By A . G. PETERKIN A N D H. W. JONES Atlantic Refining Co.
Philadelphia, Pa.
D
U R IN G th e past tw enty years a continual conflict betw een accountants and technical m en has smoldered beneath the surface of industry, characterized in its earlier stages by considerable intensity o f feeling, but m ore recently sim m ering down to a friendly recogni
tion o f different points of view and a joining of forces to attain m utual objectives. T h at this strife should have occurred is not surprising. T he accountant, steeped in the tradition o f an age old profession, and accustom ed to regard him self as the confidential stew ard o f his em ployers and his ledgers as sacred records to be exhibited only to the m em bers o f the firm, could hardly be expected to welcome the prying inquisition o f the technical u p start to whose scientific spirit nothing was sacred. T he one w as essentially a to ry and u ltra- conservative ; the other m ost certainly a progressive, and to the m in d s of m any, a radical. In this case industrial history has vindicated the latter.
\ \ ithin the last century industrial processes have gone th rough a stage of rapid evolution, and progress has always been in the direction of increasing size and com plexity. A s a result, design and operation o f equipm ent have proceeded from the hands of the ow ner in to those o f the m an u factu rin g staff w ith its num erous highly specialized sub-divisions. Intim ate knowledge o f design and operating detail has moved in the same direction.
The executive of a h undred years ago based his decisions and shaped his policies largely upon his ow n knowledge and experience, and from our point of view leaned but lightly on his subordinates. The decisions and policies o f today s executive are based on inform ation provided alm ost entirely by the m em bers of his staff, fo r the soundness of which he relies fa r m ore upon the character and reputation of the contributing individuals than upon his own fam iliarity with the various specialized aspects of each question. I t would appear th a t had the account
ing m ethods kept pace and in step w ith this m anner of grow th, inform ation would have been dissem inated m ore and m ore widely as tim e w ent on. so th a t each contribu
tion to a decision or policy would be based upon a sound knowledge of its own and general com pany economics.
O nly in recent years, how ever, has the conservatism of the accountant yielded to changed conditions.
T he general accounting system of a com pany periodi
cally lays before the m anagem ent balance sheets and oper
ating statem ents showing cu rren t assets and liabilities, gross income, cost of selling, cost o f m anufacture, and net profit fo r the period. T he cost system has contrib
u ted nothing to these figures except the evaluation of inventories of p artly finished and finished goods, which is necessary to determ ine profit or loss. T otal expenses distributed by the cost accounting procedure m ust equal
total expenditures show n by the general accounting system.
In the p ast the average cost system has been a post
m ortem instrum ent— an analysis intended to show the extent to which individual activities had contributed or failed to contribute to a successful show ing. Such state
m ents represented w ater-over-the-dam ; in so fa r as they covered extensive periods they contributed little o r noth
ing to day-to-day economy and good ju d g m e n t in handling cu rren t exigencies. T hey did provide, how ever, in fo r
m ation upon which decisions concerning long time policies could be based, and in addition served as a point of d ep artu re fo r investigations into the past efficiency of the various phases of m anagem ent.
Cost Systems in M anagem ent
T o the sales m anager w ere presented the cost of mak
ing sales, the m an u factu rin g cost of goods, and the income from th eir sale. A p a rt from the question of selling expense, it appeared a sim ple m atte r to supply all the inform ation needed to determ ine the success of his past and the direction o f his fu tu re efforts. O bvi
ously w hat he w anted from a m an u fa c tu rin g cost system was a u n it cost of each product. U n fo rtu n a te ly indi
vidual u n it costs in m any cases do not ex ist in fact, and so cannot be calculated. T h is is the case w here the m em bers of a group o f finished m aterials a re dependent fo r th eir production one upon the o ther. I t does not m atter th a t one o r m ore m ay be called byproducts, or th a t one m ay incur m ore expense than another. The only calculable thing, by the very n a tu re o f the opera
tion. is the total cost of m aking th e g ro u p . M oreover, the sales departm ent m ust dispose o f the en tire group in the relative quantities m ade. Consequently7, in th e last analysis, the sales m anager m ust com pare w hat he can g et fo r the group as a w hole w ith w h at it cost to produce and m arket it. In addition, he w ants to know how costs v ary w ith volum e o f production. A system which pre
sents costs subdivided into item s independent o f, and those varying w ith, volum e o f production will help intel
ligent consideration in this direction, b u t as the varia
tions are neither regular n o r in the sam e ra tio thro u g h out the production range any m a jo r v a ria tio n m ust be studied independently.
W e come now to the m an u fa c tu rin g m anager— in chemical plants, generally7, a chem ical engineer. Cost statem ents, to be useful to him m u st reflect currently the economy of his operations so th a t inefficiencies may be detected and rem edied as soon as they7 occur. In addition to actual plant o peration the m anufacturing m anager will participate in all questions of policy7 with the sales and financial m anagem ents, an d w ith the gen
eral m anagem ent. Q uestions as the addition of new products, increasing o r decreasing th e volum e of busi
ness in this o r th a t direction, im provem ent o r expansion
S6 Chemical & M etallurgical E n g in e e rin g—Vol.40, A 0.2
of present processes o r facilities, are all re fe rred to him fo r study and comment. H ere he assum es the role of econom ist and it is evident th at the ease w ith w hich all this can be done will depend greatly upon the skill w ith which the statistics are gathered and arranged.
I t is this field of activity, th a t of the m an u factu rin g m anager, which the cost accountant has been ta rd y to recognize as legitim ate in all its phases. I t has appeared to him a dangerous thing to broadcast, relatively speak
ing, values hith erto known only to the higher officials, and lie has natu rally felt th at the cultivation of any such policy would autom atically tend to underm ine his tim e- honored role of financial analyst and confidential investi
gator. W hen m an u factu rin g units w ere on a small scale the locations of office and factory w ere o ften identical, and it w as possible fo r the accountant to keep physically in close touch w ith p lan t operation and p lan t m anage
m ent ; the com bination of individual units geographically w ide-spread to form large corporations u nder centralized control has o ften destroyed both personal and physical contact, at once increasing the accountant’s, and decreas
ing the plant m anager’s reliance on statistical in fo rm a
tion— an u n fo rtu n a te thing fo r both. T h e very neglect of this field by his m ore conservative associates made it an especially attractive m arket fo r the consulting accountant, who, fo rg ettin g trad itio n , saw the situation as it really existed, and devised system s which would meet the requirem ents of plant m anagem ent and at the same tim e fu rn ish reports fo r the general m anagem ent.
A s a result, we now have in our hands glittering new tools such as “ standard costs,” and “budgetary control.”
Fundam ental Aims o f Costing
H aving had a m ushroom grow th, all these system s are fundam entally as alike as one m ushroom to another—
slightly different in size, shape and color, perhaps, but basically of the sam e stuff. T h e aim of all is to provide fo r each operation, fo r each group of operations and fo r the entire plant, a series of m easuring sticks by which actual perform ance m ay be scientifically evaluated. In place of the m ultitude of com parisons presented by past history w ith all its atten d an t m odifying circum stances, they apply definite, previously agreed-upon standards—
not definite in the sense of being invariable, but on the contrary constantly variable in o rd er to give a true, up to the m inute basis fo r com parison. T o take one o f the sim plest cases: if production figures are to be com pared a t the end of each calendar m onth, the volum e in F e b ru ary will be less than in Ja n u a ry , and the system au to m atically shortens the m easuring stick in the ratio 2 8 : 31.
A g ain : the change in price of raw m aterials is out of the control of the factory m a n ag em en t; w hat control is applicable is in the hands of the purchasing departm ent.
The system recognizes this, and autom atically separates the fluctuation in total cost due to increase or decrease in the price of raw m aterial. T h u s the official studying the statem ent loses no tim e in questioning the m anufac
tu rin g m anager regarding increased costs due to price changes— the system im m ediately and autom atically tu rn s his head in the rig h t direction to the purchasing departm ent. Still a th ird exam ple: to the ex ten t th a t cost m ay be show n to be above o r below standard due to change in production ra te the responsibility m ay lie either with the m an u factu rin g or the sales departm ent.
o r w ith business conditions entirely beyond the control of either, as inquiry w ill b rin g out. T h u s these systems p u rp o rt first to separate the constant and variable items of cost, then autom atically to show to w hat ex ten t the total variation of each cost from standard was influenced by each of the various factors affecting cost, and finally to lay autom atically each variation at the feet either of the responsible individual or of Providence, as the case m ay be.
W h a t D o Costs Cost?
B ut cost departm ents are expensive— w hat about the increased cost of the costs them selves? H ere again these new system s have followed the tre n d of m odern indus
trialism . By focusing expert, intelligent, and intensive study on the problem beforehand and by applying a few simple principles, an autom atic system of analysis is devised w hereby the com putation of periodic analytical statem ents becomes a mechanical routine easily p er
form ed by relatively inexpensive labor. T h e thinking is done b e fo re h a n d ; the clerical force adds, multiplies, and divides, and enters the results in the right column.
E stablishm ent of pro p er standards is obviously an im
p o rtan t factor in the practical application of such a system , and m ay proceed from one of several points of view. E ach standard m ay epitom ize p ast h isto ry ; it m ay be an ideal unattainable in practice, as the carrots hung before the donkey’s n o s e ; o r it m ay be a reasonable expectation fo r a given period, arriv ed at by considera
tion of past history, c u rren t values of raw m aterial and labor, and present and potential sales dem and. T he advantages of the first two points of view m ust be left to their p ro p o n en ts; w hat follows deals w ith the last, as it involves a general m ethod of m anagem ent to which the particular cost system used is m erely an incidental aid.
T h is m ethod consists in :
1. A detailed forecast of production, based upon a similar fore
cast of sales over a period the length of which depends upon the degree of control required to cope with the business fluctuations generally encountered in the particular industry.
2. An estimated direct cost of each individual operation involved in the production of the forecasted quantities.
3. An estimate of each item of indirect cost—of each item of burden or overhead.
4. The periodic preparation of statements comparing actual with anticipated results.
5. Comparison of actual and anticipated performance, explana
tion of the variations, and correction of faulty procedures—all by those directly responsible.
T h e production forecast perm its the scheduling of raw m aterial deliveries, the determ ination of ap p io p riate inventories to insure u n in terru p ted operation and delivery of finished goods, and should result in tying up a m ini
m um of capital in inventories. T o prepare it, reliable data on plant capacity and process yields are essential, and fo r these the m an u factu rin g m anager m ust rely either upon past experience or upon tests m ade fo r the purpose.
All costs fall under one of tw o h e a d in g s: those which apply to one operation— direct costs, and those applying to m ore th an one— indirect costs. In o rd er to m ake pos
sible the autom atic analysis by the accounting system of the effect of change in production rate, each separate item ,’ such as labor, repairs, fuel, of both direct and indirect cost, is split into tw o com ponents: ( 1 ) T h a t p art
F e b r u a r y , 1933 — Chemical ¿r M etallurgical Engineering
which varies directly as production rate changes, (2) th at which varies independent of production rate.
P lan t m anagem ent is not greatly interested in the dis
trib u tio n o f indirect costs so th at each product or group of products m ay bear its proportionate share of the total burden, b u t ra th e r in seeing th a t the total of these v ari
ous expenses is reduced to a m inim um . T he one w ay to do this is to consider each item o f indirect expense in toto— as a separate and distinct entity. F o r exam ple, it is easier to com prehend and th u s to control the cost of supervision when it is considered as a total than a fte r it has been distributed over a half dozen products or processes. In fact, no statem ent used fo r plant control should contain an y figures resulting from a proration, even though it represent an item of direct cost. P ro ra tion o f w hat should be direct costs is frequently rendered necessary due to lack of m easuring m eans— fo r instance, a common fuel bin o r a common steam line supplying two independent operations— but the necessity arises in figur
ing the cost and not in controlling the consum ption of fuel o r steam . F o r the la tter purpose the sum of esti
m ated consum ptions m ust be com pared w ith the one actual m easurem ent, otherw ise an estim ate is being com
pared w ith an estim ate.
T h is m ethod of plant m anagem ent consists first in the clean-cut delegation o f responsibility throughout the o rg a n iz a tio n ; it entails a forecast o r "budget of produc
tion volum e, rate and cost over a suitable period, itemized to correspond w ith individual responsibility; it entails a parallel record of accom plishm ent: and finally it f u r nishes to individuals and groups a statem ent com paring anticipated and actual results. T h e whole scheme is directed to w ard using to the lim it the abilities of every employee, m aking it possible for him to use his initiative and native intelligence to the fullest extent. I f the plant is adequately equipped w ith m easuring instrum ents a foundation is laid fo r bonus incentives, which usually put a keen edge on those qualities, in the individual and in the group. T he standard cost system m akes the m ethod w orkable inasm uch as it autom atically separates factors beyond the control o f the individual, leaving bare those affected by his judgm ent and intelligence. F u r therm ore, it perm its detailed routine analysis of g reat masses o f operating data at a m inim um o f expense.
P redicting Effects o f Changes
In so fa r as the plant m anager is required to play the role of econom ist and to estim ate the effect o f proposed changes, the raw m aterial fo r the job is readily available and in excellent arrangem ent. N o m atter w hat the inno
vation m ay be, one broad question is invariably p re sen ted : how m uch will the total outgo be affected, and how m uch the total incom e? In a large plant, m anufac
tu rin g a diversity o f products, the individual processes are inextricably tied together by their dependence upon m utual facilities and upon m utual labor, supervision, and m anagem ent. T o tal cost o f increasing o r decreasing p roduction from any one process is practically never directly proportional to cu rren t volum e and cost, as every item o f expense, both direct and indirect, m ay be affected to a different ex ten t an d require separate consideration.
T h e effect o f such change on an y one of th e various item s o f m utual o r overhead expense can only be arrived a t from consideration o f the total o f each, and not some
portion thereof m ore o r less a rb itra rily allotted to the process in question. T h e plant m an ag er never need concern him self w ith the d istrib u tio n o f overhead expense; he has before him the tangible cost o f each plant activity in its entirety, and he or som e m em ber of his force knows the n atu re o f it in detail an d can de
term ine the effect of changes in the processing o f any item of production.
T h e value to any one of routine finished costs— costs carried down to individual products o r gro u p s of p ro d ucts w ith all m utual items o f direct and indirect expense allocated by a set scheme of p ro ra tio n — is highly debatable. T he intricately woven re su lt usually contains so m uch shoddy in the w ay o f a rb itra ry assum ptions as to make poor fabric fo r decisions affecting dividends.
Possibly better to present every question to a trained economist w ith the raw m aterial o f specific expenditures a t his command, and allow him to arriv e a t an answ er a fte r taking into consideration not only p lan t costs but also general business conditions.
M easuring fo r Cost Accuracy
Cost system s have alw ays been considered a device of accountants, and in so far as they have failed accurately to reflect the tru th , th at failure has been laid on th e ac
cou n tan t’s doorstep. A s a m atter of fairn ess it should be stated and em phasized th at the plant d esigner an d oper
ato r is responsible fo r the com m onest and m ost im portant cause of inaccuracy, and fo r squandering a v ast am ount o f labor in arriving at approxim ations in place o f ascer
tainable fact. T he foundation of an y cost system is the accurate m easurem ent of m aterial quantities. W ere it possible so to design a plant th a t all m aterial consum ed or produced could be accurately m easured. 90 p er cent of the design of a cost system is th ere com pleted. N ow adays the design of chemical plant equipm ent, in so fa r as
tainable fact. T he foundation of an y cost system is the accurate m easurem ent of m aterial quantities. W ere it possible so to design a plant th a t all m aterial consum ed or produced could be accurately m easured. 90 p er cent of the design of a cost system is th ere com pleted. N ow adays the design of chemical plant equipm ent, in so fa r as