By Henry Gantt


Manufacturers in general recognize the vital importance of a knowledge of the cost of their product, yet but few of them have a cost system on which they are willing to rely under all conditions.


While it is possible to get quite accurately the amount of material and labor used directly in the production of an article, and several systems have been devised which accomplish this result, there does not yet seem to be in general use any system of distributing that portion of the expense known variously as indirect expense, burden, or overhead, in such a manner as to make us have any real confidence that it has been done properly.


There are in common use several methods of distributing this expense. One is to distribute to the product the total indirect expense, including interest, taxes, insurance, etc., according to the direct labor. Another is to distribute a portion of this expense according to direct labor, and a portion to machine hours.


Other methods distribute a certain amount of this expense on the material used, etc. Most of these methods contemplate the distribution of all of the indirect expense of the manufacturing plant, however much it may be, on the output produced, no matter how small it is.


Keeping the factory running at its full, or normal, capacity, this item of indirect expense per unit of product is usually small. Keeping the factory running at only a fraction of its capacity, say one-half, and turning out only one-half of its normal product, there is but little change in the total amount of this indirect expense, all of which must now be distributed over half as much product as previously, each unit of product thereby being obliged to bear approximately twice as much expense as previously.


When times are good, and there is plenty of business, this method of accounting indicates that our costs are low; but when times become bad and business is slack, it indicates high costs due to the increased proportion of burden each unit has to bear. During good times, when there is a demand for all the product we can make, it is usually sold at a high price and the element of cost is not such an important factor. When business is dull, however, we cannot get such a high price for our product, and the question of at how low a price we can afford to sell the product is of vital importance. Our cost systems, as generally operated at present, show under such conditions that our costs are high and, if business is very bad, they usually show us a cost far greater than the amount we can get for the goods. In other words, our present systems of cost accounting go to pieces when they are most needed. This being the case, many have felt for a long time that there was something radically wrong with the present theories on the subject.


As an illustration, I may cite a case which recently came to my attention. A man found that his cost on a certain article was thirty cents. When he found that he could buy it for twenty-six cents, he gave orders to stop manufacturing and to buy it, saying he did not understand how his competitor could sell at that price. He seemed to realize that there was a flaw somewhere, but he could not locate it. I asked him of what his expense consisted. His reply was, labor ten cents, material eight cents, and overhead twelve cents. I then asked if he was running his factory at full capacity, and got the reply that he was running it at less than half its capacity, possibly at one-third. The next question was : What would be the overhead on this article if the factory were running full.


The reply was that it would be about five cents. I suggested that in such a case the cost would be only twenty-three cents. The possibility that his competitor was running his factory full suggested itself at once as an explanation.


The next question that suggested itself was how the twelve cents overhead, which was charged to this article, would be paid if the article was bought. The obvious answer was that it would have to be distributed over the product still being made, and would thereby increase its cost. In such a case it would probably be found that some other article was costing more than it could be bought for; and, if the same policy were pursued, the second article should be bought, which would cause the remaining product to bear a still higher expense rate. If this policy were carried to its logical conclusion, the manufacturer would be buying everything before long, and be obliged to give up manufacturing entirely.


The illustration which I have cited is not an isolated case, but is representative of the problems before a large class of manufacturers, who believe that all of the expense, however large, must be carried by the output produced, however small. This theory of expense distribution indicates a policy which in dull times would, if followed logically, put many manufacturers out of business. In 1897 the plant of which I was superintendent was put out of business by just this kind of logic. It never started up again.


Fortunately for the country, American people as a whole will finally discard theories which conflict with common sense; and, when their cost figures indicate an absurd conclusion, most of them will repudiate the figures. A cost system, however, which fails us when we need it most, is of but little value and it is imperative for us to devise a theory of costs that will not fail us.


Most of the cost systems in use, and the theories on which they are based, have been devised by accountants for the benefit of financiers, whose aim has been to criticize the factory and to make it responsible for all the short-comings of the business. In this they have succeeded admirably, largely because the methods used are not so devised as to enable the superintendent to present his side of the case.


One of the prime functions of cost-keeping is to enable the superintendent to know whether or not he is doing the work he is responsible for as economically as possible, a function which is ignored in the majority of cost systems now in general use. Many accountants who make an attempt to show it, are so long in getting their figures in shape that they are practically-worthless for the purpose intended, the possibility of using them having passed.


In order to get a correct view of the subject we must look at the matter from a different and broader standpoint. The following illustration may put the subject in its true light:


Let us suppose that a manufacturer owns three identical plants, of an economical operating size, manufacturing the same article, — one located in Albany, one in Buffalo, and one in Chicago — and that they are all running at their normal capacity and are managed equally well.


The amount of indirect expense per unit of product would be substantially the same in each of these factories, as would be the total cost. Now suppose business suddenly falls off to one-third of its previous amount and the manufacturer shuts down the plants in Albany and Buffalo, and continues to run the one in Chicago exactly as it has been run before. The product from the Chicago plant would have the same cost that it previously had, but the expense of carrying two idle factories might be so great as to take all the profits out of the business ; in other words, the profit made from the Chicago plant might be offset entirely by the loss made by the Albany and Buffalo plants.

If these plants, instead of being in different cities, were located in the same city, a similar condition might also exist in which the expense of the two idle plants would be such a drain on the business that they would offset the profit made in the going plant.


Instead of considering these three factories to be in different parts of one city, they might be considered as being within the same yard, which would not change the conditions. Finally, we might consider that the walls between these factories were taken down and that the three factories were turned into one plant, the out-put of which had been reduced to one-third of its normal volume. In such case it would be manifestly proper to charge to this product only one-third of the indirect expense charged when the factory was running full.


If the above argument is correct, we may state the following general principle:




This theory of expense distribution, which was forced upon us by the abrupt change in conditions brought on by the war, explains many things which were inexplicable under the older theory, and gives the manufacturer uniform, or at least comparable, costs as long as the methods of manufacture do not change.


Under this method of distributing expense there will be a certain amount of undistributed expense remaining whenever the factory runs below its normal capacity. A careful consideration of this item will show that it is not chargeable to the product made, but is a business expense incurred on account of maintaining a certain portion of the factory idle, and chargeable to profit and loss. Many manufacturers have made money in a small plant, then built a large plant and lost money for years afterward, without quite understanding how it happened. This method of figuring affords an explanation and warns the manufacturer to do everything possible to increase the efficiency of the plant he has, rather than to increase its size.


This theory explains why some of our large combinations of manufacturing plants have not been as successful as was anticipated, and why the small plant is able to compete successfully and make money, while the combinations are only just holding their own.


The idea so prevalent a few years ago, that in the industrial world money is the most powerful factor, and that if we only had enough money, nothing else would matter very much, is beginning to lose its force, for it is becoming clear that the size of a business is not so important as the policy by which it is directed. If we base our policy on the idea that the cost of an article can only legitimately include the expense necessarily incurred either directly or indirectly in producing it, we shall find that our costs are much lower than we thought, and that we can do many things which under the old method of figuring appeared suicidal.


The view of costs so largely held, namely, that the product of a factory, however small, must bear the total expense, however large, is responsible for much of the confusion about costs and hence leads to unsound business policies.


If we accept the view that the article produced shall bear only that portion of the indirect expense needed to produce it, our costs will not only become lower, but relatively far more constant, for the most variable factor in the cost of an article under the usual system of accounting has been the “overhead”, which has varied almost inversely as the amount of the product. This item becomes substantially constant if the “overhead” is figured on the normal capacity of the plant.


Of course a method of cost-keeping does not diminish the expense, but it may show where the expense properly belongs, and give a more correct understanding of the business.


In our illustration of the three factories, the cost in the Chicago factory remained constant, but the expense of supporting the Buffalo and Albany factories in idleness was a charge against the business, and properly chargeable to profit and loss. If we had loaded this expense on the product of the Chicago factory, the cost of the product would probably have been so great as to have prevented our selling it, and the total loss would have been greater still.


When the factories are distinctly separate, few people make such a mistake, but where a single factory is three times as large as is needed for the output, the error is frequently made, with results that are just as misleading. As a matter of fact it seems that the attempt to make a product bear the expense of plant not needed for its production is one of the most serious defects in our industrial system today, and farther reaching than the differences between employers and employees, for if it were removed, most of the difficulties would vanish.


The problem that faces us is first to find just what plant or part of a plant, is needed to produce a given output, and then to determine the overhead expense needed to operate that plant or portion of that plant This is primarily the work of the manufacturer, or engineer, and only secondarily that of the accountant, who must, as far as costs are concerned, be the servant of the superintendent.


In the past, in almost all cost systems the amount of “overhead*’ to be charged to the product, when it did not include all the “overhead” was more or less a matter of judgment. According to the theory now presented, it is not a matter of judgment, but can be determined with an accuracy depending upon the knowledge the manufacturer has of the business. Following this line of thought it should be possible for a manufacturer to calculate just what plant and equipment he ought to have, and what the staff of officers and workmen should be to turn out a given product. If this can be correctly done, the exact cost of a product can be predicted. Such a problem cannot be solved by a cost accountant without shop knowledge, but is primarily a problem for an engineer whose knowledge of materials and processes is essential for its solution.


In any attempt to solve a problem of this type, one of the most important functions we need a cost system to perform is to keep the superintendent continually advised as to how; nearly he is realizing the ideal set, and to point out where the shortcomings are.


Many of us are accustomed to this viewpoint when we are treating operations singly, but few have as yet made an attempt to consider that this idea might be applied to a plant as a whole, except when the processes of manufacture are simple and the products few in number. When, however, the processes become numerous or complicated, the necessity for such a cheek becomes more urgent, and the cost-keeper who performs this function becomes an integral part of the manufacturing system, and acts for the superintendent, as an inspector, who keeps him advised at all times of the quality of his own work.


This conception of the duties of a cost-keeper does not at all interfere with his supplying the financier with the information he needs, but insures that the information shall be correct, for the cost-keeper is continually making a comparison for the benefit of the superintendent, of what has been done with what should have been done. Costs are valuable only as comparisons, and comparisons are of little value unless we have a standard, which it is the function of the engineer to set.


Lack of reliable cost methods has, in the past, been responsible for much of the uncertainty so prevalent in our industrial policies; but with a definite and reliable cost method which enables us to differentiate between what is lost in manufacturing and what is lost in business, it will usually become easy to define clearly the proper business policy.




In the summer of 1916 a professor of political economy in one of our most conservative universities admitted to me that the economists had been obliged to modify many of their views since the outbreak of the European war. My comment was, that the professors of political economy were not the only people who had been obliged to modify their economic and industrial views.


The war taught everybody something. Military methods have undergone radical changes, but industrial methods are undergoing changes which promise to be even more radical than the military developments have been.


If there is any one thing which has been made clear by the war it is that the most important asset which either a man or nation can have is the ABILITY TO DO THINGS. Our industrial and economic developments have in the past been largely based on the theory that the most important quality a man can possess is his ability to buy things ; but the war has distinctly shown that this quality is secondary to the ability to do things. The recognition of this fact is having a most far-reaching effect, for it makes clear that the real assets of a nation are properly equipped industries and men trained to operate them efficiently. The money which has been spent on an industrial property, whether it has been spent wisely or unwisely, and the amount of money needed to reproduce it are both secondary in importance to the ability of that plant to accomplish the object for which it was constructed, and hence cannot be given the first place in determining the value of the property.


In as much as every industrial plant is built to produce some article of commerce at a cost which will enable it to compete with other producers, the value of a plant as a producing unit must depend upon its ability to accomplish the object for which it was created.


To determine the value of an industrial property, therefore, we must be able to know with accuracy the cost at which it can produce its product, and the amount it can produce. To compare two factories on this basis, their cost systems must be alike ; for, if there is a lack of agreement as to methods of cost accounting.

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