quite sufficient to show that the selling price is too erratic and that
expense will be found more reliable when figured at cost price, which
method has, therefore, been adopted as the best practice.
=5. Expense Based on Cost of Labor or Material.= Having decided that
expense should be reduced in some manner from the direct cost price
rather than the selling price, it is remembered that we still have two
items of cost to choose from: The labor cost and that of the material.
There are those who maintain that the material cost is the correct
starting point for calculations, but there are few manufacturers, if
any, who do this.
An attempt has been made to use the combined total of labor cost and
material, but this method is hardly worthy of serious consideration.
The best practice points almost without argument to the labor cost as
the true basis of expense; this is not only the logical conclusion but
common sense:
(a) It is easy to see that the elements which go to make up the expense
of operating a factory──foremen, sub─foremen, supervision, shop clerks,
toolkeepers and grinders, helpers, the up─keep of tools and machines,
lighting, etc.──are all closely related and largely dependent upon
the number of men employed. Reduce the number employed and it will be
seen at once that some of the above mentioned items of expense can
be cut; less supervision is required and the wear and tear on tools
and machinery is also reduced. It is difficult to see wherein any
difference in cost of the material used would of itself cause any
increase or decrease in the factory expense or even be influenced by
it. It is quite contingent on the labor.
(b) That the cost of the material is not a reliable basis for
calculating expense can be quite satisfactorily demonstrated. If the
cost of an article is, say, labor $25.00, material $50.00, with expense
to be figured at 50% on material, or $25.00, it is seen at once that
the manufacturing cost would be:
Labor $25.00
Material 50.00
Expense 25.00
────────
Cost $100.00
Suppose this article were duplicated under the same identical
conditions and cost, using only this time material that cost $60.00.
It is a fair proposition that the total cost would be but $10.00 more
than in the first instance, or $110.00. But if the percentage is added
on the material as before, it is found that the expense this time is
$30.00, which would make the cost appear thus:
Labor $25.00
Material 60.00
Expense 30.00
────────
Cost $115.00
It is now noted that the cost figures $15.00 more than in the first
instance, while we are quite ready to admit it should be but $10.00,
the only difference being in the cost of the material.
=6. Conclusions.= Having established the fact that the expense is a
legitimate charge to the cost of production, we are now quite safe
in laying down for our foundation the proposition that expense is
contingent on, and should be figured from, the direct labor value of
the cost price.
METHODS OF DISTRIBUTION
=7.= Time is continually bringing improvements; old methods once
thought practical and satisfactory are replaced by more efficient
ones to meet the exacting conditions of to─day. Examine a _Practical
Bookkeeping─Manufacturer's Edition_ of thirty or forty years ago
and you will probably find nothing on this subject of _expense
distribution_, while to─day it is one of the most important and most
discussed of any in factory accounting in general, and cost accounting
in particular. Since that time different methods of handling expense
have been devised, some with more or less merit. It will be the intent
of this section to consider at some length three of the most frequently
used of these methods, endeavoring to find one which will, in the most
equitable manner, distribute into production the operating expense of a
factory with the least amount of detail and unnecessary figuring on the
part of the accountant; and at the same time prove satisfactory from
the manufacturer's standpoint.
=8. The Man─Hour Rate Method.= This method, once quite popular, is now
but little used, and it is doubtful if it can be found in operation
in many up─to─date plants at the present time. The name of the method
suggests its intent, which was to distribute factory expense over the
various production job orders according to the amount of time spent by
the workmen at an hourly rate. This rate is easily calculated, and was
established by dividing the total expense for any period by the total
number of hours spent on productive work for the same period, reducing
the rate of distribution to so much per hour. If 100 hours of labor
were spent on a productive job, the cost of the wages paid the workman
for this time was not considered, the expense to be borne by the job
being figured at the hourly rate for the 100 hours. It will be seen
that this is hardly an equitable arrangement, and to rectify a serious
defect in the method, some adjustment must be made:
(a) The inability to fix a standard for the efficiency of the labor
lays the man─hour rate open to criticism. Could this be done, this
method would in many cases prove a very equitable way of distributing
expense. It will, however, be seen at once that as it is, a skilled
workman carries no more expense than an apprentice boy, and if both
work on a productive job a full week, the expense in either case is the
same regardless of the wages paid. This is hardly a fair proposition.
Either the apprentice's time must be accepted as standard and the
skilled workman considered twice as efficient in work─hours, or _vice
versâ_. To do this would lead to endless complications, yet the
quantity and quality of the output between these two classes of labor
should be considered and adjusted in some way so that the injustice
done the manufacturing cost may be corrected. But this is not an easy
matter to regulate, and means extra work on the part of the cost
clerks in recording the time spent on job work and adjusting these
inequalities in the labor.
(b) The man─hour rate requires that the hours worked be carefully
recorded and totaled, as well as the cost. Many concerns with heavy
pay─rolls to be apportioned over a large number of job orders, ignore
the footing of the long columns of hours and fractions, and use only
the totals of labor cost, which are of course necessary for entry in
the commercial books. It is obvious that in doing this an immense
amount of clerical labor is saved. The man─hour method requires that
both hours and labor cost should be recorded and totaled──a double
operation and duplication of work, which, unless it can be simplified,
should be avoided, as it means time and unnecessary expense.
=9. Machine─Hour Rate Method.= This machine─rate plan of distributing
expense was designed to meet the needs of a shop where the product is
largely the result of a machine or tool operation, rather than the
labor of the mechanic himself. It somewhat resembles the man─hour plan
in that the rate of distributing expense is reduced to an hourly rate
for the time the machine is working on the job instead of the time of
the operator. Each machine is intended to have its own rate.
The method of arriving at the machine rate is easily understood, and
reduces itself to the item of depreciation on the original cost price
of the machine with its shafting, belting, tools, and installation cost
figured at, say, 5%, the power to operate machine at an estimated cost
per horse─power, ordinary repairs, divided by the number of hours the
machine is estimated to be in operation for the same period; this will
give the hourly rate of cost to operate. Some mechanical engineers
advocate including in the above cost, interest on the investment at
6%, also insurance and taxes; and by others, the value of the floor
space occupied by the machine is also included; but in all these latter
points referred to, engineers greatly differ in opinion, and it is
generally decided by each manufacturer for himself according to his own
ideas.
On the question of the value of machine rates there is probably more
argument by mechanical engineers and accountants than on any question
in factory accounting; in fact, engineers themselves are very far
apart in their opinions and do not seem to agree among themselves.
Accountants generally are inclined to take a somewhat different view of
the situation from our mechanical friends. While it is admitted there
is good argument for both positions, it is to be remembered that we are
considering the question of machine rates as a means of distributing
the expense account, and it seems to be the prevailing opinion among
accountants that as such it is found wanting. While, theoretically,
it is undoubtedly the correct solution of the problem, it is more
often found in practice to be a case of a "distribution that does not
distribute," and for this reason is not used by the very class of
factories and machine works for which it was designed and intended to
benefit.
Let us consider in detail a few of the objections that may be raised to
the machine─rate method:
(a) It will be noticed there are other expenses in the shop than
that of operating the machines and not covered at all by the machine
expense. Machine rates are absolutely worthless for bench labor and
the assembling room, for these two must also share in carrying the
shop burden. Not to do so would be manifestly unfair. It is therefore
necessary that a second distribution must be made entirely different in
its calculation, to handle this undistributed expense not covered by
the machine rates, which means two different operations for the same
shop.
This necessitates two different time records to be kept, one card
for each machine showing jobs worked on and hours idle, and another
time card for the workman. Is is easy to appreciate that this double
operation greatly increases the clerical work in the shop, besides two
sets of entries by the cost clerks, and more detail for all concerned.
If a method can be found which requires but one time record to be kept,
this double process can be done away with and the duplication of work
avoided.
(b) The principal factor in the calculation of the machine rate, in
fact, the real key to a successful calculation, is in establishing a
standard of work─hours for each machine. It is noted that the higher
the standard, the lower will be the rate, and the lower the hours
operated, the higher will be the rate; in other words, when the
machine is idle in excess of the standard, the rate changes. In some
shops where the output is a stable product, always in demand, and the
machine in continuous operation, a good estimate may be made, but in
most shops a machine is frequently idle on account of "no work" or
"laid up" for repairs the same as is its operator. The practice in most
shops is such that it is extremely difficult to estimate ahead what the
work─hours of a machine will be, and it resolves itself generally into
an intelligent guess with two estimators far apart in their estimates,
yet a satisfactory distribution requires a standard which will work out
in figures close to the actual facts.
Who can successfully estimate ahead for any time the activity of each
machine in a large factory? Our factory engineers are at wide variance
on this point. One authority says "full time," 300 days a year, is the
proper basis for calculation. It would seem as if this were rather an
unusual position to take; it apparently being his belief that the time
idle would be offset by the time the machine was operated overtime, or
else he expected the machinery once put in motion to neither shut down,
nor break down. Either appears to be rather a dangerous assumption on
which to base a careful calculation for rate of distribution.
Another engineer says 80% of a full day will be found to be the
maximum, and further adds: "It will doubtless fall much below that
figure." One naturally asks "How much lower?" There is quite a large
field of figures to choose from between an 80% activity and a dead
standstill for the machine.
It is quite unnecessary to attempt to demonstrate at length that the
work─hour standard may be a very elastic figure, and it is often
found that after distribution has been made, the results are very
unsatisfactory and the machine rates used have proved "way off."
(c) Again, having settled on the work─hour standard, other adjustments
appear necessary to equitably handle the machine rate question. For
instance, two machines may be of the same book valuation and in cost
of operation practically alike, yet one may be far more efficient than
the other and possibly turn out two or three times as much work. This
condition is constantly found in different shops, and whether or not
the two machines should carry the same rate, and, if not, how this
inequality shall be adjusted, forms a very interesting question for
discussion.
(d) It is noted that the essentials in the calculation of machine rates
are all based on estimates which may or may not prove correct; that
positive book figures are lacking; and that the calculations are made
on assumptions. One of the best professional opinions noted is that
expressed by one of our leading accountants, who, commenting on the
question of machine rates, observes that "it begins with estimating and
is estimating all the way through." This appears to be rather severe
criticism, yet one has but to give the subject careful consideration to
note that it quite correctly sums up the situation in a few words.
As previously stated, the machine─rate method is without doubt
theoretically correct, but, until the subject has been more thoroughly
elucidated and worked out in all its details to fit shop conditions and
furnish a satisfactory means of distributing expense, it is doubtful if
it will be used to any great extent. This method certainly requires an
elaboration of system and detail, with questionable results, and with
many serious objections apparent; it seems pertinent, therefore, to ask
the question "Is it worth while; cannot something better be devised?"
=10. The Percent Method.= A third plan of distribution, commonly
referred to as the _percentage method_, differs from the two already
outlined, in which the time employed was the basis of operation, in
that the rate of distribution is a percentage on the direct labor cost
of the product, which is, of course, commensurate with the amount of
time expended. In the first division of our subject, it was shown that
expense figured on direct labor would prove the most reliable.
This method is based on the principle that the production of each
department of a plant should shoulder its own expense, and also a share
of the general expense. In other words, the cost of the output from the
_Blacksmith Department_, for instance, would be the total productive
labor of the department, plus the material used, plus the operating
expense of the department, plus its share of the general expense of
the whole plant. It is only necessary, then, to establish the relation
between the productive labor and the expense, and express the same in
a percentage. It is immaterial how many departments or processes there
may be in the factory; this relation should be found in each case,
based on its own productive labor and expense, each department having
its own percentage ascertained from its own actual conditions; no
estimating about it. The expense, then, is figured on the labor cost.
If, in the _Blacksmith Department_ already referred to, it is found
that the expense at which the department is operated is one─fourth
of its total productive pay─roll for the same period, it is at once
apparent that if to the labor cost of every productive job, 25% is
added for shop expense, the total of these expense items added will
equal the total expense of the department. In other words, the shop
expense is split up and added to each job in proportion to the labor
expended on it.
The general expense is handled the same way. If the total general
expense is found to be one─third of the total productive labor in
the plant, it is likewise apparent that, if to the labor of every
productive job, 33⅓% is added to cover general expense, the sum
total of these percentage items added will equal the total general
expense of the plant.
Following, then, the formula outlined at the opening of our discussion
under the heading of _True Cost_, the cost of a job done in the
_Blacksmith Department_, on which the direct labor cost was $100.00,
would appear on our records as follows:
Direct labor $100.00
Material 50.00
Factory expense at 25% 25.00
────────
Factory cost 175.00
General expense 33⅓% 33.33
────────
Manufacturing cost $208.33
This is the _percentage method_. While it is quite natural in anything
of value and merit to look for its imperfections, this method is
criticised by some accountants who point to flaws in its logic and
method of computation; nevertheless, it stands to─day as the best
solution of the vexed question of expense distribution that has yet
been devised, for it not only has the approval of our best technical
authorities, but that of the practical accountant as well. It commends
itself to the intelligent judgment of the manufacturer, who is quick to
realize its superiority, and it can be recommended for many reasons:
(a) It is based on actual figures, easily extracted from the regular
books of account, and which are a true statement of fact; no guess─work
or estimating about it. There is no better way to figure what is to be,
than to use results of what can be conclusively demonstrated already
has been.
(b) It can be used in any manufacturing plant, or in all the
departments of the same plant, thereby insuring uniformity of method,
which is always desired. No argument is necessary to convince that two
methods in the same factory are undesirable when one can be found that
is satisfactory.
(c) It accomplishes its purpose──it distributes. If it is found
that factory conditions are changing, the percentages used may also
be changed so as to increase the amount of expense distributed, or
diminish it, as necessary.
(d) It requires less work for the cost accountant. The man─hour plan
requires the hours worked to be recorded and footed in addition to
the labor cost. The machine─rate plan requires not only two different
calculations, as already shown, but also necessitates the adding of
all the hours worked. The percentage plan requires only the labor cost
in money value, and renders the recording and adding of long columns
of hours entirely unnecessary, which, as can readily be seen, is an
immense saving of labor. In a large plant with an elaborate system of
job orders to be handled, the value of the percentage method, in doing
away with this double calculation, will be appreciated immediately.
[Illustration: BROOKLYN, N. Y., PLANT OF THE H. W. JOHNS─MANVILLE CO.]
(e) Figuring by percentages can be done rapidly, and in many instances
it is but a mental calculation and almost instantaneous. Were hours
recorded, the frequent use of fractions would render the process of
figuring expense less rapid.
(f) It is an equitable means of distribution, for it is based on the
direct labor cost, which is not only the most reliable element of cost
to use as a basis, but which is one of the principal factors by which
the amount of expense is influenced.
(g) It has the endorsement of our best factory accountants and
auditors, and it is noted that where "systems" are being installed by
factory organizers to─day, the percentage method is continually being
adopted as the most satisfactory, for it brings the best results with
the least machinery to operate.
PERCENTAGE METHOD EXEMPLIFIED
=11.= Before proceeding to show in detail the method to be pursued in
arriving at the various percentages to be used in distributing expense
by the _percentage method_, it may be well at the outset to clearly
understand what constitutes _productive labor_ and _expense_, or
_non─productive labor_, for it is on the former that all calculations
are based.
=12. Productive Labor.= The wages paid to the workmen for labor spent
on productive work which is offered by the manufacturer for sale,
and from which the business derives its regular revenue, is properly
classed as _productive labor_. In other words, the amount of productive
labor is commensurate with the productive output.
It is frequently asked whether labor spent on plant extensions or new
equipment, when made for one's own use, may be considered productive
labor and should carry its share of the expense in its distribution.
Most assuredly, yes. If this same work were performed to be sold again
in trade it would be considered productive labor and the expense would
be added. The reverse is also true; if it were purchased from another
manufacturer he would treat it as productive labor, and include expense
in his cost and selling price, and the purchaser would have to pay
for it, and would carry same in his ledger, in his plant or equipment
accounts, and on his balance sheet as an asset. The only difference,
if any, is in making new equipment himself, in which case it goes on
his books at the cost price to him, thereby saving the manufacturer's
profit he would have to pay if he purchased it. Is it, then, any less
productive labor because a manufacturer prefers to make his plant
extensions or new machinery, himself, instead of buying? It does not
appear so; it certainly is productive labor.
=13. Non─Productive Labor.= All other labor, not distinctly productive
as just outlined, must be classed as non─productive. This includes
_clerks_ and _offices_, _foremen_, _assistants_, _watchmen_, _repairs_
and _renewals_, _small tools_, etc., and all the many expense men
not working on product but necessary to keep the plant in repair and
operation. Non─productive labor is a question of keeping the factory
organization and management up to concert pitch, and is not regulated
by the quantity of production.
Inter─department work in a plant often raises an interesting question.
Shall labor expended by one department on repairs for another
department receive credit for same as productive labor? The foreman
of the department often claims that the repairs his men are doing
for another department are just as much production, so far as he is
concerned, as though his men were building a machine for sale, and
should shoulder part of his expense. In a certain sense, all labor is
productive, and from a selfish point of view, the foreman's argument
is a fair one. But from the broader view of the manufacturer, all
such inter─department repairs, or similar work, are a part of the
operating expense of the plant, and are necessary for the up─keep of
the equipment; they are not made for sale, as is a production order,
and must be carried as expense──non─productive labor.
=14. Expense and Production Cost Ledgers.= Without digressing from
our general subject, it may not be out of place at this point to
call attention to a most convenient method of keeping cost records.
Inasmuch as the cost of production must absorb the expense costs of
manufacturing, it will be found advantageous to keep these two classes
of accounts in separate binders, putting all the non─productive labor
cost records in one binder, calling it _Expense Ledger No. 1_, and all
the productive labor in _Production Ledger No. 2_. When the expense
distribution is to be figured, it will be noted that all the entries
will be made in _Ledger No. 2_, while _Ledger No. 1_ furnishes the
amount and details of expense to be distributed.
=15. Period for Comparisons.= Having shown that our percentages of
distribution are based on the relationship of total expenses to total
of productive labor, the first step in our calculation is to draw off
from our ledgers a statement of each for the same period as a basis for
comparison.
[Illustration: Fig. 1. Private Ledger Labor Account]