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260 INDIRECT EXPENSE
after the facts are known. Thus, both general and ad-
ministrative expense might in some cases be equitably
distributed on the basis of the pay-roll. If, for example,
the total direct labor pay-roll for the period is $100,000,
and the wages paid in one department amount to $1,000
and in another to $5,000, the departments might be
charged with 1% and 5% of the general expense
respectively.
Stores expense, i.e., the cost of operating the stores
department, can be charged with fairness only on the
basis of the use of the stores-room facilities, and in most
cases this use is indicated with sufficient accuracy by the
total issues to each department as shown on the stores
issued book. Thus, if the total issues for the period are
$10,000, and the issues to one productive department
total $1,000 while those to another are $2,000, the one
should be charged 10% and the other 20% of the cost
of operating the stores department.
Power expense can be allocated in various ways.
When a meter can be installed in each department, this
is the most satisfactory method of distributing power
costs. If this is not practicable, a meter can sometimes
be installed in the various departments using power long
enough to ascertain the average amount of power con-
sumed by each during a normal period. If the meter
measurement is unobtainable, a fairly accurate estimate
of consumption can be made by adding the horse-power
rating of the power units in each department and then
distributing the power cost among departments in pro-
portion to horse-power requirements. Such an estimate,
however, is reliable only when the machinery in all de-
partments is in constant operation.
EXPENSE DISTRIBUTION 261
When machines are used intermittently, records
should be kept in each department of the number of
hours that each machine is operated. The h. p. of each
machine is then multiplied by the operating hours it is
used and the total resulting figures give the number of
"h. p. hours" by departments. The h. p. hours for all
departments divided into the total power cost gives a
rate per h. p. hour which, multiplied by the h. p. hours
for each department, gives the power cost in each case.
Thus, if the h. p. of all the machines in one department
is 200 and the machines are run for 1,000 hours, its h. p.
hours are 200,000. If the h. p. hours for the whole of
the factory are 2,000,000, the department referred to
should be charged 10% of the total power cost. This
last method has almost the accuracy of a meter measure-
ment and can readily be used when the method of burden
distribution requires that a record be kept of the hours
of each machine's operation.
While the examples given illustrate the general prin-
ciples which govern the allocation of the expense of one
department over those to which it is tributary, or which
it serves, methods vary with circumstances and in large
organizations can be applied only by someone thorough-
ly acquainted with the physical and operating condi-
tions. In an engineering plant, for example, there
might be a pattern department operated in conjunction
with the foundry in which patterns were both made and
stored. Pattern-making would usually be treated as a
charge to a pattern plant account and absorbed by de-
preciation charges, whereas pattern storage should be
charged to foundry expense. Foundry expense might
be charged direct to orders or to the departments to
262
INDIRECT EXPENSE
ANALYSIS OF EXPE
GENERAL
MANUFAC
ADMINIS-
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RECEIVING
SHIPPING
TOTAL
GENERAL
A- BOX
MAKING
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Form 39. Expense Analysis
EXPENSE DISTRIBUTION
MSES FOR MAY !9-_
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Sheet Novelty Goods Factory
264. INDIRECT EXPENSE
which deliveries of castings have been made, on the basis
of the weight of the good castings delivered. In the
same plant there might be a dozen or more stores-rooms
operated for the needs of special departments, and the
expense of each would be a charge against its special
department. On the other hand, the cost of operating
a tool storage room in close proximity to a number of
machine shops and serving them all, would be prorated
over them on the basis of the number of requisitions
received from each, or on such other basis as the condi-
tions might indicate.
Again, in a small machine shop the power might be
purchased from outside and a sufficiently lengthy record
of its cost be kept to furnish accurate data for averag-
ing. Power expense might then be listed on the sched-
ule of fixed charges and so distributed. On the other
hand, the power plant of a big locomotive concern might
represent such a large capital expenditure as to warrant
its treatment as a separate undertaking. Power ex-
pense would then be charged to each shop in proportion
to consumption for manufacture, crane work, lighting,
and heating.
Though the departmental divisions of almost every
factory differ in some ways and the proper method of
distributing expense among them can be determined
only when the facts of the case are known, yet the same
fundamental principle is applicable in all cases, i.e., dis-
tribution should be as nearly as possible on the basis of
"value received." When the manufacturing conditions
of a particular plant are known, no difficulty should be
experienced in allocating departmental expense on a
simple and equitable basis.
EXPENSE DISTRIBUTION 265
4. Merger of Minor Department Expense
The non-productive or service departments listed on
the expense distribution sheets (Forms 37 to 39) are
presented merely to illustrate expense distribution and
not because they represent the customary classification
of service departments or the order of their allocation
over operating departments. The service departments
actually entered on the expense distribution sheet will
depend upon the conditions. In a large factory, for ex-
ample, operating a hundred or more productive depart-
ments, there might be many service departments. To
allocate each of these separately over the productive de-
partments on some approved basis would be a tedious
business involving considerable clerical work with no
compensating advantage. For these reasons, in organ-
izations of any considerable size it is customary on the
distribution sheet to merge the expenses of the service
departments until their total expenses are, perhaps,
shown under not more than a half dozen general heads.
Thus, "Administration" in a large organization would
usually cover numerous activities and might include all
expense incurred in the administration of the following
departments :
1 . Factory manager and the cost of operating his
office.
2 . Factory superintendent and the cost of operat-
ing his office.
3. Planning and dispatching departments.
4. Employment department.
5 . First aid.
6. Welfare work.
266 INDIRECT EXPENSE
7 . Cost and factory accounting.
8 . Miscellaneous administration expenses.
In the same way stores expense might include the
following :
1 . Purchasing
2 . Receiving
3. Stock and stores-room expenses
4. Testing and inspecting materials
5. Delivering materials
As already stated, the distribution of the cost of all
these different activities separately over the operating
departments is not usually worth while, and yet it may
be very advisable to show on the books the cost of oper-
ating each of them. In such a case the total collected
on the distribution sheet under "Administration," for
example, serves only as a controlling total debited to
Administration account on the general ledger, while the
details of this total are found in an expense ledger in
which accounts are kept with the minor departments
comprised within the term "Administration."
5. Allocation of Expense to Minor Departments
When some or all of the service departments appear-
ing on the expense distribution sheet are composed of a
number of minor departments, the depreciation and
fixed charges schedules and also the standing order cost
sheets must be arranged to meet this condition.
So far as the schedules are concerned, this is a simple
matter. All that is required here is a column for each
of the minor departments. The totals for these minor
or sub-departments are combined under the proper
EXPENSE DISTRIBUTION 267
headings when the transfer is made to the expense dis-
tribution sheet. Thus, if the depreciation on furniture
in the manager's office, the superintendent's office, the
planning and other departments listed under "Adminis-
tration," amounts to $150 for the period as shown on
the depreciation schedule, this total is entered on the ex-
pense distribution sheet (Form 37) under the heading
"Administration" and on the line "Depreciation of Fur-
niture and Fixtures." The detailed amounts shown on
the depreciation schedule are, however, entered in detail
in the accounts kept with each subsidiary department
on the expense ledger and the total of these accounts
must equal the corresponding totals entered on the dis-
tribution sheet.
The standing order numbers also must be so ar-
ranged as to permit the ready classification of the
routine expenses incurred by the minor departments.
This can be done by adding a letter to the standing order
number representing the department as a whole to dis-
tinguish the expense of one minor department from that
of another. For example, while all standing order cost
sheets bearing the number 205 would be a charge to ad-
ministration (space 205 on the distribution sheet) for
the labor cost of repairs done in the offices, the cost
sheets 205A might refer to the manager's office, 205B
to the superintendent's office, 205 C to the planning of-
fice, and so on. The cost sheets numbered 205A would
then be charged to the manager's department account,
205 C to the account recording the expense of the plan-
ning office, and so on in the expense ledger, while, as
just stated, all requisitions numbered 205 would be
charged to repairs under "Administration" on the dis-
268 INDIRECT EXPENSE
tribution sheet. They would also be charged to the Ad-
ministration controlling account on the general ledger.
6. Stores Expense "Short-Cut"
Instead of distributing the cost of operating the
stores department over the productive departments and
through the productive departments over the product,
direct jobs are sometimes charged, by means of burden
rates, with the expense of operating the stores depart-
ment. If the total stores expense is compared with the
total value of all material issued on jobs during a given
period, the percentage of stores expense to material
used can be determined. Every item of material used
on a job is then "loaded" with this percentage. For in-
stance, if stores expense for the period is $3,000 and the
value of the material used during the period is $100,000,
all material withdrawn from stores should be charged
3% of its value to cover the cost of operating the stores
department.
This method of distributing stores expense is com-
monly employed in plants where the cost of handling
and storing material is relatively high in proportion to
its value because of the heavy or bulky nature of the
stores. The subject is treated more fully in Chapter
XXIV.
7. Department Expense Accounts under Job Order
Method
Under the job order method, when the expense dis-
tribution sheet shows the non-productive department
expenses in sufficient detail (as would usually be the
case in an organization of not over twenty depart-
EXPENSE DISTRIBUTION 269
ments), the only advantage of opening accounts on the
ledger with the expense of the non-productive depart-
ments is that of convenience in analyzing the expense of
a particular non-productive department at a later date.
On the other hand, it is always necessary, under the
job order method, to open an expense account on the
ledger with each operating department. The operating
department expense totals cannot be closed into the con-
trolling manufacturing account direct from the distri-
bution sheet, because the actual current expense of
a department may not equal the estimated expense
charged to orders and summarized in the expense debits
to the controlling manufacturing account. Therefore,
operating department expense accounts are opened on
the expense ledger which are debited with the details
shown on the distribution sheet and credited with the de-
partmental charges made to orders. The method of ad-
justing any difference between the department expense
as taken from the distribution sheet and the department
burden applied to orders is considered in Chapter
XXII.
8. Expense Accounts under Process Method
When computing process costs the accounts can be
divided into two classes: (1) operating accounts kept
with each process, the details of which are recorded in
subsidiary accounts kept in a cost ledger; and (2) ser-
vice expense accounts which are closed out to the proc-
ess accounts. Theoretically, it is unnecessary when cal-
culating process costs to open any expense accounts
on the ledgers, as the service expenses can be computed
on the expense distribution sheet and closed out to the
270 INDIRECT EXPENSE
process accounts by journal entry. In practice, how-
ever, the service expense charges to each process account
are recorded in separate accounts so as to show the detail
on the books in more permanent form than on working
distribution sheets. When it is desired to make out a
financial statement of expense covering a long period
of time, reference to a number of unwieldy working
sheets cannot be so conveniently made as to accounts in
which the details are summarized and clearly shown.
REVIEW QUESTIONS
1 . Name the sources from which expense data are obtained.
2. What kind of a form is best suited for making an apportion-
ment of expense?
3. How should general expense be apportioned to operating de-
partments ?
4. What is the most satisfactory basis for distributing power to
departments ?
5 . Name the accounts to which power expense would be closed out
in (a) a job order factory with two manufacturing depart-
ments, (b) a process plant with two manufacturing depart-
ments. Discuss your reasons for the procedure recommended.
6. Is the expense of supervision or administration best apportioned
to operating department expense accounts on the basis of
(a) direct labor in each department, or (b) the sum of direct
labor and expense charges to each department? Give the
reasons for your answer.
7. If the expense of the stores department is not added to the
material consumed as a burden, what becomes of the stores
expense?
8. How should the time of executives be divided as between manu-
facturing and selling departments?
CHAPTER XXII
EXPENSE DISTRIBUTION OVER
PRODUCT
1 . Overhead Rates
In process cost-finding, expense is merged with
other costs in the operating department accounts, the
totals of which are averaged over the production of the
period to ascertain the cost of each unit produced. This
averaging is feasible because each unit of production
makes the same demand upon the services of men and
machines. But as soon as more work (whether of men
or machines or both) enters into the production of one
lot of articles or one job, as compared with another, the
averaging of the total cost or of expense alone over the
product no longer gives accurate costs. A job worked
upon by ten men for ten weeks in one department must
obviously bear a much greater expense charge than a
job which is completed by five men in two days in the
same department.
To meet this condition, in job order cost-finding, an
expense or "burden" rate is determined for each depart-
ment; that is, having determined the overhead expense
of a department for a given period of time, an overhead
expense rate is calculated, to be charged against the
product. This rate may be based upon any one of the
following :
1 . The cost of the labor expended upon the job.
2. The labor time expended upon the job.
271
272 INDIRECT EXPENSE
3. The machine time spent in processing the job.
4. The total cost (labor and overhead) of the
services of the department.
Two other methods of distributing overhead over
product the material cost method and the prime cost
method, i.e., direct labor and material cost are some-
times employed as the basis of expense distribution.
These two methods are, however, of limited applica-
tion and use, and cannot be regarded as standard
systems of expense distribution.
2. Methods of Distributing Expense over Product
Corresponding to the first four bases mentioned
above, there are four general methods of determining
and distributing overhead rates known as:
1 . The percentage of labor method
2. The productive-hour method
3. The machine-hour or machine-rate method
4. The sold-hour or service-hour method
These are merely different modes of distributing
expense over job orders and do not in themselves con-
stitute basic methods of cost determination. Operating
conditions frequently vary so greatly in different de-
partments of the same factory that the same method of
burden distribution cannot be employed throughout,
and two or even three methods may sometimes be used
in the different departments of a single establishment.
3. Percentage of Labor Method
The distribution of burden as a percentage on labor
is more generally used than any other method of dis-
EXPENSE DISTRIBUTION OVER PRODUCT 273
tributing expense over product, because of its simplicity
and the ease with which the calculations can be made.
The principle upon which it is based is that there is a
direct relation between the cost of labor and the factory
overhead, and as the product increases in value with the
cost of the labor expended upon it, so must the expense
of supervising this labor and the other overhead expenses
of conducting the business rise in proportion. There-
fore, if the ratio between the average cost of the direct
labor and overhead of a department during a previous
period is first ascertained, the percentage thus obtained
when applied to the direct labor cost charged to any
particular job in that department will give an equitable
and complete distribution of the departmental burden