SERVICE AND OPERATION COSTING

Basically Service can be provided by companies solely establish for the purpose of the
providing service known as service Sector. But It can also be provided by services
department within an organization.
So, Service Costing can be used by both service providing companies as well as
companies wishing to establish the cost of services carried out by some of their
departments within other than service organization as well.
Examples of Service Industry:
1) Transport Industry
2) Hotel Industry
3) Hospital Industry
4) Power Industry
5) Information Technology Services
6) Financial Institutions
7) Rail or Air Transport Industry
Examples of Service Departments:
1) Cost associated with Delivery Vans or lorries used in distribution
2) Canteen Department
3) Maintenance Department
4) IT Department
5) Research and Development Department
6) Quality Assurance Department
Service Costing Versus Product Costing (Such as Job or Process Costing)
1) In case of Manufacturing Industries cost of Direct Materials are often the
major portion of cost whereas in services the cost of direct materials consumed
will be relatively small as compared with the labour , direct expenses and
overheads.
2) Although many services are revenue earning, others are not which happens in
case of service costing applied within a department of an organization the main
purpose of which is to facilitate other departments as required or renders
services as required. For Example: Distribution Facility within an organization
and the staff canteen.
This means that the purpose of Service Costing may not be to establish a profit
or loss but may rather be to provide management with information about
 a) Comparative Costs
b) Efficiency of services
c) Planning or Estimation of Costs For future
d) Controlling Costs
But for the case of Products all are revenue earning.
3) Unlike Products, Services cannot be stored and there is no inventory for the
services.
4) The Procedures for recording material costs, labour hours and other expenses
will vary according to the Nature of Service.
Features of Output of Services/Service Industry
1) Intangibility of Output as output is in the form of performance rather than
tangible [touchable] goods.
Examples: Hair Cutting Services, Knowledge Management, Event Management
and so on other Consulting activities.
2) Dominant Costs are also intangible which includes Labour, overheads and
other expenses but not materials.
3) Heterogeneity as every service is sold by a different name for its Selling price
a) Transport Industry [ Passenger Transport Services Uses Tickets , Goods
Transport Services Uses Freight Charges]
b) Hotel Industry Uses Rent or Tariff
c) Hospital Industry Uses Consulting
d) Power Industry Uses Meter Charges
e) Information Technology Services Uses Project Cost
f) Financial Institutions Uses Processing Fees
g) Rail or Air Transport Industry Uses Tickets or Air Fare Charges

And, will be variable due to high human input [For Example Hair Cutting
Services, Knowledge Management, Event Management and so on other
Consulting activities.]

4) Every Service is measured by a different cost Units but in manufacturing its

general to be KG, Liters or Pieces.
5) Perishability as Unlike Products, Services cannot be stored and there is no
inventory for the services. Example: Haircuts are perishable.
 6) Simultaneous production and Consumption as the service that you require
cannot be inspected for quality in advance of receiving it or nor can it be
returned if it isn’t what is required.
Example: Consulting or Advice only taken when you require, Quality or
Satisfaction of Service you receive on Haircutting by hairdresser.

Unit Cost Measures

The Main problem with service costing is the difficulty in determining a
realistic cost unit that represents a suitable measure of the service provided.
Frequently, a composite cost unit may be deemed more appropriate.

Typical cost units used by companies operating in a service industry are shown
below.

Service Cost unit

1) Road, rail and air transport services -> Passenger/mile or kilometer,
ton/mile, tonne/kilometer
2) Hotels -> Occupied bed-night
3) Education -> Full-time student
4) Hospitals -> Patient
5) Catering establishment -> Meal Served
6) Vans and lorries used in distribution -> Mile or kilometer, ton/mile,
tonne/kilometer
7) Maintenance -> Man hour
What is Single Cost Unit and Composite Cost Unit?
Single Cost Unit: Let out its entire standard capacity or load / Only One Cost
Units
In Manufacturing Industry, Single Cost unit is generally used and can also be used in
service industry as well.
Composite Cost Unit: Apportions its Cost per unit of its Capacity / Multiple
Cost Units.
Composite Cost units are commonly used in Service Industry.

Cost Per Service Unit:

Total Costs for Providing the Service / Number of Service Units used to
provide the Service.
Example 1: Illustration 2 Form Kaplan Text
Example 2: Test Your Understanding 1 Form Kaplan Text

Service Cost Analysis

Service Cost Analysis should be performed in a manner which ensures that the
following objectives are attained
1) Planned Costs should be compared with actual Costs to identify the
differences and take corrective actions.
2) Cost per Unit of Service Should be calculated if each category of service has
number of Variations.
a. Maintenance Service can be provided by plumbers, electricians and
carpenters.
b. Consulting Services can be provided by Lawyers , Chartered
Accountants and so on other professionals
3) Cost per Unit of Service Should be calculated as a part of control function
to analyses the trend and if found unusual investigate.
4) Prices should be calculated for the Service being sold to third parties
which has process similar to Job Costing.
5) Costs should be analyzed into Fixed, Variable and Semi-variable costs to
help assist management with planning, control and decision making.
Service Cost Analysis in Internal Service Situations
1) Transport Costs
Represents the costs of transport services used by a company rather than
a purely service organization such as a rail network. Headings under
Transport Costs;
a. Running costs such as petrol, oil and drivers' wages
b. Loading costs (the labour costs of loading the lorries with goods for
delivery)
c. Servicing, repairs, spare parts and tyre usage
d. Annual direct expenses such as road tax, insurance and depreciation
e. Indirect costs of the distribution department such as the wages of
managers
 WHY SERVICE COST Analysis?
1) For Planning the Expected costs to be incorporated in budget
2) Control actual expenditure on transport by comparing actual costs with
budgeted costs
3) Transport Costs incurred in general will be charged to customers
4) What is the Cost and are there any alternative forms of transport which has be
better and cheaper?
5) Type of Vehicles to be used which will benefit the organization [ Cost to be
incurred on Vehicle vs. Benefit received ]

2) Canteen Costs
Represents the costs of Canteen services used by a company rather than
a purely service organization.

REAL LIFE SCENARIO OF CANTEEN in an Organization

A feature of canteen costing is that some revenue is earned when employees
pay for their meals, but the prices paid will be insufficient to cover the costs of
the canteen service. The company will subsidize the canteen and a major
purpose of canteen costing is to establish the size of the subsidy.

Headings under Canteen Costs;

a) Food and drink: separate canteen stores records may be kept, and the
consumption of food and drink recorded by means of 'materials issues' notes.
(b) Labour costs of the canteen staff: hourly paid staff will record their time
at work on a time card or timesheet. Salaried staff will be a 'fixed' cost each
month.
(c) Consumable stores such as crockery, cutlery, glassware, table linen and
cleaning materials will also be recorded in some form of inventory control
system.
(d) The cost of gas and electricity may be separately metered; otherwise
an apportionment of the total cost of such utilities for the building as a whole
will be made to the canteen department.
(e) Depreciation charges made for assets such as ovens and furniture
(f) Overhead costs of the building (for example rent, rates, building
insurance and maintenance and so on) may be apportioned and a share charged
against the canteen.
Example: Service cost analysis
Suppose that a canteen recorded the following costs and revenue during the
month.
$
Food and drink 11,250
Labour 11,250
Heating and lighting 1,875
Repairs and consumable stores 1,125
Financing costs 1,000
Depreciation 750
Other apportioned costs 875
Revenue 22,500
The canteen served 37,500 meals in the month.
The size of the subsidy could be easily identified as follows.
$
The total costs of the canteen 28,125
Revenue 22,500
Loss, to be covered by the company 5,625

The cost per meal averages 75c and the revenue per meal 60c. If the
company decided that the canteen should pay its own way, without a
subsidy, the average price of a meal would have to be raised by 15 cents.

Usefulness of Costing Services that do not earn Revenue.

Purposes of Service Costing

Service costing has two basic purposes.
(a) To control the costs in the service department. If we establish a
distribution cost per tonne/kilometre, a canteen cost per employee, or job
costs of repairs, we can establish control measures in the following ways.
(i) Comparing actual costs against a target or standard
(ii) Comparing current actual costs against actual costs in previous periods

(b) To control the costs of the user departments, and prevent the
unnecessary use of services. If the costs of services are charged to the user
departments in such a way that the charges reflect the use actually made by
each department of the service department's services then the following will
Occur.
(i) The overhead costs of user departments will be established more accurately;
indeed some service department variable costs might be identified as directly
attributable costs of the user department.
(ii) If the service department's charges for a user department are high, the user
department might be encouraged to consider whether it is making an
excessively costly and wasteful use of the service department's service.
(iii) The user department might decide that it can obtain a similar service at a
lower cost from an external service company.

Examples:
1) If maintenance costs in a factory are costed as jobs (that is, if each bit of
repair work is given a job number and costed accordingly), repair costs can
be charged to the departments on the basis of repair jobs actually
undertaken, instead of on a more generalized basis, such as apportionment
according to machine hour capacity in each department. Departments with
high repair costs could then consider their high incidence of repairs, the age
and reliability of their machines, or the skills of the machine operatives.

2) If IT costs are charged to a user department on the basis of a cost per hour,
the user department would assess whether it was getting good value from its
use of the IT department and whether it might be better to outsource some
of its IT work.

QUESTION 1: RICK SHAW

Rick Shaw operates a small fleet of delivery vehicles. Standard costs have been
established as follows.
Loading 1 hour per tonne loaded
Loading costs:
Labour (casual) $2 per hour
Equipment depreciation $80 per week
Supervision $80 per week
Drivers' wages (fixed) $100 per man per week
Petrol 10c per kilometre
Repairs 5c per kilometre
Depreciation $80 per week per vehicle
Supervision $120 per week
Other general expenses (fixed) $200 per week
There are two drivers and two vehicles in the fleet.
During a slack week, only six journeys were made.
Tonnes carried One-way distance
Journey (one way) of journey
Kilometres
1 5 100
2 8 20
3 2 60
4 4 50
5 6 200
6 5 300
Required
Calculate the expected average full cost per tonne/kilometre for the
week.
QUESTION 2:
A university with annual running costs of $3 million has the following students.
Attendance
Weeks Hours
Classification Number per annum per week
3 year 2,700 30 28
4 year 1,500 30 25
Sandwich 1,900 35 20
Required
Calculate a cost per suitable cost unit for the university to the nearest
cent.
QUESTION 3 : Test Your Understanding 2 Form Kaplan Text