Orlan William Boston METAL PROCESSING, John Wiley & Sons, New York, 1958 (15 1185 875) CHAPTER XX. ACCOUNTING AND COSTS Usually all bookkeeping for a business is done in a central office called the accounting department under the direction of an auditor, controller, or treasurer, Fig, I-2. Accounting consists of keeping records of all financial transactions, such as investments, loans, pur- chases, and payment of wages, together with a complete record of sales, administrative, and manufacturing expenses, The accounting department serves the business in several ways by submitting to those in charge of the management reports which show the state of the company’s financial condition, the income and ex- penses, the distribution of expenses, and the general trend of the busi- ness. A balance sheet is usually made up annually to show the assets and liabilities of the company in itemized form. Under assets are listed cash, accounts receivable, inventories, bonds, land, buildings, ete. Under liabilities are listed accounts or notes payable, stock issued, etc. An income and expense sheet shows gross sales, cost of sales, net sales, etc., leading to the net profit for the period. This report may be issued quarterly ot semiannually with a summary for the year. Other reports dealing with the sales, administrative, or manufac- turing departments, which, by indicating the trend of the business, as- sist in its direction, may be issued as needed. For example, a state- ment issued each month to the manufacturing department for its guidance gives the cost of direct and indirect labor, supplies, tools, repairs, supervision, heat, light, power, labor turnover, ete., as well as the fixed charges (those which remain the same regardless of the amount of production) such as interest on money invested, deprecia- tion, taxes, insurance, rent, ete, and also data on amounts of pro- duction. All such manufacturing expenses, except the fixed charges, arg controlled directly by the head of the department. knowing what they are from month to month that they can be regu- lated. The report of manufacturing expenses is often shown by de- partments and totaled for the whole factory so that the detailed distribution may be analyzed to better advantage. All expenditures of a small industry may be grouped under five main heads, as shown in Fig. 1. The factory payroll may be divided into two parts: direct and in- 739 It is only by740 ACCOUNTING AND COSTS direct labor. Direct labor is that which can be charged directly to a piece being manufactured as a product. This is an outgrowth of the term productive labor which may be defined as that consumed in changing the form of the part produced or assembling one part with another. Indirect labor is that which is neither direct nor productive. It is thrown into the factory overhead, or burden, which represents all expenses difficult to charge directly to the product. The factory materials and supplies also may be divided into direct and indirect material. Direct material may be defined as that ma- terial which enters into the product. All other material items, such as 7s 2, 4 & Factory Factory Material General Otice Sales Payratt "aad ¢ nd ‘aud actrees, Supplies Insurance, Rent Administrative Advertising tat Taxes, etc) Expense (Labor ‘and Suppies) Ditect Factory Administrative Sales Labor ‘Overhead Expense Expense $50,000) :000) ¢$100,000) ($10,000) «$25 000) Work in Process (Manufacturing Costs) Finished Goods ‘Total Expenditures $205,000 Sales —> Profits (Dividends ‘and Recerves) Fic. 1. Distribution of Total Expenditures for a Month. supplies, tools, and jigs, are indirect and become overhead. The material of column 2, Fig. 1, is separated into direct and indirect. Machine tools are purchased as capital accounts and are charged into operating expense against production as depreciation, obsolescence, repairs, interest on investment, insurance, and taxes. The deprecia- tion represents an amount which, when set aside each year during the life of the machine, will provide a fund with which it may be re- placed. This may run from 1-5 years for single-purpose, high-produc- tion machines to 10-20 years for standard machines. Obsolescence represents an amount needed to replace the machine which has been superseded by new processes or improved design. Cutting tools, jigs and fixtures, dies, ete., usually are charged against operating expenseDIVISIONS OF ACCOUNTING 741 at their whole value during the first year. This represents 100 per cent depreciation. Sometimes tools of this type are charged entirely against the particular job for which they are purchased, even though the job lasts for @ period less than one year. Columns 4 and 5, Fig. 1, become administrative expense and sales expense, respectively. Selling expenses are entirely a cost of selling, Administrative expenses represent a service partly to selling and partly to production, and include accounting work, treasury, paying em- ployees, ete. The direct labor, direct material, and factory overhead combined cover the value of the work in process which leads to finished goods. ‘The total cost then is represented by the factory or manufacturing cost of the finished goods plus administrative and sales expenses. Divisions of Accounting Accounting may be divided into two parts: general accounting and cost accounting. General accounting includes everything as described above, except that included in cost accounting. Cost accounting is confined to the compilation of data leading to direct-labor costs, direct material costs, manufacturing costs, and list prices. The proportions of the factory overhead and administrative and selling expenses to be carried by each part are determined in the general accounting office and subsequently used for cost determination so that there is a close relation between the two divisions. Cost accounting: When the product being sold by an industry is made up of a number of parts, it is desirable that the cost of each part be known. The total cost of a part (unit cost) is made up of its direct-material cost, its direct-labor cost, and a proportion of each of the factory overhead, administrative expense, and the sales expense, Fig, 2. The selling price equals the total cost plus a profit. ‘The list price of a part equals the selling price plus an additional arbitrary amount to insure that the list price is always higher than the selling price as the total cost varies from month to month. This is for con- venience in showing the price of an article in general catalogs, The discount can be changed on short notice.by issuing revised discount sheets rather than reprinting the literature containing the list prices. To illustrate, the list price of a 1-in.-diam. high speed steel twist drill with No. 3 Morse taper shank is $10.25. The current discount is 40 per cent. Steel, on the other hand, is usually sold at a certain base price per pound with extras added for size, annealing, cutting to length, ete. Apportioning overhead and expenses for unit costs: The direct-TAZ ACCOUNTING AND COSTS labor and direct-material costs of a part are quite definite, and together give the direct cost of a part. The proportions of the overhead and expenses carried by each part vary widely with the method used in distributing them. To obtain reasonably accurate unit costs, that part which requires most overhead and expense in its manufacture should carry a greater proportion in its cost. } List Price Selling Price ‘Total Cost Menufacturing Cost: |— Direct Costs Direct | Direct | Proportion | Proportion | Proportion | Profit | Discount Material |Labor | Factory | Administra-| Selling Overhead tive Expense Expense Fic, 2. The Factors Which Make Up the Unit Cost of a Part. Some methods in general use for apportioning overhead are as follows: 1. Overhead as a percentage of direct-labor wages. 2. Overhead as a percentage of direct-labor hours. 3. Overhead as a machine-hour rate. 4. Overhead broken down into departmental overhead and subsequently apportioned. The first is possibly the oldest and most commun velicle for di: bution of overhead to product. If a single percentage for the entire plant is used, its application is as follows: If the overhead for a month is $100,000 and the total direct-labor cost is $50,000, then the burden in percentage of direct labor is 200 per cent, so that, in order to absorb it, each dollar of direct labor must carry 200 per cent of itself as its share of the total burden. Assuming that labor cost for a part is 10 material cost 4 cents, and burden 200 per cent of labor, the manu- facturing cost is 10 cents + 4 cents + 20 cents = 34 cents. By this uniform overhead method the same amount of overhead is charged against a given amount of labor for all pieces. One piece may require equipment having little overhead in the form of investment, floor space, power, maintenance, supervision, ete., such as a workbench and vise valued at $50. Another piece may be produced on an expensive ma- chine such as @ Mult-Au-Matic turning machine representing an in-MECHANIZATION 743, vestment of some $38,000. The machine is driven by a high-powered motor and requires considerable maintenance. If the same number of all parts were sold during the year, this method would be simple and satisfactory. Where the product is diversified and the sales unbal- anced, the resulting gross sales might vary a great deal above or below the sales of Fig. 1. Administrative and sales expenses are added on a basis of 10 and 25 per cent, respectively, to obtain total unit cost. The direct-labor hour is sometimes used instead of direct-labor wage, because in some cases it is found that hours are more stable and satisfactory than wages. The machine-hour rate is commonly used and is probably the most accurate method of distributing overhead. A rate per hour is deter- mined for each machine su that more overhead is charged against, a given amount of labor on a large automatic screw machine than on a small drill press, the direct labor charge per piece being the same in each case. In the fourth method, items of overhead are accumulated by de- partments. Those of general overhead departments are allocated to the service and production departments according to the responsibility of each for its incurrence. The apportionment, in turn, of the over- head of the service departments is made to the production departments for which the several service centers are maintained. When this has been done, all the overhead of the plant has been applied to produc- tion. ‘There are two radically different methods of ascertaining costs, ie., to determine them after the work is completed, as illustrated by the examples given above, and to estimate them before the work is under- taken. This scoond method, known az etandard costs, is based on material costs and labor and overhead rates taken from predetermined standards, or estimated in conference by the production engineer, superintendent, rate setter, tool supervisor, foreman, etc. Standard costs are set up and modified from time to time as experience indicates. Mechanization The reduction of labor costs has been the impetus of a development of machine tools, jigs and fixtures, dies, and small tools, which is still gaining momentum. Automatic equipment and standard equipment, provided with tools for high production, usually are more expensive than manually operated devices, are more complicated in design, require more care and time in setting up, and have higher maintenance costs. Despite these apparent disadvantages, the work of automatiza- tion proceeds apace, and manufacturing costs continue to decline.744, ACCOUNTING AND COSTS Each worker in United States manufacture is assisted with equipment valued at approximately $7,500. This figure is increased to about $14,000 in the automotive industry. Through the increase in capital investment, the labor cost is materially reduced. This lowers the manufacturing cost and makes the products available to a much larger number of individuals. When the manufacture of a part is under consideration, the number involved is of paramount importance. ‘The manufacturer must pro- vide himself with machines, special fixtures, dies, tools, and gages to facilitate production at the lowest cost. Small-lot production does not, justify high expenditures for automatic machine tools, special tools, jigs and fixtures, etc., whereas mass production may support a very high investment. Such jobs must be analyzed on the basis of their own merits as there is just as much danger of spending too much for equipment and accessories as there is in undertooling. A part may be machined in 120 min, floor to floor, in an engine lathe costing $4,000, or in 6 min in a turret lathe costing $8,000. The direct-labor cost of production is $1.80 per hr for both, but it costs 90 cents in labor and tools to set up the lathe and $8 for the turret lathe. The machine load for the lathe is $1 per hr, and for the turret lathe, $2.60. The cost of making one piece on the lathe would be 2($1.80 + $1) + 90¢ = $6.50. On the turret lathe, it would cost So ($1.80 + $2.60) + $8 = $8.34, If ten parts were made, in each case the unit cost on the lathe would be $5.69, but only $1.24 on the turret lathe. QUESTIONS 1, What are some of the duties of an accounting department? 2, Why should the cost department be a part of the accounting department rather than come under the jurisdiction of the factory manager? 3. What are fixed charges? 4. What is meant by direct costs? Explain the two elements. 5. What is meant by allocation of factory overhead? 6. Explain how manufacturing costs might be reduced through increased over- head. 7. Explain the difference between depreciation and obsolescence. 8. What is meant by accelerated depreciation and what is its purpose? 9. Explain the advantages of mass production in reducing unit cost. BIBLIOGRAPHY J. Buackatt, F.S., Je. “What Is Accelerated Depreciation?” American Machinist, Suly 17, 1947, p. 105. 2, Bruxor, B.C. “Rehabilitation of Industry as an Aid to Relieving Economic Stress,” Too! Engineer, July, 1939, p. 12.