CHAPTER V
THE NATURE OF EXPENSE
LEAVING now the general principles of industrial or-
ganization and the institutions and agencies by which
industrial operations are carried on, we may view the prob-
lems of manufacturing as they present themselves to the
works manager and study the several elements of these prob-
lems from his characteristic point of view. In practice, the
processes of manufacture fall naturally into four great di-
visions: First, gathering materials of various sorts neces-
sary to the product we plan to turn out; second, operating
upon these materials in some way so as to change their form,
condition, combination, location, or bulk; third, distributing
again among buyers that which we have previously gathered
and manufactured; fourth, overseeing, safeguarding and
promoting the whole cycle. To put it more briefly, the
steps are: procuring raw materials, making them into finished
product, selling our goods, managing the business. To re-
duce it to four words, the functions are purchase, produc-
tion, selling, administration. All are necessary to the con-
duct of a manufacturing business, but to the manufacturer's
mind some elements in the scheme, such as outlay for
material and direct labor, seem to be visibly embodied in the
finished product, and these he calls "productive"; others,
like the outlay for administration, are only indirectly identi-
fied with the finished product, and are classed by him as
" non-productive." Therefore, as the manufacturer always
thinks in terms of cost, every proposition in production ap-
pears in his mind as consisting of three terms labor,
materials, and expense.
Let us examine this position again in more detail and
from a slightly different angle of vision. All business is
carried on for the sake of making money. In the simplest
conceivable kind of accounting, we would put down on one
side of the account or in one place a list of everything we
spend in the course of carrying on our business, and on the
other side of the account or in another place we would put
down a list of everything we receive. The difference be-
tween the sums of these two lists would be our profit.
Now if our business is manufacturing, we shall always
find, if we examine the items on the debit side that is, the
list of expenditures that these items fall naturally into
three great groups corresponding to three distinct sorts of
thing for which our money has been expended. One of
these groups will contain all the expenditures for the ma-
terials we use in our manufacturing iron, steel, brass,
wood, cloth, whatever it may be. The second of the three
great groups into which we can divide our expenditures will
contain all the outlay for labor the money that we have
paid to men for working and making up these materials
into our manufactured product; and the third of the great
groups will contain a list of expenditures for things that do
not go into our product as labor and materials do, but yet
are necessary to carry on the business. Such items are
advertising, selling, office salaries, insurance and repairs and
so on. This third great group of expenditure, then this
group of items of outlay for things that are necessary to
carrying on the business and yet do not go directly into
the product this is called expense.
In one sense there is not an absolutely hard and fast
line between these three classes of expenditure. In one
sense expense overlaps, so to speak, both material and
labor. For example, in a foundry, moulding sand is
physically speaking " material." In a brick yard, lumber
for runways is in the same sense a " material." But in
neither case does it go into our product. It is not sold
with our product. We can not find or weigh or measure
a fragment of it in each piece of our product. It is used
up and disappears, but the cost belongs to the business as
a whole.
So men carrying messages about a factory, or carting
shavings from a planing mill, are humanly speaking " la-
borers " labor. But again they are doing work that can
not be directly charged to any particular job it is part
of the necessary general cost of the work as a whole.
From the accounting point of view, then, the deciding
question is does the material or the labor go directly into
product; can we trace it there and say definitely u so much
material and so much labor make up this article " or
does it merely serve in some general way the making of
all or many of the articles we are turning out? If the
latter, then it is an expense item, to the accountant, even
though in a dictionary sense it might seem to be material or
labor.
Some accountants recognize this sort of double character
of certain items by calling them " expense material " and
" expense labor." It is more common, however, to speak
of the three divisions of cost as direct material (or simply
material) direct or productive labor, and " expense " in-
cluding in the latter term all indirect material and labor.
Whether the manufacturer's money is expended for ma-
terials, for labor, or for expense items, he has one great
general object, and that is that it shall be expended wisely,
economically, and efficiently. But when we get beyond this
first principal purpose and care, which is always in a manu-
facturer's mind, we can readily see that the things to be
considered second are of different and characteristic natures
in the case of materials and of labor and of expense.
The points in which the manufacturer is especially inter-
ested, so far as concerns materials, are to make sure that
they are provided and maintained in sufficient quantity for
the operations of manufacture to go on without interruption,
that receipts are verified, materials on hand properly stored
and cared for, and materials in manufacture moved safely
and in an orderly way from process to process until the
manufactured product is complete.
In the case of labor the manufacturer's leading care and
anxiety is to secure enough workers of desirable quality,
to keep them contented, to increase their productivity, and
to keep track of their time.
The fundamental problem of expense is distribution.
That is, if our business is to be intelligently and success-
fully carried on, after we have accounted for the money that
we have paid for materials and found out how much of it
has gone into each unit we have manufactured, and after
we have paid for our labor and accounted for the time and
wages spent upon each unit of our product, we must be able
to take the rest of our expenditures the confused total bulk
of general expense, which is neither direct labor nor direct
material and to divide it up into a multitude of little frac-
tions, each corresponding to one unit of our product, and
we must make this division and u levy this assessment " so
that we can say confidently that' we have charged each unit
with its fair, reasonable, and just proportion; that we have
assessed to each unit of product the actual cost of the ma-
terial that went into it and the labor that was put upon it,
and its proper share of the general expense of carrying on
the business. If we do this correctly we are sure that
when we have added to these costs a proper percentage of
profit, we will make money if we can find a market for
our goods.
The importance of being right about it is this: If we
make a mistake in the distribution and charge some . one
line of our product with more expense burden than it ought
to bear, a clever competitor who knows his costs better
than we know ours, will make a lower price which still
leaves him a safe margin and he will undersell us and
take away our market. If we charge some one line of our
product with less expense burden than it ought to bear,
we shall probably get the business in that line away from
our wiser competitors who are asking correct prices, but
the more we sell the more money we shall lose.
In other words, the reason that makes it necessary to
have a correct knowledge of our costs is competition. "And
in the correct knowledge of costs, the most difficult and
at the same time the most necessary thing is the correct
distribution of expense. Mr. A. Hamilton Church, who
is one of the leading authorities on the distribution of ex-
pense burden, says: " Very few concerns have come to grief
by ignoring labor costs " (or he might add material costs),
" but many have passed into the hands of receivers by
ignoring the relative importance of other factors of pro-
duction."
K
Selling Price
$600
Inclusive or Total Cost
$500
-Shop Cost~ >!
$400
Prime or Flat Cost *i
^i
"1
$150
Material
$150
Labor
$100
Factory
Expense
$100
General
Expense
$100
Profit
We may represent by this simple diagram the several frac-
tions making up total costs, and the several parts of which
the final selling price of an article is made up. The relative
proportions of material and labor, factory expense, selling
expense, and profit vary widely in different cases. The pro-
portions used in the diagram are wholly arbitrary, but are
not improbable.
The figure serves to show the significance of the terms
commonly used in cost accounting, and to emphasize the
division of expense into two parts, the first called u factory,"
" shop," or " manufacturing " expense, and the second
called " general," " commercial," or " selling " expense.
This division is commonly in use and is logical. There is
no necessary connection between the expense attending the
making of an article and the expense of selling it. They
may be relatively very different. There is hence no reason
why these two expense elements should be distributed at
the same time or in the same ratio, and indeed there are
many reasons why they should not.
The discussion following will leave until last the rational
mode of apportioning general expense among the varied
products of any establishment, and will take up first and
at greatest length the distribution of factory expense.
THE NATURE OF EXPENSE
LEAVING now the general principles of industrial or-
ganization and the institutions and agencies by which
industrial operations are carried on, we may view the prob-
lems of manufacturing as they present themselves to the
works manager and study the several elements of these prob-
lems from his characteristic point of view. In practice, the
processes of manufacture fall naturally into four great di-
visions: First, gathering materials of various sorts neces-
sary to the product we plan to turn out; second, operating
upon these materials in some way so as to change their form,
condition, combination, location, or bulk; third, distributing
again among buyers that which we have previously gathered
and manufactured; fourth, overseeing, safeguarding and
promoting the whole cycle. To put it more briefly, the
steps are: procuring raw materials, making them into finished
product, selling our goods, managing the business. To re-
duce it to four words, the functions are purchase, produc-
tion, selling, administration. All are necessary to the con-
duct of a manufacturing business, but to the manufacturer's
mind some elements in the scheme, such as outlay for
material and direct labor, seem to be visibly embodied in the
finished product, and these he calls "productive"; others,
like the outlay for administration, are only indirectly identi-
fied with the finished product, and are classed by him as
" non-productive." Therefore, as the manufacturer always
thinks in terms of cost, every proposition in production ap-
pears in his mind as consisting of three terms labor,
materials, and expense.
Let us examine this position again in more detail and
from a slightly different angle of vision. All business is
carried on for the sake of making money. In the simplest
conceivable kind of accounting, we would put down on one
side of the account or in one place a list of everything we
spend in the course of carrying on our business, and on the
other side of the account or in another place we would put
down a list of everything we receive. The difference be-
tween the sums of these two lists would be our profit.
Now if our business is manufacturing, we shall always
find, if we examine the items on the debit side that is, the
list of expenditures that these items fall naturally into
three great groups corresponding to three distinct sorts of
thing for which our money has been expended. One of
these groups will contain all the expenditures for the ma-
terials we use in our manufacturing iron, steel, brass,
wood, cloth, whatever it may be. The second of the three
great groups into which we can divide our expenditures will
contain all the outlay for labor the money that we have
paid to men for working and making up these materials
into our manufactured product; and the third of the great
groups will contain a list of expenditures for things that do
not go into our product as labor and materials do, but yet
are necessary to carry on the business. Such items are
advertising, selling, office salaries, insurance and repairs and
so on. This third great group of expenditure, then this
group of items of outlay for things that are necessary to
carrying on the business and yet do not go directly into
the product this is called expense.
In one sense there is not an absolutely hard and fast
line between these three classes of expenditure. In one
sense expense overlaps, so to speak, both material and
labor. For example, in a foundry, moulding sand is
physically speaking " material." In a brick yard, lumber
for runways is in the same sense a " material." But in
neither case does it go into our product. It is not sold
with our product. We can not find or weigh or measure
a fragment of it in each piece of our product. It is used
up and disappears, but the cost belongs to the business as
a whole.
So men carrying messages about a factory, or carting
shavings from a planing mill, are humanly speaking " la-
borers " labor. But again they are doing work that can
not be directly charged to any particular job it is part
of the necessary general cost of the work as a whole.
From the accounting point of view, then, the deciding
question is does the material or the labor go directly into
product; can we trace it there and say definitely u so much
material and so much labor make up this article " or
does it merely serve in some general way the making of
all or many of the articles we are turning out? If the
latter, then it is an expense item, to the accountant, even
though in a dictionary sense it might seem to be material or
labor.
Some accountants recognize this sort of double character
of certain items by calling them " expense material " and
" expense labor." It is more common, however, to speak
of the three divisions of cost as direct material (or simply
material) direct or productive labor, and " expense " in-
cluding in the latter term all indirect material and labor.
Whether the manufacturer's money is expended for ma-
terials, for labor, or for expense items, he has one great
general object, and that is that it shall be expended wisely,
economically, and efficiently. But when we get beyond this
first principal purpose and care, which is always in a manu-
facturer's mind, we can readily see that the things to be
considered second are of different and characteristic natures
in the case of materials and of labor and of expense.
The points in which the manufacturer is especially inter-
ested, so far as concerns materials, are to make sure that
they are provided and maintained in sufficient quantity for
the operations of manufacture to go on without interruption,
that receipts are verified, materials on hand properly stored
and cared for, and materials in manufacture moved safely
and in an orderly way from process to process until the
manufactured product is complete.
In the case of labor the manufacturer's leading care and
anxiety is to secure enough workers of desirable quality,
to keep them contented, to increase their productivity, and
to keep track of their time.
The fundamental problem of expense is distribution.
That is, if our business is to be intelligently and success-
fully carried on, after we have accounted for the money that
we have paid for materials and found out how much of it
has gone into each unit we have manufactured, and after
we have paid for our labor and accounted for the time and
wages spent upon each unit of our product, we must be able
to take the rest of our expenditures the confused total bulk
of general expense, which is neither direct labor nor direct
material and to divide it up into a multitude of little frac-
tions, each corresponding to one unit of our product, and
we must make this division and u levy this assessment " so
that we can say confidently that' we have charged each unit
with its fair, reasonable, and just proportion; that we have
assessed to each unit of product the actual cost of the ma-
terial that went into it and the labor that was put upon it,
and its proper share of the general expense of carrying on
the business. If we do this correctly we are sure that
when we have added to these costs a proper percentage of
profit, we will make money if we can find a market for
our goods.
The importance of being right about it is this: If we
make a mistake in the distribution and charge some . one
line of our product with more expense burden than it ought
to bear, a clever competitor who knows his costs better
than we know ours, will make a lower price which still
leaves him a safe margin and he will undersell us and
take away our market. If we charge some one line of our
product with less expense burden than it ought to bear,
we shall probably get the business in that line away from
our wiser competitors who are asking correct prices, but
the more we sell the more money we shall lose.
In other words, the reason that makes it necessary to
have a correct knowledge of our costs is competition. "And
in the correct knowledge of costs, the most difficult and
at the same time the most necessary thing is the correct
distribution of expense. Mr. A. Hamilton Church, who
is one of the leading authorities on the distribution of ex-
pense burden, says: " Very few concerns have come to grief
by ignoring labor costs " (or he might add material costs),
" but many have passed into the hands of receivers by
ignoring the relative importance of other factors of pro-
duction."
K
Selling Price
$600
Inclusive or Total Cost
$500
-Shop Cost~ >!
$400
Prime or Flat Cost *i
^i
"1
$150
Material
$150
Labor
$100
Factory
Expense
$100
General
Expense
$100
Profit
We may represent by this simple diagram the several frac-
tions making up total costs, and the several parts of which
the final selling price of an article is made up. The relative
proportions of material and labor, factory expense, selling
expense, and profit vary widely in different cases. The pro-
portions used in the diagram are wholly arbitrary, but are
not improbable.
The figure serves to show the significance of the terms
commonly used in cost accounting, and to emphasize the
division of expense into two parts, the first called u factory,"
" shop," or " manufacturing " expense, and the second
called " general," " commercial," or " selling " expense.
This division is commonly in use and is logical. There is
no necessary connection between the expense attending the
making of an article and the expense of selling it. They
may be relatively very different. There is hence no reason
why these two expense elements should be distributed at
the same time or in the same ratio, and indeed there are
many reasons why they should not.
The discussion following will leave until last the rational
mode of apportioning general expense among the varied
products of any establishment, and will take up first and
at greatest length the distribution of factory expense.
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