2. Computation of cost of patent flour.

(a) Wheat cost 4.4 bushels @ $2.20...
(b) Add milling cost 60c per barrel

$9.680 .600

(c) Total cost per barrel of flour

$10.280

(d) Credit for 1st and 2nd clear and offal at
selling prices.

.15 bbl. 1st clear @ $9.80 per bbl.... 1.470

$ 9.530

(f) Cost of one barrel of patent.

3. Determination of profit on advance sales.

(a) Selling price (bulk f.o.b. mill) ...... $10.50

(b) Cost as determined above

(c) Profit per barrel..

9.53

$ .97

Accounting for Cost of Naval Vessels under
Cost-Plus-Profit Contracts*

BY FRANCIS P. FARQUHAR

Early in 1917, when it became apparent that the United States would enter the world war, the navy department foresaw that a rapid expansion and increase in speed would be required in its construction programme. There were at that time numbers of contracts for destroyers, battleships and battle cruisers let on the usual fixed price basis, but upon which work had not been begun. The problem before the navy department and the shipbuilders was how to carry out these contracts under conditions that would inevitably result in greatly increased cost. Moreover, the new conditions called for a large addition to the construction programme which meant filling up all the available shipyards with work to capacity. This precluded any possibility of using the customary method of submitting plans for competitive bids.

Conferences between the navy department and the shipbuilders resulted in the adoption of the cost-plus-profit plan of payment. There were no precedents for contracts of this character on anything like the magnitude of the scale required. The nearest analogies that existed were certain manufacturing contracts based on actual cost plus a percentage for profit. Time was limited and necessity was urgent, so this form was adopted as the best available.

The definition of cost was only briefly considered in the contracts. It was fairly obvious as far as direct labor and materials were concerned, but the accounting for overhead, as usual, presented difficulties. Some of the shipbuilders proposed a fixed percentage of the labor and materials costs as the basis for overhead; others a fixed percentage of the direct labor cost; while others suggested actual overhead as shown by the books.

The first two plans were abandoned as being too indefinite and also because the normal percentages of overhead varied widely in the different shipyards. The contracts were finally drawn up on the basis of actual cost of labor, material and overhead. The

*A thesis presented at the May, 1919, examinations of the American Institute of Accountants.

percentage for profit was agreed upon in every case as 10% of the total cost, excluding from this cost any sums that might be paid by the navy department for increased plant facilities. A number of these cost-plus-10% contracts were signed by the navy department and the various shipbuilders during the spring and early summer of 1917.

As work proceeded, it became increasingly apparent that the cost-plus-percentage basis had certain defects which rendered these contracts not the most desirable type. It was impracticable to change the existing contracts, but when it became necessary later in the summer to place a large number of additional orders for destroyers, a new type of contract was evolved, which, while adhering to the principle of actual cost, did away with the percentage basis for profit by substituting a fixed profit with a bonus for saving in cost below an estimated figure.

Almost all the naval construction undertaken during the period of the war was on the basis of these two types of contracts. There were a few exceptions in special cases, but these were relatively unimportant. It should be borne in mind that these contracts were prepared under most difficult conditions and were the result rather of urgent necessity than of desirable policy. In looking back in the light of subsequent knowledge, it is very easy to find ways in which they could have been improved. It is not the purpose of this article, however, to criticize these contracts or to point out their defects, but rather, accepting them as they stand, to describe some of the problems involved in administering the accounting and inspection required for the determination of actual cost and the approval of bills.

CONDITIONS OF COST INSPECTION

Approximately the same problems of determining actual cost were involved in each type, the differences being in the basis of profit and in the manner of providing for additional plant facilities. In most cases work on these two types of contracts was carried on simultaneously in the same yard under practically identical conditions. Of course, in the early part of the period the work was largely on the cost-plus-10% basis, while latterly it became greater on the cost-plus-fixed-profit basis. This involved certain special problems in the control of the costs, but did not affect the principles of determining them.

To describe fully the conditions under which these contracts were operated or even to enumerate all the problems arising from them would be far beyond the scope of a brief article, but in order that some idea of their nature and extent may be perceived a brief summary of typical conditions is presented.

When the war began in the spring of 1917 there were under construction in certain of the shipyards specializing in navy work several vessels for private owners as well as several naval vessels on the original fixed price contracts. In some plants a certain portion of the facilities was also devoted to ship repair work. To this was now added the work under cost-plus-percentage contracts, which increased rapidly in proportionate volume as time went on.

The first problem that arose was to see that work performed on the fixed price contracts was not charged to the navy costplus contracts. The solution of this problem soon became contingent upon the solution of many other problems of detail.

The question of what should be classed as direct labor and what as indirect arose almost immediately. It would obviously be unfair to charge foremen's time on fixed-price contracts to indirect expense while charging it on cost-plus contracts directly to the contracts. It should either be charged in both cases to indirect or in both cases to direct expense. The latter would, of course, be satisfactory only in case the correct charge were ascertainable. It was soon apparent, however, that in many cases such expenses could not be properly allocated directly to specific jobs, and it became necessary to consider all the doubtful cases as indirect expense and to draw up rigid directions for excluding such expenses from direct costs.

Another problem occurred in the charging of material. This was a question of organization rather than of principle. With a rapidly increasing volume of work, it was very difficult to be sure that material purchased and charged to a particular vessel was actually used on such a vessel. The stores and material accounting facilities for most shipbuilders prior to this time were adequate perhaps for their own purposes, but with enormous increase in volume of material handled a state of confusion not unnaturally resulted, from which it took many months of painstaking effort to restore order and accurate accounting.