N A T I O N A L ASSOCIAT ION

of

C O S T A C C O U N T A N T S

v

Official Publications

Vol . 1 J U N E 1 9 2 0 N o . 5

Indu str ia l Accou nt ing a sa n Aid to Ma na gem ent

WOOLWORTH BUILDING233 BROADWAY NEW YORK CITY

NATIONAL ASSOCIATION OF

COST ACCOUNTANTS

Vol. I No. S

Official Publications

Industrial Accounting asan Aid to Management

HOMER N. SWEET, Ph. B ., C. P. A. (Mesa.)

Member of the firm of

LYBRAND, ROSS BROS. and MONTGOMERY

WOOLWORTH BUILDING233 BRO AD WAY N E W Y O RK CITY

June 1920

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The National Association of Cost Account-

ants does not stand sponsor for viewsexpressed by the writers of art icles issuedas Publications. All art icles are examinedby the Committee on Publications and whenthey are believed to contain ideas of valuethey are published regardless of whetheror not the then members of the Committeeagree with those ideas.

National Association of Cost Accountants

INDUSTRIAL ACCOUNTING AS

AN AID TO MA NA GE ME NT

PRIMARY FUNCTION OF INDUSTRIAL ACCOUNTING

The test of industrial accounting as applied in any manufac-turing plant is its utility as an aid to management. A system ofindustrial accounting, to be of practical worth, must serve as adependable guide to the executives in the administration of manu-facturing operations. It will be found that the best organizedconcerns have developed forms of current reports that reveal tothe executives variations between actual and standard performancewhich in turn point the way to economies and increased output.

The failure of many small plants to expand their businesshas been due to the fact that the executives have not learned toavail themselves of records as a means of control and direction ofproduction. The scope of their administrative capacity accordinglyhas been restricted. They have not appreciated the possibilitiesfor production on a larger scale and for reductions in cost whichawait the development of an adequate scheme of industrial account-ing. Failing to perceive these possibilities or the means of real-izing them, they allow the department of accounts to remain amere annex to the factory instead of making it an essential andvital part of the organization.

Production upon a large scale cannot be undertaken success-fully without dependence upon industrial accounting. This hasbeen demonstrated by the experience of the larger corporations.The successful ones have spared no effort or expense to organizetheir industrial accounting methods so that the results could beput into practical use from an administrative standpoint. It wouldnot be possible otherwise for the managing heads of the largest

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RELATION OF UNIT COSTS TO SELLING PRICES

The relation of unit costs to selling prices is frequently mis-understood. A business man must rely to a great extent upon hisjudgment and sagacity in reaching a decision as to what prices toquote or accept. With him it is more a question of trading andforecasting the future than deducing from records of past costs.From a manufacturing standpoint, however, the relation of unitcosts to selling prices has an important bearing in management.Let us consider the significance of that relation.

Selling prices usually hold for a season or contract. The priceof a 1920 model of an automobile under conditions imposed bycompetition must be announced at the beginning of the season andcannot be changed ordinarily after allotments have been arrangedwith distributors. Textile mills make their prices known at the"opening" twice a year and are thereupon committed to a fixedschedule for six months. This principle is not confined to concernslike automobile plants which turn out one type of car varyingslightly in models or to textile mills which weave a limited lineof styles in one grade of cloth, for it is inherent also in the opera-ting methods of plants which manufacture a variety of products.The prevailing practice, which affects nearly all trades and fac-tories, is that orders must be taken at a price prior to production,or in quantities larger than it is practicable to carry in stock.Orders taken to be billed at prices current at time of shipment istemporarily in vogue in certain trades, but this cannot persist asa general business practice under normal competitive conditions.

Selling prices as fixed or accepted by the manufacturer arebased on assumed costs of labor, material and expense. His judg-ment is that the margin between the selling pr ices and assumedcosts is wide enough to allow him a profit. Otherwise, he wouldnot accept the orders., The profits which are actually realizedafter production has been completed and sales have been con-summated depend largely upon the success of the manufacturer inkeeping his costs within the bounds set in fixing or accepting sell-ing prices in advance of production.

Knowledge of unit costs of products completed in a prior

'Occasionally i t may be advisable for a manufacturer to accept orders whichwill produce a loss instead of yielding a profit, but this is an in-frequent exception to the general rule.

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National Association of Cost Accountants

INDUSTRIAL ACCOUNTING AS

AN AID TO MANAGEMENT

PRIMARY FUNCTION OF INDUSTRIAL ACCOUNTING

The test of industrial accounting as applied in any manufac-turing plant is its utility as an aid to management. A system ofindustrial accounting, to be of practical worth, must serve as adependable guide to the executives in the administration of manu-facturing operations. It will be found that the best organizedconcerns have developed forms of current reports that reveal tothe executives variations between actual and standard performancewhich in turn point the way to economies and increased output.

The failure of many small plants to expand their businesshas been due to the fact that the executives have not learned toavail themselves of records as a means of control and direction ofproduction. The scope of their administrative capacity accordinglyhas been restricted. They have not appreciated the possibilitiesfor production on a larger scale and for reductions in cost whichawait the development of an adequate scheme of industrial account-ing. Failing to perceive these possibilities or the means of real-izing them, they allow the department of accounts to remain amere annex to the factory instead of making it an essential andvital part of the organization.

Production upon a large scale cannot be undertaken success-fully without dependence upon industrial accounting. This hasbeen demonstrated by the experience of the larger corporations.The successful ones have spared no effort or expense to organizetheir industrial accounting methods so that the results could beput into practical use from an administrative standpoint. It wouldnot be possible otherwise for the managing heads of the largest

corporations to gauge the relative efficiency of numerous andwidely scattered manufacturing units.

The writer is not referring to the general accounts of acorporation which are reflected in the profit and loss statement.Such accounts are of great value, of course, for they show theprofits which have been earned over a period as the result of thecombined activities of financing, purchasing, manufacturing, andselling. Such statements should be available for the executives,directors and stockholders. This, however, is not the function ofindustrial accounting. The task of the manager in charge ofmanufactur ing is, in a word, to produce goods in sufficient quantityan d a t l ow cost . He i s consta n t l y a i ming to effect r eductions incost. I t ma y be sa i d a l m ost th a t h e ha s to sha pe t h e p r ofi t a n dloss sta temen t before the record thereof can be wri tten on thebooks. He kn ows in a dvan ce of product ion , as a rule, wh a t t h esell ing pr ices are and his problem is to so organ ize production thatthe goods can be turned out a t a cost commensurate with theknown selling prices. In di recting production on a large scale, heneeds r eports wh ich wil l disclose whether the output of the factoryis m ea sur i ng up to the standard which he has planned, whetherla bor cos t s for th e fa c tor y a s a wh ol e a re bei n g kep t wi t h i n t h ebounds which wi l l a llow a fai r profit , whether mater ia ls are beingutilized without excessive waste and whether the overhead ex-penses of the producing and non - producing departments are beingconfined within the predetermined limits of a budget. Theseobjects are accomplished through indust r ia l accoun ting.

I t is evident that the planning of an adequate scheme ofindust r ial account ing as adapted to a par ticular plan t i s pr imar i lya problem of organization and management. I t should be at-tempted on l y by one who is famil iar wi th the opera t ing r equire-men ts of the business and who un der stan ds the necess i t ies of or -ganization in large industr ies. The factors of cost and output whichhave the greatest in fluence on ul t imate profi t s must be discernedand practica l means must be found for transla ting them in to char tsor reports. A sui tabl e type of syst em a nd const r uct i on of i t s de-tail s cannot be determined without an understanding of the generalopera ting policies of the business.

REQUISITES OF INDUSTRIAL ACCOUNTING

The requisi tes of an effective system of -'�--`-� �°' °�°�°� ••-� =�-�may be summed up as follows:

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First: It should furnish comprehensive information, whichcovers the entire field of manufacturing operations of the businessand includes all the factors which the manager in charge of manu-facturing should watch and control.

Second: It should furnish information in condensed form, forexecutives have little time for consideration of details and hencemust focus their attention upon significant figures which exhibitresults in perspective.

Third: It should supply information promptly, for otherwiseopportunity for correction of inefficiencies in operation may be lostor postponed too long.

The ordinary profit and loss statement does not fulfill theserequirements. It is not expressed in terms which alone wouldenable a factory manager to discover inefficiencies. The task of themanager in charge of manufacturing, as has been stated, is to keepthe items of manufacturing cost within limits which will resultin a profit. He must control operations and introduce economiesand corrective measures with a mind to their effect upon the profitson orders yet to be processed. A profit and loss statement ismerely a proof of what his efforts have accomplished with respectto orders already completed. It does not disclose the facts whichwould permit him to minimize the costs of future operations.

MEANING OF THE TERM INDUSTRIAL ACCOUNTING

The term "industrial accounting," as used in this article, isequivalent to cost accounting in its broadest sense and denotes asubject of wider scope than is ordinarily conveyed by the term"unit cost accounting." Unit cost accounting is an importantdivision of industrial accounting. Unit costs must nevertheless beresolved into composite figures to be useful in management fromthe executive's viewpoint. An executive cannot, for lack of time,inspect the unit costs of a variety of products, though he should byall means insist that unit costs be compiled and reviewed by hisfactory accounting department. He must confine his attentionneccessarily to the main factors which, if properly controlled, makefor low cost in the production of all articles in the plant. Theunit costs will take care of themselves, if a manager maintainsproduction in large volume, controls and reduces labor costs andexpenses in the aggregate, and insures economical use of materialsand supplies.

RELATION OF UNIT COSTS TO SELLING PRICES

The relation of unit costs to selling prices is frequently mis-understood. A business man must rely to a great extent upon hisjudgment and sagacity in reaching a decision as to what prices toquote or accept. With him it is more a question of trading andforecasting the future than deducing from records of past costs.From a manufacturing standpoint, however, the relation of unitcosts to selling pr ices has an important bearing in management.Let us consider the significance of that relation.

Selling prices usually hold for a season or contract. The priceof a 1920 model of an automobile under conditions imposed bycompetition must be announced at the beginning of the season andcannot be changed ordinarily after allotments have been arrangedwith distributors. Textile mills make their pr ices known at the"opening" twice a year and are thereupon committed to a fixedschedule for six months. This principle is not confined to concernslike automobile plants which turn out one type of car varyingslightly in models or to textile mills which weave a limited lineof styles in one grade of cloth, for it is inherent also in the opera-ting methods of plants which manufacture a variety of products.The prevailing practice, which affects nearly all trades and fac-tories, is that orders must be taken at a price prior to production,or in quantities larger than it is practicable to carry in stock.Orders taken to be billed at prices current at time of shipment istemporarily in vogue in certain trades, but this cannot persist asa general business practice under normal competitive conditions.

Selling prices as fixed or accepted by the manufacturer arebased on assumed costs of labor, material and expense. His judg-ment is that the margin between the selling pr ices and assumedcosts is wide enough to allow him a profit. Otherwise, he wouldnot accept the orders.' The profits which are actually realizedafter production has been completed and sales have been con-summated depend largely upon the success of the manufacturer inkeeping his costs within the bounds set in fixing or accepting sell-ing prices in advance of production.

Knowledge of unit costs of products completed in a prior

'Occasionally i t may be advisable for a manufacturer to accept orders whichwill produce a loss instead of yielding a profit, but this is an in-frequent exception to the general rule.

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period aid the manfacturer in determining what prices he canafford to accept on future production; that in fact is one of thefunctions of unit cost accounting. Industrial accounting, however,is not restricted to the determination of unit costs. An importantand imperative object of industrial accounting is to inform theexecutive whether the current operations of the plant are beingconducted so that the assumed profit, which was anticipated whenthe orders were accepted, will actually be realized after productionis completed. In other words the executive must know whetheractual labor, material, and overhead costs of the plant as a wholecompare favorably with the assumed costs; and whether the volumeof production (which determines the amount of overhead expensethat shall be borne by the various products) is being maintainedat the scheduled rate. It is one thing to negotia te a pr ice; it isanother to decide whether to accept or refuse a price which willyield a certain profit from an assumed cost. That is a function ofsalesmanship. It is quite a different matter to direct the manifoldoperations of production so that the costs of the completed articles

will not exceed the assumed costs. This is a function of factorymanagement aided by industrial accounting.

UNITS OF MEASUREMENTS

When the purpose of industrial accounting is considered inthis light, it will be seen that the installation of improved methodsshould proceed from the apex, rather than the base, of the factoryorganization. Of foremost importance is the selection of the majorfactors which offer the greatest opportunity for regulation and con-sequent savings with a minimum of administrative machinery.The fundamental factor in certain industries is the common unitof production.

Every plant should, if feasible, have a unit of measurementby which all costs and quantities can be converted into comparablefigures. Without such common denominator, costs of the plant asa whole cannot be related to output. Gross costs may be increas-ing 10% per month, but this observation in itself has no specialsignificance. At what rate is output increasing? Is the cost perunit more or less than in the preceding period? Unit cost recordswould answer these questions with respect to individual articles orpieces, but the manager seeks information relative to the perform-ance of the factory as a whole.

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In the rubber tire industry, for example, the number of tiresproduced is not the common unit, as might be supposed at firstthought. There are too many sizes and types of tires to permit ofreliable deductions being drawn from statistics based on the totalnumber. The proportion produced of each size, moreover, variesfrom week to week so that the "average" size is not a constant.The common unit has to be der ived by taking a given size of apar t icular type of t ire as the basis, and converting the numberproduced of all other sizes and types into an equivalent number of"base" tires. The conversion is done by means of differentialswhich are calculated from the standard labor hours required tocomplete each tire.

Textile mills determine their common units in a similar way.The number of square yards woven of each fabric is translated bymeans of a differential into the yards of the "base" fabric. Yarnsare converted also, but the unit for yarns must always be handledseparately from the unit for fabrics, which means that a millwhich has both spinning frames and looms must treat the twodepartments as entirely distinct divisions.

In the automobile industry the "balance" in production is quiteas important from an operating standpoint as the quantity of out-put, for the output of completed engines or cars is limited to thenumber of entire sets of component parts manufactured. If theproduction of a single component part is not timed properly, theassembling of the cars will be delayed. It is a constant problembefore automobile manufacturers, therefore, to regulate the produc-tion of each part so that deliveries of cars will not have to wait formissing parts. In the most highly organized factories continuousproduction proceeds on each operation in accordance with a pre-arranged and balanced schedule. Such plants measure output intotal number of cars assembled, and reports of parts "out ofbalance" are given immediate attention.

FACTORS VITAL TO MANAGEMENT

The following may be suggested as among the most importantfactors which should be reported to the manager in charge ofmanufacturing:

1. Direct hours. (The total actual hours should, whereverpossible, be related to total standard hours, for the per-centage of variation is an indicative factor.)

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2. Indirect hours.

3. Number of workers per normal week.

4. Number of workers (a) hired, (b) discharged, and

(c) resigned.

5. Average labor cost per direct hour.

6. Assumed direct -labor hours required to produce sales

orders accepted.

7. Assumed average labor cost per direct hour required to

produce sales orders accepted.

8. Idle machine hours due to (a) repairs, and (b) other

causes.

9. Production orders awaiting receipt of raw materials.

10. Cost of raw materials contracted for and not delivered.

11. Assembly orders awaiting component parts.

12. Worked material rejected on account of defective work-

manship.

13. Overhead expenses as predetermined by budget.

14. Overhead expenses incurred.

15. Overhead rate per direct hour as predetermined bybudget.

16. Actual overhead rate per direct hour.

Many of the above factors should be divided by the commonunit of output to give figures that will be more readily comparable.In the absence of a quantity unit of measurement, factories whichmanufacture a great variety of articles should divide the numberof direct hours into total costs in order to obtain comparablefigures.

All of these factors will not be adaptable to every plant fortheir application would differ according to industry, operating

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methods, and size of organization. They do illustrate, however,variable elements which are subject to regulation and control whenonce brought to the attention of the manager. By giving heed tothe fluctuations in such factors from week to week, he can detectthe most urgent needs for improvement. The effect of his cor-rective measures can be most far - reaching because these factorsenable him to visualize the multifarious operations of the entireplant.

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