Managerial Costing Insights from 1923

One of the topics they never seem to cover in an accounting curriculum is the history of the ideas being taught. Whether it’s Josiah Wedgewood inventing cost accounting to analyze and assign overhead costs in response to a drop in demand and rising costs during the 1772 recession in Europe or Alber Fink using the causality principle to measure the cost per ton/mile for railroads in 1860, universities exclude the rich history of accounting from the education of aspiring accountants. This omission makes accounting a bunch of rules, regulations, and methodologies that are memorized, but seldom fully understood. As a result, practicing accountants tend to apply what they’ve learned in ways that often do not reflect the economics of the phenomena they’re trying to measure. In short, they misapply their knowledge because they understand the “how,” but not the “why.”

John Maurice Clark was a managerial economist who noted these problems a century ago and addressed them in his 1923 book, “Studies in the Economics of Overhead Costs.” A few quotes from that book address issues that are still problems today.

One of those issues is the nature of direct labor. On that topic he stated:

“Yet the substitution of machine for hand labor meant nothing less than the introduction of a new species of creature, which rapidly became the dominant personality in industry, especially in the actual physical work of manufacture and transportation. Formerly the laborer was the central figure; he worked according to the laws of his being and his tools worked as he required their services. Now the machine is the central figure, and labor follows the laws of the machine’s being and works as it requires his services.” p. 7

“…the fact that human labor comes to be more and more a matter of overseeing and guiding the iron slave; the laborer has in fact become a supervisor. But the work of supervision is commonly spoken of an ‘overhead cost.’” p. 77

He also addressed the definitions of fixed and variable costs:

“In gauging the effect of added business on cost, it makes a great difference whether we are considering a long-run or a short-run policy. The wages and salaries of the indispensable nucleus of the force are sunk cost which practically cannot be avoided, with reference to a short period. But with reference to a long period they would be a variable cost. Evidently time alters the definition of costs. In fact, the way in which costs behave in response to a 20 percent increase in business is one thing if we have to deal with a 20 percent increase in the output of a current month or three months, and a very different thing if we are talking about a permanent increase of 20 percent in the total business, so that our ups and downs, our good years and our bad years, would all be on a scale 20 percent larger than before.” p. 43-4

“No one formula could be made by an accountant which would distinguish between constant and variable expenses is such a fashion that it could be used to get the correct solution to every one of these different problems.” p. 183

Perhaps one of his most well-known observations was on the need for different costs for different purposes:

“Most of this controversy will disappear if we carry our study far enough to recognize that there are different kinds of problems for which we need information about costs, and that the particular information we need differs from one problem to another.” p. 35

“We may start with the general proposition that the terminology of costs is in a state of much confusion and that it is impossible to solve this confusion by discovering and adopting the one correct usage, because there is no one correct usage, usage being governed by the varying needs of varying business situations and problems.” p. 175

“As a result, if cost accounting set out, determined to discover what the cost of everything is and convinced in advance that there is one figure which can be found and which will furnish exactly the information which is desired for every possible purpose, it will necessarily fail, because there is no such figure.” p. 235

He addressed the failure to adequate measure selling costs:

“If economics has paid insufficient attention to overhead costs of production, it has definitely ignored the costs and services of selling goods, in formulating the formal laws of value.” p. 60

Finally, he emphasized the fact that in costing there is no one simple answer:

“To be more specific, the problems of overhead costs are, above all things else, not fool-proof. The student cannot be given a formula which will furnish an absolute answer to every question. He must use the highest grade of discriminating judgment if he is to distinguish case from case and to determine which rule applies or which policy is the most promising of results. The parrot which has been trained to repeat: ‘supply and demand’ can no longer qualify as a competent economist nor even a fair caricature.” p. 480-1

Perhaps a fuller understanding of the principles that lie behind the rules, regulations, and methodologies we’re taught in school would lead management accountants to use the process of thought and arrive at better solutions to the challenges that face them in the 21st Century economy.