Robert A. Seay MURRAY STATE UNIVERSITY
and
Roger C. Schoenfeldt MURRAY STATE UNIVERSITY

H. K. HATHAWAY ON PRODUCT COSTING: RELEVANT ISSUES OF CONTEMPORARY CONCERN

Abstract: This article examines the importance of the treatment H. K. Hathaway gave to product costing issues in his depressionera writings. The paper compares Hathaway’s approach to product costing with the contributions of Alexander Hamilton Church, H. Thomas Johnson, and Robert S. Kaplan. Some of Hathaway’s product costing methods are improvements over those advanced by Church. Furthermore, Hathaway’s proposals are relevant to con temporary management accounting thought and practice.

The accounting and management literature contains abundant references to the contributions of Frederick Taylor and his “inner circle.” Gantt’s development of timeactivity charts, Barth’s slide rule invention and Cooke’s application of scientific management in public utilities are examples of individual distinctions. Unfortunatley, the recognition earned by Taylor, Gantt, Barth, and Cooke overshadows the accomplishments of a relatively unknown member of the Taylor group, a member Taylor describes as “the best allaround man” in the scientific management movement [Drury, 1918].

Horace King Hathaway learned the Taylor system of scientific management while employed at Midvale Steel between 1896 and 1902. In 1905 Hathaway was hired by James Mapes Dodge to implement the Taylor system at the LinkBelt Com pany. Later that same year Taylor recommended that Hathaway help Barth install the Taylor system at Tabor Manufacturing. Although Hathaway became the youngest member of the “inner

We wish to thank Professor Robert D. Hay at the University of Arkansas for his inspiration to initiate this research. In addition, we also thank the Commit tee on Institutional Studies and Research at Murray State University for providing research funds. Finally, we express our appreciation to the following persons for providing helpful comments on various drafts of this paper: Gary Previts, Paula Thomas, Tommy Stambaugh, and several anonymous reviewers.

circle,” he was recognized as the most successful implementor of Taylor’s system of scientific management [Drury, 1918; Urwick, 1956; Cooke, 1912].
Hathaway also established himself as an author in the scientific management discipline. According to Hathaway’s con temporaries, his papers on the Taylor approach to planning and time study were classics [Urwick, 1956; Thompson, 1917]. Un fortunately, current writers do not fully acknowledge Hath away’s contributions to management thought.

Hathaway’s expertise extended beyond the engineering aspects of scientific management. His articles on the functions of major executives [1933a], the organization of research, development and sales departments [1937d, 1938], and the respon sibilities of the works manager [1939] demonstrate a com prehension of management fundamentals and the interrelation ships of various organizational units.

Hathaway’s work also illustrates an appreciation for and an understanding of the accounting function. In 1912 Hathaway flowcharted the accounting procedures of the Newton Machine Tool Company [Urwick and Wolf, 1984]. During the early 1920s he wrote on inventory control [Hathaway, 1920a, b; Marshall, 1921]. Then in 1924 he contributed a chapter on the in adequacies of public utility accounting in Public Utility Regula tion [Hathaway, 1924]. Finally, inspired by the depression, Hathaway wrote a series of articles during the 1930s that addressed the need to improve industrial management in the United States. Ten of these papers focus on accounting.

Hathaway’s depressionera accounting articles are intricate and complete. His topics include financial statement prepara tion and use [1933c, 1934ac], budgetary control [1935b, 1937a], and the comptroller’s function [1937b]. Hathaway also emphasizes internal control and devotes one article to the role of internal auditing [1937c].

The purpose of this paper is to discuss the importance of the treatment Hathaway gave to product costing issues in his
1Nelson [1980] claims Hathaway’s interest in accounting declined by 1910. To the contrary, Hathaway’s work indicates a strong interest in accounting through the 1930s. This corroborates Vangermeersch’s [1984] assertion that engineering literature continued to address the accounting function into the 1930s.
2Hathaway was an early advocate of independent internal auditors [1937c], independent boards of directors [1932b], the statement of changes in financial position [1933b], and the distribution of selling and administrative expenses to product lines [1935a]. This paper deals exclusively with the allocation of costs to product classes and the implications for judging product profitability.

depressionera writings. The paper focuses on Hathaway’s approach to product costing in comparison with earlier contributions of Alexander Hamilton Church, and recent works of H. Thomas Johnson and Robert S. Kaplan. The common link between these individuals is their belief that each product class must absorb an equitable portion of production, selling, and administrative expenses. The distinguishing characteristic, however, is found in the methods of distributing selling and administrative charges. This paper explains how Hathaway’s distribution system was an improvement over an earlier system proposed by Church. The paper also demonstrates the relevance of Hathaway’s method with contemporary management ac counting thought.

OVERVIEW OF PRODUCT COSTING

Prior to the late 1800s the generally accepted definition of product cost was the sum of direct materials and direct labor (prime costs). Producers focused on single products, simple processes, and limited distribution channels. Factory overhead, selling expenses, and administrative charges were either insignificant or nonexistent [Garner, 1954].

As production and distribution became more sophisticated, the incidence and magnitude of nonprime costs increased. This development coupled with the production of multiple products led to the practice of allocating all costs (i.e. prime costs, factory overhead, selling expenses, and administrative charges) to product lines [Johnson and Kaplan, 1987; Garner, 1954]. This practice is hereafter referred to as full costing.

Full costing required the determination of a net profit for each product class. This challenged management accountants to develop equitable distribution methods for costs that had previously escaped allocation Full costing benefited managers by providing better information with which to judge product profitability.

After 1910 the practice of distributing full costs was modified. Opponents of full costing charged that manufacturing costs varied directly with production but selling and adminis trative expenses were essentially fixed. Therefore, a low output level translated into high unit product costs and a high level of output resulted in low unit product costs [Garner, 1954]. The modified full cost approach terminated the allocation of selling and administrative costs but retained the distribution of factory overhead.

This practice continues today and is the object of criticism from some management accountants. For instance, Johnson and Kaplan [1987] cite that management’s preoccupation with fac tory costs is a major contributor to dysfunctional management decisions concerning competing product lines. A reliable meas ure of product profitability depends on the reasonable allocation of costs inside and outside the factory.

THE INFLUENCE OF SCIENTIFIC MANAGEMENT

Participants in the scientific management movement, including Hathaway and Church, were strong proponents of full costing. Both believed that the profitability of products could be measured with reasonable accuracy only if products absorbed an equitable portion of all costs. Church [1908] considered the measurement of product net profit an essential means of “re storing personal control over the details of a large business.” Hathaway [1935a] expressed a similar view: “The importance of knowing accurately the net profit on each class of product cannot be overestimated. Without such knowledge unsound policies and practices are almost certain to develop.

Even though the works of Hathaway and Church illustrate agreement on the need for better product profitability measures, there are significant differences between the two. The source of these differences lies within their distribution systems for selling and administrative expenses. Hathaway’s method is similar to yet more comprehensive than Church’s earlier work. Furthermore, Hathaway’s system addresses many of the concerns of contemporary management accountants and could serve as a framework for current distribution systems. The following discussion of these two approaches highlights the differences.

CHURCH’S DISTRIBUTION PLAN

Alexander Hamilton Church is credited with offering the first comprehensive analysis of expense distribution [Garner, 1954]. Even though Church supported full costing, he focused a large percentage of his attention on factory costs. In particular, he is noted for introducing the “machinehour rate” method of overhead allocation [Vangermeersch, 1986].

Despite Church’s emphasis on factory costs, he supports full costing in several papers [1900, 1908, 1915]. In “The Proper Distribution of Establishment Charges,” Church [1908] offers guidance in the development of a full costing distribution system. A critical evaluation of Church’s system will help to demonstrate the significance of Hathaway’s ideas relative to current management accounting thought.

Church’s distribution plan consists of three steps. The first step requires that all selling and administrative expenses be traced to classes of work for a representative time period. This procedure is a valuable element in Church’s distribution plan and surfaces several years later in the work of both Hathaway and Kaplan. Hathaway [1935a] states: “[C]ertain Sales and Business expenses should be allocated to a certain class of product on a basis of actual expenditures for the benefit of that class of product.” Kaplan’s [1987] directions are to “trace costs using actual effort and transactions.

Table 1 shows how Church allocates selling and administra tive costs to classes of work. Church traces $7,000 and $3,000 of advertising expenses to lathes and cranes based on the adver tising requirements for the output of each product. Similarly, catalog expense and office expense are prorated by “carefully considering the items with reference to the output” [Church, 1908].

Table 1
Table Showing Method Apportioning Different Items
of General Establishment Charges on Different
Classes of Work
Adv. Catalog Office Total
Class Output Expense Expense Expense Expense %
Lathes $100,000 $ 7,000 $4,800 $1,660 $13,460 13.50
Cranes 20,000 3,000 200 1,340 4,540 22.75
Repairs 20,000 — — 2,000 2,000 10.00
Totals $140,000 $10,000 $5,000 $5,000 $20,000 *
*Average percentage of incidence would be 14.25 percent.

Source: Church, A. H., The Proper Distribution of Expense Burden (New York: The Engineering Magazine, 1908), p. 108.
Since the repair function is an internal service, no advertising and catalog expense is traceable. However, the repair department does receive a $2,000 allocation of office expense due to the services provided by the office department. Presumably, repair costs would then be allocated (as a component of factory overhead) to lathes and cranes.

The second step in Church’s plan is to select a common denominator for selling and administrative costs and compute a “percentage of incidence” for each class of work. This step is the source of two conceptual deficiencies.

The first deficiency relates to the selection of a common denominator. According to Church [1908]

. . . the connection of general charges with work is not real, but entirely arbitrary and conventional, from the very nature of the elements concerned. If, therefore, we base the incidence of general charges as a mere percentage on wages, or on works cost, we are doing . something which is very easy and simple but which is almost sure to be very misleading in cases where there are more than one or two different classes of articles concerned. At the same time, it is evident that some basis of value must be taken before we can distribute at all.
Church argues that selling and administrative expenses should not be allocated on the basis of production. However, in describing his distribution method, he suggests the use of wages cost, works cost, and production hours as common denomi nators [Church, 1908]. Church’s inability to define allocation bases outside the production area is a serious weakness of his method.

Another deficiency in Church’s plan is his assumption that all selling and administrative costs for a product class have the same relationship to a single common denominator. Church [1908] warns “the essential falsity of averaging general charges all round should be clearly recognized . . . . ” However, his distribution method requires the use of an average allocation rate for each product class. This contradiction is a weakness in his approach to expense distribution.

The use of a single allocation rate for each product class averages many types of costs over one common denominator. Different costs have different drivers (common denominators) and these drivers may vary among products. As noted by both Hathaway [1935a] and Kaplan [1987], a better plan allows the use of many common denominators and a “percentage of incidence” for each type of cost within each product class.

Church’s final step allocates actual selling and administrative costs to product classes based on the “percentages of incidence:”
In distributing general charges each month, effect is given to these percentages. The total expenditure being found, it is not averaged indiscriminately over the whole output for the month, but in such a manner that when all is distributed the proportion between the various classes is maintained [Church, 1908].

Church explained that if the value of output for lathes was $80,000 in a month, the allocation of selling and administrative expenses would not be the product of $80,000 and 13.5 percent (from Table 1). Rather, the actual charge would be distributed in a manner that “maintained the proportion of expenses between product classes” [Church, 1908]. Unfortunately, Church did not elaborate on the mechanics of this process. Hathaway, to the contrary, provided ample details of his own distribution method.

HATHAWAY’S DISTRIBUTION PLAN

During the 1930s, Hathaway [1935a] expressed dissatisfaction with the practice of not allocating selling and administrative expenses to product lines. He believed that improper expense distribution lowered the standards of U.S. industrial management, particularly in the area of measuring product profitability.
I have in mind a case in which the net profit on the business as a whole was satisfactory but which, with a reasonably accurate allocation of expenses, revealed the amazing fact that sales of a single class of product amounting to one fifth of the total accounted for seventy per cent of the net profit. Many things might happen which would result in losing such a danger ously profitable part of a business as the class of product cited. In this same company analysis of the numerous classes comprising the remaining four fifths of its sales brought to light the facts that certain products showing high gross margins provided little or no net profit and that on the other hand certain items with lower gross margins showed, contrary to popular beliefs, satisfactory net profits [Hathaway, 1935a].

Hathaway attributed the accounting treatment of selling and administrative expenses to the lack of a practical and equitable distribution system. The inability to accurately meas ure product profitability led to Hathaway’s framework for distributing selling and administrative expenses.

Because of the seeming difficulties encountered in an effort to allocate Sales and General Business expenses on an equitable basis many companies have satisfied themselves with a knowledge of gross profits on their various lines of product and have charged these classes to expense in toto against the total gross profit showing only the net profit on the business as a whole. There seemed to be no right way for the distribution of selling and administrative expenses … no such definite technique has been evolved for the distribution of this class of expense [Hathaway, 1935a].

Hathaway’s distribution system is similar to Church’s method. Both systems support the tracking of specific costs to specific products and both promote the allocation of actual rather than standard costs. However, Hathaway’s distribution framework offers a more complete and equitable allocation and addresses some concerns in current management accounting.

Hathaway’s procedure consists of four steps: 1) computation of proportional rates, 2) calculation of unadjusted allocations, 3) determination of corrected allocations, and 4) allocation of nontraceable expenses. An example with two product classes and three types of expenses illustrates the process.
Step 1: Computation of proportional (P) rates.

Hathaway’s “proporational rates” are similar to Church’s “percentages of incidence.” Both result from tracking costs to products and then dividing by a common denominator. However, Church computes a single “percentage of incidence” for each product class while Hathaway calculates a “proportional rate” for each type of cost within each product class. Table 2 illustrates the computation of proportional rates for a representative year.

A principal distinction between Church and Hathaway is in the number of allocation rates. With two products and three types of expenses, Church’s method calcuates two rates as opposed to Hathaway’s six. This is important because the Hathaway system is based on the concept that each type of cost has its own cost driver and thus requires a unique allocation rate. The indiscriminate allocation of cost resulting from the use of an overall common denominator for each product, as Church recommends, may not yield an equitable distribution of selling and administrative expenses.

The use of multiple cost drivers also establishes a more justifiable relationship between a cost and its driver. Church’s denominators were production related even though he admitted that no definite relationship between production and nonproduction costs existed [Church, 1908]. Hathaway’s system does not limit the choice of a common denominator to produc

Seay and Schoenfeldt: H. K. Hathaway on Product Costing

Table 2
Hathaway’s Distribution Method Computation of Proporational (P) Rates

Product Class I Traced Expenses
Sales Commissions Order Handling Material Procurement P Rate
Common Denominator Amount
Total Sales Number of Sales Material Value sold $1,000,000 10,000 $ 400,000 $100,000 $50,000
Product Class II Traced Expenses $100,000 10% of sales $5 per sale 25% of value
Sales Commissions Order Handling Material Procurement P Rate
Common Denominator Amount

Total Sales Number of Sales Material Value sold $500,000 3,000 $100,000 $25,000 $9,000 $40,000 5% of sales $3 per sale 40% of value
tion but allows the use of any reliable factor. This is consistent with the work of Johnson and Kaplan [1987].
Step 2: Calculation of unadjusted allocations.

Unlike Church, Hathaway’s instructions are explicit regarding the allocation of selling and administrative expenses in periods beyond the representative year. The unadjusted allocation is found by multiplying the proportional rate by the actual denominator levels. Table 3 illustrates the computation.

Table 3
Hathaway’s Distribution Method Computation of Unadjusted Allocation

Proportional Rate (from Table 2) X Actual Denominator Level Unadjusted = Allocation
Class I Expenses Sales Commissions Order Handling Procurement 10%
$5 25% x x x $1,100,000 11,000 orders $400,000 $110,000 55,000 100,000
Class I Total $265,000
Class II Expenses Sales Commissions Order Handling Procurement 5% $3 40% x x x $450,000 2,800 orders $80,000 $ 22,500 8,400 32,000
Class II Total $ 62,900
Total Unadjusted Allocation $327,900
Step 3: Calculation of corrected allocations.

Invariably the total unadjusted allocation will not agree with total actual expense in a given period. Therefore, the unadjusted allocation must be adjusted so that total actual costs are allocated. Hathaway recommends the use of a correction rate by dividing total actual expenses by total unadjusted allocation. Assume actual sales commissions of $150,000, order handling of $50,000, and procurement of $140,000. The correc tion rate is $340,000 divided by $327,900 or 1.0369014. The correction rate is then applied to the unadjusted allocations. Table 4 shows the corrected allocations.

Obviously some type of correction must be administered in order to allocate actual costs. However, the principal limitation of Hathaway’s distribution method is in the correction procedure. Step three is valid only if actual costs for each type of expense are all under or overallocated. In the example the unadjusted allocation of order handling (See Table 4) was $63,400 ($55,000 + $8,400) but the actual order handling costs were only $50,000. Hathaway’s correction procedure will not reduce the allocation of order handling which would be the proper treatment. Instead the allocation is corrected upward to $65,740 ($57,030 + $8,710). The use of individual correction rates for each type of expense would solve this problem.

Improvement could also be made by performing allocations for quarters or months rather than at year end. This would assure management of more timely information when making judgements concerning product profitability. The preparation of timely accounting reports was important to Hathaway [1933b].

Table 4 Hathaway’s Distribution Method Corrected Allocations
Expense Unadjusted Allocation Corrected Allocation
Class I
Sales Commissions Order Handling Procurement $110,000 55,000 100,000 $114,059 57,030 103,690
Class I totals $265,000 $274,779
Class II
Sales Commissions Order Handling Procurement $ 22,500 8,400 32,000 $ 23,330 8,710 33,181
Class II totals $ 62,900 $ 65,221
Grand Totals $327,900 $340,000
Step 4: Allocation of nontraceable expense.

Hathaway believed that most but not all selling and administrative expenses could be traced to product classes. His prime example of nontraceable costs was executive salaries. Hathaway suggested these types of expenses be allocated according to the relative proportions of corrected allocations. Based on Table 4, Class I would receive 81% and Class II would share 19% of the nontraceable costs.

The allocation of nontraceable expenses further distinguishes Hathaway from Church. Both supported full costing. However, Church did not discuss a procedure for allocating nontraceable expenses.

SUMMARY AND CONCLUSION

Hathaway’s desire to improve product profitability measurement was relevant not only during the scientific management era but is of concern today. Increases in domestic and global competition require a continuous evaluation of resource allocations. Case studies demonstrate the need for improve ments in judging product line performance [Johnson and Kap lan, 1987]. The inability to reliably measure product profitabil ity can lead to dysfunctional decisions.
Prior to the late 1800s the measurement of product profitability was quite simple. Firms produced few products and costs were easily traceable to output. However, since the late 1800s the importance of costs beyond direct material and direct labor has increased substantially. For a brief period of time in the early 1900s, management accountants allocated all costs to products. However, the full costing approach evolved to exclude the distribution of selling and administrative expenses to prod uct lines. This practice continues today.

Hathaway, like Church, recognized the limitations of using only production costs for product line profitability measurements. Both Hathaway and Church offered distribution plans for selling and administrative expenses. However, Hathaway’s method is more comprehensive than Church’s and is consistent with current management accounting thought and practice. Support for specific cost allocation rates and the use of produc tion and nonproduction common denominators is found in the distribution system advocated by Johnson and Kaplan [1987].

Horace King Hathaway’s loyalty to Frederick Taylor is evident throughout his writings. However, his reluctance to take credit for his own ideas and accomplishments may help explain his lack of recognition by historians. Barth, Cooke, and Gantt, the other members of the famous “inner circle” of scientific management, all achieved individual distinction and have been widely recognized for years. This discussion begins to place Hathaway in perspective with the development of management accounting and more clearly defines his position within Taylor’s “inner circle.”

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