Cost accounting

“ Cost accounting is a profession in itself, and it is not our purpose to discuss, in this paper, all of the details of collecting data in the factory and shop. The purpose of this paper is to show the accounts with which a bookkeeper for a manufacturing business should become familiar. Even when a manufacturer does not maintain a complete cost accounting system the bookkeeper can produce some valuable statistics by a proper arrangement of the accounts. ”

“ It is of utmost importance that the cost of manufacture be not understated, for it is on this cost that selling prices will be based. This is one reason why some manufacturers add a small-factory profit. Unless a complete system of cost accounting is maintained, this inventory of goods in process must be an estimate, but the record of goods in process in each department will be of considerable assistance in making the estimate. ”

“ Correct cost accounting methods are of greater importance to the manufacturer than the method of keeping accounts with his customers. He cannot afford to wait until the end of the year for results; he must know what his goods cost him if he is to intelligently make selling prices. There are so many opportunities for fluctuations in manufacturing costs that the accounts must at least show approximate results at all times. ”

“ For example, when the cost of placing the asset in efficient condition for operation is less than, say, $100, it is charged as repair cost and therefore does not increase the book value of the asset. If the cost exceeds $100, an analysis is made to determine what portion of it, if any, increases the value of the asset. The amount of the betterment is of course a charge to the asset account, while the rest of it is a charge to some expense account. ”

“ It is very vital that a clear line of demarcation be maintained between capital and revenue expenditures—that great care be exercised that no cost is charged into the asset group of accounts unless such cost really enhances the worth of an asset. A cost incurred for the purpose of maintaining the value of the asset is an expense charge, and repairs and maintenance charges must be very carefully distinguished from replacements. ”

“ If cost accounting by departments is determined upon, it becomes necessary to carry the departmental analysis beyond the gross profit stage, in which case building expense must be taken account of and spread equitably over the various departments. Likewise, within the factory it may be desirable to allocate the item of building expense over the various departments of storeskeeping, costing, and production proper, and even a further analysis may be necessary depending somewhat on the detailed information desired. ”

“ Accounting for financial management and accounting for federal income tax purposes both focus on the need for an accurate determination of the net income from operations of a given business for a fiscal period. The approach taken by the Commissioner computes depreciation expense in a manner which is far more likely to reflect correctly the actual cost over the years in which the asset is employed in the business. ”

“ Where interest is treated as a manufacturing cost, the booking of it raises a perplexing accounting problem. The charge has to be made to some factory expense account, while the credit must be carried over to possibly a financial management income account. If the entire output of the factory were sold out by the close of the fiscal period and no product was in process of manufacture at that time, the result of booking interest in this way, so far as net profit is concerned, would be nil. It would be like taking money out of one pocket and putting it in another. ”

“ Appellee further urges that so much of the Commission's order as affects property already retired is improper, because the sole purpose of original cost accounting is to show separately the amount by which the price paid by the accounting company for property now in service exceeded the original cost of that property. But the purposes of an original cost system of accounting are broader. Under such a system the inflation in accounts not only may be segregated but may also be written off. ”

“ The manufacturing cost formula comprises the three items of: (1) raw material consumed, (2) direct labor applied, and (3) factory expenses incurred, this latter item sometimes called overhead expenses. When a concern operates a detailed cost system, the valuation of the finished product is not difficult, being the goal towards which the system works. Where no cost system is used, great care must be exercised to make sure that every item of cost is calculated as accurately as possible and that a proportionate share of such costs is applied to the finished product still on hand unsold. ”

“ Charge depreciation upon actual cost less any salvage.' [23]
Such is to-day, and ever has been, the practice of public accountants. [24] Their statements are prepared in accordance with principles of accounting which are well established, generally accepted and uniformly applied. By those accustomed to read the language of accounting a depreciation charge is understood as meaning the appropriate contribution for that year to the amount required to make good the cost of the plant which ultimately must be retired. ”

“ The time during which an asset continues in use is the customary basis for a classification of its cost as between expenses and fixed assets. Thus, an asset acquired for purposes of business operation which, however, will be used up completely during the current period is charged immediately to some expense account, whereas an asset which will continue in use over several periods is charged to an asset account. Fixed asset purchases are never for purposes of resale. ”

“ The account should be charged originally with all such items at full cost. Great care must be exercised in handling repairs and betterments to avoid an inflation of values. The distinction between capital and revenue expenditures as regards all such assets already acquired is usually so slight and uncertain as to justify the establishment of a policy of charging all these to expense. Otherwise, the ease of inflation is apparent. All new purchases should be charged at full cost to the asset. ”

“ These expenses usually comprise such costs as state incorporation fees, attorney’s fees for drawing up the application and other papers, the cost of prospectuses, soliciting costs for stock subscriptions, fees paid promoters and organizers, cost of printing and issuing certificates of stock, cost of capital stock records, and similar items. These are necessary and unavoidable expenses without which the company cannot come into being. A company organized and ready to commence business is in a better position than one whose elements have not been brought into harmonious working. ”

“ The net difference between the income and the cost of securing the income, as indicated by the expense accounts, will represent the value added to the assets of the business, and will therefore be reflected tangibly in an increase in the value of the assets by that amount. This increase will usually be reflected either in the cash holdings or in claims against customers. ”

“ The cost of advertising, the cost of colonization, and canvassing by agents engaged 281in building up the business tributary to the corporation, the cost of developing an efficient business organization and an efficient plant—every possible item of developing the business finds accurate record in the development expense deduced from the accounting records as outlined. ”

“ The determination of the value of the elements of cost, the [Pg 98] proper differentiation between capital and revenue charges, and finally the calculation of the amount of depreciation necessary to the valuation of fixed assets—all are estimates. It is true, they are estimates based on experience, but, from their nature and the influence of local conditions in a given case, no universally applicable law of experience can be formulated. It is safe to say that two men would seldom, if ever, arrive at the same estimate of the values of given assets. ”

“ For the determination of individual rates local conditions are always the controlling factor. An illustration in point is given by Henry Floy, [28] showing the varying rates used by thirty-one different concerns for the depreciation of their rolling stock equipment. The methods vary in almost every case, comprising annual charges of an arbitrary amount, per cent of the original cost, cents per car mile, arbitrary deductions from income irregularly applied, per cent of gross earnings, per cent of present estimated values. ”

“ In this connection it may be pointed out that the cost of all assets subject to depreciation may well be looked upon as deferred charges to operation, some portion of that cost being charged off at the close of each fiscal period. “So we see that capital expenditures, as distinguished from expenses, are at last an arbitrary conception. It begins with the idea that certain expenditures have an efficiency which reaches over many earning periods extending indefinitely into the future. But nothing physical would last so long, and its earning power might have even less permanence. ”

“ It is inconsistent practice to separate the invoice price into two elements and term one real selling price and the other sales discount cost when the real selling price is still a composite item. Rather, the sale should be booked at its full invoiced price and actual costs recorded as they accrue, to be closed out against Sales Income at the end of the fiscal period. ”

“ From the discussion of the principles of debit and credit as applied to merchandise and to fixed assets, it has been shown that the price paid should include not alone the invoice cost but the other expenditures needed to put the article purchased in such a position that it can be used by the business in the customary way. Replacement value means the cost to replace an article. It differs from first cost mainly in that the price level may have changed between the date of the original purchase and the present time. ”

“ Original cost' or 'cost,' as applied to telephone plant, franchises, patent rights, and right-of-way, means the actual money cost of (or the current money value of any consideration other than money exchanged for) property at the time when it was first dedicated to the public use, whether by the accounting company or by a predecessor public utility.' If actual costs are unknown, estimates are to take their place. ”

“ By cost to make is meant full cost, which includes materials used, labor applied, and a fair share of the overhead expenses. Whatever the cost to make, whether lower or higher than the identical equipment could be purchased for on the market, that represents the capital outlay and is the true basis for valuation, taking cognizance of depreciation for the elapsed period. ”

“ Direct costs are sometimes called prime costs. The cost elements which can almost invariably be applied directly to the product are material and labor. The sum of these two items constitute, therefore, the prime or first cost of the product. The other items of cost which are incurred in the factory or with which the factory is chargeable are variously called factory expense, overhead, or burden. These indirect costs cannot be charged directly to any specific product, and so they are shared by the entire factory output. ”

“ It will be seen that the rule applicable to most business property of a cost basis properly adjusted leaves many problems of depreciation accounting to be answered by sound and fair tax administration. ”

“ Since, from the mathematical necessity of the proprietorship equation, proprietorship items normally have credit balances, it is evident that all income, or earnings, must be placed on the credit side of their appropriate accounts. Cost of management and all expenses of operation are deductions from that income and must therefore be recorded on the left or debit side of appropriately named accounts.
Income Debits and Credits.—With regard to their debits and credits, income accounts follow this rule:
Income accounts normally have entries only on the credit side. ”

“ It is apparent from a consideration of the single merchandise account that at any given time it includes these three items: (1) the net cost of the total goods to be accounted for; (2) the decrease in the asset merchandise brought about by sale; and (3) the profit on the goods sold. In order to bring about the separation of the merchandise records into the two elements (a) goods still on hand, that is, the asset element, and (b) the profit on goods sold, that is, the income element, it is necessary to bring the detailed accounts together for the purpose of summarization. ”

“ Make your assumptions reasonable as to the turnover and the ratios of expenses and profit to sales. Assume a merchandise turnover of 5, and a gross profit of 40% of sales. From these determine roughly the cost of goods sold, the purchases, and the sales figures. Make reasonable provision for bad debts, depreciation, interest, etc., in accordance with the balance sheet requirements. Make the other expense items whatever amounts are necessary to produce the same net profits as is shown by the comparative balance sheet. ”

“ Current assets and liabilities are converted at the rates current at the date of the balance sheet because the balance sheet should represent these values at the exact cost of converting them into cash at the present moment. If in practice they were actually liquidated, this could not be realized but in principle it represents the present condition. Revenue items are convertible at the average rate because they represent items accumulating during the entire fiscal period ”