Josiah Wedgewood. Yes, that Wedgewood, the famous potter—he invented what we now call Cost Accounting. Thanks to a lucky combination of an embezzling clerk and a depression, Josiah was forced to come up with a system of tracking bottom line costs and profit. He used this system to determine the costs of his product, and was only one of hundreds of potters to survive the depression.
Josiah Wedgwood and the Genesis of Modern Cost Accounting
Josiah Wedgwood (1730-1795) is well known as a potter and as grandfather of Charles Darwin. His research of materials, use of skilled labor and successful business organization made him a leader of the Industrial Revolution. At a time known for the craft of pottery, Wedgwood became a pottery manufacturer, a pioneer in production. He established his first pottery works in 1759, beginning with an improved cream colored earthenware later called "queensware". In 1782 his was the first factory in the industry to install a steam engine.
Wedgwood initially made little use of accounting. High prices were charged resulting in substantial profits even though costs were poorly tracked. The circumstances changed with the depression of 1772. Demand dropped, inventories rose, and prices were cut. Could he cut costs enough to avoid bankruptcy? His answer involved understanding cost accounting in enough detail to make informed decisions. An early discovery was a history of embezzlement by his head clerk, when the accounts didn't agree. A new clerk was quickly installed and a weekly accounting implemented.
Wedgwood was able to determine costs for materials and labor for each manufacturing step for each product. An attempt was made to allocate such overhead costs as breakage and interest as well as transportation costs. He discovered that certain products cost considerably more than others to manufacture, with a correspondent effect on prices and therefore profit. He also became aware of both the concepts of economies of scale and sunk costs. The large percent of fixed costs suggested the importance of greater overall volume.
Based on his cost analysis, the high price policy for pottery was changed. Lower prices could be charged differentially, increasing both demand for some products and greater overall profit. Demand became key to policies. The market could be divided between high-price high-quality products for richer customers, while a mass market could be appealed to with lower-cost lower-price products.
The cost system influenced wages paid, types of employees (e.g., apprentices were paid about one third of experienced workers and were efficient for certain tasks), amount of products produced, and specific techniques used. Prices were based on relative costs, demand, and how demand could be stimulated. Because of his pioneering accounting system Wedgwood survived, unlike hundreds of his contemporaries (Fleischman and Parker, 1991, estimate that only 10% of Industrial Revolution firms survived through the 1840s). In fact, the company he founded is still in business.
Was Wedgwood typical of entrepreneurs at the start of the Industrial Revolution? Fleischman and Parker [1991] analyzed 25 large British manufacturing companies from 1760 to 1850. Most were in the textile (13) or iron (6) industries, with one potter--Wedgwood. Cost accounting progress was made at many of these firms, some perhaps at a level of sophistication similar to Wedgwood at about the same time.
One example was Carron Co., a pioneer iron foundry in Scotland founded the same year as Wedgwood, 1759. It was the first firm in Scotland to smelt iron with coke. Out-of-control costs, lack of profit, and poor liquidity were major reasons for cost analysis. Cost estimates, monthly cost comparisons (costs per ton), performance measures for each department head, calculation of revenues and expenses for each cost center, and overhead allocation (including depreciation on an ad hoc basis) were some of Carron's innovations contemporary with Wedgwood. Competition was fierce and the company withdrew from the anchor trade and nails production because cost evaluations proved them to be unprofitable. Carron became a large-scale, vertically integrated company which included specialty products. Complexity stimulated product quality control and overhead allocation.
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