Jerome Lee Nicholson.

Cost accounting, theory and practice online

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cases much friction and dissatisfaction have arisen from its
use. A question at once arises concerning the cause.

To answer this we may sketch an imaginary case. An
employer, having decided to introduce the piece-work
system in his business, sets out to determine the allow-
ance he should make on each piece of work. He and his
assistants watch the men and their work for some time
beforehand. Then he makes what he considers a fair
allowance for the increased production that will follow
under the new plan, and waits for results. Under the
stimulus of payment proportioned to efifort, the rate of
production soon shows enormous gains; and the employer
finds that production has increased 50 per cent, 60 per
cent, or has even doubled, instead of increasing accord-
ing to the low per cent he allowed in discounting the new
rates. As a result, the men who were earning, say $2.75
per day, are soon earning $4 or more.

By this time the employer is likely to think that his


employees cheated him in the beginning, and, as a result
of this, are now receiving altogether too much pay; so
he proceeds to cut the rate per piece, and the trouble with
his workmen begins. They, on their part, soon discover
that they are between two fires; if they produce too little
their wages are small, and if they produce too much they
receive a cut, after which they must continue to work
harder and receive no more pay than they did formerly.
The natural result of this is an agreement between the
workmen in each class to limit their production to a cer-
tain amount which they consider safe. At this point the
piece-work system has broken down and failed in the pur-
pose for which it was introduced.

In studying the above instance, two conflicting lines
of action are seen. The employer is working for the
largest possible results for a given wage scale, and the
men are working to receive the maximum wages for their
time and work. The employer must have had in mind
that the wages would not increase much over what they
were before, or at least not in the same proportion as the
production increased. So he fails to see where he has
gained anything by his change of methods. The work-
men consider that they have been trapped by the cut in
the piece rate, and are correspondingly bitter over the

It is clear to be seen that the critical point here lies
in the rate per article. In the example given, the em-
ployer was ignorant as to just what the men could do;
and this is the basis of trouble in nine cases out of ten.
To establish a successful piece-work system it is essential
to set such a rate that, barring unusual business depres-
sion or some equally untoward event, it can be main-
tained fixed and unchanging.

If the employer wishes to approximate maximum pro-



duction, he must be prepared and willing to pay more
than the ordinary day rate he paid before; and no piece-
work plan will attain its object unless he takes that stand.
If he can afford to pay a certain amount for the making
of an article now, he can surely afiford to pay the same
amount per article when a larger number are produced
per day; and all the more so because the indirect ex-
penses are increased comparatively Httle for an increased
production in the same time, while, as these expenses are
distributed over a larger number of articles produced, the
cost of each article is proportionately decreased.

The first step necessary to determine the proper rate
is to get true records of the work that can be done. In
the matter of small, or wholly machine-made articles, this
is not difificult. If the operations are complex and in-
clude much handling of the material, it will be necessary
to separate the whole process into simple operations, and
fix a time for each one. The sum of these time rates,
plus a percentage for unavoidable delays, will determine
the time to be taken on the article as a whole. These
analyses are important items in establishing a cost sys-
tem; and experience has shown them to be the most ac-
curate and practical methods of fixing the proper rate.

(3) Differential (Piece) Rate Plan

The "Diliferential Rate" plan is a specialized piece-
work method modified by an application of time rate to
the work. The idea is to pay a certain piece rate up to
a certain amount of production in a given time, and above
that amount to pay an increased rate either on the whole
amount produced, or only on the output above the set

The considerations and cautions mentioned in the
straight piece-work plan are all applicable here, and with


double force, since the ideas are the same but more

The dififerential rate plan is devised specially to meet
conditions where the indirect expenses are relatively very
large. To get the best results in such a case the pro-
ductive capacity must be made as effective as possible
even at a sacrifice in the labor cost. What is lost there
will be more than made up by distributing the large
amount of indirect expenses over the increased output.
The principal disadvantage connected with the differential
plan lies in the danger of making ill-judged rates at its
introduction. The utmost skill and judgment are neces-
sary to guard against this. The differential rate plan
also calls for a well-organized supervising corps, the
actual increase of cost for this depending entirely on local
conditions, the nature of the shop, and the organization.

(4) Premium Plan

The "Premium" plan, together with its modifications,
differs from piece-work methods in basing the wages pri-
marily on a time rate instead of on the product, and then
paying extra wages for time saved in the operations. It
resembles piece-work in that it presupposes fixing a time
rate on the process of manufacturing single articles, or
on the separate steps in such processes. The fact that
it guarantees a minimum wage, at least, places it in a
more favorable light before employees, and often results
in less opposition on their part to its introduction than
they show toward the piece-work plan.

(5) Bonus Plan

Linked to the premium plan and related to it in gen-
eral principles, are the several forms of "Bonus" plans.
There is an increase of pay as the time to do a definite


amount of work is shortened; but instead of being cal-
culated directly from the time saved, it takes the form of
an increase in the hourly wages for the time actually
spent, the rate depending on the per cent of time gained,
and increasing in proportion.

(5a) Gillette and Dana Bonus Plan

A form of the bonus system described by Gillette and
Dana proposes to pay each workman a daily wage plus
a piece rate on each unit in excess of a specified minimum.
Thus, a laborer receives $1.50 a day for shoveling earth,
and on each cubic yard in excess of 15 cubic yards per
day, he receives a bonus of 7 cents per yard. If he shovels
25 cubic yards, he receives $1.50 plus $o.7o=$2.20.

(5b) Differential Bonus Plan

The "Differential Bonus" is much the same, except
that there is an increasing scale for big performances.
In the foregoing example the workman might receive 7
cents bonus for every cubic yard above 15, and an ad-
ditional 7 cents bonus for every cubic yard over 20. His
day's pay for the above work would then be $1.50 plus
$0.35 plus $o.7o=$2.55.

(5c) Gantt System

The Gantt system of differential payment is known as
"Task Work with a Bonus." A high standard is set, but
one entirely possible of attainment. The workman re-
ceives a regular day rate; and in addition, if he reaches
the standard, he is paid a lump bonus, which may be 25
per cent or 33 1-3 per cent more than his regular wages.
This system seems to have worked out very well in prac-
tice, and it is specially recommended as a good transition
step from the old day rate to some form of piece-work.


A very important feature of the Gantt plan is the
bonus that the foreman gets for every man under him
who makes his bonus. Thus, if a foreman had twelve
men under him and eight of the twelve made their bonus,
the foreman would get, say 80 cents bonus, or 10 cents
for each man. The result in practice has been to make
the foreman a teacher of the men, invariably giving his
attention to the men below grade in order to get them
up to the bonus standard.

(5d) Sundry Bonus Systems

The names "Merit," "Standard Operation Plan,"
"Gain-Sharing," and others, are sometimes given to wage-
payment plans worked out in particular shops or in-
dustries. If they differ at all from plans here described,
it is only in details devised to meet particular conditions.

Since the plans described as "Premium" or "Bonus"
are so closely related in object and principle, they may
be grouped together for discussion and comparison with
other methods.

In introducing a premium or bonus system, the same
caution must be observed as with the piece-work sys-
tems. It is essential to be quite sure of the correct
standard before the step is taken, if the disastrous re-
sults that have accompanied too high piece rates are to be
avoided. If an error is made on the side of too high a
scale, it is less costly than in piece-work, because the em-
ployer is not working on so narrow a margin; also, the
effect of such an error would be more evenly divided.

(6) "Stint" System

In the "Stint" system the appeal is made to the work-
man by a gift of all the time he may save. A certain
output is assigned as a day's or a week's work. If he


does it in less time, say seven hours, he has earned his
wages and is free to go home.

(7) Contract System and List Percentage System

Each employee is regarded as a contractor who has a
given time to finish a definite job. As in the case of the
"Stint" system, if he gets through beforehand he has
earned his wages, but, instead of leaving, he undertakes
a new contract. In some cases he is penaHzed if his
work is not done in contract time.

When the units of work are large, the foreman often
becomes the contractor, and becomes responsible for the
completion of the job. There is a wide amount of free-
dom in the arrangements for wage paying and profit mak-
ing between him and the management. Under the con-
tract system in its pure form, he hires his own men and
arranges the work as seems best to him, while the com-
pany allows him a certain amount for the job. Anything
that he saves out of this goes to him as profit. Strict in-
spection of his work is necessary, of course, to hold him up
to the proper standard.

(8-9) Profit Sharing and Stock Distributing

The "Profit Sharing" plan provides that the workmen
shall share in a certain percentage of the profits of the
shop as a whole.

Stock distributing makes the employee a part owner
in the business, and so gives him an interest and incentive
to use his best efforts for its welfare.

A special form of profit sharing which has proved suc-
cessful in operation, though it can be used only under
special conditions, consists in setting a price on every
article manufactured. The factory is charged only with
such expenditures as relate directly to the production of


this article and over which the factory management has
supervision. Credit is then given to the factory at these
scheduled prices for all articles produced, whether they
are sold or not. At the end of the year, or when an
actual inventory is taken, the factory account in the
ledger will show the factory profit, and will represent the
saving or difference between the actual cost and scheduled
prices. The saving, according to this plan, is distributed
among the foremen of the various departments, and some-
times among the employees as well, according to the rate
of pay of each. A penalt}' is provided for poor attend-
ance; and other penalties of various kinds may be incor-
porated in the plan, according to the conditions under
which it is operated.




Requirements of Cost Finding

The final cost of any order, article or process may be
divided into four principal parts, viz:

(i) Material cost

(2) Labor cost

(3) Department indirect expense

(4) General indirect expense

Three important considerations are involved in arriv-
ing at final costs.

(i) The cost data must be recorded.

Reports and forms are devised upon which are recorded
the various transactions involving raw or part-finished
material, the time spent by employees upon various jobs
and operations, the wages paid, and the amounts that go
to make up the various items of indirect expense. These
forms are the original records.

(2) The cost data must be compiled and dis-

The data, as recorded, must be arranged and classified
so as to facilitate the distribution of costs to the particu-


lar class of product, to the department, or to the opera-
tion, as the case may be.

(3) The cost books must be interlocked with
the financial books.

The cost books contain the data showing the analysis
of the elements of cost, all of which should be controlled
by the financial books, so as to permit of a verification of
the mathematical accuracy of the transactions in the cost

Recording the Material Cost

The transactions that deal with material may be classi-
fied as buying it, receiving it, storing it, putting it into
operation, tracing it, and re-storing it as part-finished or
finished stock. Part-finished stock includes all parts of
the product made in different parts of the plant and
transferred either to stock or to an assembling depart-
ment. Any product on which the operating processes
have begun but are not yet finished, is termed work in
process, except where part-finished stock is transferred
from Work in Process account to Part-Finished Stock

The forms upon which information about material is
ordinarily recorded, are:

(i) Purchase Requisition

(2) Purchase Order

(3) Material Received Sheet

(4) Stock Record — Raw Material

(5) Production or Factory Order

(6) Material Requisition or Bill of Material

(7) Inventory Test


When the information on any of these records is to
be used by different departments, carbon copies should
be provided, the duplicates being distinguished by differ-
ent headings, colors, or textures in the card or paper.

(i) Purchase Requisition (Form i)

A "Purchase Requisition" is a request for the pur-
chase of raw material or supplies, made out preferably
by the stores clerk, but sometimes by the superintendent,
or the man in charge of the department requiring the
material or supplies. Every factory should determine
standard maximum and minimum amounts of raw stock
and supplies to be carried, below which it is not safe to
go on account of the risk of delay in filling orders, and
above which it is inadvisable to go on account of the
capital that would be tied up. This being settled, the
maximum and minimum amounts to be carried should
be posted where the material is stored, and should also
appear on the stock record. When the amount on hand
approaches or passes the minimum, a purchase requisi-
tion is made out, and after being approved by some per-
son in authority, is sent to the purchasing department.
A rush order should be so indicated on the requisition.

A form of this description does not usually enter into
the practical part of a cost system. It may be properly
termed an organization form, pure and simple. It must
clearly indicate the material desired, but beyond this al-
most any design will answer the purpose intended, as the
information on the form is not often needed after the goods
ordered have been received.

(2) Purchase Order (Form 2)

The filing of catalogues and quotations is a matter of
ofBce organization, and only the purchase order concerns



the cost clerk. The form is made out in duplicate, or in
as many more copies as desired. The original copy goes
to the selling firm, and the duplicate is kept by the pur-
chasing concern on the file of unfilled orders. The purchase
order is given a serial number, which should be entered
by the selling firm on its invoice, as a means of simplifying
reference to the order if any question arises.

Should it be desired to use a copy of the purchase
order as a material received record, short width carbon
paper is used, and a triplicate copy made containing the
items only, without specifying the quantity or price. The
copy goes to the receiving clerk, who then enters in the
"Quantity" column of the order the actual amount of
material received. The receiving clerk is thus compelled
to count or measure the incoming material, and cannot
shirk this duty by using the figures on the purchase or-
der. When the goods have been received, counted and
inspected, the triplicate is returned to the office for the
purpose of checking it with the material as billed upon
the invoice from the creditor; and claims for shortage or
damaged goods can then be made at once.

(3) Material Received Sheet (Forms 3 and 4)

Where it is not advisable to use a copy of the pur-
chase order as a material received record, a distinct and
separate form is used.

The choice of forms for this purpose will depend
largely upon whether charges consisting of freight, dray-
age, etc., on raw material received are to be added to the
material cost. If this is not the case, a very simple form
will answer the purpose; but if such charges are included,
the design will depend largely on the class of product re-
ceived and the distribution of the charges.

Provision should be made on the material received


record for showing the purchase order number, the items,
name of article, quantity, and the apportioned amount
of freight and deHvery charges for each item, if these
charges are to be added to the material cost. If the ma-
terial is to be used at once, especially for certain orders
or departments, columns may be provided for recording
the distribution of the cost and the charges.

If the goods are not to be opened until they are used
in certain departments, the invoice must be accepted
temporarily as the record, and any "over, short or d...ii-
age" claim made later. It will be seen that the purchase
requisition, purchase order, material received sheet and
invoice act as a complete check of the transactions from
four different sources. One reason for using a material
received sheet to report goods received, instead of fol-
lowing the usual method of checking up from the invoice,
is to insure an actual count and inspection of the goods,
with the resulting accuracy secured, instead of depending
entirely upon the honesty or carefulness of the clerk re-
ceiving the goods or checking them ofif.

(4) Stock Record — Raw Material (Forms 10, 11, 12)

The "Stock Record" is one of the most important of
the factory records. It bears the same relation to stock
that the cash book does to money, and should be kept
with just as much care as the cash book. Stock repre-
sents money, and is, indeed, only another form of it. In
the same way that the cash book shows the receipt and
disbursement of money and the balance on hand, the
stock record shows the material received, material de-
livered, and what should be in the storeroom.

The effectiveness of a stock record depends much on
the actual storeroom accommodation, and on precau-
tions taken for not allowing any but properly authorized


persons to remove material from its designated place. If
access to the storeroom is easy for anyone, material is
likely to be taken to fill orders when the material requisi-
tion is incomplete; or the men will replace material dam-
aged in process, without making a record of such with-
drawals. The latter is an important leak, and must be
watched closely, for if it exists, it both falsifies the costs
and creates trouble in the stores department.

The storeroom should be centrally placed, unless a
separate storeroom is conducted for each department. In
the latter case the storeroom and tool-room may be run
in connection with each other. The racks, bins, etc.,
should be arranged with reference to the materials, so
that the whole will have an orderly appearance and not
look like a junkroom. Disorder in appearance tends to
create disorder in handling. The matter of bin tickets
and finding lists, etc., depends on whether the stores are
complex and contain a great variety of articles more or
less similar.

To record the location of material and to save time
and space, a system of reference numbers and letters
should be devised. Thus B-4-C-17 might mean a 4-inch
bolt to be found in division C, section 17, in the store-
room, where B is the reference letter that stands for all
bolts. These symbols may be used throughout the sys-
tem of records and accounts with a great saving of time
and trouble.

Special storerooms or yard places should be reserved
for heavy and cumbersome materials, close to the place
where these materials will be needed.

A systematically conducted stock record performs
other valuable functions besides showing leaks. One of
the most important of these is to provide the data for the
"perpetual" or "going" inventory. The troubles of in-


ventory taking are well known. It usually takes a long
time, causes much work, and sometimes necessitates the
temporary closing of the plant. Even then the accuracy
of the inventory is questionable, especially as to goods
in process; yet its information is essential in the prepara-
tion of any reliable statement of financial standing and
earnings. With a well-kept stock record these usual in-
ventory troubles are avoided, as a complete inventory is
at hand at any time, showing both the amount and the
value of materials in the storeroom, in process, and in
finished parts. In order to do all this, the record must
be designed with columns for material ordered, received,
requisitioned out, and balance on hand.

Besides these columns for inventory information, extra
columns may be added to distinguish between material
reserved for orders already received and the balance
available. This distinction, together with the record of
the maximum and minimum amounts, and a column show-
ing material ordered but not yet received, gives all the
information necessary for keeping the stock supplies up
to working requirements in every respect.

When the same article is carried in stock in numerous
sizes, colors, styles, etc., it is sometimes advisable for easy
reference to use one sheet for the article as a class, and
group the different varieties in separate columns. Active
stock will require separate sheets for each article; but
where purchases are infrequent and the stock is drawn out
in large quantities, one sheet may be sufTficient for sev-
eral, blank lines being left between the different articles.

The stock record should be verified from time to time
by actual count, so that any discrepancy or leak may be
discovered. It is good policy to verify a certain number
of articles each day or week, without letting it be known
in advance which articles are to be inventoried. This


plan is described in connection with the inventory test
(Form 60).

(5) Production or Factory Order (Forms 13-17)

The importance of the production order depends on
the functions it is designed to perform. In practice it
ranges from a mere informal notice to begin operations upon
a certain class of work up to a complete controlling and
cost-finding agent of a special order. Its primary pur-
pose is to substitute written for verbal instructions, so as
to avoid mistakes. Besides this, it may be so designed
as to describe the order, state the material, patterns and
dies needed, plan the work as to time and department, trace
the work at any stage, report the actual production and
classify it as good or defective, collect the costs as they
are incurred, and also show their distribution. It is not
recommended, however, that the form be used for all these
purposes, except under certain conditions in a special order

Production orders are of three kinds, and each kind
should have a distinctive size, color, or heading, as the
costs incurred are of different nature and must be charged
to different accounts. The three classes of orders are:

(i) Manufacturing production order, which ap-

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Online LibraryJerome Lee NicholsonCost accounting, theory and practice → online text (page 5 of 19)