The conditions of manufacture determine the basis on which costs are calculated; and according to these conditions, costs are found either (1) on the order, job or article, or (2) on the product or process, without relation to a particular order or article. The former method is known as the “Special Order System,” and the latter as the “Product System.”
Applying Cost Charges
There are two general methods of applying the items of cost, known as
(1) Productive labor method (hours or wages)
(2) Process method
In the first method, the labor and material are charged directly to the order, article or product, and to these charges is added a pro rata share of the indirect expenses, based upon the amount or the time of the productive labor consumed in the production of that order, article or product. This gives the total cost.
Under the second method, the charges are made against the process or operation, and after the total cost is ascertained it is distributed over the product according to its nature—i.e., on the basis of weight, measure or number, as the case may be.
Machine Cost Method
A special type of the process method, particularly valuable when it can be used, is the “Machine Cost Method,” which employs the same principle, but applies it to machines or groups of machines. Its effectiveness is due to its ability to absorb many of the usual indirect expenses, such as power, heat, light, etc., as direct charges, thus lessening the amount of indirect cost that must be distributed over the product as a whole. The importance of this must not be underestimated. The direct material and labor charges are not, as a rule, difficult to compile or distribute, and can be accurately determined; but the proper distribution of indirect expense is difficult; and almost all the trouble and mistakes in finding costs are due to this fact. Any method that provides for transforming a large part of these indirect expenses into direct charges attacks the difficulty at its source.
Types of Systems
Four types of systems are founded on this double classification—i.e., the special order system and the product system as bases for calculating costs, and the productive labor method and process method for applying costs. These typical systems may be designated as follows:
(1) Special order system, using the productive labor method.
(2) Special order system, using process or machine cost method.
(3) Product system, using the productive labor method.
(4) Product system, using process or machine cost method.
Cost finding for most phases of manufacturing may be effectively served by one of these four types; but in actual practice it is common to utilize the features of two or more of them in finding the costs in different parts of a plant. Each type is susceptible of more or less modification to fit special conditions, while still retaining its general characistics. The success or failure of a cost system sometimes largely depends on the recognition of these special conditions, and the proper adaptation of the cost system or systems to meet their needs.
Partial or incomplete cost systems are frequently devised for particular purposes. In such cases, as a rule, the object is to find the cost of certain lines of goods as a class, without going into details for each production order or article. A partial system of this kind is described in Chapter XIII.
There are also in use systems or methods of estimating costs and of verifying these estimates to a certain degree of accuracy. These are not cost systems in the true sense of the word, as they do not provide for finding actual costs: but, nevertheless, they may be of considerable practical value in small shops. In larger factories they often serve to indicate where accurate cost methods should be installed. These methods are described under the head of “Estimating Cost Systems” in Chapter XII.
Analysis of Operations
Since one of the principal functions of a cost system is to analyze the costs into their component parts, it follows that there must be a corresponding analysis of the manufacturing operations. This is accomplished by dividing the factory more or less arbitrarily into operating departments or production centers, the aim being to limit each department, as far as possible, to simple and uniform operations.
The operating department plays a very important part in making up and arranging the cost accounts. It furnishes a center about which various expenses may be grouped, and from which the indirect expenses may be distributed over a limited field with a greater degree of accuracy. A distinction must be maintained between direct production departments and indirect production departments. The latter often have to carry their share of general operating expenses until the cost incurred in them is distributed as a burden on direct production.
The following list gives the operating departments of a plant manufacturing axles and springs:
Direct Production Departments
Light Axle Finishing
Pleasure Auto Assembly
Indirect Production Departments
Supervision and Inspection
Engineering and Draughting
Purchasing and Stores
Time and Cost
Auto Parts Tool
Yard and Local Transport
Accounts are kept for each department, and these should show the cost for material and labor and the indirect expense involved in its operations.
The cost of direct material is a matter of market price at the time of purchase, plus the freight and yard charges when these are included in the cost. Sometimes the raw material is purchased in bulk, and has to be sorted and revalued according to grade, as in the case of feathers, tobacco, or wool in the grease. The material cost must then be adjusted over the various grades, so as to equal the original price.
Complications sometimes arise in the treatment of scrap material used in making by-products. The custom is to determine the per cent of the original material so used, and consider its cost as the material cost of the by-product, this being deducted from the cost of the primary product. If, however, there is no way of determining the percentage of the waste used, except at considerable expense, or if it varies greatly in quantity and quality, its scrap value is estimated; and when the by-product is sold, the amount received for it is usually entered under the head of sundry income. When this last method is used no deduction is made from the material cost for scrap value.
The direct labor cost is often easier to determine than the direct cost of material. In piece-work it is given directly on the product without further calculation, unless the several costs of the parts are to be added to find the cost of the whole. In time methods of payment it is only necessary to show how much time each workman has put on the product, and the value of that time in wages paid.
There are, however, in a few lines of manufacturing, conditions where a workman may spend only from three to five minutes on a single order or article. In such cases it is not practicable to charge this direct labor specifically to the individual order or article, and a plan must be arranged for its distribution over the number of articles worked on during a given time. In other words, the principle of the process plan must be used for this particular class of labor.
In such cases an estimate of the cost involved in an operation or process is quite often made, based on previous experience or tests; and these figures are then used as a basis for applying the direct costs. If the conditions remain exactly the same, the results may be fairly accurate.
Distribution of Indirect Expenses
The ideal cost system would make all indirect expense apply to the related product in the same way as the direct costs. This, however, is hardly ever possible. The practical or working ideal is to assign as many of the indirect expenses as possible directly to the product to which they relate, and so reduce the general indirect expenses to a minimum. There is a close relation between the amount of unassigned or general indirect expense and the accuracy of the costs obtained.
The machine cost method was commended specifically on this ground,* its principle being to gather all the expenses possible “at the point of the tool,” where they are easily applied to the product operated on. The value of the operating department as a similar agent has also been pointed out, the idea there being to gather such indirect expenses as pertained to any department, and distribute them over its own particular output.
However, when the best has been done, there is necessarily a residue of expense that cannot be conceived of as applying to any particular part of production. This is sometimes distributed over the product as a whole, but the best method is to distribute it first over the departments as units, and then to have each department distribute its share in its own way.
The method frequently followed, of distributing the indirect expense over the whole production by adding a certain percentage to the prime cost, implies the fixing of an accurate rate, and is subject to very grave criticism unless the output of the factory is unusually uniform both as to nature and quantity. Ordinarily the indirect expense is not the same for each class of article, as each involves differences in process peculiar to itself; and this throws the method out of adjustment. The fault is very marked when certain articles pass through only a few departments, while others have to go through the whole, or nearly the whole, routine. The former then have to help bear the indirect expenses of several departments in which they have never been at all, while the latter are relieved of a burden that properly applies to them. A manufacturer may easily be
led into fatal errors of policy by depending upon costs so obtained.
Even at its best, this percentage plan does not provide for an analysis of costs; and the organization and efficiency value of more accurate expense distribution is given up entirely for the sake of simplicity. It must be remembered that each department has its own equipment, and possibly differs from the other departments in capital invested, floor space, power used, etc. Therefore, any method which does not utilise this natural center for collecting and distributing expenses, fails to use its most efficient weapon.
Supposing the departmental method to have been adopted, there still remains the most vexatious problem of all—upon what basis shall the indirect expenses be distributed within the department so as to charge each order or article with the portion that properly belongs to it? To illustrate, let us suppose that high-priced and lowpriced men work side by side, or that there are machines of very different size and value operated by men who draw the same wages, or that the operations involve about equal parts of machine work and work by hand—all of which are quite ordinary conditions. Shall the basis of expense distribution be the cost of labor or the time spent on the work? Does the cost of material enter in as a factor? Is a machine rate possible or practical? If so, just what ground can it cover? These are some of the questions which must be answered, and answered correctly, if the cost results are to be accurate.
No one method of distributing indirect expense can be considered as orthodox for all cases. Everything depends on the particular existing conditions. The purpose here is to describe the standard methods, stating their underlying principles, and indicating the conditions where each is effective.
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