Our December Book Feature is Double Entry: How the Merchants of Venice Created Modern Finance by Jane Gleeson-White. As the merchants in Venice were creating what would eventually become modern accounting and financial principles, some of them were also trying to figure out what their costs were and how to become more profitable, a novel concept even today. Jane Gleeson-White holds degrees in economics and accounting, she takes us from those early beginnings of accounting and shows us how our field developed and turned into what it is today.
As a special feature just for the Society of Cost Management, in this article she focuses on the history and early development of Cost Accounting. An interesting read for anyone interested in the history of our field and great for that special numbers person this Christmas.
Josiah Wedgwood and the Origins of Cost Accounting by Jane Gleeson-White
In 1772 Josiah Wedgwood arguably became the world’s first cost accountant. Three years earlier his business was booming, his profits were soaring, such was the demand for Wedgwood pottery. In 1769 Wedgwood wrote to his partner Thomas Bentley that their new London showrooms were so crowded there was ‘no getting to the door for Coaches, nor into the rooms for Ladies & Gentlemen … Vases was all the cry. We must endeavour to gratify this universal passion.’
An entrepreneurial and marketing genius, Wedgwood built the world’s first industrialised pottery manufactory. His products became so coveted that he could charge high prices and profits rolled in. But during an economic downturn in 1772, demand for Wedgwood vases slackened. With serious cash flow problems and an accumulation of stock, Wedgwood turned to his books to solve his dilemma: should he cut production – or reduce prices?
And so Wedgwood made a ‘price book of workmanship’, which included ‘every expence of Vase making’ from the crude materials to the retail counter in London. Through his investigation he discovered the distinction between fixed and variable costs. As he noted to Bentley, their greatest manufacturing costs were modelling and molds, rent, fuel, bookkeepers and wages: ‘Consider that these expences move like clockwork, & are much the same whether the quantity of goods made be large or small.’ Thus ‘you will see the vast consequence in most manufactures of making the greatest quantity possible in a given time.’
Wedgwood used the findings of his cost analysis to make management decisions. He revised his policy of soliciting special commissions and made-to-order sales; lengthened his production runs for certain products; varied his usual high-price policy; reduced his stock in market downturns; and kept a careful eye on sales and marketing costs.
Financial crisis and severe depression forced Wedgwood to develop a new business method: the use of accounts to guide business management. And thus the world’s first recorded cost accountant was born.
His detailed costings also revealed something unexpected: a history of embezzlement, blackmail and dissipation at the heart of his firm. He discovered his head clerk had been fiddling the books and his cashier had been playing up with the housekeeper. He fired the culprits and introduced weekly accounting reports so he could keep a closer watch on his finances.
Many successful businesses failed during the financial crisis of 1772 – but Wedgwood’s survived, thanks to cost accounting.
The steam engine manufacturer Boulton & Watt was another innovative business of the time. In the 1790s they used accounting to manage the massive cultural shift required of their workers. Their employees – first-time factory workers in an era when factory production was brand new – worked together in family units and had no work discipline. The problem of worker supervision and discipline was solved with cost accounting. Boulton & Watt worked out how long a task took to complete, priced it as fairly as possible and then offered bonuses to anyone who exceeded the target. In this way their workers were trained to become more efficient.
Although this method of analysing accounts developed by early industrialists such as Wedgwood was not unprecedented – the medieval Florentine cloth manufacturers had pioneered a type of cost accounting – something like Wedgwood’s system did spread slowly through the industrial world and formed the basis of today’s accounting practice. Cost information was collected to provide regular information which was used to help manage a business. And so Josiah Wedgwood has been called the father of management accounting.
But others argue that cost accounting for management began in the United States. This view finds the origin of modern cost accounting in the Springfield Armoury in the 1830s and 1840s, and the Lowell cotton textile mills, where accounting costs were assigned to products to manage pricing decisions and select factory sites. In both enterprises management accounting was practised and used to monitor labour processes.
Another formative moment in the development of management accounting was made at the end of the 19th century with Frederick Taylor’s managerial approach to business. In an environment of increasing competition in industry, Taylor realised the crucial importance of comprehensive, accurate and regular accounting information. And so in the 1880s he studied accounting and developed new methods of cost accounting which were widely used until the 1920s. The bookkeeping and costing systems he devised were key to his method of ‘scientific management’.
In the 1920s the era of modern industrial cost accounting was inaugurated by Controller Donaldson Brown and Chairman Alfred Sloan at the General Motors Company. In 1923 they developed the major cost accounting techniques which would be used in the 20th century, including return on investment, return on equity and flexible budgeting. These accounting innovations allowed General Motors to manage its massive business empire and become one of the most successful companies in the world. And Sloan’s memoir My Years with General Motors, published in 1964, became a seminal text of modern management.
The 2008 financial crisis and the need for wise environmental and resource management have prompted new scrutiny of accounting practices. Sustainability and integrated reporting are the new buzzwords. Today the challenge is to integrate non-financial information into corporate accounts, to account for new value such as social and environmental performance. The shift in outlook required to move our present accounting systems beyond their origins in an industrial economy into the information age and an era of integrated reporting is huge. But as early cost accountants like Josiah Wedgwood have shown, crisis is the mother of management accounting invention.