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MICHEGAN STHE UNIVERSITY

Ronald John Lewis
1965

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ABSTRACT

ACCOUNTING CONSEQUENCES OF PHYSICAL
DISTRIBUTION SYSTEM CHANGES

by Ronald John Lewis

This thesis concerns the procedural effects and finan-
cial implications that a change in the physical distribution
system has on the accounting system of a company. The term
"physical distribution" refers to the marketing concept en-
compassing the activities involved in servicing demand, such
as warehousing, transportation, material handling, packaging,
inventory management and order processing.

The evidence collected consists mainly of three case
studies. The first traces the procedural, financial and
auditing effects on the accounting system from a change in
the warehousing system of one division of a large Midwestern
company.

The other two, representing changes in the transporta-
tion system and in the channel of distribution, point out
how traditional accounting practices failed to provide the
distribution manager with the total cost information he need-
ed to control his activities. Improvements in a physical
distribution system are frequently reflected, by traditional
accounting practices, as apparent changes in net sales or in

l

2 Ronald John Lewis

production costs, rather than in distribution costs. Thus,
the production manager's costs may have been reduced, or the
sales manager's net sales may have increased, through an im—
provement made by the physical distribution manager. Credit
for the improvement then falls upon the beneficiaries rather
than upon the originator. The physical distributionists are
determined to make accountants aware of these procedural and
conceptual deficiencies.

The conclusions of this research project are:

1) There are unique, identifiable accounting implica-
tions and responsibilities in the functional marketing area
of physical distribution within the general area of distri-
bution cost accounting.

2) The recognition of physical distribution as an
unique marketing concept by marketing executives and academ-
icians demands a corresponding response from accounting
executives and academicians.

3) There is a decided lack of awareness by accounting
management, public accountants and academic accountants of
the informational needs of the executives responsible for
physical distribution activities. In the firms studied the

accounting departments did not appear to be cognizant of the

3 Ronald John Lewis

physical distribution concept.

Among the six public accounting firms contacted not one
was able to produce a change in the physical distribution
system which they felt had accounting consequences. And the
literature produced by academic accountants includes few
specific references to the physical distribution problems re-
ferred to in this study.

4) The change in warehousing, inventory control and
order processing systems resulted in the following proced-
ural, financial and auditing effects on the accounting
system:

a) Billing and invoicing, accounts receivable

collection and inventory control methods were

modified.

b) The costs of carrying inventory and accounts

receivable were reduced.

c) Cash flow was considerable accelerated.

d) The role of the computer was substantially

increased.

e) Some auditing procedures were affected.
Certain types of changes in physical distribution sys-

tems are more likely to produce procedural effects in

4 Ronald John Lewis

accounting systems, whereas other types will probably produce
financial effects. For example, a change in order processing
may affect invoicing and accounts receivable procedures.
Materials handling equipment changes, however, will have
financial effects rather than procedural effects.

5) The accounting system changes resulting from
changes in the physical distribution system did not
reflect any incremental conceptual understanding by the
accounting departments. In each case studied the desired
changes in accounting systems which indicate a conceptual
understanding have been initiated by the physical distribu-
tion peOple.

6) With a few modifications of existing practices
accountants could provide distribution managers with the
total cost control data that they require. These modifica-
tions should include:

a) Improvements in the determination of bases and
the methods of allocating costs for analytical pur-
poses to physical distribution activities.

b) A reclassification of in—plant physical dis-
tribution accounts which are presently classified

as production accounts.

5 Ronald John Lewis

c) A modification of the income statement to
reflect the above reclassifications.

Implications of this study indicate that further re-
search could be initiated concerning: (1) the auditing
consequences of a distribution system change, and (2) the
justification of price differentials which come under the
scrutiny of the Robinson-Patman Act.

Also it is concluded that accountants have an opportun-
ity from this challenge to enhance their professional

stature.

ACCOUNTING CONSEQUENCES OF PHYSICAL

DISTRIBUTION SYSTEM CHANGES

BY

Ronald John Lewis

A THESIS

Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY

Department of Accounting and Financial Administration

1965

Copyright by
RONALD JOHN LEWIS

1966

ACKNOWLEDGEMENTS

Several people have contributed suggestions, ideas,
time and skills to assist me in this endeavor. I would like
to mention those who have given special guidance and made
extraordinary contributions to this research.

The dissertation committee included:

Dr. Gardner M. Jones, Professor of Accounting, chairman
of the committee, who adroitly directed my research efforts.
His sincerity and personal interest from beginning to end
are particularly appreciated.

Dr. Richard J. Lewis, Assistant Professor of Marketing
and Transportation and Research Associate of the Bureau of
BuSiness and Economic Research, whose inspiration and fertil-
ization of latent ideas were especially helpful, and are
appreciated.

Dr. Edward W. Smykay, Professor of Marketing and Trans-
portation, whose constructive suggestions and knowledge of
the marketing aspects of the topic were indispensable.

Next, I wish to thank:

Mr. Kenneth Hessler, Manager, Distribution Research,

International Minerals and Chemical Corporation, for his

ii

enthusiastic cooperation in providing data and other informa-
tion. Also, my appreciation goes to representatives of the
other companies, who though preferring to remain anonymous,
contributed valuable data to the study.

Finally, my gratitude is expressed to my wife, Margie,
who provided typing and illustrative skills and who

participated in the many anxieties associated with the task.

iii

TABLE OF CONTENTS

LIST OF TABLES . . . . . . .
LIST OF FIGURES. . . . . . .
Chapter

I. INTRODUCTION . . . .

Need for Study . .
Setting for Study.

Distribution Cost
Critics of Distribution Cost Accounting
Statement of Objectives.
Methodology - Case Studies .

Accounting.

II. THE PHYSICAL DISTRIBUTION CONCEPT.

Marketing Definitions and Interpretations.
Development and Present Status of Concept.

Functions and Activities

Organization . . .

The Total Cost Approach.

III.

ACCOUNTING FOR PHYSICAL DISTRIBUTION COSTS

The Accounting Interpretation of the Concept

Present State of Accounting for Physical

Distribution Costs

Definitions . .

Nature of Distribution Cost Accounting.
Research on Practices

Evaluation of Methods and Proposed

Solutions. . . .

IV. CHANGES IN PHYSICAL DISTRIBUTION SYSTEMS AND
EVIDENCE FROM

THEIR ACCOUNTING CONSEQUENCES:

COMPANY EXPERIENCES.

iv

Page
vii

viii

H

H-m'q.p.br4

l

14
17
20
24
31

37
38
43
44

46
51

55

64

TABLE OF CONTENTS - Continued

Chapter
Introduction . . . . . . . . . . . . . .
Changes in Physical Distribution Systems
Cost Trade-offs . . . . . . . . . . .
Examples of Kinds of Changes
Case Studies . . . . . . . . . . . . . .

Case One: Change in Warehousing . .
Reasons for Change . . . . . .
Description of Old System . . .

Product and Its Movement . .
Order Processing and Billing

System. . . . . . . . . . .
Inventory Control System. . . .
Revisions of Physical Distribution
System . . . . . . . . . . . . .

Product and Its Movement. . . .

Order Processing, Billing and
Accounts Receivable . . . . .

Inventory Control System. .

Effects on the Accounting System and

Financial Implications . . . .
Procedural Effects. . . . . . .
Financial Statements . . . . .
Financial Effects . . . . . . .
Role of Computer and Auditing

Effects . . . . . . . . . . .

Case Two: Change in Transportation .
Case Three: Change in Channel of

Distribution. . . . . . . . . . . .

V. SOME PROPOSED ACCOUNTING MODIFICATIONS . .

Evidence of Need . . . . . . . . . . . .
Proposed Modifications . . . . . . . . .
Model Accounting System . . . . . . .

Bases and Methods of Allocating Costs.

Classification of Accounts . . . .
Financial Statement. . . . . . . .

VI. CONCLUSIONS AND IMPLICATIONS OF STUDY. . .

Additional Implications and Suggestions
for Further Research . . . . . . . . .

V

Page

64
65
65
67
70
70
71
72
72

74
74

77
77

77
86

86
86
87
87

87
87

93
97
97
103
104
105
108
110

112

120

TABLE OF CONTENTS - Continued

Chapter Page

Auditing Implications . . . . . . . . . . 120
Robinson-Patman Act . . . . . . . . . . . 120
Opportunity for Profession. . . . . . . . 121

APPENDIX . . . . . . . . . . . . . . . . . . . . . . . 123

BIBLIOGRAPHY . . . . . . . . . . . . . . . . . . . . . 127

vi

LIST OF TABLES

Drummond

Drummond - New Method .

Examples of Effects on Costs by Changes in

- Present Method

Physical Distribution Systems.

Estimate of 1—2 Day Delivery Service Capability

from Various Numbers of Regional Warehouses.

Case Two:

Terminal Closer to Customers than Plant.

Case Two:
Case Three:
through a Terminal .

Case Three:

A Midwestern Company - Functional Redistribu-

tion of Plant Costs.

vii

Effects on Accounting System .

Change in Distribution System
from Bulk Shipment Direct to Bulk Shipment

Effect on Accounting System.

Change in Distribution System‘from
Shipping Direct Rail to Shipping through

Page
58

59

69

82

89

92

94

96

99

10.

ll.

12.

13.

14.

LIST OF FIGURES

Page

Comparison of "Physical Distribution"

and "Logistics" Definitions . . . . . . . . 18
Marketing Activities Involving Distribution

Costs . . . . . . . . . . . . . . . . . . . 47
Before: Warehouse Locations and Service Areas 73
Before: Order System . . . . . . . . . . . . . 75
Before: Product Information Flow . . . . . . . 76
After: Warehouse Locations and Service Areas . 78
Variable System Costs and Inventory vs. Number

of Warehouses. . . . . . . . . . . . . . . . 79
Variable Costs and Service vs. Number of

Warehouses . . . . . . . . . . . . . . . . . 80
Delivery Service Capability vs. Number of

Warehouses . . . . . . . . . . . . . . . . . 81
After: Product Information Flow. . . . . . . . 83
Inventory Control - Billing - Sales Analysis -

Production and Shipping Scheduling . . . . . 84
After: Order System. . . . . . . . . . . . . . 85

A Midwestern Company - Functional Cost
Accounting Method. . . . . . . . . . . . . . 101

A Midwestern Company - Annual Operating Cost
Redistribution . . . . . . . . . . . . . . . 102

viii

CHAPTER I

INTRODUCTION

Symptoms of the Need for the Study

Historical concentration by accountants and industrial
engineers on production costs has resulted in detailed cost
control and planning in production. In spite of a rising
emphasis on marketing and product distribution, there is a
paucity of accounting emphasis on the subject of physical
distribution costs, both in practice and in accounting lit-
erature. Some attention has been given by accountants to
selling costs, but conventional accounting methods and
procedures do not provide adequate differentiation of costs
under the jurisdiction of physical distribution management.
There is little evidence of an effort by accountants to
provide the information necessary to identify and isolate
these physical distribution costs for centralized manage-
ment and control. The lead in cost analysis has been taken
by physical distribution specialists themselves.

Executives and academicians in the field of physical
distribution have expressed a desire for the provision by

1

accountants of the data necessary to control and manage the
costs of their activities. They have moved into cost analy-
sis only by default. Specific references to this deficiency
in current accounting concepts and procedures include the
following remarks.

H. G. Miller, Distribution Manager, Diamond Crystal
Salt Company, writes, "Traditional accounting methods tend
to hide true distribution costs, create illusory savings and
relocate costs rather than reduce them."1

Donald W. Drummond, Vice President, Olin Mathieson
Chemical Corporation, compares the most commonly used method
of accounting for physical distribution costs with a new
method which he has devised. The purpose of his device is
to pinpoint more precisely the costs which are the responsi-
bility of the physical distribution managers. He comments,
"The accounting department is generally working to the
advantage of everyone except the marketing department. Only
if this service function can be more fully utilized by this
department (marketing) can their full contribution to

profits be realized."2

I;

1H. G. Miller, "Accounting for Physical Distribution,"
Transportation and Distribution Management, December, 1961,
p. 7.

2Donald W. Drummond, "A Marketing Yardstick," Transpor-
tation and Distribution, February 1962, p. 13-16.

Richard J. Lewis, Assistant Professor, Michigan State
University, points out several aspects of this accounting
deficiency in his unpublished doctoral dissertation.3
Dr. Lewis suggests that the conventional methods used in
accounting for distribution costs ignore the geographical
variability of costs. He asserts that by allocating total
costs to the various activities of marketing on the basis
of standards or standard costs, rather than building up
the individual charges at the source of their incurrence,
the accountant is completely ignoring the variability of
marketing costs due to locational differences. He applies
this hypothesis to the area of physical distribution and
provides geographic cost control units for the accumulation
of costs at their origin.

Edward W. Smykay, Frank H. Mossman and Donald J.
Bowersox contribute to this same argument. Speaking of
averages, such as those applied by standard cost techniques
used in distribution cost analysis, they state, "If ....

variations within the average are neglected, then a stan-

dard uniform cost is assessed against all geographic

 

3Richard J. Lewis, "A Business Logistics Information
and Accounting System for Marketing Analysis." Unpublished
doctoral dissertation, Michigan State University, 1964.

markets. Neglecting the variations of spatially separated
markets will mean that no market is accurately measured as
to the precise cost of servicing it."

These are examples of executives and academicians in
the field of physical distribution who are pointing to an
area of serious deficiency in distribution cost accounting
procedures and methods. Although accountants have defi-
nitely recognized some of the deficiencies in distribution
cost accounting they have not indicated an awareness of the
uniqueness of the physical distribution function and its
demands for greater cost control. The foregoing references
are presented as symptoms of the need for research on this

subject.

Setting for the Study

Distribution Cost Accounting

Accounting for distribution costs has been the subject
of accounting literature since at least 1926 when J. R.
Hilgert's book, Cost Accounting for Sales was published.
In 1927, four articles were published in the Accounting,

Review, one by Professor William Paton, on the subject of

 

4Edward W. Smykay, Frank H. Mossman, Donald J. Bowersox,
Physical Distribution Management, New York: The Macmillan
Company, 1961, p. 77.

distribution costs.

"Distribution costs“ as used in accounting textbooks
and in most other literature mean marketing costs. Market-
ing embraces two basic functions: the Obtaining of demand
for the product or services of a company and the servicing
of that demand. Costs of obtaining demand include advertis-
ing, personal selling, merchandising, sales promotion and
market research. Costs of servicing demand include ware-
housing, transportation, order processing, inventory holding
costs, and customer servicing costs.

The definition of marketing functions by Longman and
Schiff refers to the activities performed rather than to
the goals of these activities. "A marketing function is an
activity that is performed because it is individually
necessary to business operation under existing policies
(the plan of operation), not merely incidental to other
activities, and that encompasses work of the same general
kind."5

Marketing textbooks refer to these functions of

obtaining and servicing demand in the broader social and

 

5Donald R. Longman and Michael Schiff, Practical Dis-
tribution Cost Analysis, (Homewood, Ill.: Richard D. Irwin,
Inc., 1955, p. 107.

economic sense. The difference in accounting literature
treatment versus marketing literature treatment of the
functions is analogous to the accounting controversy over
accounting postulates, principles, conCepts, practices,
methods and other similar terms. Although ostensibly in-
significant, differences in the underlying conceptual
framework may be the key to criticisms, by physical dis-
tribution writers, of unconventional accounting for dis-
tribution costs.

The recognition of the uniqueness of physical distri-
bution as an integration of several different components of
marketing is relatively recent. The treatment of the
components separately dates back to the nineteenth century.
Transportation, plant location, and inventory management
have been taught as parts; now they are thought of as one
whole.

Accounting for physical distribution costs has not yet
been recognized in accounting literature apart from its
inclusion in distribution costs. As far as can be deter-
mined, concern for the control of physical distribution
costs has been voiced mainly in the marketing journals and

books.

Critics of Distribution Cost Accounting

Several practitioners in the field of physical distri-
bution have deprecated the concepts and procedures in
current use in accounting for physical distribution costs.
The main criticism hinges on the observation that current
accounting practices are not adapted to the functional iso—
lation of physical distribution costs. Since the emergence
of physical distribution as an unique, identifiable organi-
zational and functional concept is of recent origin, there
is a lag in the recognition by the accounting field of the
cost control implications of this concept.

In its burden of already attempting to satisfy many
masters, accounting is reluctant to reshuffle its accounts
without considerable persuasive evidence. The physical
distributionists must first persuade tOp management of the
need for better cost control. If this is accomplished
perhaps accountants will make adjustments to satisfy the
physical distributionists.

Critics such as H. G. Miller and Donald W. Drummond
would make it a general accounting problem by asking for
changes in the account classifications and the financial
statements.

They contend that the customary accounting treatment

of distribution costs does not provide adequate information
for the control of these costs. Accounting procedures are
designed to serve the needs of financial officers, inventory
valuation, the S.E.C., and tax officials, often with disre-
gard for important internal control functions. Managers
responsible for physical distribution costs are usually not
provided with the figures they need to make enlightened
decisions.

The criticism should not rest entirely upon accountants,
however; all.toofrequent1y managers of distribution and of
other functional areas cannot tell the accountants what it
is they want; they only know that they are not happy with
the accounting data that comes to them. Or they are not
willing to undergo the burden of the detailed data-gathering
which is necessary to produce useful accounting information

for control.

Statement of Objectives

A range of unanswered questions is symptomatic of the
need for research in this subject. The following questions
lead directly to the setting of objectives for such a re-
search study.

(1) Within the general subject area of distribution

cost accounting are there unique, identifiable accounting

implications and responsibilities in the functional market-
ing area of physical distribution?

(2) Does the recognition of physical distribution as
an unique marketing concept by marketing executives and
academicians demand a corresponding response from accounting
executives and academicians?

(3) Is there an awareness by the firm's accounting
management, public accounting firms and academic accountants
of the informational needs of the executives responsible for
physical distribution activities?

(4) What actually occurs in the accounting system of
a company which has substantially altered its physical
distribution system? What are the procedural and financial
effects and implications?

(5) Are there attempts to satisfy the informational
needs of the distribution manager as evidenced by the modi-
fications in the accounting system accompanying the changes
in the physical distribution system?

(6) What can be done by accountants to satisfy the
criticisms of physical distributionists and to provide them
with total cost control?

In the preliminary research done on this subject these

and similar questions are raised. In an attempt to answer

10

them, the objectives of the study stated below will be
pursued:

(1) To attempt to clarify definitions and summarize
for the reader the meaning of the physical distribution
concept, as it has been conceived by the marketing people
and as it is understood by the accounting profession.

(This is done in Chapter Two).

(2) To examine thoroughly the accounting practices
and responsibilities in the area of physical distribution
costs; and to assess the awareness of accounting executives,
public accountants and academic accountants of the cost in-
formational requirements of the physical distribution
managers. (This is attempted in Chapter Three).

(3) To trace the effects of a substantial change in
the physical distribution system of a business on its
accounting system; and to determine by the actual effects on
the accounting system if there were significant procedural
modifications and if there were important financial require—
ments alterations caused by the change in the physical
distribution system. (This is the purpose of Chapter Four).

(4) To offer a response to physical distribution
executives and academicians who have challenged the adequacy

of the cost information provided them by accountants; and

11

to suggest how the accounting profession might respond to

this critical need. (This is done in Chapter Five).

Methodology - Case-Studies

The purpose of the case-studies is to examine the
effects of a major or minor change in a firm's physical
distribution system on its accounting system. The impact
on the accounting system could range from no significant
effects to major procedural and financial consequences. It
is intended in this project to examine the actual changes
that have taken place in the physical distribution and
accounting systems of three Midwestern companies.

The first case study will involve a single product
marketed to the ultimate consumer. The company recently
made major changes in its method of distributing this pro-
duct to its customers. The decision to modify the physical
distribution system was provoked by symptoms of both
structural and financial deficiencies. The subsequent ex-
tensive revision of the physical distribution system was
implemented to correct these deficiencies. The other two
case-studies point out accounting practices which obscure
physical distribution costs.

It is intended that the following questions will be

answered as a result of these case—studies:

12

1. What was the role of accounting personnel in effect-
ing the changes?

2. What changes in accounting procedures were brought
about by the physical distribution changeover?

Eg. a) billing and order system

b) accounts receivable
c) inventories

3. What were the financial implications of the change-
over?

Eg. a) cash flows and working capital

b) interest on receivables
c) carrying cost of inventories

4. What changes in the use of the electronic account-
ing devices were made?

5. Do traditional accounting practices tend to obscure
costs under the control of the distribution manager?

6. Were any changes in the traditional concepts of
reporting physical distribution costs made? That is, was
there recognition by the accounting department of the need
for isolation of those costs assignable to the physical dis-
tribution function, but not conventionally reported to
facilitate such isolation?

The answers to these questions will be the localized

13

goal of the case-studies. It is not likely that sweeping
generalizations will result from this type of study. The
implications, however, may serve as evidence for further

survey-type research.

CHAPTER II

THE PHYSICAL DISTRIBUTION CONCEPT

Marketinngefinitions and Interpretations

 

of "Physical Distribution"

It is necessary for the purposes of this report to
clearly define physical distribution since there are some
inconsistencies in the use of the term in marketing litera-
ture. In accounting literature the term suffers from lack
of use in addition to some misuse.

In 1948, the American Marketing Association formulated
an official definition for physical distribution: "The
movement and handling of goods from the point of production
to the point of consumption or use."1 The interpretation of
this definition can be gleaned from subsequent definitions
found in marketing literature.

"Physical distribution refers to the integration

of all aspects of physically handling, storing,
and transporting goods on their way to the market."

 

lDefinition Committee of the American Marketing Associ—
ation. "1948 Report." The Journal of Marketing, October,
1948, p. 202.

2 . . .
William Lazer, "A Systems Approach to Transportation,"
Distribution Age, September, 1960, p. 34.

14

15

"Physical distribution can be broadly defined as
that area of business management responsible for
the movement of raw materials and finished products
and the development of movement systems."

"Those functions involved in the physical movement
of goods from the end of the manufacturer's pro-
duction line into the buyer's point of use. The
concept includes materials handling, packaging,
storage and all transportation costs. It does not
include selling or purchasing. It does cover both
the inbound movement of raw materials and supplies
and the outbound movement of products."

".... The concern of physical distribution is the
inbound movement of raw materials through a pro-
duction unit, followed by an outbound movement
through established channels to consumers. The
key function of physical distribution is movement.
Physical distribution is the planned movement of
materials and products."

These definitions interpret and perhaps expand the
A.M.A. definition to include both movement of supplies and
materials to a given firm and movement of finished products
from the firm to its customers.

Another interpretation, although it forms a substantial

contribution to the concept of physical distribution,

 

3Edward W. Smykay, Frank H. Mossman, Donald J. Bowersox,
Physical Distribution Management, (New York: The Macmillan
Company, 1961), p. l.

4H. G. Miller, "Accounting for Physical Distribution,"
Transportation and Distribution Management, December, 1961,
p. 6.

5Eugene Landis, "Marketing Management and Distribution

Planning," Transpprtation and Distribution Management, July,
1962, p. 18.

16

changes the semantics used in the original definition. One
set of authors has merely renamed the above concept of
physical distribution, "business logistics." Their defini—
tion is as follows:
"Business logistics will ....refer to the management
of all activities which facilitate movement and the
coordination of supply and demand in the creation of
time and place utility in goods."

They claim economic justification for this terminology
(referred to as a new concept) in the need for distinguish-
ing between the inflow of supplies and materials (which
they call "physical supply"), and the outflow of products
beyond the production facility (which they term "physical
distribution.")7 Just as a sale by one business entity is a
purchase by another entity so physical distribution by one
firm represents physical supply to another.

It is not within the scope of this report to discuss
the relative merits of the use of relevant terms, but to
establish the meanings intended herein. Thus, the term,

"physical distribution," is intended to encompass movement

both to and from a given firm. It is equivalent to the term

 

6J. L. Heskett, Robert M. Ivie and Nickolas A.

Glaskowsky, Jr., Business Logistics Management of Physical
Supply and Distribution, (New York: The Ronald Press Co.,
1964). p. 21.

71bid.

17

"business logistics" used by the latter authors, rather than
their use of the term "physical distribution." The terms
"physical distribution" and "logistics" will be used synony-

mously herein. (See Figure 1).

Development and Present Status of

Physical Distribution Concept

The understanding of the concepts of physical distri-
bution as an integrated body of marketing functions or
activities is in its infant stages. Marketing writers have
contributed to some confusion in the terminology. Business
management has been slow in implementing needed organiza-
tional changes. Accountants have failed to recognize the
need for cost control and analysis information beyond con-
ventional distribution cost analysis.

These handicaps may be traced to the fact that some of
the components of physical distribution have been treated
separately since the nineteenth century. Plant location
theory dates back to the early German writers, such as
von Thunen and Weber. Transportation and warehousing are
subjects in early marketing literature. Organizational
patterns have long been established for separate control of
these components. Assignment of responsibility has been

spread in varying ways to different levels of management, both

18

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92¢ :ZOHBDmHmbHQ A<UHmNmm:

m0 ZOmHM¢ASOO

19

vertically and horizontally. Relationships among the com-
ponents have been obscured by the established organizational
framework.

Since World War II there has been increasing recogni-
tion of the uniqueness of physical distribution; and present-
ly there is an accelerating awareness of the importance of
the integrated approach to physical distribution analysis.

The present stage of business development emphasizes
systems of internal control over operations based on mathe-
matical and analytical methods.8 Unlike the other side of
marketing, demand obtaining activities such as direct sell-
ing and advertising, physical distribution activities are
more easily quantified and subjected to mathematical analy-
sis. Accounting for distribution costs has been hampered by
the difficulties in determining bases for allocation and in
developing standards for cost control and cost analysis. It
has been recognized by many accountants that most of the
difficulties apply to the demand-obtaining rather than to
the demand—servicing activities. In this respect, physical
distribution activities are more like the production activi-
ties than they are like the demand obtaining activities of

marketing. H. G. Miller states that physical distribution

 

8
SmYkay, Mossman and Bowersox, Chapter 1.

20

functions, while divided managerially and physically, have
closely interrelated cost implications. These functions,
material handling, packaging, traffic, transportation, in-
ventory control, terminaling and warehousing, are more
closely related than production and sales as centers of
cost. They connect geographically and temporally the span
between the production line and the customer.

It is important to stress that although failure to ad-
just organizational structure to new managerial demands is
a severe handicap, it is the understanding of the new con-
cept which is most imperative.

....we would venture to say that many companies
which are not 'organized' for physical distribution
management - either by chart or by use of the term -
are in fact doing a first-rate physical distribution
job because they understand the function, while
'other companies with beautifully drawn charts en-
compassing a physical distribution hierarchy are
falling down on the job because they still haven't
learned what physical distribution is all about.“

The Function and Activities of Physical Distribution

Use of the term "function" by authors of distribution

cost accounting texts and articles has been subjected to

A

9Miller, p. 6.

0Editorial, "Organization vs. Function in Physical
Distribution Management, "Transportation and Distribution
Management, February, 1962, p. 3.

 

21

criticism by some marketing writers. For example, the
definition of marketing functions by Longman and Schiff re-
fers to the activities performed rather than to the goals
of these activities, i.e., what the job is that is getting
accomplished through the activities.

"A marketing function is an activity that is per-
formed because it is individually necessary to
business operation under existing policies (the
plan of operation), not merely incidental to other
activities, and that encompasses work of the same
general kind."

Dr. Richard J. Lewis in his unpublished doctoral
dissertation states in reference to this usage of the term:

"....it is unfortunate that the breakdown of
natural accounts to the various marketing activi-
ties has been termed functional cost analysis.

The use of the term function to describe the
activities of marketing is not consistent with

the nature of distribution costs presented earlier
in the chapter (Chapter III) where obtaining and
servicing demand were listed as the functional
costs of marketing."12

Professor Lewis emphasizes that there are two basic
functions of marketing: obtaining demand for the products

or services of a firm, and servicing and supplying this

 

11Donald R. Longman and Michael Schiff, Practical Dis-
tribution Cost Analysis, (Homewood, Illinois: Richard D.
Irwin, Inc.), 1955, p. 107.

12Richard J. Lewis, "A Business Logistics Information
and Accounting for Marketing Analysis." Unpublished doctoral
dissertation, Michigan State University, 1964, p. 80.

22

demand. Personal selling, advertising, sales promotion,
merchandising, and market research are activities the func-
tion of which is to "....make the customer aware of his
needs and desires, demonstrate how the company's goods and
services are the best need satisfiers available in the mar-
ket place, and provide information to continually adjust
the products and demand-inducing forces to changes in the
market place."13

Warehousing, inventory (management), transportation and
order processing and handling are activities the function
of which is to "....coordinate supply with demand for its
(the firm's) products and services. The coordination re-
quires that the firm have the right products in the right
place at the right time."14

What are the activities of physical distribution?
Although different authors may assign different names to the
same activity it should be possible to ascertain the activi-
ties which perform the function of physical distribution,
i.e., servicing and supplying demand.

In order to accomplish this task the activities given

by several marketing authors will be listed and compared.

 

23

Those activities included by Professor Lewis have already
been noted above:

warehousing

inventory (management)

transportation

order processing and handling

The activities included by Heskett, Ivie and Glaskowsky

15
are:
Movement Control

traffic and transportation

warehousing

materials handling
Demand - Supply Coordination

order processing and information flow

inventory management

supply scheduling

Smykay-Bowersox-Mossman do not list the activities as
such,but would include all of the above by implication of
their chapter content.

H. G. Miller includes:

material handling

packaging

traffic and transportation

inventory control

terminaling and warehousing16

Eugene Landis provides a list of physical distribution

 

15Heskett, Ivie and Glaskowsky, p. 22.

16Miller, p. 8.

24

functions (activities) which he calls just a starter.

traffic and transportation

warehousing

inventory control

order processing

material handling

production con 01

sales planning

The variation in these descriptions of physical dis-
tribution activities is an indication that there are
inherent semantic deterrents to defining a general all-
purpose set of distribution activities. There are some
activities such as traffic and warehousing which are un—
equivocally included in the serving of the logistics

function, whereas there are others which may vary with the

varying characteristics of different industries.

Organization of the Physical Distribution Function

It is not surprising that the organization of physical
distribution activities is less well developed than its
counterparts in finance and production and in the other half
of marketing. The concept of physical distribution is still
in its infant stages in many areas of business. Even when
the concept is acknowledged by executives the implementation

of organizational modifications meets resistances both of a

 

17Landis, p. 18.

25

human and structural nature. Each firm must be analyzed
according to its particular needs and characteristics in the
establishment of its organizational lines. No two firms are
exactly alike in their organizational requirements. "Experi-
ence has shown that of the many companies which have embraced
the idea of creating a distribution department or division,
each has done so in quite an individual manner."

Heskett-Ivie-Glaskowsky suggest guidelines for the
appropriate organization of the logistics activities by ask-
ing these questions:

"1. Are the logistics activities in the firm of
sufficient importance to warrant or require their formal
organization at one or more places in the company's organi-
zation.structure?

2. What activities logically might be included in a
formally organized logistics function in this company?

Which ones should be?

3. What should be the internal organization of the
logistics function? What activities should be identified
and groups as its sub-functions? What should be the author-

ity relationships among these sub-functions?

 

18Ibid., p. 16.

26

4. What should be the position and relationships of
logistics function relative to other functions in the
firm?"19

One indicator of the importance of the logistics acti-
vities is their absolute and relative costs° The authors
state: "There is only one meaningful standard: relative to
other functional cost categories (e.g., production, adver-
tising, public relations), does logistics 'rate' in this
firm as a function warranting separate organization recog-
nition from the standpoint of costs?"20

The other indicators are: the size of the firm, cus-
tomer service standards, nature of the product and raw
materials, whether goods are produced to order or for stock,
the pricing policy of the company, and the structure of the
shipping mix.

The second series of questions asks what activities
would be included in the logistics function. There are
activities which are readily identified with the physical
distribution function: traffic warehousing, order process-
ing, inventory maintenance, movement and production

scheduling and others. There are nevertheless some

 

19Heskett, Ivie and Glaskowsky, p. 480.

20Ibid., p. 484.

27

activities which will not always require the same organiza-
tional treatment; and even those listed above, though
conceptually they belong in logistics, may in practice more
effectively be placed under other organizational jurisdic-
tion.

The authors summarize that a desirable organizational
plan is one that provides for and lubricates the machinery
for proper use of specialist skills, coordination of tasks
of managerial supervision, and effective planning.

The rest of the series of questions on the internal
sub-functions and relationships can be answered by applying
conventional management criteria such as deciding on the
span of management, delegation of authority, authority rela-
tionships, and centralization or decentralization.

Mellman and Schiff's study to examine and evaluate the
practices of a selected group of twenty-eight large companies
(twenty-two of which were listed by Fortune Magazine in the
top 500 manufacturing firms in 1960) reveals the variability
in the organization of physical distribution activities.

The study concerned physical distribution only incidentally
as a part of the whole marketing picture but some salient
implications for physical distribution were revealed. They

developed a list of the range of marketing activities

28

assigned to the marketing department.

Marketing Administration

Marketing Research

Product Administration

Personal Selling

Advertising

Sales Promotion

Physical Order-filling (warehousing, packaging and
shipping, delivery)

Order Processing and Billing (clerical)

. Credit and Collections

\lO‘Uln-PWNH

\OCD

Few companies assigned all_of these activities to the
marketing department. Several firms assigned the last three
elsewhere.

In the new marketing concept new activities such as
product planning, production scheduling, inventory control
and pricing have been added to marketing responsibility.

"Seldom noted is a concurrent reduction in one re-
sponsibility which is normally considered to be a part of
marketing. This relates to physical distribution of goods
which includes order handling, inventory control, shipping,
loading, packing, traffic, receiving, warehousing and
materials handling."2

Dividing responsibility between marketing and manu-

facturing has created problems. Five of the companies

 

2 . . . . .
lMichael SChlff and Martin Mellman, F1nanc1a1 Manage-
ment of the Marketing Function, (New York: Financial
Executives Research Foundation, 1962), p. 11.

22Ibid., p. 18.

29

studied established a separate physical handling department,
but with varying practices of organization.

In a kind of ideal-type organization proposed by the
authors, the order—filling activities would be assigned to
manufacturing while the order processing and billing would
be assigned to the accounting department. This represents
the most typical method of handling physical distribution
costs.

To show the variations in the actual practices, six
firms selling similar products to similar markets were se-
lected from the twenty-eight. The order-filling activities
were found to be handled in three different ways. The most
frequent practice used by three companies, was to assign
these activities to the manufacturing department, as in the
model referred to above. One firm assigned the responsi-
bility for field warehousing and order filling to the
district sales manager and shipping at the plant site to the
marketing vice-president. The remaining two firms assigned
the bulk of the physical distribution activities to a
separate unit reporting directly to the president.

Perhaps the most significant attempt to establish the

 

23Ibid., p. 12.

30

specific activities and responsibilities of the physical
distribution function is the 1962 T&DM study of 50 firms
with formally organized physical distribution departments.
The study covered only companies having either a "Distribu-
tion Department" or an individual with the corresponding
title. The average gross annual sales of the responding
firms was $208 million (with extremes deleted to prevent
distortion). The modified mean of the number of plants
operated was 16, and of the warehouses, 39. The average
longevity (modified) of the formal existence of the distri-
bution department was three years. The range of ages was
three months to 48 years.

Of particular significance was the range of activities
under the jurisdiction of the department. Ninety per cent
of the 50 responding firms reported that the transportation
activity was the responsibility of the distribution depart-
ment. Responsibility for shipping and receiving activities
was reported by 86% of the firms. Inventory control was
reported by 72% of the firms, warehousing 66%, material
handling 64%» protective packaging 40%, production planning

36% and order processing 12%.25

 

24Warren Blanding, Ed., "Profile of P.D.M.", Transporta-
tion and Distribution Management, June, 1962, p. 13.

25Ibid., p. 14.

31

The wide discrepancies and inconsistencies in marketing
literature regarding what functions and activities lie with-
in the "physical distribution concept" can be more readily
understood when the interpretation of the above figures is
undertaken. When such a wide variation of responsibilities
even under the formally designated (physical) distribution
department exists, what might exist where no formal depart-

ment is identified with the concept?

The Total Cost Approach

 

The total cost approach to the logistics function is
. . . 26 . .
well documented in current marketing literature. It is in
effect an extension of marginal cost analysis in Economic
theory. Assuming perfect competition, a perfect allocation
of all resources occurs where:

MPPa = MPPb = ... MPPn = l_ _ 1_
Pa Pb Pn MCx P x

 

MPP = marginal physical product

P price

MC marginal cost

a,b,..n = resources or inputs; eg. labor, machines.
x Product or output

At this stage a dollar's worth of any single resource

is exactly equal to a dollar's worth of all other resources.

 

26See: Richard J. Lewis, p. 66; Heskett, Ivie and
Glaskowsky, p. 454; Smykay, Bowersox, and Mossman, p. 77.

32

Prior to reaching this state of equilibrium, applications of
either A or B or substitutions of A for B or B for A are in
order to attain the above balance.

In the total cost approach to physical distribution
problems, the various logistics activities are analogous to
A and B, the resources. Any incipient combination of the
logistics activities may be assumed to be out of balance,
that is, where a change in an activity could improve the
revenue less cost picture. The drive toward perfect balance
(although perhaps unattainable in the real world) would be
attempted by trading off costs where necessary as long as
the net effect is favorable. A speedier but costlier trans-
portation mix would be implemented if it reduced pipeline
inventory costs and warehouse costs more than the transpor-
tation cost increase. This is an example of an intra-func-
tion cost trade-off. A change of this type could also
affect other marketing costs or revenues or it could affect
manufacturing or finance costs.

"The illusory trade—off is one resulting from
improper organization of accounting information
which leads one function in a firm's organization
to believe it has brought about an economy by its
action only to find that an offsetting diseconomy
is the result for a sister function. One of the
~most common examples of the illusory trade-off is

the accumulation of inventories on a seasonal basis
to allow level production scheduling... . The basic

33

nature of the trade-off, that of increased in-
ventory holding costs for decreased manufacturing
costs, is often obscured by the failure of most
accounting systems to identify the cost of capital
invested in such inventories."27

The recognition of cost trade-offs in physical distri-
bution has been deterred by the traditional segmented con-
trol over the various activities. Recognition and
understanding of the total cost approach is imperative for
optimum control of logistics costs. Otherwise, as stated

eloquently, "...the popular corporate pastime of relocating
rather than reducing costs,"28 will persist.

"Distribution costs, in total, are rather elusive
things because they involve many order—getting
costs ...which are difficult, if not impossible,

to allocate to specific products or orders. On

the other hand, the physical distribution function
is much more tangible and would lend itself to the
use of well-established cost accounting techniques.
We feel, therefore, that the use of the 'total cost'
concept as applied to the physical distribution
function would have at least three advantages:

(1) it would concentrate management attention on an
area well worth the time and effort in potential
savings; (2) it would furnish the data necessary to
make a sound judgment about alternative forms of
transportation, warehousing, etc.; (3) it would be
a very real start on getting facts on one portion of
the total cost of distribution."29

 

27Heskett, Ivie and Glaskowsky, p. 453.

28Miller, p. 12.

9Howard T. Lewis, James W. Culliton and Jack D. Steele,
The Role of Air Freight in Physical Distribution, (Boston:
Harvard University, Division of Research, 1956), p. 64.

34

As viewed by Heskett, Ivie and Glaskowsky, total cost
analysis is one of the three underlying principles of logis-
tics. They are:

"1) viewing the movement of goods and the coordi-

nation of demand and supply not as an activity
carried on by or for one firm, but by and for firms
at two or more levels in a channel of logistics,

2) analyzing all costs resulting from the use of

alternate methods of accomplishing a logistics
task, and

3) designing a system involving the use of men,

machines, and information in such a way that the
parts are closely integrated to create greater
productivity in the system than that produced by
the sum of its component parts."30

The first principle stresses the inter-firm relation-
ships of physical distribution; that the final price of a
product includes not only the effect of the final seller's
physiCal distribution costs but the effect of the whole
stream of physical distribution costs of the final seller's
suppliers and their suppliers. This concept is called "the

. . . . . 3
logistics of macrodistribution systems" by Mossman-Morton.

The second principle represents the total cost analysis

approach described above. The main problems encountered in

the total cost analysis are:

 

30Heskett, Ivie and Glaskowsky, p. 445.

1Frank H. Mossman and Newton Morton, Logistics of Dis-
tribution Systems, (Boston: Allyn & Bacon, 1965), p. 4.

35

"1) separating and identifying logistics costs,
2) establishing accounting cost centers which are
capable of providing the type of information
necessary for continuing logistics cost analyses,
and

3) analyzing the results of changes in the per-
formance of a system after new concepts have been
implemented."

Solutions to these problems require the services of the
accounting department. But the physical distribution people
need more than just accounting services. They are demand-
ing recognition and understanding by accountants of these
physical distribution principles, particularly the total
cost approach.

"Physical distribution must become an accounting con-

. . "33
cept as well as an organizational concept.

"To fully benefit long range from treatment of all
physical distribution operations as a unified system, the
organization must be backed up by an accounting system that
permits recognition, accumulation and control of these

34

costs."

The following chapter will discuss to what extent the

 

32Heskett, Ivie and Glaskowsky, p. 455.

33Miller, p. 7.

34Ibid., p. 6.

36

accountant understands the physical distribution concept,
how he presently applies his systems, procedures and tools
to account for costs generated by physical distribution
activities, and what can be done by the aCcountant to solve
the problems so prolifically penned by the physical

distributionists.

CHAPTER III

ACCOUNTING FOR PHYSICAL DISTRIBUTION COSTS

To appreciate fully the accountant's comprehension of
the physical distribution concept it is necessary to refer
occasionally to principles and procedures of conventional
distribution cost accounting. Because of the accessibility
of literature on the subject of distribution costs, re-
sponsible knowledge and comprehension by the reader will be
assumed. Thus a burdensome review of the whole field of
distribution cost accounting will be obviated. Effort can
then be focused on the elements of distribution cost account-
ing which are relevant to this study.

This chapter will attempt to present the accountant's
understanding of the marketing concept, "physical distribu-
tion," to evaluate the existing accounting principles,
methods and procedures applied to logistics activities; and
to explore the possibility of modifying and improving the
present state of conceptual and implemental development to

satisfy the criticisms of the physical distributionists.

37

38

Accounting Interpretation of Physical Distribution Concept
The marketing academicians and executives who are de-
sirous of promoting the "physical distribution" concept have
emphasized the lack of adequate cost control information.
In stressing the total cost approach, emphasis is concomi-
tantly placed on obtaining "appropriate" cost data. By
selecting a few relevant comments by these authors and
executives, virtual agreement on this one point can be
reasonably substantiated: that adequate information for
cost control and cost analysis necessary in the total cost
approach to the physical distribution concept is not satis-
factorily provided by presently applied conventional
accounting methods and procedures.
"To fully benefit long range from treatment of all
physical distribution operations as a unified system,
the organization must be backed up by an accounting
system that permits recognition, accumulation and
control of these costs."
Mr. Miller indicates a firm conviction that traditional

accounting procedures do not provide adequate data for the

. . . . 2
total cost approach to phySical distribution cost control.

 

1H. G. Miller, "Accounting for Physical Distribution,"

Transportation and Distribution Management, December, 1961,
p. 6.

2Ibid., p. 7.

39

"What is needed in business today is not another
'Parkinsonian Empire.‘ Rather, the complex de-
mands of modern business management require:

(1) An over-all corporate sensitivity to the
needs for highest inter-departmental coordination
between the many specialized areas of management
influential in successful distribution management.

(2) A functional method of distribution cost
accounting capable of adjusting inter-departmental
cost trade-offs on a corporate wide basis."3

"The accounting system most widely used is set up
to serve the president, financial officers, the
SEC, and the Internal Revenue Service."4

"The accounting department is generally working to
the advantage of everyone except the marketing
department."

It is evident from these comments that the advocates
of the total cost approach to the physical distribution
function are requesting assistance and cooperation from the
accounting staff. They do not necessarily expect immediate
panaceac changes in conventional systems, but rather request
modifications of present methods in order to obtain more

useful cost data for their objectives. Actual changes

necessary to provide this information may be minor; in some

 

3Donald J. Bowersox, "The Forces Influencing Finished
Inventory Distribution," Transportation and Distribution
Management, January 1962, p. 11°

4 . .
Donald W. Drummond, "A Marketing Yardstick," Trans-
pgrtation and Distribution Management, February, 1962,
p. 13.

5Ibid., p. 16.

40

cases the present electronic data processing equipment may
make this information available at little or no extra cost.

The main obstacle is bringing the need for this infor-
mation to the attention of the accounting department, rather
than the cost of obtaining it. The physical distribution
executives will probably have to convince the upper levels
of management of the crucial need for the desired cost data
in order to effect changes in the accounting system.

"Physical distribution cost accounting will more
than likely receive increasing attention from top
management in 1964, and although there's little
chance you'll be able to make over your company's
accounting system exactly as you'd like it, there
is a good possibility that the way will be cleared
for developing far more meaningful and accurate
cost figures than ever before."6

"Don't expect the impossible. Remember that manage-
ment has many uses for its existing accounting - a
number of them required by law - and comptrollers
and accountants are notoriously reluctant to change
their systems and therefore lose the continuity of
year-to-year figures which enable them to make com-
parisons and spot trouble. And top management will
usually back them up."7

It could be stated that leaders in the field of account-
ing do not formally recognize the "physical distribution"

concept as it is interpreted in this study. This statement

 

6Editorial, "Distribution Management Tips," Transporta-
tion and Distribution Management, January 1964, p. 4.

7Ibid.

41

can be justified by the almost complete absence of any
reference to the concept in any of the leading accounting
textbooks, monographs, journals and research studies. The
concept as contemplated by the marketing executive and
academician has apparently not been equivalently contem-
plated by his accounting counterpart insofar as it is not
reflected in the latter's major media of formal intellectual
communication.

But it is non sequitur to assume that the accounting
department within a given company does not recognize the
concept. Several accounting departments in firms which
apply the total cost approach to physical distribution have
already modified their systems to satisfy the needs of the
physical distribution function. But these firms are rela-
tively few in number. If the marketing managers have not
implemented the new concept into their organizational and
responsibility framework it is unlikely that the accounting
department has initiated any changes.

"In many firms attempts have been made to establish
accounting cost centers to coincide with the scope
of authority of various members of a company's
management. These recent attempts have benefited
logistics cost analysis only where organizational
recognition is given to the functional importance of
logistics. If costs are difficult to obtain in the

course of system analysis, it is likely that the
appraisal of the result of system change will be

42

just as taxing unless the original study which in-
itiated the system change is able to bring about,
as a by-product, a temporary or permanent change in
cost reporting and accounting procedures. The only
substitute for adequate cost information is estima-
tion based on an analysis of other types of company
records and field observation."8

Why has the literary endowed accountant apparently fail-
ed to recognize this area of marketing which has received so
much attention in some marketing media in recent years? The
answer may be that the accountant interprets the activities
of physical distribution as a part of total distribution
cost accounting and not as a system with unique character-
istics. Leading textbooks of distribution cost accounting
treat physical distribution as consisting separately of
transportation and warehousing and handling costs.

The new concept as it has evolved in marketing litera-
ture treats physical distribution as an integrated system.
There is a lag in the communication of the integrated concept
to the conscious mind of the accountant, if we judge by the
accounting literature.

Extremely important to the comprehension of the

"physical distribution" concept is the difference in the

measurement of physical distribution costs and the

 

8J. L. Heskett, Robert M. Ivie and Nicholas A.

Glaskowsky, Jr., Business Logistics Management of Physical
Supply and Distribution, (New York: The Ronald Press Co.,
1964), p. 455.

 

43

measurement of the costs of the other marketing activities.
Recognition by the accountant that physical distribution
activities are closer to production activities in terms of
cost measurement than they are to promotional activities is
an important step to more precise measurement attempts.

"....the problems of physical distribution are,

in essence, not unlike other areas of the market-

ing operation in that the selection of operation

methods among alternatives and the planning, con-

trolling, and evaluating of performance is essential

to management. Yet, the intangible nature of the

personal and impersonal selling efforts and the

resultant impact on measurement and evaluation do

not plague the physical functions. To this extent

it would be reasonable to expect a wide application

of the use of quantitative analysis in this area."9

That costs of physical distribution activities are more
amenable to precise measurement is an advantage for the im-

plementation of a successful physical distribution cost

accounting system.

Present State of Accounting for Physical Distribution Costs
Physical distribution accounting falls within the scope

of distribution cost accounting, a sub-division of industrial

cost accounting. Cost accounting is considered a special-

ized branch of accounting the purpose of which is to measure

 

9 . .

Michael Schiff and Martin Mellman, FinanCIal Manage-
ment of the Marketing Function, (New York: Financial
Executives Research Foundation, 1962), p. 53.

44

the total costs of producing and distributing products and
services for control and analysis by management.

In the economic system, distribution refers to the
activities involved in the creation of time, place and
ownership utility while production refers to the activities
involved in the creation of form utility. Most business
firms carry on activities which perform both production and
distribution functions, but usually specialize in one or the
other. Physical distribution activities are performed by

all complex firms which sell goods rather than services.

Distribution Costs - Definitions

There is evidence of some variation in accountants'
definitions of "distribution costs." In the broad sense,
"distribution" refers to all activities engaged in both ob-
taining demand for the product and in servicing this demand.
That is, those activities engaged in promoting and selling
the product and those activities engaged in the physical
distribution of the product to the customer.

"Distribution costs are the costs of all business

activities necessary to effect transfers in the
ownership of tangible goods and to provide for

 

10Donald R. Longman and Michael Schiff, Practical Dis-

tribution Cost Analysis, (Homewood, Illinois: Richard D.
Irwin, Inc.), 1955, p. 24.

45

their physical distribution."11

Longman and Schiff describe distribution costs as the
"....expenses which follow the gross profit figure in the
accountant's profit and loss statement."12 In substance
this is the same concept, but as pointed out by H. G. Miller
and Donald Drummond this definition obscures many of the
elements necessary for adequate physical distribution cost
control.

In the narrow sense, "distribution" has been defined in
two different ways by accountants. The Accountant's Hand-
book states that distribution costs are those expenses re-
lated to the promotional activities controlled by the sales
manager.13

The Marketing Handbook and at least one accounting
author have described "distribution" in the narrow sense to
mean the "physical" distribution activities.

"In its broadest sense, distribution includes the

following functions: shipping, freight and delivery,
warehousing, selling, advertising, ordering and credit."

 

.‘

llJ. Brooks Heckert and Robert Miner, Distribution

Costs, (New York: Ronald Press Company, 1952), p. 1.

12Longman and Schiff, p. 69.

13Robert Miner, "Distribution Costs," Accountant's
Handbook, Edited by Rufus Wixon, (New York: The Ronald
Press, 1956), p. 9'1.

46

"In a narrower sense, distribution means getting

the merchandise from the production departments to

the customer."14

Use of the term "distribution costs" in this study will
refer to the broader sense as described in the Accountant's
Handbook. Thus, all costs allocable to selling, physical
movement, financial and administrative activities which are
engaged in getting the product from the terminal point of
the production line into the consumer's hands are "distri-
bution costs." (See Figure 2).
The Nature of Distribution
Cost Accounting

The principles and techniques of distribution cost
accounting are patterned after those of production cost
accounting. There are unique characteristics, however, in
the nature of distribution costs, some of which have negated
the application of many techniques useful in production cost
accounting. Consequently, there has been limited progress
in the field of distribution cost accounting. These char-

acteristics are summarized in the Accountant's Handbook from

several of the leading cost accounting texts.

 

l4Lyle M. Farmen, "Accounting for Distribution Costs by

Product Groups," Cost and Management (Canada), September,
1960, p. 317.

15Miner, p. 9'4.

47

FIGURE 2

 

 

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4

 

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Amumoo cowusnfinumflnv
mcfiuoxumz

 

 

mBmOU ZOHBDmHMBmHQ OZH>AO>ZH mMHBH>HBU< OZHBMMM<S

 

48

1. Distribution costs are not usually tied into the
financial accounts. They tend to be used more for informal
and statistical purposes than for formal incorporation into
the accounts.

2. Distribution costs are not centered at the place of
production. They may occur at geographically scattered
centers.

3. They are applied to functions and to segments of
the business rather than to the product alone. The purpose
is to assign to products, sales territories, customers or
order sizes the variability in costs which may be controlled
by management.

4. Distribution costs are considered period costs
rather than product costs. Factory overhead costs are pro-
duct costs and are capitalized in inventory.

5. Standard cost systems are not widely used in dis-
tribution cost accounting, because of the difficulty in
establishing standards for many of the promotional type
activities.

6. There is more flexibility in the choiZe of alter-
native methods of distribution than of production. This

implies that managerial emphasis should be placed on dis-

tribution cost analysis.

49

"A company has two primary reasons for ascertaining
distribution costs:
1. To provide a basis for profitable management.
2. To promote the observance and administration
of federal and state laws."16
Distribution cost control serves these management prob-
lems concerning:
1. Commodities to be sold.
2. Prices to be charged.
3. Extent of territory to be served.
4. Classes of trade to be cultivated.
5. Distribution channels and agencies to be used.
6. Profitable size of order to handle.
7. Profitable size of unit of sale.
8. Credit terms to be granted.
9. Favorable time to expand.

10. Size of inventories to be carried.

11. Control of individual distribution operations and
cost items.

12. Results to be obtained from selling expenditures.17
There is general agreement that there are three bases

for classifying distribution costs. These three bases are:

 

l6Theodore Lang, "Distribution Costs," Marketing Hand-

book, Edited by P. H. Nystrom, (New York: The Ronald Press
Company, 1958), p. 1147.

l7Heckert and Miner, p. 12.

50

1. By nature of cost item or object of expenditure,
generally called the primagyyaccount basis.

2. By functions performed, usually referred to as the
functional basis.

3. By manner of application, such as product group,
territories or customers.

There are two methods used in (3) above:

1. Unit functional analysis

2. Primary account analysis

Under unit functional analysis all costs are first
allocated or charged to specific functions and then a unit
rate for each function is developed in terms of the
function's factor of variability. Under the primary account
analysis method functional classification is obviated.
Costs are divided into three groups, direct, semi-direct,
and indirect. Individual items of costs collected in the
primary expense accounts are applied to each segment, such
as a territory or a customer. The process in both unit
functional analysis and primary account analysis is not con-
tinuous and is made after the data is accumulated, not in

connection with their collection. This practice is the

 

8
See Lang, p. 1148 and Heckert and Miner, p. 17.

51

reason for much of the current criticism of distribution

cost accounting.

Research on Distribution
Cost Practices

The findings of a study of the distribution cost
accounting practices used by seventy companies were publish—
ed in 1951 by the National Association of Cost Accountants.

This study emphasized the analysis of distribution

costs for decision making.

"The processes of cost accounting have been developed
most extensively for the purposes of producing cost
figures needed in preparing periodic financial reports
and for aiding management in its exercise of control
over costs. Substantially less attention has been
given to the determination of costs for decisions
which fall in the realm of policy making. This study
is concerned with the latter field - ...." 0

In applying distribution cost analysis to decision
making in the areas of planning and policy formulation the
following types of problems are indicative of those consid-

ered in the study:

1. Products to be sold, relative quantities, and their

prices.

 

19Analysis of Non-manufacturing Costs for Managerial
Decisions, N.A.C.A. Research Series 19, 20 and 21, (New York:
National Association of Cost Accountants, 1951).

20Ibid., p. l.

 

52

2. Geoqraphic areas to be covered.

3. Classes of customers to be serviced.

4. Channels of distribution, alternate modes of trans-
portation.
5. Services to be offered customer.

6. Relative emphasis placed on each product, customer
or territory.

The study began with the premise that some products,
territories and customers bring in more profit than others.
Only by using cost studies employing adroit cost analysis
techniques can the contribution of each component of a busi-
ness segment be measured accurately.

The seventy companies interviewed indicated that the
principal segments for which these measurements are wanted
are products and sales territories. The study concentrated
on these two segments.

The study concluded that there was much variation in
the development of techniques used to analyze distribution
.costs, but that there is a trend toward acquiring informa-
tion more useful to management.

"A substantial number of companies group all non-

manufacturing costs into a few broad classes and
allocate them on the basis of sales volume or

factory cost of goods sold. The resulting segment

costs are averages which tend to obscure the very
differences which management needs to know. On

53

the other hand, the study disclosed a comparatively
limited number of companies which had progressed
well beyond the majority in methods for analyzing
nonmanufacturing costs. The principal features of
methods followed by these latter companies are:

1. Through coding and classification, costs are
charged directly to products, territories, and other
segments wherever this is practicable.

2. Methods used in allocating indirect costs have
been carefully studied to minimize arbitrariness.
Functions (which correspond to the cost centers in
which manufacturing costs are accumulated and
applied) are defined in such a way that each in-
cludes only like activities. This makes it easier
to find a basis for cost allocation which is
demonstrably related to the costs being allocated.

3. Allocations of order getting costs follow effort
expended rather than actual results obtained. This
leads to use of budgeted sales or budgeted distri-
bution of salesmen's time in place of actual sales
or actual time as bases for allocating related
costs.

4. Recognition is given to the fact that differences
between costs and income margins are sufficient to
guide decisions involving choice between alternatives.
Allocation of costs which will be the same in total
regardless of which alternative is chosen are un—
necessary in arriving at costs for such purposes.
Similarly, where cost control is the major objective,
as it often is in dealing with territories, costs
assigned to a given responsibility include only those
costs controllable within the bounds of the specific
responsibility."2

Another notable study made about a decade later corrob-

orated some of the conclusions of the N.A.C.A. research.

 

21Ibid., p. 93.

54

Indications are that scant progress was made in practice to
obtain better distribution cost control and analysis.

"It can be assumed, considering the fact that the

examination of the practices of twenty-eight com-

panies revealed only five special studies, that

either the companies were reluctant to exhibit such

data, or, as we believe, communication between

accounting and marketing executives has not reached

the state currently enjoyed by accounting and pro-

duction executives."22

A conclusion reached from the field study of twenty-
eight companies, twenty-two of which were included in the
1960 Fortune Magazine list of the top 500 manufacturing
companies, indicated that practices in the analysis of dis-
tribution costs were falling behind the need as indicated
by the rapidly changing marketing scene. The study reveal-
ed that:

1. Customer, channel, salesman and order size analyses
are not widely prepared.

2. Product studies were generally done without regard
to the interrelationships with customers and territories.
Product analyses were separate, not integrated, analyses.

3. Central service costs were generally omitted from

territorial analyses, because of the simplicity of including

 

2 . . .

Martin Mellman, "Marketing Cost AnalySis-Development
and Current Practices," Accounting Review, January, 1963,
p. 123.

55

only the traceable costs.

4. Fixed and variable, controllable and non-controll-
able cost distinctions were either absent or inadequate.

5. Standards and standard costs were not used by the

companies.

Evaluation of Accounting for Physical Distribution Costs

The current interest in the magnitude of costs associ-
ated with the physical distribution activities has stimulated
an interest in the control and analysis of these costs. The
new physical distribution concept cuts across traditional
accounting classifications and defines many activities
Whose costs are charged to manufacturing as part of the'
physical distribution function. Generally accepted account-
ing practices may camouflage many of the true costs of
physical distribution. The physical distributionist claims
that in order to apply the total cost approach for optimum
control and analysis, he must be aware of all costs assign-
able to the logistics activities.

What the physical distribution executives are asking of
the accounting executives can be summarized as follows:

1. Recognition and comprehension of the physical dis-
tribution concept and the total cost approach.

2. Modifications in present accounting techniques and

56

practices to:

(a) provide more precise measurements of logistics
costs,

(b) isolate logistics costs presently charged to
other functions, and

(c) identify all costs associated with logistics
activities by some type of coding system.

3. Cooperation in implementing these changes where
they will satisfy the overall objectives of the firm.

The research studies cited in the preceding section
pointed out many of the deficiencies in practice in account-
ing for distribution costs. Some of the most serious
handicaps in distribution cost accounting do not apply to
the logistics (physical distribution) costs. Thus, there is
an optimistic outlook for the solution of the problems of

the physical distributionists.

Proposed Solutions

Three contributions to the solution of some of the
problems in accounting for logistics costs are described be-
low. The first was described by Donald W. Drummond in his
article entitled, "A Marketing Yardstick." The purpose of
his proposal is to disclose some of the costs of marketing
obscured by conventional accounting procedures. His analy-

sis is confined to a single product or a small group of

57

products, and must contain all relevant marketing cost
elements. He compares the present method of presenting in-
come statement information with his suggested new method.
These two methods are shown in Tables 1 and 2, respectively.

The present method starts with net sales, subtracts
cost of goods sold to show gross profit. Operating expenses,
other income and deductions and state taxes are accounted
for to obtain earnings before income tax. It is argued that
by beginning with net sales, as in Table 1, many significant
cost elements relevant to the total cost analysis of the
various marketing segments may be overlooked. Examples
given are deductions for freight equalization or allowances,
price allowances, and sales commissions.

Mr. Drummond further points out that some of the costs
conventionally charged to cost of goods sold are actually
physical distribution or promotional costs. He mentions
shipping, warehousing, tank car rentals and bad debts as ex—
amples.

The proposed method starts with gross sales which he
defines as the maximum revenue that could be realized for
the product. (See Table 2). From this figure the cost of
goods sold is subtracted, but this is not the conventional

cost of goods sold. All elements of physical distribution

58

TABLE I

DRUMMOND — PRESENT METHOD

 

Net Sales
Cost of Goods Sold
Manufacturing Profit
Operating Expenses:
General and Administrative
Selling Expenses
Research and Development
Advertising and Sales Promotion
Other Income and Deductions
State Taxes

Pre-Tax Profit

 

 

 

 

59

TABLE 2

DRUMMOND - NEW METHOD

Gross Sales

Cost of Goods Sold:
Raw Materials
Operating Expenses
Plant Overhead

Manufacturing Profit

Operating Expenses Excluding
Sales Controllable
General and Administrative
Research and Development

 

Other Income and Deductions
State Taxes
Profit Before Selling

Sales Controllable
Shipping
Freight Equalization or Allowance
Sales Commission
Price Allowances
Cash Discounts
Tank Car Rentals
Warehousing
Direct Sales Costs
Sales Administration
.Advertising and Promotion
Bad Debts

Pre-Tax Profit

 

 

 

 

 

60

or other marketing activites are extirpated to leave only
true production costs. The result is called manufacturing
profit. From this figure operating expenses excluding
those considered sales controllable are deducted; state
taxes and other income and deductions are subtracted ( or
added) and the result is termed "profit before selling."

The purpose of arriving at this figure is to reveal the
true diminution of the revenue, obtained by the segment (eg.
product) under observation, attributable to costs controll-
able by the executives assigned the responsibility. Those
items that follow "profit before selling" in Table 2 should
be controllable by marketing executives, such as a sales
manager, or a physical distribution manager or the equiva-
lent.

Complementary to Mr. Drummond's new method of present-
ing income statement information to isolate controllable
marketing costs is a model of physical distribution cost
account descriptions categorized by point of occurrence.
This model, reproduced in the Appendix, was devised by
Mr. H. G. Miller of the Diamond Crystal Salt Company.23

Mr. Miller establishes four categories of physical

distribution costs by point of occurrence:

 

23See Miller, p. 10.

61

1. Costs at production point.

2. Cost of moving materials to the customer.

3. Cost of outside storage and warehousing.

4. Costs of the customers.

Many of the charges for activities placed in the first
category are included in production costs. Those included
in the second group are normally charged to freight on sales
or netted against gross sales. Costs of outside storage and
warehousing may be charged to cost of goods sold, to selling
expense or to a distribution account.

The purpose of Mr. Miller's model which is designed for
industrial marketing is to assign all of the physical dis-
tribution costs to common accounts. This system of classi-
fying physical distribution costs would combine management
responsibility with accountability. The manager would be
relieved of being accountable for costs of activities over
which he has no decision-making control; and the activities
which he controls would be assigned their appropriate
accounting charges.

The third contribution to the solution of one of the
problems in accounting for physical distribution costs is
provided by Dr. Richard J. Lewis in his unpublished doctoral

dissertation entitled, "A Business Logistics Information and

62

Accounting System for Marketing Analysis."

One of the vociferous criticisms of the current prac-
tices in distribution cost accounting is that the allocation
methods used tend to obscure the variability found at the
origin of the costs. Total costs are accumulated and then
allocated to the segments on the basis of averages.

Dr. Lewis provides a new basis for cost control at the
source of cost incurrence. This basis is geometrically
patterned geographic blocks which become the cost centers.
Thus, he introduces geographic cost variation to the tradi-
tional variations of product and customer. Geographic
variability of the costs of servicing demand can be deter-
mined for each spherical grid block. This was done in a
study by Dr. Lewis. He found that the costs which vary
geographically were the majority of the total physical dis-
tribution costs of the industrial goods firm studied. The
use of these spherical grid blocks as cost incurrence
centers would enable the accounting department to obtain
physical distribution costs at their origin to construct
total costs rather than to allocate a portion of the total
costs to the segments by averaging techniques.

The three contributions described above have been pro-

posed to solve some of the problems which plague managers of

63

marketing activities. The loss of the identity of variabil-
ity at cost incurrence centers and the separation of account-
ing responsibility from decision—making responsibility are
prevalent in distribution cost accounting systems. By com-
bining these three proposed modifications to the current
methods of collection of data, classification of accounts

and presentation of the summarized information the physical
distribution manager, as well as other marketing managers,

would be assured of a more reliable basis for decision-making.

CHAPTER IV

CHANGES IN PHYSICAL DISTRIBUTION SYSTEMS
AND THEIR ACCOUNTING CONSEQUENCES:
EVIDENCE FROM COMPANY EXPERIENCES

Introduction

The purpose of this chapter is: (l) to describe the
different kinds of changes made in the physical distribution
systems of industrial firms and why they are made; (2) to
present case studies describing the actual changes made by
firms in their physical distribution systems in order to,
(3) trace the procedural, financial, auditing and other
effects on the accounting system.

To accomplish these objectives this chapter will ex-
amine three examples of actual changes in physical distri-
bution systems. The effects of these changes on the total
intra—firm costs will be traced and their accounting impli-
cations will be evaluated. The original intent of this
study to examine intensively the accounting system of only
one firm which had recently made changes in its physical
distribution system was modified to include three less in-
tensive case studies. Although some of the questions con-

templated early in this study will be left for later attempts

64

65

at research in this subject area, answers to many important
ones will be pursued herein.

Case One describes a major change in the physical dis-
tribution system of a division of a large company. The
division produces and markets a consumer good. Without the
use of detailed figures, Case One provides an exemplary
description of the changes in the physical distribution
system and the resulting accounting implications. Cases Two
and Three, describing the physical distribution changes made
by a second company, provide the detailed quantitative data
to show cost trade-offs within the company's own cost con-
trol centers and how they may be obscured by traditional
accounting methods. The amounts, though modified somewhat,

are based on the firm's records.
Changes in Physical Distribution Systems

Cost Trade-offs

Changes in physical distribution systems may affect
only the company's own divisions or departments (intra-firm)
or they may affect the company's vendors or customers
(inter-firm). A cost trade-off which is strictly intra-firm

either in the short-run or in the long-run is, according to

66

Heskett, Ivie and Glaskowsky, illusory or ineffective.

Cost trade-offs must have an effect on either the ven-
dors or customers to be effective. To explain this state-
ment these authors classify all logistics costs into three
categories: operating costs (physical movement), possession
costs (inventory holding), and service costs (lost supply,
production and/or sales). The above authors' diagram ill-
ustrates the possible kinds of trade-offs.

Operating costs are those associated with the physical
movement of goods. Possession costs are those associated
with the holding of tangible goods over time. Service costs
are probably the most difficult to measure; they involve
lost sales due to poor logistics arrangements, high pro-
duction costs due to inefficient logistics or foregone cost
reductions in the supply area because of poor logistics
service.

The illusory cost trade-off is described by the authors
as involving the accounting procedures. Conventional
accounting handling of costs allows one segment of the firm

to realize a cost reduction while it obscures a commensurate

 

1J. L. Heskett, Robert M. Ivie and Nicholas A.

Glaskowsky, Jr., Business Logistics of Physical Supply and
Distribution (New York: The Ronald Press Co., 1964), p. 453.

21bid.

67

cost increase in another segment. The trading of operating
costs within the company would lend itself to such an
illusion. This is possible, particularly where the trade-
off involves inventory levels, since inventory holding costs
are not usually accounted for formally in the records.

To be effective the change in the physical distribution
system must have external implications; that is, it must re-
sult in improved customer service or bring about an eventual
downward revision in product price (or forestall a price
increase) rather than merely swapping costs within the firm.
Examples of Changes in Physical
Distribution Systems

Based on industry experience there are many changes in
costs which can be expected from changes in physical distri-
bution systems. The magnitude of the cost increases or de-
creases cannot be determined but the direction of the change
in costs can be anticipated. For example, if a firm changes
from the use of public warehousing facilities to the use of
its own private warehouses several changes in costs can be

anticipated. Increases in costs can be expected in the

following areas: local delivery at destination, the company's

materials handling costs, inventory taxes while en route in

carrier's equipment and the fixed costs of the private

68

warehouses. Cost decreases would occur only in variable

costs for the public warehousing facilities.

The following table, based on a table from Heskett,

Ivie and Glaskowsky, traces the cost effects of several

typical physical distribution system changes.3 The system

changes are:

1.

Use of premium methods of transportation for out-
going finished products (accompanied by a reduc-
tion in warehouses, overhaul of communications).
Purchasing and shipping supplies and components by
means of fewer orders of greater quantity.
Consolidation of shipments from supply points
(allowing smaller, but requiring better timing of,
purchases).

Increase in the number of distribution warehouses
(reducing service times to customers).
Establishment of distribution warehouses as mixing
points for shipments between plants and customers
(allowing volume shipments to customers).

Shifting packing and/or packaging operations from
plant to distribution warehouse (allowing shipment

in bulk).

 

3Ibid., p. 448-51.

69

7. Use of faster communications and mechanized proced-
ures in handling orders from customers.

(Note: The numbers in the caption of Table 3 refer to the
above seven types of changes.)

TABLE 3

EXAMPLES OF EFFECTS ON COSTS BY CHANGES IN
PHYSICAL DISTRIBUTION SYSTEMS

Type of Change
1 2 3 4 5 6 7
Lonngistance Transportation From:
Vendor to Facility (Plant or Warehouse) - +
Intra—Facility - + - —
Facility to Customer + - -
Local Delivery at Destination(s):
Materials Handlipg:
Vendor -
Company - -
Customer's:
Equipment -
Labor -
Supplies -
Inventory_Holding In:
Vendor's Facilities + -
Company Assembly Warehouses + -
Company Factories - -
Company Distribution Warehouses - + + +
Customer's Facilities - - - -
Carrier's Equipment (En Route):
Obsolescence —
Pilferage and Damage
Inventory Taxes
Rehandling -
All of above - + - -

+ Increase in costs
- Decrease in costs

70

TABLE 3 (continued)

Type of Change
1 2 3 4 5 6 7

 

 

Warehousing: .
Vendor +
Company Assembly + +
Company Distribution - + +
Customer _ _ _

All of Above
Fixed - Private Facilities
Variable - Public Facilities
Packing:
Vendor Packing - +
Company Packing - Unpacking
Customer Unpacking -
Order Processing:

 

Vendor - +

Company + - +

Customer +
Manufacturing (If Applicable):

Fixed

Labor Variable +

Equipment Variable

Sales Losses Due to Logistics:
Customer Service Deficiencies - - — —
Market Territory Restrictions — _ _ _

+ Increase in costs
- Decrease in costs

 

Case Studies of Changes in Physical

Distribution Systems

Case One - Change in
Warehousing System

The purpose of this case study is to describe, without

the use of detailed figures, the changes in the warehousing

71

facilities of a division of the International Minerals and
Chemical Corporation in order to trace the effects on the
accounting system of the firm. The changes in the physical
distribution system are described in an article written by
Kenneth W. Hessler, Manager of the Distribution Research
Department.4 The company recently made a major change in
its method of distributing its product to its customers.
The decision to modify the physical distribution system was
provoked by symptoms of both structural and financial de-
ficiencies. The subsequent extensive revision of the ware-
housing and billing system was implemented to correct these
deficiencies.
I. Reasons for Change

The physical distribution system of the subject company
as it existed before the changes had many deficiencies.
Those that management was becoming aware of were:

a) poor inventory control

b) vague communication links

c) inefficient order processing control

d) over-investment in unbilled accounts

e) slow cash collections

 

4Kenneth W. Hessler, "Assignment: Design and Phase-in
a New Distribution System," Transportation and Distribution
Management, January, 1965, p. 35-43.

72

The symptoms were high distribution costs and an un-
favorable cash position in spite of satisfactorily low
manufacturing and sales costs. The most obvious deficiency
in the physical distribution system was the use of 44 ware-
houses to provide one or two days service nationwide. Other
firms with similar marketing coverage were using fewer
warehouses.

The second obvious deficiency was in the billing sys-
tem; invoices were being mailed five to ten days after ship-
ment. The computer was not being fully exploited. The
result was a less than optimum use of cash balances.

The awareness of these symptoms by management precipitated

the desire for a "physical distribution breakthrough."

II. Description of Old System

A. The Product and its Movement

The product under study is sold for ultimate consump-
tion. It is produced in San Francisco, shipped in 200 pound
drums to Chicago, where it is packaged in containers ranging
from one ounce to ten pounds. These containers are shipped
to 44 public warehouses, from where they are distributed to
the final customer. These warehouses, overlapping in cover-

age, offered one to two days service. (See Figure 3).

M j ‘

I pf-

 

 

: fir-1% - \ .
. ..«gmgogee‘é - .- .- '
W 1?: “I. V \'r v! .
VSVVA’J‘M'uQKEQ .’\Q "’
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z. I
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74

B. The Order Processing and Billing System

Broker orders are sent to the warehouse for shipment.
Upon shipment, the warehouse sends the broker a copy of the
bill of lading and forwards a copy of the order to home
office by mail. The order is coded, key punched, and pro-
cessed through the computer; the customer is then billed.
The time lag from shipment to billing ranges from five to
ten days. (See Figures 4 and 5).

C. Inventory Control System

Each size package is assigned a maximum stock level and
order point, based on quarterly sales information from the
warehouses. In each territory, the warehouse sends weekly
inventory reports to the broker. When the stock of any
size package is below the order point, the broker informs
the home office by mail. The home office inventory analyst
requests the Chicago packaging plant to ship a replenishment
stock to reach the maximum stock level (which is two-thirds
of the quarterly sales).

Each month the warehouse sends the home office complete
records of inventory levels, transactions, customer's name

and quantity, and package size for accounting reconciliation.

75
FIGURE 4

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4.

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76

FIGURE 5

 

 

PIODUCT IIIOIIATIOI 310' - PIISIIT

 

 

 

 

 

annexe

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Lelia;

 

 

 

 

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ltetue

 

 

 

 

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77

III. Revisions of Physical Distribution System

A. The Product and its Movement

The number of warehouses was substantially reduced to
less than one-third the original number, from 44 to thirteen.
This new figure was based on an analysis of service time to
customers and variable costs of maintaining inventories at
warehouses. For the desired service time, one to two days,
the reduction in warehouses meant that more than 85% of the
customers could still be serviced in this time. Formerly,
over 95% of the customers could be serviced in one to two
days. A widespread overlapping of service coverage was
eliminated by reducing the number of warehouses. (See
Figures 6—9 and Table 4).

B. Order Processing, Billing and Accounts Receivable

Under the new system the computer became the center of
the information flow. Billing, formerly done by hand, is
now done by the computer. Broker orders upon receipt by the
warehouses are relayed to the computer at the home office
immediately where they are recorded. The orders are first
edited by the accounting department for prices, accuracy,
etc. From there they are forwarded to data processing for
key punching and to the computer. (See Figure 10-12).

All shipments made by the warehouse are teletyped to

 

79

FIGURE 7
'IIIAILI IYOTIIIODUTI AID
II'IIIOIY'VI. IUIIII.OI IAIIIOUIII

    

Veruine Oeete

Ooete Per tee:- - figure/fee:
8

p
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.3.

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1 n .ij_Ei is l l 1 1 EE 1 L

 

 

 

 

0 10 30 30 40 50

W plum IN 1-2 DA”

100

80‘
70‘
60‘
504
404
30‘
204

10‘

 

300q

Vfllm 8Y8?“ “1'8 m m - mum nouns/nu

J

§

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'5

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80

FIGURE 8

ueneu ”1'8 AND SERVICE
V8. noun 0" Innovate

Verieb1e Coetes .

 

J

18
I Delivery Service

10 20 30 40 50
noun 0? nemesis

mm Mimi!) IN 1-2 “'8

40

30

10

 

 

81

FIGURE 9

lelm SERVICE CAPABILITY
V8. mu 0! IWSIB

 

13 werehoueee

 

44 wereboueee

 

 

6!

82

TABLE 4

ESTIMATE OF 1-2 DAY DELIVERY SERVICE CAPABILITY
FROM VARIOUS NUMBERS OF REGIONAL WAREHOUSES

 

 

Percent Within 200 Miles Of Warehouse

 

REGION: 44-Warehouse System 134Warehouse System
New England 100% 92.6%

(6 states)
Middle Atlantic 100% 97.3%

(5 states + D.C.)

East Central 100% 85.8%
(5 states)

South East 100% 82.4%
(8 states)

Central 95.2% 81.0%

(12 states)

 

Southwest 98.5% 56.6%
(5 states)

Pacific 88.5% 84.5%
(7 states)

TOTAL: 97.0% 87.5%

 

83

FIGURE 10
PRODUCT [RECREATION ELO' - REVISED

BROKER f
3F°30r 1 { File I
Order
Bill of
Leding

to cueteeer a/L.0rder

..Q IAIIIOUBI vieDete-

\
\
Ie—etock Fll‘ll'll ‘\
-\
- \

\
., [Chiceeo Pecheeine Fleet ] \4
- yeicel

Inventory
port

‘70roer to Ie-eteek
Vereheuee

 

 

 

 

 

 

 

 

 

 

 

 

I

Inventory
Anelyeie

 

--..--[Reconci1e]

 

 

 

 

 

 

.111
“pl-IE or }

 

84

FIGURE 11

INVENTORY CONTROL - BILLING - SALES ANALYSIS

 

PRODUCTION AND SHIPPING SCHEDULING

 

 

 

 

 

 

 

PACKAGING IAREROUSE
PLANT SHIPITS. SHIPMENTS T0
T0 IAREROUSES CUSTOMERS

 

 

 

 

 

 

 

C O I P U T E R

 

 

 

Shipping end
Production
Plen

 

 

 

 

Pecknginz Requi-
renent Report-

 

 

 

 

Ierehouee In-
ventory Stetue

 

 

 

Cuetoeer
Invoice

 

 

 

 

Accounts
Receiveble

 

 

 

 

Selee
Anelyeie

 

 

 

 

 

Phyeicel Inven
tory Reconcil-

 

 

 

 

 

E:
m
5;
>4
U)
a: .
m
a
o
a?
m
e
52’

 

 

 

 

 

 

 

 

 

86

the home office daily. The computer matches the information
with the recorded order data and immediately prepares the
invoice, using the shipping advice as the authority to bill.
The computer provides a check on accuracy and prevents most
of the potential errors.

The accounts receivable entries are automatically pre-
pared and later reconciled with cash receipts. As each
invoice is prepared an entry to the accounts receivable
ledger is originated by punch card output. These cards are
processed daily by data processing equipment as part of the
customer accounting procedures and are held pending notifi-
cation of payment. Customers are instructed to remit
directly to strategically located banks to speed up cash
flow.

C. Inventory Control System

A self-adjusting centralized inventory control system
was accomplished via the computer. The result was optimum
inventory levels with reduced costs of maintaining inventory.

IV. Effects on the Accounting System and Financial
Implications

A. Procedural Effects
As described above changes occurred in:
l. billing and invoicing

2. accounts receivable

87

3. inventory control
B. Financial Statements

No change in the financial statements was reported.
C. Financial Effects

1. Significantly less inventory carrying cost.

2. Significantly less accounts receivable carrying
cost.

3. The cash flow is considerable improved; there is
a five day average acceleration in billing over
the old method.

D. Role of the Computer and Auditing Effects
The computer has become the heart of the new system.
Its use and importance has been substantially increased in
billing, accounts receivable and inventory control. Some of
the effects which have auditing implications are:

1. Matching of accounts receivable punch cards with
cash receipts information received from the
collection point banks.

2. The matching of shipment information against
customer order information by the computer, re-
placing some manual reconciliations.

3. Correction of the inventory by the computer once
the warehouse sends the variable information on

the shipment made.

4. Centralization of inventory records at one point.

Case Two - Change in
Transportation Method

Case Two represents a change mainly in the method of

88

shipping the product to the customer. Before the change the
product was packaged in 55 gallon drums at the plant and
shipped to customers by carload rail shipments. The new
method was to ship the product by barge to a terminal (not
company owned). The product is packaged in 55 gallon drums
at the terminal and shipped by truckload to the customers.
The effects of the change in the distribution system
are:
Without Accounting Implications
1. Improved service to customers.
With Accounting Implications
2. Order processing and billing - adds terminal to
the order system and thus causes an increase in
interdivision orders to get the product shipped

to the terminal.

3. An inventory control system is needed at the
terminal.

4. The total inventory on hand (at the plant plus
the terminal) is increased.

5. Working capital requirements are decreased.

6. Physical distribution expenses (as indicated by
traditional accounting methods) are increased.

7. Total costs are decreased.
Table 5 shows the comparison of the costs which are
affected by the change. They are categorized into produc-

tion plant cost, transportation cost and terminal expense

89

TABLE 5

CASE TWO: CHANGE IN DISTRIBUTION SYSTEM FROM
SHIPPING DIRECT RAIL TO SHIPPING THRU TERMINAL
CLOSER TO CUSTOMERS THAN PLANT
(PRICE IS A DELIVERED PRICE)

Pounds of product per year - 50,000,000

 

Barge-
Rail Terminal-
Direct Truck
1. Production Plant Cost Cost/cwt.
Packaging $2.80 $ .03
Storage and handling .40 .15
Financial costs of inventory .10 .30
Administrative .15 .05
$3.45 $ .53
2. Transportation Cost
To customer (incl. stopoffs) 3.00 .50
To terminal -- y .50
3. Terminal Expense
Barge unloading .00 .07
Storage and handling .00 .40
Financial cost of inventories .00 .10
Packaging .00 3.00
Administrative incl. labor .00 .15
§ .00 $3.72
Total Cost per th. $6.45 $5.25
Total Cost 50,000,000
lbs/yr. $3,225,000 $2,625,000

Saving per Year

 

 

$600,000

 

 

90

for analytical reasons. The costs are quoted per hundred
weight for the fifty million pounds of the product per
year.5 The two methods under comparison are labeled:

(1) rail direct and (2) barge-terminal—truck. The change is
from the former to the latter.

The change in the physical distribution system resulted
in a reduction of production plant cost from $3.45 to $ .53.
Packaging represents the major cost change in this category,
from $2.80 to $ .03. Storage and handling was reduced from
$ .40 to $ .15, and administrative costs were reduced from
$ .15 to $ .05. In this same group the financial costs of
inventory were increased from $ .10 to $ .30.

The next group is transportation costs, which were re-
duced from $3.00 to $1.00. Transportation costs to the
customers (including stopoffs) were reduced from $3.00 to
$ .50 while additional costs to the terminal of $ .50 were
created.

The third group of related expenses is at the terminal.
These expenses were all added, summing to $3.72. They are
comprised of barge unloading $ .07, storage and handling

$ .40, financial costs of inventories $ .10, packaging $3.00

 

5See H. G. Miller, p. 10, for a similar example of this

type.

91

and administrative (including labor) $ .15.

The total cost (per cwt.) for rail direct sums to $6.45
while that for barge-terminal-truck sums to $5.25. For the
annual product of fifty million pounds per year the savings
arising from the new system is $600,000.

This case illustrates the intra-firm cost trade-offs.
By improving customer service it also produces inter-firm
or external effects. Increasing gross sales or forestalling
lost sales could be an objective of such an action. Of
particular interest to this study, however, is the way in
which the traditional accounting methods of handling the
charges obscure the figures needed by the distribution man-
ager for his total-cost analysis of the physical distribu-
tion system change.

Table 6 shows the effects of the change on the account-
ing system. Traditional accounting methods would include
some of the herein defined physical distribution costs in
production costs. If the distribution manager were not aware
of this he would observe above that his transportation costs
plus terminal costs after the change would be $4.72/cwt. as
compared with $3.00/cwt. before the change. Also the reader

of the accounting statements would observe that distribution

costs were increased by the change. The production costs on

92

TABLE 6

CASE TWO:

1. Production Costs (Plant)

All costs except physical
distribution
Physical distribution
Total production cost
Decrease in production costs

2. Transportation Costs
Gross sales price
Freight cost

Net sales
Increase in net sales

3. Terminal Costs

Substantial increase in terminal costs

EFFECTS ON ACCOUNTING SYSTEM

Rail Barge-
Direct Truck
Cost/cwt.
$12.00 $12.00
3.45 .53
$15.45 $12.53
$20.00 $20.00
3.00 1.00
$17.00 $19.00
$ .00 $ 3.72

 

the other hand were reduced substantially by the change.

The production manager gets credit for a reduction in costs

over which he has no control whereas the distribution mana-

ger receives an increase in costs under his jurisdiction.

Therefore his incentive to initiate a change resulting in a

reduction in total costs and an improvement in customer

93

service may be stifled by the method of reporting the finan-
cial results. Even though he can cogently explain the
results to upper management levels he will still appear in-
efficient in the records.

A paradox in the changeover is its effect on reported
net sales. For any given gross sales price ($20.00/cwt. in
the example) this change in the physical distribution system
causes a reported increase in the net sales figure. This
increase in net sales ($2.00/cwt. in the example) is due
only to the accounting practice of subtracting freight costs
from gross sales.

Case Three: Change in Channel
of Distribution

Case Three represents a change mainly in the channel of
distribution, from shipping via tank truck (bulk) directly
to the customer to shipping via tank truck (bulk) to a ter-
minal. As in Case Two a reduction in total costs was
obtained with improved customer service as a co-objective.
Table 7 shows the savings per year obtained by the new
method along with the detailed figures substantiating the
savings.

The product per year amounts to three million pounds or

360,000 gallons. A delivered price system is in effect.

94

TABLE 7

CASE THREE: CHANGE IN DISTRIBUTION SYSTEM FROM BULK
SHIPMENT DIRECT TO BULK SHIPMENT THROUGH A TERMINAL
(Pricing is Based on Delivered Price)

Pounds of Product per year 3,000,000
Gallons of Product per year 360,000

Units $ Cost
Cost Basis (900's) Per Year

A. Direct from Production

 

 

Plant
1. Frt. via tank truck
(incl. loading) $ 3.16/th. 30 $94,800
Total cost $94,800
B. Via Terminal Stock Point
1. Loading cost $10.00/Trk. .09 $ 900
2. Frt. via tank truck
to terminal 1.47/th. 30 44,100
3. Bulk terminal costs: .
Throughput .00625/Ga1. 360 2,250
Terminal and in tran—
sit product loss .02/th. 30 600
4. Frt. from terminal to
customer .6l/th. 30 18,300
5. Administrative cost 1.00/Ton .18 180
6. Inventory cost .0144/th. 30 432
Total cost $66,762

Savings per year over direct shipment $28,038

95

The costs per year under the old system, direct from produc-
tion plant, involves only one item: freight via tank truck
(including loading). Total cost is $94,800 per year.

Under the new system, via terminal stock point, several
items of costs are included, they are: (1) freight via tank
truck to terminal $44,100, (2) freight from terminal to
customer $18,300, (3) bulk terminal costs $2,850, (4) load-
ing cost $900, (5) inventory cost $432 and (6) administra-
tive cost (including labor) $180. The total of these items
is $66,762, a reduction of $28,038 per year over the old
system.

Table 8 shows the accounting implications. In this
case production costs have been increased slightly because
of the change in physical distribution, rather than de-
creased as in Case Two. Again, reported net sales have in-
creased substantially after the change. These two effects
are due to accounting practices rather than to the change in
the distribution system. If the accounting practices obscure
the physical distribution charges ($900) in the production
costs and bury the net freight costs in the net sales figure,
the result is an increase in terminal charges of $3,462.
This is the only charge controlled by the physical distribu-

tion manager. Thus, he shows an increase in his controllable

CASE THREE:

96

TABLE 8

Production costs (3,000,000 lbs.)

Physical distribution costs
Total company defined production

costs

Transportation cost
To customer
To terminal

Total

Terminal costs
Total cost

Gross Sales Price
Net Freight Cost

Net Sales

EFFECT ON ACCOUNTING SYSTEM

Direct

$300,000
0

$300,000

$ 94,800
.______31
$ 94,800

_______11
$394,800

$500,000
94,800

$405,200

Via
Terminal

$300,000
900

$300,900

$ 18,300

44,100

$ 62,400

3 462
$366,762

 

$500,000
62,400

$437,600

 

costs, along with the production manager, while in fact

total costs are reduced by the change.

The following chapter will;

(1) present additional evi-

dence of the need for some changes in the existing methods

of functional distribution cost accounting,

and (2) will

propose modifications to these methods in the form of a

simplified model accounting system for physical distribution.

Chapter Six will then present a summary of the conclusions

and implications of the case-studies and of the evidence

found in the entire research project.

CHAPTER V

SOME PROPOSED ACCOUNTING MODIFICATIONS

The purpose of this chapter is to propose some modifi-
cations to conventional distribution cost accounting methods
which will answer the criticisms made by the physical dis-
tributionists by providing them with improved information

for total cost control.

Evidence of Need for Modifications

Evidence obtained in the preceding chapters, particu-
larly Cases Two and Three in Chapter Four point out the need
for improvements in selected accounting procedures and con-
cepts. Additional evidence is presented in the first part
of this chapter to substantiate the need for accounting
action in this direction. The following data was obtained
from a Midwestern firm. This firm is progressive in the
area of distribution. It has an advanced understanding of
the physical distribution concept; it has a separate depart-
ment which controls the activities defined herein as
physical distribution functions. Yet, its accounting system,
When analyzed by an outside consulting firm revealed, tar

97

k0.

98

its expense allocation practices,an absence of understanding
of the control needs of the distribution manager.

Table 9 presents a list of accounts showing twelve-
month actual operating costs as recorded in the accounts.
These are the total costs of manufacturing, excluding raw
materials, for the entire plant operation. It was shocking
to learn that a full three-fourths of these costs were
charged to overhead. In the existing method of recording
the expenses $53,390 or 25% of the total operating expenses
was charged to direct labor and $161,229 (75%) was charged
to overhead.

Redistributed functionally it was found that $145,209
or 68.1% of the total operating expenses could be charged to
manufacturing and shipping leaving only 31.9% fOr overhead.
(Figures 13 and 14). The 68.1% is further broken down into
manufacturing $53,385 or 24.8%, shipping $51,751 or 24.6%,
handling in process $30,227 or 14.1%, and unloading raw
materials $9,846 or 4.6% of the total.

By having these accounts redistributed functionally the
distribution manager is able to identify and control 43.3%
of the total operating expenses as in-plant materials move-
ment. Before, with the existing accounting system, he could

isolate none of these physical distribution costs for

99

TABLE 9

A MIDWESTERN COMPANY
REDISTRIBUTION OF PLANT COSTS

- FUNCTIONAL

 

Actual Operating Statement Prepared for a 12-Month Period

 

 

Per
DIRECT LABOR: Amount Ton Std.
Mfg. Super $10,359 .41 .29
Mfg. Base 8,343 .43 .34
Mix. & Bag. 12,974 .52 .49
Shp. Bulk 4,458 .28 .26
Shp. Bag. 15,150 .66 .49
Mfg. Gran. Base 2,106 .56 .58
TOTAL: $53,390
OVERHEAD EXPENSE:
33 Supplies $ 6,143
42 Indirect Labor 20,663
43 Premium Time 2,950
44 Salaries 34,240
45 Off-Duty Comp. 5,606
46 Asso. Payroll Costs 15,940
51 Depreciation 15,060
55 Taxes & Insurance 19,658
56 Repair Materials 18,194
57 Repair Labor 11,930
58 Electrical Power 4,315
59 Fuel 4,171
60 Defects & Losses 1,689
85 Other Expense 12,231
86 Standard Prorates 0
87 Chgs. From Others 0
89 Chgs. To Others (11,561)
TOTAL: $161,229

GRAND TOTAL:

$214,619

100

TABLE 9 (continued)

Cost Redistribution Functionally

MANUFACTURING & SHIPPING:

Unloading $ 9,846
Handling In Process 30,227
Shipping 52,849
Delivery (1,098)
Manufacturing 53,385

TOTAL: $145,209

OVERHEAD EXPENSE:

Custodial $ 9,942
Administrative 22,468
Misc. Overhead 37,000
TOTAL: $ 69,410

' GRAND TOTAL: $214,619

 

managerial control.

In an interview with the firm's physical distribution
manager it was found that before this functional analysis
he could not attempt to control the expenses under his
jurisdiction since none was assigned functionally to his
activities. Yet, these figures represent the total plant
costs, exclusive of raw materials. He was aware that some
of the charges for supplies, indirect labor, premium time

and depreciation, for example, were assignable to unloading,

101

FIGURE 13

A MIDWESTERN COMPANY

FUNCTIONAL COST ACCOUNTING METHOD REVEALS:
PHYSICAL DISTRIBUTION COSTS = 43.3% OF_TOTAL OPERATING CHARGES

Present Cost

 

 

Method
Direct
Labor 25%
for
Mfg. and
Shipping
Overhead 5%

 

 

\\\\\\\\\

Costs Redistributed

Manufacturing
and Shipping
Actually
\ 68.1% of
\ total

\
\

Overhead

Actually

31.9% of
total

 

 

 

 

 

 

 

 

 

 

Functionally
‘ Tnloading
4.6% Raw Eat? $9.
.2
H
14.1% Handling 3
in g
Process
4J
c
m
....
“r
24.6% Shipping ,5
32
m
m
h _. ' ___,St.
E 24.8% Mfg.
q
l
4{6%1// Custodial
.Ey/o//2 Administra-
//// tive
iMiscell.
Overhead

 

 

100%

 

Movement

102

FIGURE 14

A MIDWESTERN COMPANY - ANNUAL
OPERATING COST REDISTRIBUTION

 

 

Present Reporting Method Redistributed Functionally
Manufacturing Manufacturing
and Shipping - and Shipping -
$ 53,000 $145,000

 

/

Over ead \

/
/

 

 

 

 

 

 

 

$ 214,000 $ 214,000

103

handling in process and other physical distribution activi-
ties; but the existing accounting system did not provide him
with the allocations.

Even after the analysis (presented in Figure 13) seven-
teen per cent of the total plant costs shown are allocated
to miscellaneous overhead. The firm's analyst agreed that
this was too large an amount to be unidentified and that
further investigation would probably reveal more physical
distribution costs in the miscellaneous overhead category.

This actual case points out the importance of recogni-
tion by the accounting people of the requirements of the
distribution managers if they are to perform their tasks

adequately.

Proposed Modifications

The second part of this chapter presents proposed modi-
fications of existing distribution cost accounting systems.
These modifications are based on the evidence presented in
the study which indicates that some changes should be made
by accountants to eliminate the deficiencies revealed.

It is recommended that the following model system for
physical distribution cost accounting be considered by the

accounting profession as a possible solution to the problems

104

placed before them by the managers of physical distribution
activities.

A Model Accounting System for

Physical Distribution Costs

In describing a model accounting system for physical
distribution costs it is well to keep in mind Heskett, Ivie
and Glaskowsky's summary statement cited in Chapter Two,

p. 35. The main problems found in total cost analysis are:

"1) separating and identifying logistics costs,

2) establishing accounting cost centers which are
capable of providing the type of information
necessary for continuing logistics cost analyses,
and,

3) analyzing the results of changes in the perform-
ance of a system after new concepts have been
implemented."

The main obstacles expressed by distribution executives
contacted in this study center around these three problems.
They want an accounting system which allows complete control
of distribution costs and allows comparisons between various
year's performances and with similar type installations.

An accounting system for physical distribution costs
must incorporate characteristics which will overcome these
obstacles, yet remain simple and operable. It must start at

the point of separating and identifying physical distribu-

tion costs; this is where the most important changes must be

105

adopted. Traditional accounting procedures would be affect-
ed mainly in three different areas:

1) Bases and methods of allocating costs

2) Classification of accounts

3) Financial statements

The model described herein is designed for a manufactur-
ing firm in the chemical industry and could be modified to

apply to other industries.

Bases and Methods of Allocating Costs

In the unit functional analysis method used in distri-
bution cost accounting the expenses are originally accumu-
lated in the natural accounts, eg. auto expense, commissions,
and then assigned to functions (activities) eg. selling
expense. Then a unit rate for each function is developed in
terms of the function's factor of variability and the total
expense is allocated by manner of application, eg. product,
customer, territory. This process of cost analysis is
followed to identify profitable or unprofitable customers,
products, sizes of orders or territories.

The bases for allocating these expenses by manner of
application (segments) are often arbitrary. That is, the
basis may not be representative of the factor of variability.

Also the unit rate is in effect an average. The use of an

106

average without statistical analysis is an example of spur-
ious accuracy. An average of 50 may be obtained by 40 and
60 or by 5 and 95. Where the use of averages is desirable
in assigning unit costs by manner of application, eg. pro-
duct, customer, a measure of dispersion such as the standard
deviation could be applied to the data. Thus, wide disper-
sion might indicate that the use of an average would result
in inappropriate allocations.

Another major deficiency in distribution cost methods
as presently applied is their assumption of independent
causation by each of the segments analyzed, eg. product,
customer, order size and territory. The segments are ana-
lyzed independently; that is, inferior customers are isolat-
ed, then inferior products are isolated. There is no
attempt to assess the interdependence of these four segments.
For example, customer A may be found unprofitable when total
costs are allocated by customer alone. But, customer A may
order in large sizes, may order only the most profitable
product lines, and may be located in a low cost territory.

These four segments are interrelated and should be
considered concomitantly for the cost analysis to be fruit-
ful. The objective would be to show that: customer A

buying product A, with order size C in territory C would be

107

unprofitable; whereas, customer A buying product A with
order size D in territory B would be profitable.

Professor Richard Lewis has experimented with a system
which is an attempt to solve some of the problems inherent
in physical distribution cost analysis methods. (See
Chapter III, p. 61). The system would obviate the arbitrary
bases for allocation and the averaging techniques. It would
accumulate costs at homogeneous geographical cost centers
identified by customer, product, etc. at the source of in-
currence. Homogeneous geographical grid blocks are coded
for the entire United States. These control unit numbers
are reported on the various marketing records, eg. sales
order, showing the location numbers for the origins and
destinations of shipments. The control unit location number
for each manufacturing point, distribution point and cus-
tomer must be determined.

Electronic data processing equipment makes a contin-
uous flow of information possible from the coded documents.
Professor Lewis' system was applied to the area of physical
distribution and if incorporated into an accounting system
it would provide the cost centers for accumulating the geo-
graphically variable physical distribution costs. Identi-

fication of the customer, the product he buys, the size of

108

his order, and the geographical control unit could all be
interrelated with this system. At present it has been
applied only to geographically variable logistics costs,
such as freight and pipeline inventory, but has additional

applications relevant to distribution cost accounting.

Classification of Accounts

The second accounting practice which requires modifica-
tions to satisfy the needs of distribution executives is the
traditional method of classifying accounts. The bases for
allocating charges to the functional accounts in servicing
demand are more precise than in the marketing area of ob-
taining demand. Professor Lewis' system is designed to
control geographical variability primarily. Within the pro-
duction and warehousing facilities there are logistics
activities with no geographical variability. The main
criticism in this area is that many accounts which reflect
logistics activities are charged to production (or cost of
sales) accounts.

In a model accounting system modifications to current
practices would be required. The model set of physical dis-
tribution accounts which follows represents a system which
is already in the process of being implemented. It is not

merely hypothetical or a theoretical ideal; it is soon to

109

become a reality.

Accounts to be Assigned to Physical
Distribution Control

 

A. Presently assigned to production department control
1. Packaging labor
2. Packaging material

3. Material handling equipment depreciation (or rent)
and maintenance

4. Handling labor

5. Warehouse space cost (depreciation, maintenance,
taxes)

6. Taxes and insurance on inventories

7. Order handling costs at the plant

8. Transportation equipment cost-net rental on shipper
owned or leased equipment (such as tank cars,

barges, ships) plus cleaning and maintenance

B. Accounts controlled by the Distribution and Traffic
Department

1. Terminal and warehousing expenses outside the plant -
this includes the analogue of accounts 1-7 in A
above.

2. Freight - plant to customer (or terminal) and ter-
minal to customer. This includes miscellaneous
charges such as demurrage, pump and line costs for
tank trucks and barges, tolls, insurance, and others.

3. Administration of distribution function.

To complete the system the physical distribution manager

would require:

110

1. Customer absorbed freight.

2. Supplemental information of the same type on in-
bound purchases (vendor-absorbed and vendee-absorbed) along
with such information as origin, commodity, tonnage, type

shipment, etc., for a complete inbound analysis.

Financial Statements

Some distribution managers do not foresee any advantage
in altering the formal financial statements. They feel that
the information they require can be obtained from supple-
mentary reports. Others feel that the present financial
statements are misleading by reporting in such a way that
some physical distribution costs are assigned to production
and cost of goods sold.

In a model system of accounting for physical distribu-
tion costs two changes would be made in the income statement:

1. Freight should be shown as an expense rather than
netted against gross sales. This would eliminate the possi-
bility of net sales increasing or decreasing due to a change
in the logistics system. (See Chapter IV, Cases Two and

Three).

 

1For a more detailed chart of physical distribution
accounts see Appendix.

2.

111

The accounts listed in A above, normally charged to

production, would become distribution expenses, thus changing

the face of the income statement.

In summary a model accounting system for physical dis-

tribution would be the present accounting system with these

recommendations and modifications:

A.

General Recommendations

1.

Refinements in selecting bases for functional cost
allocation where necessary.

An analysis of present plant overhead charges to
isolate functionally costs of either production or
physical distribution which may be buried there.
Application of more sophisticated statistical tests
to averages used in allocating costs, where

appropriate.

Specific Innovations

1.

Implementation of Professor Lewis' system of collect-
ing cost information for the geographically variable
costs, such as freight and pipeline inventory time.
Revision of present account classification to remove
physical distribution activities from the production
accounts.

Revision of the income statement to reflect the above

refinements, eg. freight.

CHAPTER VI

CONCLUSIONS AND IMPLICATIONS OF STUDY

In Chapter I several questions were raised, the answers
to which are included in the conclusions of this study.

(1) Within the general subject area of distribution
cost accounting are there unique, identifiable accounting
implications and responsibilities in the functional market-
ing area of physical distribution?

From the evidence presented in Chapters Two and Three
there is little doubt that there is a separate, unique area
of physical distribution within the broader realm of dis-
tribution which has accounting implications and requires
responsible action.

(2) Does the recognition of physical distribution as
an unique marketing concept by marketing executives and
academicians demand a corresponding response from accounting
executives and academicians?

In order to solve the problems which many distribution
managers are encountering which originate in traditional
accounting practices, the accounting people must recognize
and understand the marketing concept of physical distribution

112

113

and its accounting consequences. Evidence presented in the
cases in Chapter Four and in the first part of Chapter Five
indicates that serious obstacles to the correct interpreta-
tion of decision—making cost information are embodied in
existing accounting procedures and practices.

The classification of accounts which does not coincide
with cost control centers may lead to misleading managerial
interpretations. Also the preponderant lumping of physical
distribution charges to overhead at the plant level provides
insufficient information for total cost control.

Where the correction of these deficiencies is feasible
and does not result in serious loss of comparability and
consistency it behooves the accountant to respond to the de-
mand of the physical distributionists. Accounting serves
the needs of the whole firm as well as interests outside the
internal structure of the firm. Their informational demands
must be balanced. This requires considerable discretion on
the part of accounting management. It appears here that
accounting executives and academicians can improve this bal-
ance by a response to the requests of the physical distribu—
tion people.

(3) Is there an awareness by the firm's accounting

management, public accounting firms and academic accountants

114

of the informational needs of the executives responsible
for physical distribution activities?

The awareness of accounting management as indicated by
the research referred to in Chapter Three is scarce. Lit-
erature cited, however, indicates an increasing awareness by
accountants of this management control area. In one of the
companies from which data was received for this study the
observation that the accounting management was not cognizant
of the needs of the distribution manager is based on intra-
company communications. Furthermore, in a second firm in
this study, the accounting department did not provide satis-
factory information to the managers of physical distribution
activities.

In regard to public accounting firms, preliminary
observations indicate that few public accounting firms are
aware of any problems in the area of physical distribution.
Among six branch offices of well—known public accounting
firms contacted for this study, only one could produce or
even acknowledge the existence of a change in a physical dis-
tribution activity which resulted in a change in accounting
procedures or required attention by the public accounting

firm. Yet, this kind of a change in distribution systems

115

frequently occurs.1 It can be deduced from this evidence
that the public accountants are not aware of the concept,
perhaps being too occupied with other demands to acknowledge
it; or the marketing people are not making them aware of
their problems.

Academic accountants are not ostensibly concerned with
this marketing problem. This observation is based on the
almost complete absence of literature in accounting journals
dealing specifically with the physical distribution concept.

The accounting profession at all levels has failed to
emphasize or even to recognize in some cases this problem
area for the distribution manager. Understandably the
accounting profession cannot shift emphasis at the command
of each functional area of the business firm.‘ This major
decision is made only at the top management level. Thus,
apparently the distribution manager's message has yet not
been effectively communicated to top management. When such
communication has been accomplished the accounting profession
may respond with a solution.

In summary, the accountant:

 

1See Arthur Andersen & Co., Operations Research in the
Firm, (February, 1961), pp. II-7, II-l4, II-23 and II-32,
for examples of physical distribution changes which engaged
the attention of Certified Public Accountants.

116

a) is not familiar with the physical distribution con-
cept, as presently developed, and

b) faces many specialized areas in the firm: tax,
auditing, financial, legal reporting, manufacturing, product
costing, administrative budgets by jurisdiction. Distribu-
tion costing - in the sense comprehended here - is just
another specialized area, and not one making as pressing de-
mands as tax and financial accounting.

(4) What actually occurs in the accounting system of a
company which has substantially altered its physical distri—
bution system? What are the procedural and financial
effects and implications?

The list of physical distribution activities in Chapter
Two includes material handling, packaging, traffic and trans-
portation, warehousing and terminaling, inventory management
and order processing. Others may be included but there is
less agreement on their inclusion. Changes in warehouses,
transportation equipment, material handling equipment,
packaging equipment and inventory levels are more likely to
have financial implications than procedural effects.

Changes in order processing and inventory control systems
are more likely to have procedural effects on accounting

systems.

117

In Case One a major change was made in warehousing, the
inventory control system and order processing. In a change
of this magnitude both procedural and financial effects
would be anticipated and did occur. Billing and invoicing,
accounts receivable collection and inventory control methods
were modified. The costs of carrying inventory and accounts
receivable were reduced, and cash flow was considerably
accelerated. Changes in auditing and the role of the com-
puter were effected also.

In the second case order processing and inventory con-
trol systems and inventory levels were changed. These
changes affected billing procedures, increased inventory
carrying costs and decreased working capital requirements.

The role of accounting personnel was minor in these
changes. The changes were initiated by the physical distri-
bution management with the cooperation of other involved de-
partments. In one case the accounting department appeared
not to be fully cognizant of the accounting implications of
the changes.

The cases also show that traditional accounting proced-
ures can and in these examples do obscure the costs under
the control of the distribution manager. A change in his

jurisdictional area to improve customer service at a lower

118

total cost was reflected by accounting methods in both net
sales and production costs. For managerial control pur-
poses, considering that managerial accounting is gaining in
importance, the accounting practices here fall short of
expected performance.

(5) Are there attempts to satisfy the informational
needs of the distribution manager as evidenced by the modi-
fications in the accounting system accompanying the changes
in the physical distribution system? ,

These modifications in physical distribution and
accounting systems did bring about substantial reductions
in total costs. The accounting systems changes did not,
however, reflect any conceptual changes by the accounting
department. That is, the improved flow of information to
the distribution manager was not a result of a more sophis-
ticated comprehension of the physical distribution concept
by the accountants. In each case studied, the desired
changes in accounting systems which indicate a conceptual
understanding have been initiated by the physical distribu-
tion people.

(6) What can be done by accountants to satisfy the

criticisms of physical distributionists and to provide them

with total cost control?

119

Accountants will make changes in their practices and
procedures where the advantages are clear and no prohibitive
handicaps are present. It is suggested from the evidence in
this study that the accounting profession should modify pro-
cedures and financial reporting methods to provide the
physical distributionists with more tractable cost informa-
tion. This can be done without major handicaps or disadvan-
tages by implementing the proposed modifications described
in the preceding chapter. Some of these modifications are
being tested in progressive companies right now. Professor
Lewis' system has been tested with positive results. It has
been received with enthusiasm. The reclassification of
accounts proposed to separate the physical distribution
activities charged to production accounts is now in the pro-
cess of being tested by a large firm.

Changes in the financial statements, such as that
suggested by Mr. Donald Drummond in Chapter Three, would re-
quire sweeping changes in the face of the income statement.
Comparability would be sacrificed for a specialized purpose
which is one among many. The changes proposed in the pre-
ceding chapter would reflect a more precise classification of
the accounts, and yet would not require burdensome alter-

ations to the income statement.

120

Additional Implications and Suggestions
For Further Research
Auditing Implications

This study has left an untapped reservoir of potential
research projects to be explored. There are many accounting
implications which could not be thoroughly researched in
this study. There are undoubtedly additional auditing im-
plications arising from a change in the physical distribu-
tion system of a company, which did not become apparent
from the data collected. It is suspected that these audit-
ing consequences in the change-in-warehousing case probably
occurred even though not specifically detected:

1) A reduction in the extent of the audit job via
(a) a reduction in the number of locations and (b) by having
current inventory lists to test with physical counts.

2) Improved ease of testing accounts receivable bal-
ances of customers by their being current. Probable reduca
tions in discrepancies requiring reconciliation.

3) Reduction of the total auditing requirements by
virtue of improvement in the quality of internal control

over accounts receivable and inventories.

Robinson—Patman Act

Another research provoking aspect of this subject area -

121

distribution cost accounting - is the relevant portion of
the Rebinson-Patman Act. Price discrimination provisions of
the Act make it imperative to defend price differentials in
specified circumstances. Refinements in the methods of
accounting for all distribution activities are necessary for
more reliable justification of cost differentials and their

corresponding price differentials.

Opportunity for Accounting Profession

The accounting profession has been confronted with a
challenge by colleagues from a functional segment of market-
ing. The challenge may be overlooked or it may be viewed as
an opportunity. There is a void in the flow of needed
information that is being partially filled by marketing
people themselves. What is significant is that, taken up,
this opportunity could enhance the professional image of the
accountant.

The challenge elicits a response of an analytical, not
technical, nature. The stature of the accounting profession
rests on its analytical ability. The technical activities
are ephemeral; they will be gradually absorbed by mechanical
and electronic processes. The more analytical are the tasks
of accounting, the more inviting will be the profession to

really capable young men and women.

122

The opportunity to extend the usefulness of accounting
will stimulate the interaction between accounting and market-
ing colleagues. A closer relationship can be attained if
accountants recognize this analytical opportunity and accept
it. The alternative is to allow other existing or newly
formed departments to perform these accounting functions.

It is hoped that accountants will take this opportunity to
broaden their horizons and expand their professional image

as viewed by colleagues.

APPENDIX

PHYSICAL DISTRIBUTION COST CATEGORIES
- INDUSTRIAL MARKETING -

By H. G. Miller

Summary By Boint Of Occurrence

COSTS AT PRODUCTION POINT
(Normally included in production cost by accounting)

A. Packaging
1. Package cost
a. Drums, bags or other single trip containers.
Purchase cost plus freight and receiving.
b. Tank cars, barges, ships and other returnable
containers.
(1) Ownership or rental costs.
(2) Maintenance and insurance.
(3) Record keeping and scheduling.
2. Materials handling and filling costs
. Loading or packaging labor.
. Cleaning and inspection of containers.
. Ownership costs of filling equipment.
. Quality control and analysis.
. Losses in filling.

(DO-00"!”

B. Storage And Handling Costs
1. Labor costs for material handling, order assembly
and loading.
2. Equipment cost - materials handling equipment.
3. Space cost — rental or amortization, maintenance
and taxes on facilities.

C. Financial Costs On Finished Goods Inventories
1. Cost of working capital.
2. Taxes and insurance on inventories.
3. Loss from deterioration or obsolescence.

123

II.

124

 

Administrative
1. Order processing and inventory control.
2. Supervision of physical distribution functions.

3. Communications and travel.

COST OF MOVING MATERIALS TO CUSTOMERS

(Normally included in Freight On Sales. May be deducted
from Gross Sales to get Net Sales Dollar Figure used in
Profit and Loss Statement)

A.

Freight - From Plant To Terminal Or Customer And

From Terminal To Customer

1. Freight payments to carriers, or

2. Cost of operating private transportation
facilities (trucking, marine operations).

3. Charges for return of containers.

Transportation Equipment Cost

1. Rental or ownership cost of transportation equip-
ment furnished by shipper.
(Note - While this is covered in item I.A.l.b.
as part of manufacturing cost in accordance with
standard accounting practice, thre are strong
arguments for considering transportation equip-
ment as part of the freight or transportation
cost.) A

2. Include cost for round trip transit time plus
normal lost time from scheduling and delays at
terminals or customer's plant.

Product Loss
Losses in transit not recovered from carriers or
insurance.

 

Miscellaneous Costs .

1. Insurance on product while in transit.

2. Stevedoring, dockage, wharfage and similar
charges on marine movements.

3. Demurrage payments for delay of carrier's
equipment.

 

III.

IV.

125

COST OF STORAGE AND WAREHOUSING OUTSIDE OF PLANT
(May be included in Cost of Goods Sold, Selling Expense
or Distribution Account)

A.

Packaging Expense (If packaging performed at terminal
or redistribution point)

Same items as I.A.

Storage And Handling Costs

Same basic cost categories as item I.B. On public
facilities same element applies but payments will be
contract charges for rental, handling and other
services.

Financial Costs Of Finished Goods Inventories

 

Same as item I.C.

Administrative

Same as item I.B. The following may also be appli-
cable:

1. Office and laboratory space rentals.

2. Utilities.

3. Quality control costs.

 

Premium Freight Incurred As Result Of Improper
Location Of Stocks

Since exact area forecasting of markets is generally
not possible, some cross hauling is generally
necessary to relocate stocks where they are needed.

CUSTOMER'S COSTS

A.

Transportation Cost

 

If customer absorbs part or all of freight.

Storage And Handling7Costs

1. Labor costs to inspect, receive, store and move
product to production unit.

2. Equipment cost - materials handling equipment.

3. Space costs - rental or amortization, mainten-
ance and taxes on receiving, handling and storage
facilities.

126

Financial Costs On Raw Materials Inventories

Same as item I.C.

Rental Or Demurrage Charges On Carrier Or Supplier
Furnished Returnable Containers

BIBLIOGRAPHY

Books and Monographs

Analysis of Non-manufacturing7Costs for Managerial Decisions.
N.A.C.A. Research Series 19, 20 and 21, New York:
National Association of Cost Accountants, 1951.

Arthur Andersen & Co. Operations Research in the Firm, 1961.

Castenholz, Wm. B. The Control of Distribution Costs and
Sales. New York: Harper Brothers, 1930.

Culliton, J. W. The Management of Marketing Costs. Boston:
Harvard University, 1948.

Crisp, Richard D. How to Reduce Distribution Costs. New
York: Funk & Wagnalls Co., 1948.

Heckert, J. Brooks and Miner, Robert B. Distribution Costs.
2nd ed. New York: The Ronald Press Co., 1953.

Heskett, J. L., Ivie, Robert M., and Glaskowsky, Nicholas A.
Business Logistics Management of Physical Supplyyand
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Lang, Theodore. "Distribution Costs," Marketing Handbook.
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Lewis, Howard T., Culliton, James W. and Steele, Jack D.
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Longman, Donald R., and Schiff, Michael. Practical Distri-
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127

128

 

Miner, Robert. "Distribution Costs," Accountant's Handbook.
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Mossman, Frank H. Differential Distribution Cost and
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East Lansing, Mich.,: Bureau of Business and Economic
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Mossman, Frank H. and Morton, Newton. Logistics of Distri-
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Schiff, Michael and Mellman, Martin. Financial Management
of the Marketing Function. New York: Financial
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Sevin, Charles H. Distribution Cost Analysis. Economic
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Sevin, Charles H. How Manufacturers Reduce their Distribu-
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Sevin, Charles H. Marketing Productivity Analysis. New
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Smykay, Edward W., Bowersox, Donald J., and Mossman, Frank H.
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Definition Committee of the American Marketing Association.
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Drummond, Donald W., "A Marketing Yardstick," Transportation 9
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Editorial, "Distribution Management Tips," Transportation
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Editorial, "Organization vs. Function in Physical Distribu-
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Management, February, 1962, 3.

 

 

Edwards, James Don, "Distribution Costs and Marketing
Decisions," Business Topics, Spring, 1960, 15-20.

 

Elliott, N. J., "Other Distribution Costs," Journal of
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Farmen, Lyle M., "Accounting for Distribution Costs by Pro-
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Fox, Harold W., "Don't Neglect Half the Costs," Cost and
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Hessler, Kenneth W., "Assignment: Design and Phase-in a New
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Jaedicke, Robert K., "Marketing Cost Analysis - A Reply,"
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Mellman, Martin, "Marketing Cost Analysis - Development and
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L—/'

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