Service Costing

• Service Costing or operation costing is normally used in service sector.
• It is a method of costing applied to undertakings which provide services rather than production of commodities.
• Service may be performed internally and externally.
• Services are termed as internal when they have to be performed on interdepartmental basis in factory itself e.g. Power house services, canteen service etc.
• Services are termed as external when they are to be rendered to outside parties. Public utility services like transport, water supply, electricity supply, hospitals are the best example for the service costing.
• Thus Service costing is a method of cost accumulation which is designed to determine the cost of services.
• Service costs are collected periodically like process cost.
• The cost of rendering the service for particular period is related to quantum of services rendered during the particular period to arrive at cost per unit of service rendered.
• So the principal of unit costing is used in service costing.

CIMA London, defines Service Costing as “that form of operation costing which applies where standardized services are rendered either by an undertaking or by a service cost center within an undertaking”.

It differs in the following ways due to some basic and peculiar nature.

(i)      Unlike products, services are intangible and cannot be stored, hence, there is no inventory for the services.

(ii)     Use of Composite cost units for cost measurement and to express the volume of outputs.

(iii)    Unlike a product manufacturing, employee (labour) cost constitutes a major cost element than material cost.

(iv)    Indirect costs like administration overheads are generally have a significant proportion in total cost of a service as unlike manufacturing sector.

1. Companies here render unique services & do not produce any tangible goods.
2. The expenses are divided into fixed and variable cost which helps to calculate cost per unit of service.
3. Total cost is averaged over the total amount of service rendered.
4. Costs are usually computed period-wise. However, in the case of utilization of vehicles, use of road rollers etc., the costs are computed order wise.
5. Documents like the daily log sheet, cost sheet etc. are used for the collection of cost data.

Service costing is extensively used in Transport industries, Hotel industries, Electricity companies, etc. Service costing helps in ascertaining

• Inter-departmental service prices.
• Service cost to be charged from outside clients.
• Benchmarking the processes/operations.
• Tracking and controlling the excess cost

Determining the suitable cost unit to be used for cost ascertainment is a major problem in service costing. Selection of a proper cost unit is a difficult task. The cost unit to be applied needs to be defined carefully and frequently, a composite cost unit may be deemed more appropriate.

For example, Hotels may use the ‘Occupied Room Days’ as an appropriate unit for cost ascertainment and control.

Other typical cost units that may be used include:

The costing should be comprehensive enough to show the effects like off-season and peak-season demand, full time, part time, etc.

Composite Cost Unit:

Sometime two measurement units are combined together to know the cost of service or operation. These are called composite cost units.

Examples of Composite units are Ton- km., Quintal- km, Passenger-km., Patient- day etc. Composite unit may be computed in two ways.

(i)      Weighted Average or Absolute basis– It is summation of the products of qualitative and quantitative factors. For example, to calculate absolute Ton-Km for a goods transport is calculated as follows.:

∑(Weight Carried × Distance)₁ + (Weight Carried × Distance)₂ +….+(Weight Carried × Distance)_n

 (ii)       Simple Average or Commercial basis – It is the product of average qualitative and total quantitative factors. For example, in case of goods transport, Commercial Ton-Km is arrived at by multiplying total distance km., by average load quantity.

∑(Distance₁ + Distance₂ + ………………+ Distance_n ) ×

Operating costs are usually collected under following headings:

1. Fixed or standard charges.
2. Semi-fixed or maintenance charges
3. Variable or running charges.

Note: In the absence of information about semi-variable costs, the costs would be shown under fixed and variable heads only.

Treatment of Depreciation:

If life of asset is given in years it will be treated as fixed and if life is based on usage in kms or hours, it will be treated as variable cost.

Treatment of Interest:

Interest and finance charges are treated as fixed cost shown in cost statement.

Transport organizations can be divided into two categories viz. Goods transport and Passenger transport.

The cost unit for Goods transport organization is Ton– Kilometer – that means cost of carrying one Ton of goods over a distance of one kilometer.

Cost unit for Passenger transport organization is Passenger– Kilometer – that means cost of carrying one Passenger over a distance of one kilometer.

The costs are shown under the following heads:

(i)      Standing Charges or Fixed costs include the following:

o        Insurance

o        License fees

o        Salary to Driver, Conductor, Cleaners, etc if paid on monthly basis

o        Garage costs, including garage rent

o        Taxes

o        Administration expenses, etc

(ii)     Variable costs or Running costs include the following:

o        Petrol and Diesel

o        Lubricant oils,

o        Wages to Driver, Conductor, Cleaners, etc if it is related to operations

o        Any other variable costs identified.

(iii)    Semi-variable costs or Maintenance costs include the following:

o        Repairs and maintenance

o        Tyres

o        Spares, etc

For hotels it is necessary to compute the cost – to fix the price of various services provided by the hotel such as Restaurant, Lodging & Banquets along with

• Ascertaining the operating cost of running a hotel
• Fix room rent per day &
• Fix hire charges of banquet hall
• Along with finding out the profit or loss at the end of a particular period.

In this case, the costs associated with different services offered should be identified and cost per unit should be worked out. The cost unit may be Guest-day or Room day. For calculation of cost per Guest day or Room day, estimated occupancy rate – at different point of time, for example – Peak season or lien season, are taken in to account.

A Hospital is providing various types of medical services to the patients. Hospital costing is applied to decide the cost of these services.

A hospital may have different departments catering to varied services to the patients – such as Out Patient, In Patient, X-Ray, Scanning, Catering, Laundry, Power house, Transport, Dispensary, etc. Common unit of costs of various departments are as follows:

• Out Patient – Per Out-patient
• In Patient – Per Room Day
• Scanning – Per Case
• Laundry – Per 100 items laundered

The objectives of Hospital costing are as follows

• Ascertaining the operating cost of running a hotel
• Fix room rent per day

Fixed costs based on timelines are Staff salaries, Depreciation on Building and Equipment, etc & Variable costs vary with the level of services rendered are Laundry charges, Cost of food supplied to patients, Power, etc.

Information Technology (IT) and Information Technology Enabled Services (ITES) organizations provide their customers with services or intangible products internally and externally both. These organizations are highly labour intensive and constitute a significant portion of the total operating costs. The direct employee cost is traceable to services rendered.
In addition to employee cost, significant overhead costs for offering the services are incurred and are classified as service overhead. To arrive at the cost incurred for rendering the services, it is necessary to allocate / apportion such overheads to cost units on the basis of labour cost.

The Construction of roads is very important for the infrastructural development of any country and the cost consists of the following two components

1. Capital Costs

The cost incurred during the construction of roads, other structures, consultancy charges, tool booths etc are called as capital costs and run across multiple financial years. Construction expenses can be broadly classified as follows:

• Preliminary and pre-operative expenses
• Land Acquisition
• Materials
• Labour
• Overheads incurred in the course of actual construction
• Contingency allowance
• Interest during construction period

2. Operating and Maintenance Costs

Routine maintenance cost would be incurred once the Toll road is operational. Routine maintenance involves Patching of potholes, sealing of cracks, Edge Repair, Surface Renewal, Periodic maintenance for new highways would be met with in accordance with the analysis of the life cycle model carried out for the project. Operating and Maintenance expenses can be broadly classified as follows:

• Toll collection expenses
• Administrative expenses for day-to-day operation.
• Maintenance expenses include routine and periodic maintenance.
• Interest expenses incurred for servicing term loans.

Toll Rate

The main purpose of costing for toll roads is to calculate the Toll rate. In general, the toll rate should have a direct relation with the benefits that the road users would gain from its improvements. The benefits to road users are likely to be in terms of fuel savings, improvement in travel time and Good riding quality calculation of which is as follows

User Fee = Total Distance × Toll Rate per km

Educational institutions like schools, colleges, technical institutes for education and training, are run to impart education and training to students. The objective of running these institutions may be ‘Not-for profit’ or ‘For profit’. Like other business entities, cost and management accounting is also inevitable for this sector.

Income of the Educational Institutions

The source of income of an institute may be classified on the basis of recurrence as follows:

One-time fees such as Admission fee, Development fee, Annual fee etc.

Recurring fees i.e. Tuition fee, laboratory, computer and internet fee, library fee, training fee, amenities fee, sports fee, extracurricular activities fee etc.

Other indirect incomes like transport, hostel, mess and canteen for the students and staff are provided by the educational institutions normally on no profit no loss basis.

Expenditure of the Educational Institutions

• Operational Cost includes
• The salary of the teaching and non-teaching staff
• Laboratory maintenance charges
• Computer maintenance and internet charges,
• Building maintenance,
• Repairs and maintenance of equipment,
• Administrative expenses,
• Finance charges etc.

Cost Centres and basis of cost allocation

Cost centres in educational institutions are classified as follows:

• Primary or Direct cost centres (like Civil Engineering department, Mechanical Engineering department, etc.)
• Service cost centres (like Laboratory, Library, Sports, etc.)
• Student’s Self-Supporting Services (like Transport, Hostel & Mess, etc.)
• Administration Cost centres (like Research & Improvement, Examination)

Costs incurred are allocated to the respective cost centres, if they are identifiable with a cost centre and apportioned to service and administration cost centres on suitable basis.

(ii)          Research and Development Cost

Educational institutions undertake academic research on various fields of specialisations. The costs of such research including personal costs, books etc. are to be collected through a cost centre approach. All costs incurred in that cost centre are collected and set off against the revenue generated from such research projects.

If any balance is left out as undistributed, then such balance costs can be collectively distributed to all other course cost centre as a separate cost element namely “Research costs”.

(iii)         Cost of Publication of research and other materials

In an educational institution, there will be a separate department for conducting research publication related exercise. The cost incurred would be directly allocated to that department.

The insurance companies are required to analyse its various insurance product for profitability. The product offered by insurance companies may include:

(i)      Life Insurance policies- with or without maturity benefits

(ii)     General insurance- Health, Fire, Property, Travel Insurance etc.

(iii)    Others services- Re-insurance, Fund management- Pension, Gratuity and other etc.

Income of Insurance companies

Income of insurance companies may include

(i)      Premium on policy (periodic or one time)

(ii)     Commission on re-insurance

(iii)    Fund administration fee and return on investment of fundsetc.

Expenditure of Insurance companies

The Expenditure of an insurance company can be classified as direct and indirect to a policy or product.

Direct- Commission paid to agents, claim settlement, cost of valuation, premium for re-insurance, legal and other costs etc.

Indirect Cost-Actuarial fees, market and product development costs, administration cost, asset management cost etc.

Method of Costing in Insurance Company

The cost object in an insurance company may be a product, a policy, a department or region, an agent etc.

Activity Based Costing in Insurance Companies

Activity based costing (ABC) is used for analysis of cost-benefit of a product (Direct Product Profitability), policy profitability (Customer Profitability Analysis) etc.

The activity costs are assigned to the products on the basis of appropriate cost drivers. The cost drivers may include no. of hours spent on processing of an application and claim processing, no. of application, no. of policy, no. of claim etc.

If the financial institution has to survive under the present challenging economic conditions, it will have to add value to its products and services. It is imperative to note that the financial institution needs to know the contribution of its products, services and customers to value creation.

Cost measurement in financial institutions

The objectives of cost measurement includes –

–        Understand the profitability by products offered and by customers

–        Establishing a mechanism for pricing the products, by identifying the product level and activity level unit costs

–        Understanding productivity issues and their relationship with strategic goals of the organization

In nutshell, financial institutions need to understand their position in various product lines and to find out how they can stay in competing edge or becomes a leader.

Activity Based Costing in Financial Institutions

Activity based costing can be a useful tool in allocating the cost elements to various products offered and the customers being served. Activity based costing can help financial institutions to –

• Identify and analyze the profitability by product
• Analyze the profitability by customer
• Identify the activity level unit costs and build up product level costs, which in turn forms basis for product level pricing / customer level pricing

Financial institutions can improve their profitability by –

• Concentrating on products that are more profitable
• Focus on high margin customers

Costs that occur in financial institutions are to be identified with appropriate activities that have caused its occurrence. Then costs must be reassigned from activities to cost objects (various loan products offered by the organization, customers, etc.) based on identified cost drivers.

Power houses are engaged either in electricity generation or steam generation. It uses the concepts of service costing i.e. ‘Power House Costing.’ Service cost statement can be prepared by identifying the costs associated with the power generation or steam generation.

Cost unit is different for electricity generation and steam generation.

The cost unit for electricity generation organization is cost per kilowatt-hour (kWh) – that means cost of generating one kilowatt of power per hour. Please note that kWh is commonly known as a “Unit”.

The costs are shown under the following heads:

(i)      Standing Charges or Fixed costs: These are the fixed costs that remain constant irrespective of the power or stream generated. These costs include the following:

• Rent, Rates & Taxes o Insurance
• Depreciation
• Salaries, if paid on Time (Monthly) basis
• Administration expenses, etc.

(ii)     Variable costs or Running costs: These costs are generally associated with the power or stream generated. These costs include the following:

• Fuel Charges
• Water Charges
• Wages / Labour charges, if paid on the basis of production
• Any other variable costs identified.
• Semi-variable costs or Maintenance costs: These costs include the following:
• Meters
• Furnaces
• Service materials
• Tools, etc.