The element of time enters into costs in the shape of a return to the capitalist for the use of his accumulated savings, represented either by natural products for temporary use such as land, or by natural products for consumption such as material or subsistence. The latter, being consumed, are an element of cost; the former remaining unchanged is not; the consideration given to the capitalist for permitting his accumulated savings to be temporarily used or consumed is a share of the ultimate profit, or interest. This is not theoretically, therefore, an element of cost, though in practice the demand for capital like the demand for labor is such that the capitalist is frequently able to stipulate for a fixed immediate return for the use of his accumulations, thereby, as in the case of labor, compounding for his share of the ultimate profit and throwing the whole risk of profit or loss upon the borrower. To this extent interest in such cases might perhaps be considered as an element of cost, although it seems better not only theoretically but as a matter of practice and business expediency to treat it as a division of profits. When the capitalist is himself the manufacturer no such condition exists, and interest cannot in such cases be treated in any way except as a division of the ultimate profit if any.

In the first outline of the theoretical elements of cost all profit of any kind was excluded; enough has now been said to show that this theoretical condition is impossible in practice and that in everyday affairs those who contribute to production, whether as owners of natural products, as laborers, or as capitalists, frequently compound by the receipt of a fixed sum for their share of the profit and so relieve themselves of any loss, leaving the entire ultimate profit or loss to be borne by one or more individuals among the other contributors. The amounts so paid by way of composition for these shares of profits thus come to form a part of the cost to those who continue to take the risk; and it follows therefore that the commercial cost of two identical articles, the absolute or theoretical cost of which would be identical, may be widely different because of the different conditions under which the processes of manufacture have taken place. As an instance, consider a piece of complicated machinery made entirely of steel or iron. The following possible conditions of manufacture may exist:

1. The manufacturer may own his own iron, coal, and other mines, and may at his own factories produce everything up to

the finished product. In this case his costs will include no profits except that accruing to labor.

2. He may purchase all his natural products but carry on all manufacturing himself at his own factories. In this case his costs will include the profits of the owner of the natural products as well as those of labor.

He may purchase from other manufacturers the whole or a portion of the parts that enter into his finished machines. In this case his costs will include not only the profits accruing to labor and to the natural products but also the profits of any number of other manufacturers who have preferred to limit their risk at a certain point of the manufacturing process, leaving to the final manufacturer of the complete finished product the whole of the ultimate profit or loss.

It is easily seen that in the first case the manufacturer's costs will be very much lower and his profits very much higher than in the other two; and, on the other hand, that he is taking much greater risks not only by reason of the longer time involved in the manufacture and the consequent greater chance of eventual fluctuations in demand and supply, but also because he has compounded with a great many more intermediaries for their share of an ultimate profit which may never be realized. A practical illustration of these conditions may be found in a comparison of the United States Steel Corporation, which owns its ore and other mines and converts these materials into finished buildings and plants, and a contracting company which buys all its finished material and itself only erects the building or plant.

Turning now from the economic to the commercial aspect of cost accounts, some further elaboration of the primary principles laid down becomes necessary.

The elements involved have been shown to be natural products or material, subsistence or labor, and time or interest; but in practice these elements are seldom found in this simple form. Natural products, as already shown, are combined with other elements with the addition of profit either to form the primary material for some other manufacturing business or to form the instruments used in the processes of manufacture, whether buildings, machinery, or equipment. The result of these more complicated groupings is that the principal headings under which commercial cost accounts fall are generally somewhat as follows:

Material

1. That to which manufacturing processes are applied

to convert them into some different form.

2. That which is used or consumed in the processes of manufacture.

Labor

(a) Directly.
(b) Indirectly.

1. That employed directly in and upon the materials under process of conversion.

2. That employed indirectly in operations necessary for the manufacture but not a part of it, such as upon repairs to and up-keep of machinery, buildings, or equipment.

Expenses

Consisting partly of material and partly of labor, which are incidental to the carrying on of a manufacturing business but have not any direct relation to the process of manufacturing.

Wear and Tear

Or the gradual consumption of the buildings, machinery, or equipment employed in the manufacturing process,― more commonly known as depreciation.

Now the object of any system of cost accounts being to ascertain the cost of manufacture of each article or class of articles, it is at once evident that in a factory producing many different classes of product some method must be adopted for distributing many of the items of cost over the different classes.

Material in process of direct conversion and labor directly employed in such conversion present no difficulties, being easily chargeable to the process; and the same is true of auxiliary material consumed in the process or of auxiliary labor which can be segregated at the moment.

There is, however, a large class of items, such as rent (where payable), power, light and heat, payment of general staff of clerks and superintendents, wear and tear, and many others which cannot be distributed exactly and yet are a necessary and integral part of the cost of manufacture. These items consisting of part of the items of material and labor, and the whole of the items of expense and wear and tear, are usually grouped under

the term "overhead expense" or "burden", and distributed on a more or less arbitrary basis among the different products. This distribution involves most difficult questions, and the adoption of an erroneous method may easily appear to show that certain articles are manufactured at a cost well below their selling price while a more accurate distribution would show a reverse condition. The most usual method of distribution is by a straight percentage on the direct labor cost, and where all products are of the same nature this may give fairly accurate results; but it is not scientific. On the other hand, a more elaborate system of distribution based on an exhaustive examination of processes with a view to determining what share each operation should bear of each class of overhead expense, and requiring an elaborate analysis thereof, may involve so much expense as to be prohibitive; and the final result may be found not to differ materially from the more simple and ready method of a percentage division.

Modern factories are usually operated by departments, between which there are well marked divisions. Each department within its own limits occupies a certain floor space, involving light and heat proportionate thereto; uses an amount of power which can be estimated within reasonable limits; and has certain labor and other costs for general assistance, cleaning, stores, and superintendence, which belong entirely to its operations in total. All these can be charged to the department and serve to determine the burden of that department. Some items, such as rent (if any), insurance, heating, and light, may be charged to the department on the basis of floor space; others, such as steam or electric power, on the basis of horse power hours worked; others again, such as general labor, on the basis of the direct labor pay roll; and others, such as superintendence and general expenses, on the basis of labor and material costs combined. This main division is a comparatively simple one, although the circumstances of each case require careful study in order to determine the most nearly correct method; and if the industry is such that each department is carrying out only one class of operation, easily measured on some unit basis, the division of this burden over unit costs presents few difficulties. It is in cases where the operations in a department are of a varied and complicated nature, such, for instance, as a large machine shop, that almost insuperable difficulties arise; and it may well be doubted whether any really accurate distribution is possible.

In considering the item of overhead expense, it is necessary to emphasize the distinction which must be made between expenses necessary for the production of manufactured articles in a form in which they are ready for sale and the expenses incurred in offering them for sale to the public and in carrying through the sales when made. The former item, as has already been shown, is an essential element of cost of manufacture; the latter is an essential element of cost only from the point of view that without such expense the products could not be sold and the profits could not be earned. Strictly speaking, therefore, these selling expenses should be deducted from the price ultimately obtained for the product, and the difference only should be considered as the amount realized for the manufactured article. In practice this same result is often achieved in a different way by distinguishing between manufacturing cost and selling cost, manufacturing cost alone being employed for the purpose of valuing the product which remains on hand unsold at the time of taking an annual inventory, and selling cost being dealt with only in memorandum form in order that those engaged in selling the products may know the limit below which they should not be disposed of.

The necessity for accurate cost keeping by commerical enterprises lies in the fact that without such cost keeping, whether it be of a highly scientific nature or merely by rule of thumb, it is impossible for a manufacturer to know whether the price at which he decides to sell his articles will or will not yield a profit. The objection to rule of thumb methods is that they are generally quite inaccurate, except in cases where manufacturing processes are relatively simple. In the most usual cases, where the process of manufacture is divided over a number of separate departments each representing a different set of operations, any such methods can only lead to serious errors and frequently to ultimate loss.

It is necessary here to note that, while the ascertainment of accurate costs is essential, it does not necessarily follow that no profit can be realized by selling at a price which appears to be below such cost. In any factory equipped for a certain volume of production, the overhead charges will remain practically stationary whether the factory be operated to its full extent or to only a small proportion thereof. It will follow, therefore, that the unit cost of manufacture, including overhead expense, will be much higher when the factory is partly operated than when it is fully operated; and consequently a manufacturer can earn profits for himself by