Once Upon a Time: When Accountants and Manufacturers Agreed

Close to a century ago, the accounting community acknowledged the correctness of Gantt’s handling of indirect overhead and idle/excess capacity costs. That changed along the way.

Larry White, Executive Director, Research Consumption Accounting Institute
Larry White, Executive Director, Research Consumption Accounting Institute

Welcome to the great costing debates of 1915. They pitted a manufacturer against an accountant; the manufacturer’s position prevailed. What makes this interesting—and frustrating—is today most costing follows the loser’s approach. The elements of their debate are relevant today and could provide useful points for discussions with your CFO.

In the manufacturer’s corner is H.L. Gantt, industrial engineer. In the accountant’s corner is A.H. Church. Over five years, they engaged in a colorful and heated debate about the correct handling of indirect overhead and idle/excess capacity costs. In the end, Church and the accounting community acknowledged the correctness of Gantt’s position. Let’s look at what they discussed.

Gantt argued that the accounting rules applying the full cost of overhead to products created absurd results. “When times are good and there is plenty of business, this method of accounting indicates that our costs (per product) 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,” he writes. “Our cost systems, as generally operated at present, show us under such conditions our costs are high…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.”

Gantt’s primary culprit was idle and excess capacity, which he argued should be explicitly identified on profit and loss statements for management’s attention, and never reallocated back to product cost where it was hidden. Along with his famous Gantt charts for project management, he created “idleness expense charts” to track the cause and handling of “avoidable” and “unavoidable” idle/excess capacity costs. Gantt argued that the concept of fully loaded cost hurt decision-making and profitability because it made it difficult for managers to determine the “true” cost of production (meaning marginal/incremental costs) for make vs. buy decisions and profitability in highly competitive price-taking situations.

Church also viewed idle and excess capacity as wasteful, but argued that all costs associated with production needed to be applied to product cost. He developed very creative (and complex) “supplemental rates” to identify these costs within a product cost. However, he felt business leaders and investors would never accept anything but full costing for products and would resist placing idle capacity costs on the income statement.

Financial reporting was not regulated until the 1930s, so these debates rested purely on logic. Gantt took the management point of view, while Church walked a tightrope between established accounting practice and management information. By 1920, Gantt’s position dominated management and accounting literature. His key points:

  1. Products should only be charged with “true” or attributable costs of their production.
  2. The competitive market will reimburse a company only for the “true” or attributable cost of a product.
  3. The connection between product cost and market price is, at best, tenuous.
  4. Idle/excess capacity costs should be charged to the profit and loss (income) statement.

Unfortunately, these tenants were lost as the Great Depression and WWII’s industrial buildup required cost and financial reporting to become more regulated to achieve social, governmental/economic and military objectives.

I need to acknowledge the value of two books in writing this column: Total Capacity Management by C.J. McNair and Richard Vangermeersch, and Capacity Measurement and Improvement edited by Thomas Klammer. The former provides the historical context of how Gantt’s logical approach was reversed in the accounting profession. They are the only books I’ve found that recognize and illustrate the value of resource capacities as the foundation for costing to support management decisions.

>> Larry White, CMA, CFM, CPA, CGFM, lwhite@rcainstitute.org, is the Executive Director of the Resource Consumption Accounting Institute (www.rcainstitute.org), which trains and advocates for improved cost information connecting operations to business performance.


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