly expressed only when it relates 
 to the total sales of the period as the base, or 
 one hundred per cent. 
 
 113 
 
Fundamentals of Cost and Profit Calculation 
 
 Profit on Transactions — The amount by 
 which the selling price of a sold item exceeds 
 its cost. Percentage of profits is correctly ex- 
 pressed only when it relates to the selling price 
 as the base, or one hundred per cent. Profit 
 differs from margin in that it is all net gain. 
 
 Margin — The percentage by which the 
 selling price exceeds the purchase price with- 
 out relation to either the cost of doing busi- 
 ness or the percentage of profit in the item. 
 It is expressed properly when the purchase 
 price is used as the base or one hundred per 
 cent. Never should it be added to the pur- 
 chase price as a means of determining the sell- 
 ing price. Erroneously called ^^gross profit." 
 
 .Gross Profit — A term used where neither 
 the cost nor the percentage of profit is known, 
 to designate the margin between purchase 
 price and selling price of merchandise. It is 
 frequently employed by persons ignorant of 
 correct methods, as a means of determining a 
 selling price. Such usage is frequently pro- 
 ductive of losses where profits were intended. 
 
 Selling Price — ^The price which a cus- 
 tomer is expected to pay or does pay for an 
 item sold. In all calculations of profit per- 
 centages the selling price represents the base 
 or one hundred per cent. 
 
 114 
 
The Terminology of Ct)st Engineering 
 
 Turnover — The total of the sales of a des- 
 ignated period, usually a year. Used princi- 
 pally for the purpose of expressing the rela- 
 tion of the total sales of a period to the invest- 
 ment used in the business. When the sales of 
 the period are equal to the investment, the 
 turnover is said to be loo per cent. If they 
 are five times the investment, the turnover is 
 500 per cent, etc. 
 
 Investment — The amount of money em- 
 ployed in a business without relation either to 
 the assets or the ownership of the money. It 
 includes investment in realty and buildings 
 used, in equipment, merchandise stocks, work 
 in process, if a factory; accounts receivable, 
 reserves, and cash in bank for normal require- 
 ments of the business. 
 
 Interest on Investment — The wages of the 
 money employed in the business. It is a part 
 of income but not profit. Being included in 
 cost of production, and a part of the selling 
 price of product, it must be deducted from re- 
 ceipts before profit can be ascertained. As a 
 part of income it must be included in income 
 statements. 
 
 Capital Stock — The amount of the issued 
 certificates of stock of a corporation calculated 
 
 115 
 
Fundamentals of Cost and Profit Calculation 
 
 at par. Capital stock has no relation to invest- 
 ment. 
 
 Net Worth — The remainder after deduct- 
 ing all liabilities from the total of assets. Has 
 no relation to investment. 
 
 Assets — The property of a person or cor- 
 poration representing investment immediately 
 or eventually convertible into money for the 
 purpose of meeting liabilities. 
 
 Liquid Assets — Items of assets readily con- 
 vertible into cash, such as securities, accounts 
 receivable, etc. 
 
 Surplus — ^The undivided profits of the 
 business. Surplus is sometimes employed in 
 the business as capital, and sometimes carried 
 as a safeguard against embarrassment because 
 of losses at unprofitable seasons. 
 
 Dividends — ^The payment made to stock- 
 holders in disbursing the earnings of the busi- 
 ness or such part of the earnings as the direc- 
 tors of the corporation decide is to be used for 
 dividends. They are paid to stockholders in 
 the ratios of stock held by them. 
 
 Wages — The remuneration of employes 
 whose pay is calculated at a rate per hour, day 
 or week. Wage earners forfeit pay for time 
 absent or not used in the service of the em- 
 ployer, but are paid for overtime. 
 
 116 
 
The Terminology of Cost Engineering 
 
 Salary — The remuneration of employes 
 whose pay is calculated per month or year. 
 Salaried employes do not forfeit pay for holi- 
 days, or other absences, including vacations, 
 but are not paid for overtime. Salaried em- 
 ployes are sometimes paid by the week. In 
 cases of willful absence purely for the bene- 
 fit of the employe, the employer may elect 
 whether any or no payment is to be made 
 for the period of absence. 
 
 Commissions — The remuneration of sales- 
 men, when they are compensated in the ratio 
 of sales of goods or product. 
 
 Cost — The sum of the expenses involved in 
 the production and distribution of an item up 
 to the moment at which cost is ascertained. 
 
 Invoice Price — The price shown on the 
 invoice without regard to discounts, or ex- 
 penses of handling and selling, which must be 
 included in ascertaining cost. 
 
 Expense — Any element of cost. The term 
 is sometimes misused as the title of an account. 
 Properly used it should always be preceded 
 by a descriptive title, as building expense, 
 wage expense. 
 
 Direct Expense — An element of cost hav- 
 ing but one beneficiary to which alone it is 
 chargeable in total. 
 
 117 
 
Fundamentals of Cost and Profit Calculation 
 
 Indirect Expense — An element of cost 
 having two or more beneficiaries among which 
 it must be distributed. 
 
 Major Direct Expenses — Usually the 
 items of material and wages which may be 
 charged directly to a factory order. 
 
 Minor Direct Expenses — Direct expense 
 items, such as repairs, supplies, etc. 
 
 Immediate Expense — An item which be- 
 comes a recognized liability as soon as in- 
 curred and paid in the regular course of busi- 
 ness, as rent, insurance, etc. 
 
 Ultimate Expense — An item of expense 
 necessarily considered in cost because it must 
 ultimately be paid although there is not likely 
 to be an insistent demand at a definite date, 
 as replacement reserve to counterbalance de- 
 preciation, interest on investment, etc. 
 
 Economic Expense — Items or charges 
 made to cover the normal losses of business 
 that the equilibrium of capital may be main- 
 tained, such as charges required to cover 
 shrinkage of stocks, waste in cutting, spoilage, 
 depreciation of equipment, good will, bad 
 debts, etc. 
 
 Expense Distribution — The act of deter- 
 mining the amount of benefit obtained from 
 
 118 
 
The Terminology of Cost Engineering 
 
 an indirect expenditure, by the several bene- 
 ficiaries, and charging each with that propor- 
 tion of the expense item represented by its 
 proportion of benefit derived. 
 
 Process Cost — The result found by divid- 
 ing the total of expenses involved in a process, 
 over a given period, by the number of salable 
 units produced. Usually expressed as Process 
 Hour Rate. 
 
 Cost of Production — The cost of making 
 an item of product without consideration of 
 the expenses of distribution or sale. Cost of 
 production is the total of Material Cost and 
 Process Costs involved. 
 
 Estimate — An opinion or guess as to the 
 cost or probable cost of an item already man- 
 ufactured or to be manufactured. Usually 
 made by some authorized person presumed to 
 be informed as to processes and their cost 
 and competent to make the estimate. 
 
 Quotation — ^The amount of an ofTer or bid 
 to furnish specified items at a specified price. 
 
 Selling Expense — All items of expense in- 
 curred for the purpose of making or increas- 
 ing the sales of goods or product. 
 
 Cost of Sales — The total cost of the mer- 
 chandise or product sold in a designated per- 
 
 119 
 
Fundamentals of Cost and Profit Calculation 
 
 iod, including all expense elements in connec- 
 tion therewith. The total of all item costs for 
 the period. 
 
 Replacement Reserve — A cash reserve 
 provided by including in the cost of produc- 
 tion of all items a charge calculated to equal 
 the depreciation of equipment. Included in 
 the charge for product it becomes a part of 
 receipts, when payment is received, and 
 should be deducted before profit is calculated. 
 
 Depreciation — Deterioration or shrinkage 
 in values for any reason. Commonly used 
 with reference to wear and tear on machinery 
 or other equipment. All assets except cash are 
 subject to more or less depreciation. The 
 chief causes of depreciation are obsolescence, 
 inutility, wear and tear, neglect, etc. 
 
 Shrinkage — Commonly used with refer- 
 ence to the losses or depreciation in merchan- 
 dise stocks, caused by the elements, handling, 
 theft and carelessness. 
 
 Principle — A principle is a fundamental 
 truth — a comprehensive law or doctrine from 
 which others are derived, or on which others 
 are founded. A general truth — an elementary 
 proposition. There can be no exceptions to 
 the application of a fundamental principle. 
 
 120 
 
The Terminology of Cost Engineering 
 
 Rule — A rule is a law supposedly but not 
 necessarily having as its basis a principle. A 
 rule, unlike a principle, is subject to change 
 under certain conditions. 
 
 Unit — A unit is one of the parts of a divis- 
 ible thing and may be expressed by any term 
 denoting weight, measure, or count, according 
 to the nature of the thing to which it is ap- 
 plied. 
 
 Good Will — A trade-attracting influence 
 in favor of a concern resulting from the pol- 
 icy of delivering to each customer or client, in 
 addition to the requirements of his order, an 
 element of unexpected courtesy or service 
 which has the effect of not only causing a de- 
 sire to patronize the concern again but to tell 
 others about it. 
 
 System — A plan or routine intended for 
 the purpose of, and actually having the effect 
 of, economizing effort. 
 
 Red Tape — A plan or system, or part of a 
 plan or system, requiring for its operation 
 either unnecessary effort, or unprofitable ef- 
 fort. If the cost of the effort equals or exceeds 
 the value of the result it is unprofitable and 
 consequently *^red tape.'' 
 
 121 
 
INDEX OF TERMINOLOGY 
 
 Assets 116 
 
 Assets, Liquid 116 
 
 Capital Stock 115 
 
 Commissions 117 
 
 Cost ....117 
 
 Cost of Production 119 
 
 Cost of Sales ^ 119 
 
 Cost, Process 119 
 
 Depreciation 120 
 
 Direct Expense 117 
 
 Direct Elxpense, Major 118 
 
 Direct Expense, Minor 118 
 
 Distribution of Expense... .118 
 
 Dividends ^ 116 
 
 Earnings 113 
 
 Economic Expense 118 
 
 Estimate 1 19 
 
 Expense ....117 
 
 Expense, Direct 117 
 
 Expense, Distribution 118 
 
 Expense, Economic 118 
 
 Expense, Immediate 118 
 
 Expense, Indirect 118 
 
 Expense, Major Direct...ll8 
 Expense, Minor Direct.... 118 
 
 Expense, Selling 119 
 
 Expense, Ultimate 118 
 
 Good Will 121 
 
 Gross Profit 114 
 
 Income 113 
 
 Immediate Expense 118 
 
 Indirect Expense 117 
 
 Interest on Investment — 115 
 
 Investment 115 
 
 Investment, Interest on 115 
 
 Invoice Price 117 
 
 Liquid Assets .....116 
 
 Margin 114 
 
 Net Worth 116 
 
 Price, Selling 114 
 
 Price, Invoice ^ 117 
 
 Principle 120 
 
 Process Cost 119 
 
 Production, Cost of ..119 
 
 Profit, Gross 114 
 
 Profit of Time Period 113 
 
 Profit on Transactions 114 
 
 Quotation ....1 19 
 
 Receipts 1 12 
 
 Red Tape ^ 121 
 
 Replacement Reserve 120 
 
 Reserve, Replacement 120 
 
 Rule 121 
 
 Salary 117 
 
 Sales, Cost of...., 119 
 
 Selling Expense 119 
 
 Selling Price 114 
 
 Shrinkage! 120 
 
 Surplus 1 16 
 
 System 121 
 
 Tape, Red 121 
 
 Turnover 115 
 
 Ultimate Expense 118 
 
 Unit 121 
 
 Wages , 1 16 
 
 122 
 
GENERAL INDEX 
 
 PAGES 
 
 Accuracy, Practical, defined 75 
 
 Accuracy, prime requisite in cost system. 75 
 
 Assets, tendency to shrinkage 41 
 
 Bases of Expense Distribution ~ ...^ 79 
 
 Capital, source of 52 
 
 Contents 7 
 
 Contingent Expense, fundamental principle of 69 
 
 Cost, defined 10 
 
 Cost, erroneous usage of term 9 
 
 Cost, fundamental principle of 67 
 
 Cost Accounting, origin of - 29 
 
 Cost Engineering, proof of practicability 36 
 
 Cost Engineering, a practical science ^ 69 
 
 Cost and Profit Statements, fundamentals required.... 106 
 
 Definiteness the keynote of Cost Engineering 62 
 
 Depreciation, causes of „ - 44 
 
 Depreciation, "charging off'* impractical ~ 46 
 
 Depreciation, items for consideration 47 
 
 Dictionaries, some definitions impractical 85 
 
 Direct Expense, defined 19 
 
 Economic Expenses, definition 42 
 
 Effort, the rewards for „ - 83 
 
 Energy, three kinds in industries 41 
 
 Estimate, when complete , SO 
 
 Expense, Contingent, principle of ^... 69 
 
 Expense, fundamental principle of 67 
 
 Expense Distribution, Bases of ~ 80 
 
 Expense Distribution, Church methods 31 
 
 Expense Distribution, fundamental principle of 68 
 
 Expense Distribution, makeshift methods of 30 
 
 Expense Grouping, examples of -. 76 
 
 Expense Grouping, fundamental principle of 67 
 
 Expenses, Definite and Limited ,. ^ 11 
 
 Expenses, Economic, defined 42 
 
 Elxpenses, Immediate, examples of 38 
 
 Expenses, list of 71 
 
 Expenses, primary grouping of 12 
 
 Expenses, related to Functions of Business 14 
 
 Expenses, Ultimate, examples of 3S 
 
 Expenses, when possible to group 15 
 
 Factory and Store identical in principle 91 
 
 Finances, importance to industries.... 41 
 
 Good Will, defined. _... 56 
 
 123 
 
Fundamentals of Cost and Profit Calculation 
 
 PAGES 
 
 Good Will, depreciation of « .„ 47 
 
 Good Will, discussion of ~ 55 
 
 Gross Profit, a myth ^ , 18 
 
 Immediate Expenses, examples of -. 38 
 
 Indirect Expense, defined 33 
 
 Interest on Investment, arguments for 48 
 
 Interest on Investment, defined ^ 48 
 
 Interest on Investment not part of profit 17 
 
 Interest Rates, related to risk. 52 
 
 Investment, classification of 54 
 
 Labor-saving Machines, confusion caused by ^ 22 
 
 Margin, definition of ^ 88 
 
 Material Cost, what is included 81 
 
 Material Expense not related to Operating 23 
 
 Overhead accoimt defeats correct efforts 14 
 
 Overhead Account, measure of ignorance 35 
 
 Patents, Royalty on 47 
 
 Philosophy of Cost and Profit, the 9 
 
 Piecework Wages, not an aid to Costfinding 25 
 
 Preface 3 
 
 Principle, invariable 36 
 
 Process Grouping, fundamental principle of 68 
 
 Process Hour Rate, how found 81 
 
 Profit, anticipation not justifiable 17 
 
 Profit, confused with Dividends ^ 98 
 
 Profit, defined — .. 15 
 
 Profit, related to Turnover 15 
 
 Red Tape, contrasted with system 74 
 
 Reserves, importance of 109 
 
 Rules, limitation of application ^ 36 
 
 Schools, impractical teachings of 51 
 
 Selling Price, Basis of Profit and Selling Expense.. 92 
 
 Selling Prices, right method of making „... 95 
 
 Selling Prices, wrong method of making 93 
 
 Selling Prices and Profits 83 
 
 Statements, Cost and Profit, purposes of 101 
 
 Statements, Financial, frequently wrong - ....107 
 
 Stocks and Bonds, relation to capital 52 
 
 System and Red Tape contrasted 74 
 
 Terminology of Business, uncertainty of - 60 
 
 Ultimate Expenses, examples of 38 
 
 Wages, not basic expense ~— 24 
 
 War Taxes, basis of levy ~ ....104 
 
 Wealth, the source of ^ 41 
 
 124 
 
BOOKS BY ROBERT S, DENHAM 
 
 MANUAL OF COST ENGINEERING 
 AND ESTIMATING 
 
 FOR PAPER BOX MANUFACTURERS 
 
 With Addenda by 
 
 Joint Cost Committee of the National Federation 
 
 of Paper Box Manufacturers Assns 
 
 Publication authorized by the Federated Paper Box Manufac- 
 turers Associations of United States and Canada 
 
 Buckram, 316 pages - - - - $10.00 per copy 
 
 FUNDAMENTALS OF COST AND 
 PROFIT CALCULATION 
 
 REVISED EDITION 
 
 A vigorous discussion of the vital elements of business 
 
 A book every man engaged in active business in any 
 capacity can read with interest and profit 
 
 Cloth, 128 pages $1.00 per copy 
 
 PRACTICAL COST ENGINEERING 
 
 Covers the philosophy of Cost Engineering with detailed 
 
 exposition of the application of the Principles and 
 
 Rules of Cost Engineering Practice. A book 
 
 for the manufacturer or student 
 
 Cloth, about 300 pages .... $10.00 per copy 
 
 COST ENGINEER PUBLISHING CO., Cleveland, O. 
 
 125 
 
COST ENGINEERING SERVICE 
 THE DENHAM COSTFINDING CO. 
 
 CLEVELAND, OHIO 
 
 Provides Cost Engineering Service 
 for the planning and installation 
 of Cost Engineering Systems in 
 factories 
 
 Six hundred users in over one hun- 
 dred cities of the United States and 
 Canada attest the practicability and 
 profitableness of the service 
 
 SEND FOR LITERATURE OR REPRESENTATIVE 
 
 THE A-B-C OF COST ENGINEERING— 
 
 104 pages, Cloth 
 
 By Robert S. Denham 
 
 THE DENHAM COSTFINDER FOR GENERAL 
 
 MANAGERS 
 
 A periodical publication 
 
 The above will be sent free on request of 
 General Managers or Corporation Officers of 
 Manufacturing concerns. Will not be sent to 
 accountants or clerks. 
 
 Address THE DENHAM COSTFINDING CO., Cleveland 
 126 
 
?«■■ 
 
 THIS BOOK IS DUE ON THF, LAST DATE 
 STAMPED BELOW 
 
 AN INITIAL FINE OP 25 CENTS 
 
 WILL BE ASSESSED FOR FAILURE TO RETURN 
 THIS BOOK ON THE DATE DUE. THE PENALTY 
 WILL INCREASE TO 50 CENTS ON THE FOURTH 
 DAY AND TO $1.00 ON THE SEVENTH DAY 
 OVERDUE. 
 
 
 
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 1939 
 
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 LD 21-95w-7,*37 
 
YB 1852 
 
 UNIVERSITY OF CALIFORNIA LIBRARY