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57.77

32.10

Cr Profit and loss-joint accounts

To close the joint accounts on

"our lines" of April 30, 1919 Dr Berlin bank-nostro

Mks 2140.39
Marks position (joint account) Mks 4380.00
Cr Marks position-nostro

Berlin bank (joint a/c) "their lines"
Profit and loss on joint accounts

To close the joint account on
"their lines” as per their letter
dated April 30, 1919, viz:

Debit bal. on a/c Mks 4380.00
Cr. for cable charges Mks 100.00

2140.39
4380.00

32.10

[blocks in formation]

Credit P & L for Mks 2140.39
at 1.50

$32.10 The entries posted to forms 1 and 2 will show that, by the above method, a clear view of the position is furnished for the trader and that the various transactions can be easily followed through their successive stages on the joint ledger account.

Treatment of Overhead when Production is

Below Normal*

By C. B. WILLIAMS Treatment of overhead when production is below normal is a timely subject, not only and not merely because this is a period of sub-normal production, but because it is time that we determined and adopted better methods of treating overhead expense. This statement assumes that our present methods of treating overhead are incorrect and it is my belief that, to a considerable extent at least, this is true.

There is an old proverb which says: "There is no great loss without some small gain.” One gain that may be derived from the present period of sub-normal production, one that would accrue both to the accountant and to the business man, is the adoption of better methods of determining costs, especially overhead costs.

The present period of sub-normal production is compelling a searching investigation of our cost-finding methods in order to determine how they may be adjusted to a period like this. If we consider what is really at the bottom of this investigation, we must come to the conclusion that our former methods of handling costs, particularly overhead costs, have been wrong. Certainly, a thing which is right in principle today does not become wrong in principle tomorrow because conditions change. If in the present period of sub-normal production it is found that our method of treating overhead will not apply, then we must assume that, although it appeared to be correct in normal periods, it was, nevertheless, wrong in principle.

Frequently errors in our methods do not stand out prominently because, under conditions such as existed in the past, we obtained fairly acceptable results from the methods we were using, in spite of their errors. This has probably been the case in the treatment of overhead. If we can accept this as true, the real subject of our discussion is the proper treatment of overhead at any time.

Many business concerns and some accountants have adopted methods such as I shall propose and therefore have no especial problem growing out of the change in business conditions. It is not necessary to find a new method, but rather universally to adopt a method which has stood the test of changing conditions.

*A paper read at a regional meeting of the American Institute of Accountants, Detroit, Michigan, April 8, 1921.

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Because the time is limited and we cannot discuss all kinds of business, permit me to discuss this question from the standpoint of a manufacturing business, because that business probably presents the most complex problems and also because it will be the business most prominently in our minds when we discuss overhead distribution.

In a manufacturing enterprise we first invest capital to provide a suitable working place and suitable machines and equipment with which to work. As a preliminary to production, we provide a force of superintendents, foremen and other supervisors, and we are then ready to employ workmen and to start production.

Let us see what these expenditures mean. A suitable place in which to work requires heat and light. It must be kept clean and in repair. It must have the services of watchmen and janitors. Expenses are incurred for taxes and insurance, and the plant depreciates. Machinery and other factory equipment consume power and a certain amount of supplies. They must be kept in repair. They involve expenses for taxes, insurance and depreciation.

Superintendents, foremen and other supervisors, who form the nucleus of the organization, must be kept together, regardless of the volume of production. All this means a certain outlay which is based on the supposed normal production of the plant, but the expense goes on at about the same rate whether the plant produces below or above the supposed normal.

When a new enterprise is contemplated, one of the chief considerations is the probable volume of business. In fact, almost every other decision depends upon this. The expected profit per unit is based on a certain volume and, of course, this expected profit is the difference between an expected cost and a known or estimated selling price. In the mind of the investor, therefore, every calculation is based on the expected normal volume of business over a period of years.

Most accountants have been in the habit of considering one year as the proper accounting period. It many cases the accounting period has been fixed as a single month. May I venture to suggest that in this we have sometimes been mistaken? Capitalists do not invest their money and erect a manufacturing plant with any idea that it is to be a yearly proposition. They do not invest their money with the sole thought of getting a particular rate of return in any one year. Rather do they look to a satisfactory return over a period of years; and this return is predicated as much on the normal cost of production as on an expected selling price.

This may be very well illustrated in the case of the establishment of a certain large department store, the name of which you would recognize were I to mention it. This store was started with the expectation that it would not show a profit for the first three years, and a large sum was set aside to cover the losses expected during the period in which the store was being established and a definite line of customers being obtained. Certainly, the amount set aside to cover these expected losses indicated that the owners were considering their investment from the standpoint of a period of years rather than a single year. They surely would not consider the excess of expenditures over receipts in the first year as a loss. Rather would they consider it an investment, which was expected to be returned in succeeding years. An accountant would not have thought of closing the books of the concern at the end of the first year, writing off the difference between income and expense as a loss and showing a deficit on the balance-sheet.

We have this problem in every new concern and we commonly set up what we call “organization expenses,” which are written off during a period of time, the length of which may be more or less influenced by subsequent profits. Does this not prove that we are not entitled to consider the costs of one year independently of the costs of other years?

If perchance you disagree with the foregoing, permit me to give an illustration with which I am sure you cannot disagree.

In making income-tax returns, you doubtless have wished you could find a way to make the loss of one year offset the gain of another year. You have said that it was not fair to industry to tax heavily a profitable year which might come between two losing years. This has frequently been cited as one of the inequities of the income-tax law. If you have had such an idea it means that you have believed that a single year should not be considered independently of other years. If the foregoing be true about both general accounting and income tax returns, it is equally true about cost accounting and that particular part of cost accounting which deals with overhead expense.

We have said that the management invests money in plant and equipment and hires a force of supervisors and that supervision expense goes on at about the same rate regardless of the

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volume of production. The investment is made to provide the producing machine which, over a period of years, is expected to give a satisfactory return on the investment. This being the case, are we not entitled to consider overhead from the standpoint of a reasonably long period of time, rather than from the standpoint of a single month or year?

The next question is how overhead expense should be distributed to equalize it over periods of unequal production. This can be done by using normal overhead rates. Normal overhead rates are established by determining the expenses of a normal period and by establishing a normal divisor for the same period. Ordinarily, the longer the period covered, the more satisfactory the result. The period should be long enough at least to embrace one complete cycle of normal, below-normal and above-normal production. The divisor can be any of several bases commonly used for distributing overhead, such as weights, quantities, direct labor, man hours or machine hours.

Let us assume that the business is one in which productive man hours is a correct basis. From past records, together with our knowledge of present and future conditions, we can determine the probable hours for the period or we can use engineering estimates. The number of hours divided into the expense would give the rate per hour for overhead which would be applied under normal conditions. It is, of course, necessary that a factory cost system be in operation and that the productive hours be collected in such classifications as would be required for overhead distribution purposes. The normal rates established for the departments or machines could be applied to the time cards or to the cost sheets or in any other way that might fit the cost system in use.

In establishing normal rates we must be careful
(1) That we get a proper analysis of the expenses over a

sufficiently long period; and
(2) That we make provision for increases or decreases which

may be brought about by a change in the policy or

through a difference in market conditions; and (3) That we establish the number of normal hours at a cor

rect figure. "Normal hours” does not mean possible working hours. If we assume that the number of working days in a year is 300, excluding Sundays and holidays, and that the working day is 8 hours, our

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