Henry Rand Hatfield.

Modern accounting, its principles and some of its problems online

. (page 23 of 27)
Online LibraryHenry Rand HatfieldModern accounting, its principles and some of its problems → online text (page 23 of 27)
Font size
QR-code for this ebook

sion of the costing system to the operation of the individual
machines themselves, so as to determine scientifically what
is the real cost of running each one of them for an hour.

This system has been strongly advocated by A. Hamil-
ton Church, who outlines it as follows:

" First we consider each machine as an independent
production center, allocating to such centers all the ex-
penses and charges which can on reasonable analysis be
considered as chargeable as a composite rent or machine
rate for all the factors of production therein concerned.
Second, we charge to a monthly shop-charges account all
charges whatever incurred by that shop, including all the
items specifically represented in fractional detail by the
machine rates, and also including, of course, such general


items as cannot be represented in the machine rates, of
which the most obvious item is the supervision of a head
or foreman.

" Then as each machine is occupied on jobs, the latter
are debited with so much per hour as machine rate, and
at the end of the month the total amount so earned by
the machines is deducted from the total shop expenses,
leaving a balance which is distributed over the same jobs
as a supplementary rate. The ratio of the supplementary
rate to the amount distributed by the machine rates forms
a varying barometer whose fluctuation is an index of the
efficiency of the shop.

" It will of course be obvious that when the machines
are all running full time the supplementary rate will con-
sist of the general charges alone, such as the foreman's
wages, which have not any individual connection with the
particular machines. This will be the condition of maxi-
mum efficiency in the shop. In proportion as all machines
are not kept full of work all the time, this ratio of the
supplementary rate to the amount distributed by the ma-
chine rates will begin to rise. The same effect will occur
if any general kind of expenditure is increased. ' ' 1

In determining the special hour-rate to be applied to
a given machine the following method is advocated by
Church. First the costs of the factory building as such
are determined. These include interest, insurance, depre-
ciation and repairs on the building, ground rent, if any,
and taxes on the real estate. All these expenses are appor-
tioned between the various machines on the basis of the
floor space occupied. This rate may be further varied by
distinguishing between space occupied in one or another
part of the building. Second, the cost of lighting is de-
termined, which is also distributed according to floor
space where there is general overhead lighting, with spe-

1 Engineering Magazine, XXI, 909.


cial charges for individual lights for a particular machine.
Third, the cost of power, which includes fuel, boiler and
engine costs, wages of firemen and engineers, etc., all of
which is reduced to a rate per horse-power hour, which
is then charged to each machine on the basis of the esti-
mated power used by each machine. Fourth, the cost of
the machine itself, which as before stated includes interest,
depreciation, etc., and all of which is apportioned accord-
ing to the estimated annual working hours. 1 The several
factors just enumerated give a machine-hour rate, differ-
ent for each type of machine, which is supposed with some
degree of accuracy to cover all the costs of operating that
machine, assuming that the machine is fully occupied.
But it still leaves two elements of indirect cost not yet
apportioned. One of these covers the general expenses of
the factory which cannot with any show of reason be con-
sidered part of the cost of operating the machine, and the
other that element of expense which remains unappor-
tioned because the machines are not run to their full esti-
mated capacity.

It is apparent, therefore, that even the elaborate scheme
of machine costs proposed by Church does not entirely
remove the problem as to the distribution of indirect fac-
tory costs. It has, however, made that problem of much
less practical importance, for instead of considering all the
expenses over and above the wages and cost of material as
indirect expenses, the apportionment of which must be
largely by a crude and unscientific ratio, the bulk of the
general factory expenses are found to be directly attrib-
utable to particular jobs through the machine rate, and
there remains as unallocated expenses only the two items
mentioned in the last paragraph those by nature not as-
signable to a machine rate, and those due to idle plant.

The treatment of the unassignable expenses is relatively

1 Engineering Magazine, XXII, 31 ff.



unimportant, for it cannot constitute a very large propor-
tion of the total expenses. Church suggests that the appor-
tionment be on the basis of the hours spent on the various
jobs. But where there is a considerable margin due to idle
plant the apportionment of this sum is of some theoretic

The illustration given by Church assumes a factory
with four machines on which the machine rate was based
on the assumption that thej" would each work 200 hours,
the rate charged to each machine being 40, 30, 20 and 10
cents respectively. Had each of the machines been used
for the full assumed time the charges would have covered
the total indirect expenses of $200, but because of idleness
there remains a balance of unassigned charges amounting
to $58, the charges to each machine being as shown below :

FORM 115.


Time used

Rate per


A .


















In this case, the author argues, the $58 may either be
apportioned on the basis of the hours employed, making a
supplementary rate of 9| cents per hour, or on the basis
of the amount of the machine charges, making a supple-
mentary rate of 40.8 per cent, (ibid., xxii, 910). "Which-
ever method is used, the result is that the cost of produc-
tion is increased because of the idle machines.

To this some critics vigorously object. If the costs are
taken as the basis for making estimates, or bids, it leads
to the illogical result that at the very time when, because


of an idle factory, it is most desirable to get new work,
the accounts will show that the work cannot profitably
be done except at a price higher than normal. Whit-
more, writing in the Journal of Accountancy, therefore
urges that these costs representing idle time should not be
charged up against the goods produced. In his opinion
they should be put in "a separate account which would be
treated as a general expense of the establishment, not as
part of the immediate cost of manufacturing. But the
practical results are the same whether supplementary
charges are treated as Whitmore suggests or are all dis-
tributed over the goods produced. So long as the elements
representing idle machines are shown in a supplementary
rate, attention is clearly drawn to the loss that comes from
idle plant. There is the same incentive to try for new
business whether that loss appears among the manufac-
turing costs or is separately shown as one of the general
expenses of the establishment.

A vital difference in method of estimating cost turns
on the point whether the indirect factory expenses which
are apportioned to different jobs are the actual expenses
incurred during the period in which the operations are
performed, or whether they are to be based on the experi-
ences of past operations. For instance, in a given factory
it may be desirable to treat the indirect costs as a per-
centage to be added to the prime cost. This may be done
by taking account, say, at the end of each month of all
such expenses and accurately apportioning them to the
work then in progress. But others, as for instance Oberlin
Smith and Nisbet, recommend that the added charge be
based on the experience of a preceding year, or series of
years, so that the charge can at any time be made without
waiting for the results of the current period.

To some it seems that by taking the current figures a
greater degree of accuracy is obtained. But it should be


remembered that for certain purposes what is desired is
not so much the actual amount which it cost to produce a
certain commodity, as an estimate of what it will cost to
produce more of the same kind of goods. This is particu-
larly true where special contracts are undertaken. Just
w r hat experience will give the best indication of future
costs may be debatable. It does not necessarily follow that
the experience of the present month is any better criterion
than that of last year.

The distribution of general establishment charges offers
somewhat similar difficulties. These expenses include the
office expenses, the expenses of selling, and the general
expenses of financing and managing the whole enterprise.
Alternative methods of dividing these expenses among the
products are to apportion them in proportion to:

1. The Wages Cost.

2. The Factory cost, i. e., the cost of wages, material
and the indirect factory expenses, or

3. The hours consumed in manufacturing the product.

4. The selling price.

The second method seems the most logical, for it appar-
ently covers all the elements for which the establishment
exists. Church, however, advocates employing the hours as
the basis, making, however, certain modifications in the
rates charged to different classes of commodities.

In the preceding pages have been discussed the prob-
lems concerning the distribution of indirect charges jn gen-
eral. Further difficulties arise in reference to the appor-
tionment of certain special costs. One of these, relating
to the cost of patterns, requires particular mention. Not
only is there the general question as to how far the costs
of designing and making patterns should be charged to
expense, and how far the patterns should be considered
an asset, but there is a further difficulty. After having
decided that a given amount is really an expense, is it to


be allocated to the particular products made from the
pattern or treated as a general expense of the factory?
This is particularly clear where unsuccessful patterns or
designs are made. Are these all to be charged against the
cost of the article made from a later satisfactory model,
or do the preliminary attempts represent merely general
expenses of the factory as such? Somewhat similarly: is
the cost of making a special pattern for an article made
on contract to be considered as cost of completing the
contract or is there a residual value representing the
serviceability of that same pattern for future possible
contracts ?

Three points of uncertainty arise even in regard to the
best system of cost accounting. 1. The first is whether the
information acquired is after all worth the expense of
acquiring it. This is more than doubtful in some of the
more elaborate and expensive systems of cost keeping that
are occasionally introduced. To take a flagrant and noto-
rious case the cost system introduced into the Government
Printing Office seems to have cost decidedly more than it
was worth. In this instance the committee investigating
the system reported that it ' ' is principally to be criticised
upon the score that in an attempt to secure all classes of
detail, the amount of labor entailed upon each employee
for the purpose of recording necessary facts, and the
amount of labor required for subsequent tabulation, were
so great as to make the system almost prohibitive. ' ' 1

2. The second point of doubt is as to the degree of
accuracy which may be obtained and the danger which
arises from treating as actual what is merely hypothetical.
It has been shown that even the division between the Manu-
facturing Account and the other portions of the Profit
and Loss Account is with difficulty drawn and can never
be regarded as of absolute value. Much more is it true

LX Cong. 1. Seas. H. Doc. 974, p. IL


that the detailed apportionment of expenses among the dif-
ferent processes or the various commodities is to some ex-
tent a matter of estimate. To be sure accounts can be
prepared, though with great difficulty and much expense,
in which every cent expended will be allocated to some
v unit of product. But it must be remembered that this rests
on estimates which can never be exact. To illustrate: It
is difficult to determine the exact cost of power in a fac-
tory. Coal and wages may be known, but depreciation of
plant is an estimate merely. But granting a substantial
accuracy as to the cost of the total power this can be
divided to the last cent by some system of machine rates.
But much of this ostensible accuracy is specious. It is a
rough estimate at best which attempts to divide the horse
power among the different machines, and the degree of
accuracy obtained in the final results can never surmount
this fundamental defect. And the whole system of fixing
the machine rate depends on an incorrect estimate of the
hours during which the machine will be at work. As Bur-
ton said, " Cost accounts based on separate charges for
each machine employed must be generally hypothetical,
and in many if not the majority of eases they must be
delusively hypothetical. ' '

3. A third point bears on the application which is to-
be made of the result. Are they to be used in determining
whether capital shall go into a given industry? If so, it
is evident that what is wanted is a correct estimate of the
net income after deducting all interest on capital and other
items frequently, indeed generally, excluded from the cost
accounts themselves. The information necessary to show
whether an enterprise is ultimately successful is very dif-
ferent from that which shows whether an enterprise once
established should be continued. Cost accounts as they are
frequently prepared confuse these two points of view.
Thus Whitmore criticises the inclusion of idle-machine cost


as not showing whether to a new concern it is desirable to
undertake certain work. The idle-machine cost, says he,
Jg incidental to the establishment of a new concern and
should not be included in an estimate which shows whether
goods can be produced profitably at a certain price. But
the same author includes interest on the cost of machines
and buildings in his estimate of machine costs, while these
have nothing to do with the cost of producing further
goods by a factory already established. As is well known
in railroad practice, when a road is once permanently con-
stiucted it is better to carry freight at a price not cover-
ing interest than to refuse traffic. The same principle, of
course, applies to a factory. If, as seems to be the opinion
in discussing idle-plant costs, the purpose of the cost ac-
count is to show the figure at which the established factory
can afford to produce, it is clearly illogical to include in
this figure interest, which indeed bears on the ultimate
profitableness of the enterprise, but not on the desirability
of undertaking a given contract.

As to the technic of cost accounting little can here be'
said. It is impossible to frame a system of cost accounting
applicable to establishments of different character. Iron
works producing a single form of staple commodity, a fac-
tory making a few standard grades of cloth, each involving
a succession of separate processes, works manufacturing
special machines where it is desirable to learn the cost of
the entire machine and of each of its parts, and a shipyard
undertaking special contracts, each needs an entirely dif-
ferent system of keeping its cost accounts. No general
scheme of forms can be outlined which will apply to all
of them. Nor can a scheme be outlined which will apply
in detail to the different individual establishments of a
single class. of undertakings. As Dicksee has said:

" It need hardly be pointed out that the requirements
of undertakings carrying on a similar business are by no


means uniform. Special and local considerations have to
be taken into account, and the most desirable system for
any particular undertaking can only be ascertained after a
full and detailed inquiry has been made into its peculiar
circumstances and conditions. ' ' x

Even to describe a system serviceable to a particular
establishment, while it might have illustrative and suggest-
ive value, would require so extended a treatment as to
exclude it from a treatise on the general principles of
modern accounting.

The best that can be done is to call attention to some of
the most elementary matters of the technic of cost account-
ing, referring the reader to the more extended treatises on
cost accounting, as indicated in the bibliographical note
appended to this chapter, for more detailed information,
or better still to emphasize the necessity of employing a
technical expert to arrange a system of cost accounting
adapted to the particular needs of a given establishment.

Cost accounting, as shown above, requires (1) an accu-
rate recording of the wages directly paid, (2) of the ma-
terial consumed, and (3) a systematic allocation of the
indirect factory and establishment charges incurred in con-
nection with each contract, process or product. To keep
track of the direct wages it is evidently necessary to have
a daily record kept showing the exact nature of the work
on which each laborer is employed. Only by such an elab-
orate system can the proper amount be charged to the
separate accounts representing the direct wages cost of the
particular contract or process. From these daily individ-
ual slips can be prepared a summary of wages showing by
individuals or departments the total direct wages charge.
Sheets ruled in columns representing the various subdi-
visions will most conveniently serve for such records.

The material consumed needs similar treatment. Here,

1 Advanced Accounting, p. 232.


however, it is well to emphasize the need for careful rec-
ords, as the keeping track of materials used is generally not
so accurately done as in the case of wages paid. Strangely
enough accountants who require the pay roll to balance to
the last cent pay little attention to the accuracy of the
accounts representing material consumed. A discrepancy
in the cash drawer excites immediate attention while valu-
able material and finished parts are often treated with
carelessness and no exact balancing is expected of the store-
keeper. The first requisite is, therefore, a more careful
accounting for the materials as well as for the cash in the
drawer, an accuracy regarding amount of material used
not dissimilar to that required in regard to wages paid.

Where the materials are directly .purchased for a par-
ticular contract this is simply done, and probably with
greater accuracy than where material on hand is taken
from the warehouse for a similar purpose. Again the fic-
tion that the cash directly paid out is more important than
a similar value of other assets is seen to affect accounting

It is in the treatment of stores that the greatest im-
provements have been introduced. In any system of ade-
quate cost accounting it is now recognized that it is neces-
sary to keep accurate track of all goods coming into the
stores, of all goods issued for different jobs, or all returned
goods not needed for the job for which they were originally
issued. In this way it is possible (1) to verify the amount
of goods on hand at any time and so prevent peculation
and waste, and (2) to keep account of the material actu-
ally used in each job. Model forms of a stores record
sheet, and a requisition are given on pages 311 and 312.
From the slips regarding the wages and materials con-
sumed, and from similar records showing the machine
rates, the proper entries can be made in a ledger account
opened for each job. These ledger accounts are most con-

2 Q











































- g

~ Q

g H

t^ H





veniently kept in loose leaf ledgers, ruled somewhat as iit
Form 118. On the same sheet may be entered the sup-
plementary charges and such other information as may be

The forms given above apply particularly to an estab-
lishment where it is desired to ascertain the cost of special
contracts. Where machines, for instance, are being made
for stock, or where merchandise such as cloth is being simi-
larly made, the items, for which columns are to be ruled,
in the Cost Ledger Accounts would of course vary. The
cost account of the finished machine would probably indi-
cate not the labor, and material and machine rates as a
whole, but rather the total cost of the several parts mak-
ing up the machine. The cost of the cloth would not be
divided into wages and material but into the costs of the
several processes involved in making the finished product.
In each case the elements must be combined so as to
give most easily the information wanted in the particular

In many of the forms used great economy is secured
by the use of duplicating devices, so that, for instance, the
filling out in triplicate of an order for stores will provide
an order to the storekeeper, a memorandum for the fore-
man issuing the order, and a memorandum for the cost
accountant whereby the proper entry can be made in his


ARNOLD, H. L. The Factory Manager and Accountant. New York,
1903. [Gives description of systems of cost accounting used
in various factories.]
The Complete Cost-Keeper. New York, 1900.

BEAN, B. C. The Cost of Production. New York, 1905.

BURTON, F. G. Engineers' and Shipbuilders' Accounts. London,


CHURCH, A. H. The Proper Distribution of Expense Burden. New
York, 1908. [An elaborate presentation of the "improved
machine cost " system and a criticism of other systems of cost

DAY, C. M. Accounting Practice. New York, 1908. [A valuable
technical treatise, containing numerous forms.]

EDHIS, W. C. and TINDALL, W. B. Manufacturers' Accounts.
Toronto, 1904.

GARCKE, E. and FELLS, J. M. Factory accounts. Fifth edition.
London, 1902. [A pioneer work on the subject and still

HALL, H. L. C. Manufacturing Cost. Detroit, 1904.

HAWKINS, L. W. Cost Accounts. London, 1905.

WEBNER, F. E. Obtaining Actual Knowledge of the Cost of Pro-
duction. Engineering Magazine, XXXV-XXXVI.

WHITMORE, J. Factory Accounting as Applied to Machine Shops.
Journal of Accountancy, II, pp. 248, 345, 430, III, p. 20, 106,

Encyclopaedia of Accounting, II, p. 299.
Engineering Magazine, XXVII, p. 645.

The Accountants' Library, London, a series of some forty volumes
treating of special branches of accounting gives many forms
applicable to the particular needs of various classes of estab-



PARTNERSHIP accounts constitute no separate system of
accounting. Whether the proprietorship is vested in one
or more persons the general principle of double entry
bookkeeping, that there is an equation between the sum
of the Proprietorship accounts and the sum of the Goods
accounts, holds true. The mere subdivision of the pro-
prietorship into various accounts introduces no new prin-

The essential problems of partnership are those which
bear upon the essential character of the partnership rela-
tion and refer to the proper division to be made of profits
and losses, of assets and liabilities. If it is clearly under-
stood in each case just what contract has been made there
is ordinarily little difficulty in formulating the accounts.
But, unfortunately, the terms of partnership agreements
are at times vague, and even the courts have not always
agreed on their interpretation. Some of the cases in which
difficulties arise are therefore of importance to the account-
ant even though there may be no really vital accounting

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 23 25 26 27

Online LibraryHenry Rand HatfieldModern accounting, its principles and some of its problems → online text (page 23 of 27)