Jerome Lee Nicholson.

Cost accounting, theory and practice online

. (page 11 of 19)
Online LibraryJerome Lee NicholsonCost accounting, theory and practice → online text (page 11 of 19)
Font size
QR-code for this ebook

The figures should remain constant until the verification has
shown them to be inaccurate, when they should be revised,
and the revised figures used at the beginning of the new

The form may be provided with extra columns to show
variations from period to period in the elements of cost ;
but such variations should not be incorporated in the other
forms of the system until a new inventory is taken at the
beginning of a new period.

Inventory Sheet (Form 61)

The "Inventory Sheet," based on the schedule of esti-
mated costs, shows the estimated cost value of all the product
in the plant divided into its elements ; that is, material,
labor and indirect expenses. In the case of raw material,
the cost appears only in the material column. The cost of
articles in process is estimated as closely as possible. The


errors that may exist in such an estimate will probably l^e
cancelled by the same errors in the ending inventory, and
will not be appreciable unless there is a great difference in
the amount of materials in process in the two inventories.

The totals of the three elements of cost are posted from
the inventory sheet to the ledger to the debit of their re-
spective accounts at the beginning of the period, and serve
to open these accounts upon the books.

Analysis of Cost of Sales (Form 65)

In order that the estimates may be verified, a record
must be kept of all articles sold and the quantity of each,
this information appearing on the analysis of cost of sales.
The costs of the articles are entered and classified on the
analysis of cost of sales in the same way as the costs on the
inventory sheet. By adding the several columns, the total
of each element of cost as estimated is shown for each article

Verification Under First Plan

It will be noticed that the totals of each of the elements
of cost are debited to their respective accounts from the in-
ventory sheet at the beginning of the period. During the
period all expenditures for material, labor and expense
should be charged against the proper accounts ; and in doing
this great care must be exercised to keep the original classi-
fication unchanged ; i. e., the items charged to the labor or
indirect expense account must include only the items that
were considered as labor and indirect expense charges in
making the schedule of estimated costs. If there is any
change in the classification, the validity of the whole plan is
destroyed. Only the totals need be considered in posting
to the accounts for material, labor and indirect expense.

It is clear that the debit side of the three accounts rep-



resents the estimated value of the inventory at tlie beginning
of the period, plus the actual expenditures relating to these
accounts for the period.

The totals of the material, labor and indirect expense
columns on the analysis of cost of sales are credited to their
respective accounts in the ledger. The balance of these
accounts will be in effect a book inventory classified in the
same way as before, and based partly on the estimated be-
ginning inventory, and partly on the actual charges incurred
during the period. The next step is to take an actual in-
ventory at the end of the period based on the schedule of
estimated costs.

It is obvious that the book inventory will agree with the
physical inventory if the estimates are correct. Any differ-
ence shown between the two is due to inaccuracies in the
estimates. If any element in the book inventory exceeds the
corresponding element in the physical inventory, it show^s
that the estimated costs were too low as regards that element,
and if the reverse, the estimated costs were too high, pro-
vided of course that there has not been any theft or waste of
the stock.

The manufacturer must judge from the amount of the
differences where the trouble lies, and to what extent the
estimates should be revised. For instance, if the material
costs are considerably underestimated, it is probable that
leaks of considerable importance exist in the methods of
handling and safeguarding the material, or that wastes
occur in the processes. If the estimates for labor are much
too low, the cause may lie in the classification of labor; that
is, labor that is really direct may have been classed as in-
direct. The principal difference, however, is almost always
found in the indirect expense account, since comparatively
few manufacturers calculate all the phases of overhead cost
in their estimates.


If the cause of the differences cannot be found, the
estimates should be revised on the basis of the known con-
ditions. No method of revision will give the exact figures,
but if the difference between any corresponding elements in
the book inventory and physical inventory be divided by the
number of units of product manufactured during the period,
the result will be, approximately, the amount to be added to
or subtracted from the original estimates relating to that
element. This rule is fairly accurate provided no changes
have occurred in the methods and routine of manufacture
since the original estimate was made.

When the material, labor and indirect expense accounts
are credited from the analysis of cost of sales, the total of
the three elements as shown by the total column on the
analysis of cost of sales is debited to the Sales account. The
balance of the Sales account will then be the estimated gross
profit or loss. If the book inventory exceeds the physical
inventory, showing that the estimates were too low, the
difference should be credited to the Inventory account ac-
cording to its proper classification, and charged against the
Sales account. If the estimates were too high, the entry
would be reversed ; i. c, the Inventory account should be
debited, and the Sales account be credited. The balance in
the Sales account will then show the true gross profit or
loss instead of the estimated figure.

Monthly statements may be prepared based on the esti-
mated costs, the differences being adjusted at the end of the
inventory period. The monthly statement, however, is likely
to be misleading unless the estimates are fairly accurate.

If such a system of verifying and revising estimates is
followed up, it will sooner or later bring the estimates close
to the true costs. But it will often be necessary to locate
and correct seeming inaccuracies in the cost estimates. To
do this, the estimates will have to be made by departments or



operations, and the plan of verification will have to be ex-
tended to meet the divisions in the estimates.

Second Plan of Estimating Costs

The second plan provides for the departmental classifi-
cation of material and labor; but in order to avoid the
clerical work necessary for distributing and determining de-
partmental indirect expenses, that element is still treated as
an unclassified whole, covering the entire factory.

The " Schedule of Estimated Costs," "Inventory Sheet,"
and "Analysis of Cost of Sales," are used in the same way
as before, but the material and labor estimates are divided
into as many sub-heads as there are departmental classifi-

To accomplish this, the follow^ing additional details
should be shown on the three forms used in the first esti-
mating method. On the inventory sheet should appear the
heading "Department" ; and columns should be ruled under
the captions "Material" and "Labor" for the number of
operations under each classification, and also a column for
indirect expenses and a column for the total cost. The same
captions and columns should appear on the schedule of
estimated costs and analysis of cost of sales.

Besides these three forms, the system requires a purchase
journal and a pay-roll form for dissecting and arranging the
material and labor cost.

Purchase Journal (Form 5)

When purchases of material are made, they are classified
in the purchase journal according to the sub-divisions under
the head of "Material." The purchases are credited to the
accounts of the creditors and charged in total at the end of
the month or period to the account appearing at the head of
the column.



Pay-Roll (Form 38)

The entries on the pay-roll are classified into direct labor
for each operating department, and columns are also added
to show the indirect labor, supervision, etc. The totals of
the direct labor columns are debited to the department labor
accounts ; and the totals of the other columns are charged to
the proper accounts under indirect expenses. If certain items
of indirect labor are made a part of the estimates for labor
cost, these items must be separated from the rest and entered
under the same labor classification as in the estimates. Other-
wise the comparison will not show dependable results.

Verification Under Second Plan

The plan of verification is the same as in the first
system, and precisely the same steps are followed in locating
and adjusting discrepancies. The only different feature is
the number of accounts involved. By using the department
accounts, sources of errors and leaks are often located that
would be concealed in the first plan.

While the system of cost-finding just described localizes
costs to some extent, there are many important facts that it
does not disclose. For example, it may be known that a
profit is being made on the product as a whole, but it may
also be suspected that certain articles or classes of product
are being sold at a loss, and that this loss is being paid out
of the profits on other goods. This is a condition existing
so often that it may almost be said to be prevalent.

Third Plan of Estimating Costs

The third estimating system is devised to solve the
problem just mentioned by making an analysis of estimates,
primarily by class of product, and secondarily by operating
department. As might be expected, there is considerably


more detail work than in the other two plans, although the
underlying principle of verification is the same.
The forms used are :

Schedule of Estimated Costs

Inventory Sheet

Analysis of Cost of Sales

Purchase Journal

Material Requisition

Summary of Material Requisitions

Time Report


Schedule of Estimated Costs

The "Schedule of Estimated Costs" is the same in de-
sign as that used in the second plan, the sub-heads under
"Material" and "Labor" referring to different operating
departments. The estimates, however, are classified accord-
ing to the nature of the article.

Inventory Sheet

The "Inventory Sheet" is the same form as the one used
in the second plan, but separate inventory sheets are used
for each class of product, and the raw material not yet put
in process is not included in any class, but is inventoried by
itself. The total amount of raw material is charged to a
separate account in the ledger, and this account is credited
with the raw material drawai out on material requisitions.

The finished and part-finished stock are entered as
before, each article on its proper sheet. The totals appear-
ing on each inventory sheet then represent the total esti-
mated cost of all articles belonging to that class of product.

An account is opened in the ledger with each class of
product, and with the various sub-divisions of expenditures



relating to it, viz. : the departmental accounts for material
and labor, and one account for indirect expenses.

Analysis of Cost of Sales

This form is the same as that used in the second plan ;
but separate sheets are used for each class of product, and
the inventory classification must be rigidly adhered to.

Purchase Journal (Form 5)

This record is to be used for the purpose of entering
invoices for goods purchased, and differs from the form
used in the preceding plan only to the extent that one column
for raw material is used in place of several, as material
requisitions are to be used in connection with this plan. All
material purchased can now be charged to one account, the
distribution to the respective departments being made from
the material requisitions. The total purchases of material
for the month, exclusive of supplies in the nature of an
expense, should be posted to the debit of the Storeroom
account, which account has been previously charged with
the inventory of raw material at the beginning of the period.

Material Requisition (Form 20)

The material requisitioned out is credited to the Raw
Material account and charged to the proper class of product
in the Material account for the department drawing the
material. The form should state the date, the department.
and the order number, or give some similar information
indicating the class of product, as well as the name, quantity
and cost of the material asked for.

Summary of Material Requisitions (Form 24)

It may save time in posting if the requisition sheets are
classified and summarized on a summary sheet for entry



to the journal or ledger accounts. The form is generally
analyzed according to departments, the different classes of
product being the sub-heads. Thus, by adding the totals of
the first columns under each department, the total material
cost applying to the class of product represented in that
department is obtained. The posting may then be made in
totals for each account at the end of the month or inventory

Time Report (Form 26)

The time report must be designed to show the depart-
ment, classification number or other indication of class of
product, besides the name of the employee, date, time or
quantity, rate and amount. Each employee engaged in direct
production work in any way should make out such a time
report for the work in hand.

Pay-Roil (Form 38)

The pay-roll is used to summarize and classify the time
reports so that the proper charges may be made against the
various direct labor and indirect labor accounts. A separate
sheet should be prepared for each operating department,
with sub-heads referring to the different classes of product
operated upon in that department. The complete pay-roll
is thus dissected both by department and by class of product,
and the charges can be made accordingly. It may save time,
however, if the pay-roll as analyzed is entered in the cash
book and posted directly to the debit of the accounts affected.

Verification Under Third Plan

All direct charges to the accounts for the different classes
of product being provided for as described, the indirect
expenses still remain in an account by themselves. One
feasible way of applying them to the different classes of



product is by making a distribution on the basis of labor
cost. The total indirect expenses are divided by the total
labor cost for all the product, and the rate or per cent
obtained. The labor cost charged to each classification of
product may then be multiplied by this rate and the pro
rata share of the indirect expenses determined. The amounts
distributed are charged to the various products through the
journal, and the total is credited to the indirect expense
account, which then balances.

The totals of all the charges then represent the estimated
inventory value at the beginning of the period, plus the
actual expenditures for the period. The accounts are now
credited with the goods sold at the estimated cost prices,
and classified in the same way. This information is taken,
of course, from the analysis of cost of sales. The balance
represents the book inventory, and — if the estimates are
correct — will agree with the ending inventory when this is

Wrong estimates as to labor or material can be located
according to department and class of product. It is also
possible to see, to a certain extent, how errors in calculating
indirect expenses have affected the costs.

The methods of discovering sources of error and of
revising estimates, and the verification of figures in the
ledger, are the same as in the other plans of estimating costs,
and need not be repeated here.

Profit and Loss Statement (Form 68)

The results of the third plan may readily be exhibited
on a monthly statement of profit and loss, which is prepared
from the ledger accounts entirely on the basis of the esti-
mated costs, and without reference to the ending inventory.

The amount and cost of sales are entered in their columns
according to the class of product, and the difference extended



into the next column headed "Gross Profit." The total
selling expenses are then distributed over the several classes
of products on an arbitrary percentage basis. The admin-
istrative expenses are distributed in the same manner, and
the totals of the selling and administrative expenses for each
column should be extended to the "Total Expense" column.

The difference between the gross profit and the total
expenses is then entered in the "Net Profit" column for
each class of product, and represents the estimated net profit
or loss on that class of product. The total of the column
will, of course, represent the total estimated net profits or
losses of the business.

When the actual ending inventory is taken, the adjust-
ments may be made in the ledger by debiting or crediting
the Sales account in the same manner as before explained,
and the statement may then be prepared on the basis of
actual costs.



Departmental and Estimating Cost Systems

The departmental cost system is the next step in ad-
vance upon the estimating system last described. In both
systems the class of product is the unit on which costs are
based, the difference being that in the estimating system the
costs are estimated and verified at the inventory periods,
while in the departmental system they are not estimated,
but are determined either at inventory periods or by com-
piling the costs monthly. It must be kept in mind that the
word "Department" in this system does not refer to factory
departments, but to departments or divisions of finished
stock, as men's shoes, women's shoes, children's shoes, etc.
To avoid confusion, the term "Operating Department" will
be used when reference is made to the divisions in the
processes of manufacture.

Scope of the Departmental System

A departmental system is not supposed to do the work
of a complete system ; but manufacturers often object to
the extra work and clerical help necessary to operate a com-
plete system, and for that reason provision has been made
for the more elementary methods of finding costs exempli-
fied by the departmental system. As a rule the results are
satisfactory; and where they are not, the elementary
methods of the system are sufficient to show the cause, and
often indicate along what lines a complete system should



be conducted. It is not to be expected that a departmental
system will perform all the organization and efficiency
functions that are provided for in complete system work.

Conditions Where Applicable

It should be clearly understood that a system of this
character is only applicable to those plants where the pro-
duction order may be made to cover a distinct class of
product which is to be identified with the selling classification
in finished product. This principle must apply to every
operating department of the plant. In some factories one
or more operating departments manufacture product which
cannot be identified clearly with the selling classifications
until it has reached the final stages, or can be identified
only in the finishing and assembling departments. In such
cases a departmental system will not be practical unless it
is supplemented by a different system used in the beginning
processes of manufacture, and based on the unit of produc-
tion. Even then it would be preferable to use one of the
complete systems, as under such conditions the departmental
plan loses the simplicity which is the chief point in its favor.

Methods and Principles

The principles and methods of the departmental system
may be outlined as follows :

( 1 ) The costs are to be found on the different classes
of product as units. No distinction is made between dif-
ferent articles or kinds of articles belonging to the same
class and only incidental attention is given to operating
department costs.

(2) The unit of time chosen is the inventory period.
The accuracy of the calculated costs is checked up and
adjusted by means of the beginning and ending inventories.

(3) All material taken from the storeroom is recorded


and classified according to its use in the various classes of

(4) The cost of direct labor is classified in the same way,
and the distinction between direct and indirect labor is
ddinitely fixed.

(5) The total indirect expenses are computed from the
various accounts, and are distributed over the departments of
product as units. The only basis of distribution provided
for in the system is the direct labor cost. If any other basis
is required to meet a particular condition, the system should
be amplified, and special arrangements made for collecting
the necessary data.

(6) The sales made during the period are classified
according to the classes of product, so that the gross profit
or loss for each department may be determined.

(7) The selling and administrative expenses are pro-
rated over the different departments on some arbitrary basis,
and the net profits or losses for each determined accordingly.

(8) The proper accounts must be opened in the ledger
to classify and summarize the data according to the fore-
going plan of operation.

Forms Used

Six forms are ordinarily used in the departmental system,

( 1 ) Purchase Journal

(2) Factory Order

(3) Bill of Material

(4) Time Report

(5) Analysis of Pay- Roll

(6) Register of Sales

While the forms described in this system are limited to
the number specified above, it does not mean that organiza-


tion and efficiency forms described in other systems may not
be used in a departmental system. Only the forms actually
necessary are described here.

Purchase Journal (Form 6)

A simple form of purchase journal is used to good ad-
vantage in a departmental system. At the end of each
month the party from whom goods and supplies are pur-
chased is credited, and the totals of the raw material and
other classifications named at the top of the purchase
journal columns are debited. An account with raw material
is kept in the ledger, and the material used is requisitioned
out through a bill of material, according to classification of

All indirect expenses which are general in character are
entered in the purchase journal under the captions "Sup-
plies," "Repairs and Maintenance," "Insurance, Taxes and
Rent," "Factory Expenses," etc., but wherever it is possible
to charge factory indirect expenses of any kind against a
classification of product, these items should be entered under
"Sundry Accounts" according to the department affected,
and should be posted directly to those department accounts.

Factory Order (Form 13)

The "Factory" or "Production" order is simple in
design, and shows no costs on its face. It is the key, how-
ever, to the analysis of costs on the bill of material and
time reports. A single order may be issued for different
articles belonging to the same class, but the same order
should never include articles of different classes. The
order number and bill of material number specified on the
order serve to identify the class ; and all costs arising in con-
nection with a particular order are at once identified by
the classification number.


Bill of Material (Form 23)

A bill of material should be made out for every article
manufactured. A material requisition will only be neces-
sary for special orders outside the usual routine. The
prices should be revised or new bills made out whenever
there is a change in the cost of materials issued. The bill
of material may be so devised that it will also serve as a
receipt for material actually delivered under that bill, and
the summary may be shown at the bottom of the sheet.

The total amount of each bill of material is credited
to the Raw Material account, which has previously been
charged with the beginning inventory, and with all material
purchases made since.

Time Report (Form 26)

A "Time Report" or piece-work report that will apply

1 2 3 4 5 6 7 8 9 11 13 14 15 16 17 18 19

Online LibraryJerome Lee NicholsonCost accounting, theory and practice → online text (page 11 of 19)