METHODS OF DISTRIBUTION
7. Time is continually bringing improvements; old methods once thought practical and satisfactory are replaced by more efficient ones to meet the exacting conditions of to-day. Examine a Practical Bookkeeping-Manufacturer's Edition of thirty or forty years ago and you will probably find nothing on this subject of expense distribution, while to-day it is one of the most important and most discussed of any in factory accounting in general, and cost accounting in particular. Since that time different methods of handling expense have been devised, some with more or less merit. It will be the intent of this section to consider at some length three of the most frequently used of these methods, endeavoring to find one which will, in the most equitable manner, distribute into production the operating expense of a factory with the least amount of detail and unnecessary figuring on the part of the accountant; and at the same time prove satisfactory from the manufacturer's standpoint.
8. The Man-Hour Rate Method. This method, once quite popular, is now but little used, and it is doubtful if it can be found in operation in many up-to-date plants at the present time. The name of the method suggests its intent, which was to distribute factory expense over the various production job orders according to the amount of time spent by the workmen at an hourly rate. This rate is easily calculated, and was established by dividing the total expense for any period by the total number of hours spent on productive work for the same period, reducing the rate of distribution to so much per hour. If 100 hours of labor were spent on a productive job, the cost of the wages paid the workman for this time was not considered, the expense to be borne by the job being figured at the hourly rate for the 100 hours. It will be seen that this is hardly an equitable arrangement, and to rectify a serious defect in the method, some adjustment must be made:
(a) The inability to fix a standard for the efficiency of the labor lays the man-hour rate open to criticism. Could this be done, this method would in many cases prove a very equitable way of distributing expense. It will, however, be seen at once that as it is, a skilled workman carries no more expense than an apprentice boy, and if both work on a productive job a full week, the expense in either case is the same regardless of the wages paid. This is hardly a fair proposition. Either the apprentice's time must be accepted as standard and the skilled workman considered twice as efficient in work-hours, or vice versâ. To do this would lead to endless complications, yet the quantity and quality of the output between these two classes of labor should be considered and adjusted in some way so that the injustice done the manufacturing cost may be corrected. But this is not an easy matter to regulate, and means extra work on the part of the cost clerks in recording the time spent on job work and adjusting these inequalities in the labor.
(b) The man-hour rate requires that the hours worked be carefully recorded and totaled, as well as the cost. Many concerns with heavy pay-rolls to be apportioned over a large number of job orders, ignore the footing of the long columns of hours and fractions, and use only the totals of labor cost, which are of course necessary for entry in the commercial books. It is obvious that in doing this an immense amount of clerical labor is saved. The man-hour method requires that both hours and labor cost should be recorded and totaled—a double operation and duplication of work, which, unless it can be simplified, should be avoided, as it means time and unnecessary expense.
9. Machine-Hour Rate Method. This machine-rate plan of distributing expense was designed to meet the needs of a shop where the product is largely the result of a machine or tool operation, rather than the labor of the mechanic himself. It somewhat resembles the man-hour plan in that the rate of distributing expense is reduced to an hourly rate for the time the machine is working on the job instead of the time of the operator. Each machine is intended to have its own rate.
The method of arriving at the machine rate is easily understood, and reduces itself to the item of depreciation on the original cost price of the machine with its shafting, belting, tools, and installation cost figured at, say, 5%, the power to operate machine at an estimated cost per horse-power, ordinary repairs, divided by the number of hours the machine is estimated to be in operation for the same period; this will give the hourly rate of cost to operate. Some mechanical engineers advocate including in the above cost, interest on the investment at 6%, also insurance and taxes; and by others, the value of the floor space occupied by the machine is also included; but in all these latter points referred to, engineers greatly differ in opinion, and it is generally decided by each manufacturer for himself according to his own ideas.
On the question of the value of machine rates there is probably more argument by mechanical engineers and accountants than on any question in factory accounting; in fact, engineers themselves are very far apart in their opinions and do not seem to agree among themselves. Accountants generally are inclined to take a somewhat different view of the situation from our mechanical friends. While it is admitted there is good argument for both positions, it is to be remembered that we are considering the question of machine rates as a means of distributing the expense account, and it seems to be the prevailing opinion among accountants that as such it is found wanting. While, theoretically, it is undoubtedly the correct solution of the problem, it is more often found in practice to be a case of a "distribution that does not distribute," and for this reason is not used by the very class of factories and machine works for which it was designed and intended to benefit.
Let us consider in detail a few of the objections that may be raised to the machine-rate method:
(a) It will be noticed there are other expenses in the shop than that of operating the machines and not covered at all by the machine expense. Machine rates are absolutely worthless for bench labor and the assembling room, for these two must also share in carrying the shop burden. Not to do so would be manifestly unfair. It is therefore necessary that a second distribution must be made entirely different in its calculation, to handle this undistributed expense not covered by the machine rates, which means two different operations for the same shop.
This necessitates two different time records to be kept, one card for each machine showing jobs worked on and hours idle, and another time card for the workman. Is is easy to appreciate that this double operation greatly increases the clerical work in the shop, besides two sets of entries by the cost clerks, and more detail for all concerned. If a method can be found which requires but one time record to be kept, this double process can be done away with and the duplication of work avoided.
(b) The principal factor in the calculation of the machine rate, in fact, the real key to a successful calculation, is in establishing a standard of work-hours for each machine. It is noted that the higher the standard, the lower will be the rate, and the lower the hours operated, the higher will be the rate; in other words, when the machine is idle in excess of the standard, the rate changes. In some shops where the output is a stable product, always in demand, and the machine in continuous operation, a good estimate may be made, but in most shops a machine is frequently idle on account of "no work" or "laid up" for repairs the same as is its operator. The practice in most shops is such that it is extremely difficult to estimate ahead what the work-hours of a machine will be, and it resolves itself generally into an intelligent guess with two estimators far apart in their estimates, yet a satisfactory distribution requires a standard which will work out in figures close to the actual facts.
Who can successfully estimate ahead for any time the activity of each machine in a large factory? Our factory engineers are at wide variance on this point. One authority says "full time," 300 days a year, is the proper basis for calculation. It would seem as if this were rather an unusual position to take; it apparently being his belief that the time idle would be offset by the time the machine was operated overtime, or else he expected the machinery once put in motion to neither shut down, nor break down. Either appears to be rather a dangerous assumption on which to base a careful calculation for rate of distribution.
Another engineer says 80% of a full day will be found to be the maximum, and further adds: "It will doubtless fall much below that figure." One naturally asks "How much lower?" There is quite a large field of figures to choose from between an 80% activity and a dead standstill for the machine.
It is quite unnecessary to attempt to demonstrate at length that the work-hour standard may be a very elastic figure, and it is often found that after distribution has been made, the results are very unsatisfactory and the machine rates used have proved "way off."
(c) Again, having settled on the work-hour standard, other adjustments appear necessary to equitably handle the machine rate question. For instance, two machines may be of the same book valuation and in cost of operation practically alike, yet one may be far more efficient than the other and possibly turn out two or three times as much work. This condition is constantly found in different shops, and whether or not the two machines should carry the same rate, and, if not, how this inequality shall be adjusted, forms a very interesting question for discussion.
(d) It is noted that the essentials in the calculation of machine rates are all based on estimates which may or may not prove correct; that positive book figures are lacking; and that the calculations are made on assumptions. One of the best professional opinions noted is that expressed by one of our leading accountants, who, commenting on the question of machine rates, observes that "it begins with estimating and is estimating all the way through." This appears to be rather severe criticism, yet one has but to give the subject careful consideration to note that it quite correctly sums up the situation in a few words.
As previously stated, the machine-rate method is without doubt theoretically correct, but, until the subject has been more thoroughly elucidated and worked out in all its details to fit shop conditions and furnish a satisfactory means of distributing expense, it is doubtful if it will be used to any great extent. This method certainly requires an elaboration of system and detail, with questionable results, and with many serious objections apparent; it seems pertinent, therefore, to ask the question "Is it worth while; cannot something better be devised?"
10. The Percent Method. A third plan of distribution, commonly referred to as the percentage method, differs from the two already outlined, in which the time employed was the basis of operation, in that the rate of distribution is a percentage on the direct labor cost of the product, which is, of course, commensurate with the amount of time expended. In the first division of our subject, it was shown that expense figured on direct labor would prove the most reliable.
This method is based on the principle that the production of each department of a plant should shoulder its own expense, and also a share of the general expense. In other words, the cost of the output from the Blacksmith Department, for instance, would be the total productive labor of the department, plus the material used, plus the operating expense of the department, plus its share of the general expense of the whole plant. It is only necessary, then, to establish the relation between the productive labor and the expense, and express the same in a percentage. It is immaterial how many departments or processes there may be in the factory; this relation should be found in each case, based on its own productive labor and expense, each department having its own percentage ascertained from its own actual conditions; no estimating about it. The expense, then, is figured on the labor cost. If, in the Blacksmith Department already referred to, it is found that the expense at which the department is operated is one-fourth of its total productive pay-roll for the same period, it is at once apparent that if to the labor cost of every productive job, 25% is added for shop expense, the total of these expense items added will equal the total expense of the department. In other words, the shop expense is split up and added to each job in proportion to the labor expended on it.
The general expense is handled the same way. If the total general expense is found to be one-third of the total productive labor in the plant, it is likewise apparent that, if to the labor of every productive job, 33⅓% is added to cover general expense, the sum total of these percentage items added will equal the total general expense of the plant.
Following, then, the formula outlined at the opening of our discussion under the heading of True Cost, the cost of a job done in the Blacksmith Department, on which the direct labor cost was $100.00, would appear on our records as follows:
| Direct labor | $100.00 |
| Material | 50.00 |
| Factory expense at 25% | 25.00 |
| ———— | |
| Factory cost | 175.00 |
| General expense 33⅓% | 33.33 |
| ———— | |
| Manufacturing cost | $208.33 |
This is the percentage method. While it is quite natural in anything of value and merit to look for its imperfections, this method is criticised by some accountants who point to flaws in its logic and method of computation; nevertheless, it stands to-day as the best solution of the vexed question of expense distribution that has yet been devised, for it not only has the approval of our best technical authorities, but that of the practical accountant as well. It commends itself to the intelligent judgment of the manufacturer, who is quick to realize its superiority, and it can be recommended for many reasons:
(a) It is based on actual figures, easily extracted from the regular books of account, and which are a true statement of fact; no guess-work or estimating about it. There is no better way to figure what is to be, than to use results of what can be conclusively demonstrated already has been.
(b) It can be used in any manufacturing plant, or in all the departments of the same plant, thereby insuring uniformity of method, which is always desired. No argument is necessary to convince that two methods in the same factory are undesirable when one can be found that is satisfactory.
(c) It accomplishes its purpose—it distributes. If it is found that factory conditions are changing, the percentages used may also be changed so as to increase the amount of expense distributed, or diminish it, as necessary.
(d) It requires less work for the cost accountant. The man-hour plan requires the hours worked to be recorded and footed in addition to the labor cost. The machine-rate plan requires not only two different calculations, as already shown, but also necessitates the adding of all the hours worked. The percentage plan requires only the labor cost in money value, and renders the recording and adding of long columns of hours entirely unnecessary, which, as can readily be seen, is an immense saving of labor. In a large plant with an elaborate system of job orders to be handled, the value of the percentage method, in doing away with this double calculation, will be appreciated immediately.
BROOKLYN, N. Y., PLANT OF THE H. W. JOHNS-MANVILLE CO.
(e) Figuring by percentages can be done rapidly, and in many instances it is but a mental calculation and almost instantaneous. Were hours recorded, the frequent use of fractions would render the process of figuring expense less rapid.
(f) It is an equitable means of distribution, for it is based on the direct labor cost, which is not only the most reliable element of cost to use as a basis, but which is one of the principal factors by which the amount of expense is influenced.
(g) It has the endorsement of our best factory accountants and auditors, and it is noted that where "systems" are being installed by factory organizers to-day, the percentage method is continually being adopted as the most satisfactory, for it brings the best results with the least machinery to operate.