Principles of factory cost keeping

Front matter

Google to make the world's books discoverable online.

It has survived long enough for the copyright to expire and the book to enter the public domain. A public domain book is one that was never subject

to copyright or whose legal copyright term has expired. Whether a book is in the public domain may vary country to country. Public domain books

Preface

The literature in which an activity finds its expression depends upon the interest in, and the development of, that activity. It is therefore not surprising to find that there is comparatively little literature on accounting at the present time. Charles W. Haskins says : "The literature of accounting is virtually in its infancy, awaiting the fostering care of cultured authorship."

Mr. Haskins' statement is particularly applicable to the subject of cost accounting. Although many valuable articles have been written on different phases of this subject, and while excellent books on costs have appeared from time to time, it is a notable fact that such articles and such books have been either of a highly technical character, or otherwise treating of special systems of costs as actually installed and used by certain manufacturing plants.

As a result of this, there exists in many minds the idea that the principles of cost accounting are more or less mysterious and vague, and that the

subject is one for the expert, only to be underiv PREFACE

Stood after years of study and experience. This idea is due largely to the lack of a clear and simple presentation of the principles upon which cost accounting rests; and it is to supply this need that the present book has been prepared.

The use of diagrams in illustrating the principles of cost accounting is not new. They were used quite successfully in the early eighties by Garcke & Fels in their book "Factory Accounts"; but the idea has been further developed by the author, and has been made applicable to conditions of the present.

The book is offered to those interested along cost accounting lines, with the hope that it may help to a clearer understanding of the true aims of this important branch of accounting science.

Edward P. Moxey, Jr.

October, 191 3.

Chapter I. Introductory Development of Accountancy

Ends Attained by Cost Keeping

Cost Accounting a Development

Temporary and Permanent Expenditures

Classification of Merchandising Expenditures

Analysis of General Ledger

Elements of Manufacturing Cost

Process of Cost Keeping

Relation Between Cost and General Books

Conversion of Values in Manufacturing

Advantages of Cost System

Chapter II. Accounting for Stores Stores Records

Relation of the Stores Records to the Commercial Books

Receiving Stores

Issuing Stores

The Production Order

Stores Debit Notes

Designating and Arranging Materials

The Stores Ledger

The Tallv Card

Bill of Materials

Keeping Up Stores

Inventories

Reconciling Inventories

Chapter III. Accounting for Labor Materials and Labor Compared

Methods of Recording Time

Piece Work

Towne-Halsey Plan of Wage Payment

Taylor Premium Plan of Wage Payment

Time Recording Devices

Recording Labor Costs

Paying the Workmen

General Ledger Labor Account

CONTENTS

Chapter IV. Acbbiintihg for Indirect Expenses Importance of Indirect Expenses

Methods of Distributing the Expense Burden

(1) Direct Labor Cost

(2) Direct Labor Hour

(3) Material Cost

(4) Prime Cost

(5) Machine Rates Classification of Indirect Expenses Floor Space

Distributing Floor Space Costs Power Cost Machine Cost

Non-Productive Supervising Labor Miscellaneous Expenses Distribution of Costs Over Output Idle Time Supplementary Rate Idle Capacity Account

Chapter V. Summary FORMS

DIAGRAM PACK

1. Analysis of General Ledger 12

2. Relation of Cost Books to Commercial Books. 15

3. Operations of a Factory Cost System 20

4. Relation of Stores Records to Commercial

Records 25

5. Stores Requisition ]]] 29

6. Stores Ledger [[[ 34

7. Relation Between Time Cards and Work

Tickets 5q

PRINCIPLES OF FACTORY COST KEEPING

CHAPTER I INTRODUCTORY Development of Accountancy

Accountancy as a profession has undergone its greatest development within recent years. Accounting records which a few years ago were either unknown or were considered superfluous and unnecessary, are today an integral part of the accounting systems of practically every business. That portion of accounting in which the greatest advance has been made is the ascertaining of factory costs.

Manufacturers used to consider it wholly unnecessary to keep books other than those employed to record the major business transactions. The necessity for an accurate cost system, which is now recognized as imperative for success in business, was not then apparent. But the demand for greater efficiency in industry, and the keen competition which exists between the various manufacturers in the same line of trade, have rendered necessary more accurate accounting records whereby each may know absolutely and accurately his cost of production.

Ends Attained by Cost Keeping

There are two reasons which warrant the keeping of cost records and which justify the consequent expense involved.

First: Cost keeping furnishes the manufacturer with accurate and reliable information concerning the costs incurred in production, enabling him to fix prices and bid intelligently against others in the same field.

Second: Through his cost accounting department the manufacturer is enabled to detect, locate, and eliminate waste or leakage in materials, labor, and other expenses incident to production.

Cost Accounting a Development

All factory cost accounting is based directly on the principles of double-entry bookkeeping. It is, in fact, a highly specialized development of double-entry bookkeeping — which docs not, in its usual form, go far enough for cost accounting purposes.

In the ordinary routine of business, money, or its equivalent, is paid in for the purpose of making a profit by increasing its amount through the operation of the business. It is obvious that in order to secure this increase the money must first be expended, the expenditure being always made with the expectation that there will be produced something which can be sold to the consumer for an amount greater than the cost to the producer. The difference between the costs of production added to the other expenses of the business and the amount received from sales represents profit.

But a system of accounting that did not go beyond this elementary presentation of facts would not furnish information sufficient or accurate enough for the requirements of modem business. Some classes of expense are not of a temporary nature. The use of certain articles in production — such as machinery — extends over a series of years. It is not right to charge the original cost of such purchases to profit and loss in the period in which they are made, for they will figure in the manufacture of hundreds of subsequent lots of goods.

Temporary and Permanent Expenditures

For cost accounting purposes, therefore, a first distinction — considering expenditures only for the present — must be made between expenditures for' assets of a more permanent type — generally known as fixed assets, and comprehended in the term "Plant" — and those of a more or less temporary character, known as "Profit and Loss" items, or those comprehended in the general class of "Nominal Accounts."

Classification of Merchandising Expenditures

Following this a more detailed classification becomes desirable. Taking a merchandising concern for the sake of illustration, we find that "Profit and Loss" expenditure is divided into two parts, the distinguishing feature being the difference between payments for that which is dealt in, classified under the heading "Merchandise," and payments for services and other items necessary to the proper conduct of the business, known as "General Expense."

A further subdivision of "General Expense" must then be made to show the items which make up its total amount. Two subheadings, known respectively as "Trading Expense" and "Administrative Expense/' are usually employed. The former covers the detailed expense accounts which go to make up the cost of distributing the goods, including salesmen's salaries and expenses, rent of the store in the case of a merchandising house, costs of advertising and of the delivery service; while the latter includes those accounts which show the cost of managing the financial and business affairs of the concern, including all administrative salaries and general office expense, such as, for example, office supplies.

On the other hand, "Merchandise," being entirely too general in its character, is also subdivided. The first distinction is that made between purchases and sales. The sales may also be divided into classified sales accounts, while in the division of the purchases we find the first sig^s of detailed costs.

Analysis of General Ledger

The following analysis of the general ledger of any typical merchandising business, from the standpoint of expenditures, will serve to present diagrammatically the discussion up to this point:

e «

I

I

I

Elements of Manufacturing Cost

If, instead of purchasing the goods ready for sale, as we have presumed heretofore, a manufacturing plant is erected or leased and the goods are produced, it becomes necessary to split up the expenditures directly involved in the production of these goods into their component parts, which together compose manufacturing costs. These component parts of manufacturing cost may be grouped under, three headings:

(i) Materials

(2) Labor used directly in production

(3) Indirect expenses, or overhead costs

The details of manufacturing or production cost, composed of the classes of expenses stated above, are shown by the factory cost books. The costs appearing in detail in the cost books are entered in total, at stated periods, in the general ledger.

Process of Cost Keeping

The main steps in manufacturing for which an accurate accounting must be made are as follows:

(i) The purchase and storing of materials and supplies and their issuance to the producing departments as required.

(2) The manufacturing processes through which the product must pass, the accounting for which involves not only the cost of materials consumed, but also the direct labor cost, and a certain amount of the indirect expenses, applied to each unit of production.

(3) The storage and issuance of finished stock.

Relation Between Cost and General Books

Corresponding to each of these divisions, we have certain factory cost books, *. e,, the "Stores Ledger," the "Cost Ledger," and the "Stock Ledger." The relation of these cost books to the general commercial books is shown by the diagram on page 15.

In explanation of this diagram and to illustrate the operation of the books, let us suppose that a certain sum of money is disbursed for the purchase of materials, labor, and other supplies and services connected with the production of the goods. This, in the ordinary journal form, would be represented by the entry:

Materials

Labor V Dr.

Indirect Expense

To Cash Cr.

By this entry the accounts costing the business value are debited, and the account which has produced value, viz., cash, is credited. In a small business this method of accomplishing the result might be satisfactory. In a large business, however, there are numerous transactions involving these accounts which occur every business day. If these were to be separately recorded in the journal, the work required and the expense involved would be out of all proportion to the results obtained. To avoid this labor, transactions of a similar nature, when there are many of them, are brought together in one subsidiary record, and the totals only are posted to the ledger. Thus there is usually a book devoted to the detailed recording of cash receipts and payments, while the general ledger cas'h account is concerned merely with the totals. Likewise the "Stores Ledger" contains a number of accounts — usually kept upon cards for convenience in handling, or else in loose-leaf books — whose totals appear in a general ledger "Stores" account. If, then, a certain amount of money should be paid out for the purchase of stores, the cash book entry expressing such transaction is as follows:

Stores or Materials, Dr.

To Cash Cr,

Both the stores item and the cash item find their way to the general ledger in totals. The stores item also appears in the stores ledger in detail, being taken from the original purchase invoices. When the stores purchased, after having been received and placed in the storeroom, are requisitioned and delivered to the producing departments, there must be a credit to the Stores account for the value of the quantity delivered. This credit is offset by a debit to the general ledger account which controls the costs of goods in process— designated on the diagram as "Manufacturing Account."

In the course of a day, the stores issued to the producing departments will be consumed on many orders in process, so that from the factory standpoint it will be necessary to make entries in each of the individual cost accounts representing the orders in process. The aggregate of the material costs so assigned appears in the general ledger in the Manufacturing account, for it must be borne in mind that, generally speaking, a system of factory accounting does not reach its highest efficiency unless there is this control exercised by the general ledger over the balances of the subsidiary ledgers.

When the goods are finished they must be transferred on the books to the finished stock de^ partment. This is conveniently accomplished through the medium of a voucher designated as "Stock Debit Note." There will, of course, be many orders continually passing through the manufacturing processes into the finished stock department. The subsidiary book entries which record the finished orders so transferred serve to credit the cost account representing each order in the cost ledger, and to debit in the stock ledger the particular finished goods account to which the goods belong.

As in the case of the issuance of stores, so in the case of the transference of finished stock from the factory, there must be an entry on the general books to record such transfer. This entry deals with the totals of the corresponding entries in the subsidiary books, and its effect is to debit Finished Goods account in the general ledger, and credit Manufacturing account.

All finished goods on hand are usually available for sale. As soon as an order is received from a customer for the delivery of a certain kind and quantity of goods, entries must be made in the stock ledger crediting the account to which the goods were charged when they were placed in finished stock, and a similar entry — in totals— crediting Manufacturing account in the general ledger. The goods which have been sold are debited to an account in the general ledger which may be designated as "G>st of Sales."

Accompanying each shipment of goods there is a "Sales Invoice," on which appears the price at which the goods are charged to the customer and the total amount of the sale. A record of each sale is made in a sales book, debiting the account of the customer and crediting the Sales account — in totals — ^with the selling price. The difference between the cost of goods sold and the amount charged to customers as shown by the Sales account must therefore be the gross manufacturing profit. When money is received from the customer in payment of his account, there is a debit to cash for the amount paid, offsetting a credit to the customer's account.

Conversion of Values in Manufacturing

The progress of factory work as it appears in the books may be illustrated by the diagram on page 20, which shows the operation of a factory cost system from the time payment of cash is made to begin production until the goods have been completed and are available for sale.

Advantages of Cost System The manufacturer who has his factory cost s)rstem

^reh«««« of

R««uii|Mo««t

TlOMtt

MANUFACTURJMQ

FINISHED GOODS

SalM fiivolo**

Diagram j Operations of a Factory Cost System.

arranged on this general plan is in a position enabling him to adjust his selling prices so as to bring to him the largest amount of profit.

He possesses a cost system organized along the same lines as his system of factory management; a system economical of operation, accurate in its results as to current operations, and one from which estimates or bids on future work can be accurately and quickly made. By a subdivision of his sales account into the different classes or grades of goods manufactured, and by carrying corresponding cost accounts, he can accurately determine the cost of producing each line of goods and the profit or loss on each grade sold.

We have seen that the factors which enter into the manufacturing cost of any product can be grouped under the main headings of "Stores," "Direct Labor," and "Indirect Expenses." We are now in a position to take up each of these in the order given, and to show the method of determining the amount and value of each. At the same time, we shall see how to detect and prevent waste and leaks, which are important items to the manufacturer from the standpoint of profits.

CHAPTER n ACCOUNTING FOR STORES

Stores Records

Subsidiary records constitute one of the distinctive features of a really effective system of cost accounting. The difference between modem systems of factory cost keeping and a system of accounts not including subsidiary cost records, can be clearly shown by the respective methods of handling stores.

In a business which does not keep stores records, the inventory at the beginning of the period is used as a starting point in order to find the cost of materials consumed. To this amount is added the cost of the purchases during the period, which gives the total amount available for that period. If from this amount there is deducted the value of the materials on hand at the end of the period — ^ascertained through actual inventory of the stock on hand at that time — the difference is supposed to be the cost of the materials consumed. Whether this is true or not depends on the accuracy of the inventories, and on the absence or presence of leaks resulting in shortages of material during the period. It is as if a man starting out with $ioo in money, and receiving during a given year $1,200 more — Shaving thus $1,300 to spend — should keep no account of his expenditures, but, taking count of his money at the end of the period, and finding that he has on hand $300, should conclude that he has paid out $1,000 during the year. Certainly $1,000 has gone in some way ; but whether he has actually spent that amount and received value for it cannot be determined — it can only be inferred. Under this method there is no means whatever of knowing whether or not any moneys have been stolen or lost.

An accurate cost system, however, does not work on a basis of conjecture or inference. Starting with the inventory at the beginning of the period, the cost of all purchases is added to this, and a careful account is kept of the consumption during the same time. The balance of the accounts at the end of the period then shows the amount which should be on hand, and whether or not this is actually so can be ascertained through a physical inventory. If the "book inventory" and the actual inventory do not agree, something is wrong, and it must be traced down. If they do agree, the presumption is that there have been no leaks or other losses.

The difference in the two methods can be shown by the same illustration which we gave before. If our man starting out with $ioo at the beginning of the year should receive during the year $1,200, and should, during the same period, actually account for payments of $1,000, then, by a count of the money on hand at the end of the year, he can ascertain whether or not the amount called for by his record (viz. : $300) is in agreement with the actual money on hand. If it is, he knows there have been no leaks. If it is not, he is immediately put upon inquiry.

Relation of the Stores Records to the Commercial Books

If we keep in mind that any system of accounting for stores must provide an accurate method of measuring not only the purchases but the amount of stores consumed, we can better understand the relation of the stores records to the general commercial books, which is shown by Diagram 4. This differs from Diagram 2 in showing the stores records only and giving these in much greater detail.

Receiving Stores

The accounting methods employed in receiving materials, as graphically shown in Diagram 4, can be illustrated as follows :

Starting from the purchase invoice which accomii Si

I

I ■

I I

I i5 panics all goods received, an entry is made in the purchase book, or in its equivalent, the voucher register — according to the character of the record kept — ^the ultimate effect of which is to debit the general ledger account of "Stores" and give credit to the party from whom the goods have been purchased. Of course there would be no economy in keeping the purchase book if every purchase were posted to the general ledger as soon as it had been recorded therein, so the bookkeeper usually waits until the end of the month. He then makes his postings by totaling the columns of the purchase book, and posting to the debit side of the Stores account in the general ledger the total cost price of all goods purchased during the month, an equivalent credit at the same time being posted to the "Accounts Payable" account, which in like manner controls the individual accounts of the creditors — ^kept in a creditors' ledger, not shown on the diagram. The creditors' ledger, which is subsidiary to the general ledger, is posted daily from the purchase and cash books. The reason for this is that the bookkeeper is enabled thereby to ascertain at all times the exact status of each creditor's account, without the necessity of posting the general ledger.

In the stores department, each purchase invoiceafter being checked up with the goods which it accompanies — ^is entered in a "Stores Received Book," from which it is posted to the debit side of its proper account in the "Stores Ledger." Oftentimes it happens that the materials received are not up to the required standard, so that some of them must be returned to the vendors. In such a case it is better to allow the original invoice to go through in the ordinary way, and then, on the basis of a "credit memo, for goods returned," to make a record through both commercial and factory books, reversing in part the entries made at the time of purchase. On the commercial side, an entry is made in a "Returns and Allowances Book," the effect of which is to debit the account of the creditor and credit the "Stores" account In the stores department, an entry is made in the "Stores Rejected Book," from which it is posted to the stores ledger as a credit to the material accounts concerned.

Issuing Stores

Having traced the materials coming in from and returning to outside parties, let us now take up the materials as they are issued from stores for use in the producing departments. The vouchers on which all stores are issued originate in the producing departments, or else in the cost office. They are known by several different names, but "Stores

Requiisition*' is a common term. A specimen of such requisition is submitted on page 29.

As the stores requisitions are presented to the storekeeper, he issues the materials called for, ascertains the price of the goods, and extends the amount on the requisition. Entry is then made by him in the "Stores Issued" book, from which postings are made to the credit side of the various stores accounts involved. At stated periods, generally monthly, the storekeeper renders his report to the general office, showing the numbers of the stores requisitions honored by him during the period, together with the money value of the stores issued on each. The total of this report is the basis for a journal entry which debits Manufacturing account and credits Stores account in the general ledger.

The Production Order

A "Production Order" is a formal written or printed order used by manufacturing concerns to authorize definitely the manufacture of the specified goods or articles. To ascertain accurately the cost of each order or lot of goods, a production order account is opened in the cost ledger for each and every order. These accounts are usually designated by numbers corresponding to the numbers of the production orders.

COST DEPARTMENT

STORES REQUISITION

No

Use this Requisition to report ttoret withdrawn or returned to storeroom, blacksmith store or any other shop store.

MATIRIAL

DESCRIPTION OF ARTICLC8 OR WORK

WEIGH1

Material Received by.

Material Delivered by.

Credit

Charge

Qhar^e...-

PRICft

AMOUNT

Order No-

Date

.Stock Clerk.

Diagram 5. Stores Requisition.

As the work of manufacturing progresses, all materials requisitioned for a particular order are charged to its account, as is also all labor expended on it, and its proportionate part of the overhead charges. Thus it is possible, when the goods are finished, to tell their cost by the debit balance in the corresponding production order account

Stores Debit Notes

It happens sometimes that stores are issued in excess of the requirements of the order. In such cases it would not be right to use the surplus on another order without first making the necessary adjusting entries on the books. Otherwise it is plain that the original order would be charged with more than its share of the material cost. Therefore, to keep the records in agreement with the facts, a "Stores Debit Note,'* or similar device, is used to return to stores such materials as may have been issued in excess of the requirements of any one order in process. These notes are turned in to the storekeeper and are entered by him in a "Stores Returned Book," from which they are posted to the debit side of the stores ledger accounts involved. The general eflfect on the storekeeper's records is to increase the amount of material shown to be on hand in the accounts affected by the returns. On the commercial side a journal entry is made — ^usually covering all notes issued during a month — which debits "Stores" and credits "Manufacturing" in the general ledger.

Designating and Arranging Materials

In devising a system of accounts for a storeroom it is of prime importance that some method of designating goods subject to requisition be adopted which shall be short and accurate, and at the same time provide a means of quickly finding the various accounts in the stores ledger. In order to accomplish this, various systems of account numbers are used, so as to avoid a long detailed description of each kind of material handled, special numbers or letters being associated with each stores account.

One of the best systems of account numbers in use is that known as the decimal system, which is the invention of Melvil Dewey, formerly Director of the New York State Library. As the name of the system implies, it is founded on the use of the decimal point. All figures to the left of the point refer to the various major classes of materials handled. For instance, if the plant uses not more than nine main classes of materials, then to each class is assigned a single place number. If there should be more than nine general classes, then the numbers indicating them should run from i to 99, two places instead of one being assigned to the main classification. Numbers to the right of the decimal point indicate the size, grade, etc., of the material called for by the number to the left. As there is a possibility that the point may be omitted or overlooked in posting, some manufacturers use an o in its place.

In those cases where the kinds of materials are so many that they cannot readily be covered by a series of numbers, a modification of the decimal system may be used. This modification consists in assigning letters to the major classes of materials, and indicating the character of such materials by numbers to the left of the decimal point or cipher, while numbers to the right are devoted to the size, grade, etc.

To illustrate the working of this system, suppose the letter "A" is used to indicate a general class of iron, while the number "3" represents the subclass of rivets. Then, if we indicate the length of the rivet by the first number to the right of the decimal point or cipher, while the second number shows the thickness, and the third number the character of the head, we can represent iron rivets, two inches long by five-eighths of an inch thick, with round heads, by the following simple number : A30642. Here we use o in place of the decimal point; and do not use the figures to the right in their ordinary numerical significance, but according to a prearranged code. The advantages of such a system can hardly be overestimated. It saves time and space, and avoids, in great measure, clerical errors. The system as outlined is elastic, and can be used in cases where the material is divided into a few classes, as well as in those where the material is very complex and the number of classes is consequently enormously increased.

If, finally, the material is arranged in the storeroom in a definite order, corresponding to the account numbers, the economy is apparent in the promptness with which it can be found and issued when called for, and the ease with which an inventory can be taken.

The Stores Ledger

Having our material properly arranged and the account numbers assigned, the form of the stores ledger account is next to be considered. In speaking of the stores ledger we must not have in mind a bound book with ruling similar to that of the ordinary double-entry ledger, but a loose-leaf file, or more frequently a card ledger. A typical stores ledger sheet or page is illustrated by the following :

1 1