Reviewed by Daniel L. Jensen The Ohio State University
This important scholarly work is an interpretative history of cost accounting with particular attention to the treatment of overhead costs in cost accounting systems. The work rests on an exhaustive examination of writings on cost accounting by engineers and economists as well as accountants. The complete bibliography, which is published separately under the title A Bibliography of Cost Accounting: Its Origins and Development to 1914, fills two volumes and contains 1,875 entries accompanied by copious annotations. In ad-dition, Accounting for Common Costs contains a bibliography of 150 items published after 1914 which are cited in its pages.
The purpose of the work, succinctly stated, is “(1) to argue that unit cost accounting, particularly insofar as it involves the allocation of overhead costs, is wrong in principle; and (2) to demonstrate that the error occurred when costing systems were first being developed and described” (p. 145). Accordingly the reader must evaluate Professor Wells’ work both as a work of history and as an argu-ment in principle.
Confusion in Textbooks
A survey of current cost accounting textbooks leads Professor Wells to conclude that their arguments in support of overhead allocations to units of production are “confused and inconclusive.” “For, while nearly all of the authors point to the irrelevance of allocated indirect costs for planning, control, and decision making, they also advocate and describe the calculation of average unit product costs which include some allocated indirect costs. Similarly with respect to inventory valuation, the authors either accept practices supported by professional accounting bodies or make explicit appeal to the ‘principles’ of objectivity and matching costs with revenue. Yet they advocate methods of valuing inventories which are almost entirely subjective and which will match the costs and revenues of goods produced only by coincidence” (p. 19).
Wells attributes this rhetorical confusion to errors of authorship in the revision of textbooks and to a more fundamental misconception of the proposition that different costs are required for different purposes. Decision making, control and financial reporting require different costs, but discussion of the differences frequently obscures fundamental similarities among the costs and displaces more fruitful discussion of “an integrated accounting system capable of producing information which is necessary for each of the three functions it is said to serve” (p. 23).
Other Historians
Professor Wells begins his historical analysis with a critical review of “studies by accountants of the origins and development of cost accounting” with particular attention to studies by R. S. Edwards, David Solomons, S. Paul Garner, R. H. Parker and Sidney
Buckmaster: Book Reviews 85
Pollard. Professor Wells concludes that “Edwards, Solomons and Garner all emphasize techniques” and are “too restricted in their coverage to enable any evaluation to be made of the relative roles played by various professional groups in the development of cost accounting” (pp. 28-29). Parker, he believes, is somewhat broader but is also “deficient because it is isolated from other events of the time.” A separate chapter reviews the work of Sidney Pollard to establish that departmental accounts and periodic reporting were inherited by industrialists from earlier times and were in fairly widespread use by the beginning of the 19th century.
Professor Wells views history as the interaction of various groups, each with a distinctive perspective, that must be interpreted in the context of its time. His history does more than chronicle the de-velopment of specific accounting techniques. His objective is to explain technical developments as products of an institutional con-text—a context peopled by engineers and economists as well as accountants.
Origins of Overhead Costing
Professor Wells agrees with most historical analysts that overhead costing emerged after 1870 when “investment in fixed facilities had brought about a significant increase in the amount of fixed costs” (p. 69). However, he disputes “the common view that com-petition provided the stimulus for the introduction of costing systems” (p. 66). Rather, he argues that the “real impetus to the emer-gence of an interest in cost accounting arose out of the unique environment enjoyed by American mechanical engineers”—an en-vironment characterized by excess productive capacity and the associated problems of price determination and efficiency improvement (p. 70). “Only after the engineers had discussed the introduction of cost records did professional accounting bodies (and their associated publications) break down the long-standing tradition of secrecy in industrial works and take an interest in cost accounts” (p. 70).
Influence of Engineers
From’ about 1895 onward, intensifying competition stimulated heightened interest among engineers in methods of estimating future prices (p. 76). Most engineers accepted the proposition that estimates of product cost for pricing purposes should make provision for indirect costs as well as direct costs. Moreover, by 1910, “engineers generally appear to have respected the role of accountants, and in doing so accepted as automatic that the cost accounts and financial accounts should be linked. They accepted the necessity of allocating overhead, and of determining different rates for different departments, machines, and workmen. They accepted the notion that production time spent was the most important element in any allocation method” (p. 92). In this way, overhead allocations arising in price estimation procedures were introduced into the financial accounts. Professor Wells observes that the “appeal of a cost theory of value to engineers familiar with identifiable physical relationships is . . . understandable, but that does not make the theory any less incorrect” (p. 88).
Widespread concern with the efficiency of operations in the early years of the 20th century gave “impetus . . . to the adoption of costing systems” but the spread of scientific management was also associated with distortion of the “connection between economic efficiency and cost accounting” (p. 94). Advocates of scientific management failed to restrict the relationship between cost accounting and scientific management “to those aspects of scientific management which were relevant to cost accounting—identification of responsibility, comparison of achieved with expected performance, the exception principle” (p. 102). Professor Wells identifies two unfortunate consequences: “Support for overhead allocation was claimed from a source which could lend no support; and standard costs took on a prominence which was incompatible with their nature” (p. 102).
Influence of Economists
Although an examination of the literature leads Professor Wells to conclude that “economic thought and doctrine did not directly influence the development of cost accounting,” he finds “some grounds for suggesting a pervasive indirect influence stemming from the classical economists of the eighteenth and nineteenth cen-turies” (pp. 105-106). The idea that costs attach to goods during production is in substance the cost theory of value advanced by Adam Smith and modified by Carey, Ricardo and other economists (p. 106). Despite this indirect influence, Wells concludes that “the direct influence which leads to the adoption of the notion that costs attach came from the mechanical engineers and their experience with the build up of physical goods” (p. 107). With few exceptions, economists “paid no attention to business problems as such” (p. 108) until the “adoption of marginalist principles by economic theorists” which directed the attention of economists to decision mak-ing and particularly the relationship between costs and prices (p. 110).
“By 1914, the economists appear to have been in substantial agreement about at least two matters—(1) that while an unattain-able long-run normal price may be determined in part by costs, short-run prices are not, and (2) the cost of an article (or service) is indeterminate if the production of that article (service) involves joint or common costs” (p. 119). Yet, owing in part to the failure of economists “to make their work intelligible or relevant to accoun-tants and businessmen,” accounting writers continued to assert the necessity of costs as a basis for prices.
Concluding Comment
The evidence compiled by Professor Wells reveals a century of devotion to a rhetoric in support of integrated data-gathering and estimation systems, which has produced confusion in textbooks and elsewhere. Moreover, the record reveals a preponderance of support for the use of cost allocations in such systems. Professor Wells argues that this is all a mistake—a failure of communication between economists and accountants and an unfortunate artifact of the engineering roots of cost accounting. This reviewer is uneasy with such an interpretation. However one may feel about cost allocations as a matter of principle, casting them among the mistakes of history offers no explanation for their persistence or pervasiveness. Yet Professor Wells’ prodigious and careful scholarship in describing the events and writings associated with the rise of cost accounting is a major contribution to accounting history. His work is no mere chronicle of events and writings, but makes a concerted effort to explain technical developments in terms of the larger historical context in which they occur. Accounting for Common Costs is an important work that deserves not merely to be read but to be carefully studied by all students of cost accounting history.
