SERVICE COSTING

Introduction

Service costing (also called operation costing or function costing) is a costing method concerned with establishing the costs, not of items of production, but the cost of services provided.

Service costing is a method of accounting for services or function. These service centres or service functions include maintenance, personnel, canteen or stores.

Service organisations do not make or sell tangible goods. Profit seeking service organisations include accountancy firms, law firms, transport companies, hair saloons, banks and hotels. Non-profit organisations include hospitals, schools and libraries.

The use of service costing

Service costing is used in:

  • External services: provided by a company in a service industry, e.g. car hire services, air transport services, courier services, etc.
  • Internal services: carried out by internal departments of a company, e.g. the costs of the vans or Lorries used in distribution departments, the costs in computer departments or costs for staff canteens.

Service costing differs from product costing (such as job or process costing) in the following ways:

  • Composite cost units are used
  • Intangibility of output
  • Can be used for both internal and external services
  • Low level of direct costs as a proportion of total costs since for most services it is difficult to identify many attributable direct costs. For example, cost of direct materials consumed will be relatively small.

The unit cost measurement

One particular problem with service costing is the difficulty in defining a realistic cost unit that represents a suitable measure of the service provided. Frequently, a composite cost unit may be deemed more appropriate. Hotels, for example, may use the ‘occupied bed-night’ as an appropriate unit for cost ascertainment and control. Other typical cost unit that can be used include:

Service Cost unit
Transport company passenger-kilometre
Education student-subject
Hospital patient-night
Canteen meals served
Cost per service unit = Total costs for the period

No of services units in the period

Example 1

The following information is available for Rose Motel for the last ten days period.

Number of rooms available per night 40
Percentage occupancy achieved 60%
Room servicing cost incurred £24,000

Required

What is the room servicing cost per occupied room-night last period?

Example 2

The maintenance department of Winnie Ltd charges user departments for its service as follows.

  • A predetermined hourly rate for labour hours worked on maintenance jobs
  • Specifically identifiable materials are charged at actual cost

The budgeted maintenance labour hours for the latest period were 2,000 hours, during which maintenance costs of £22,000 were budgeted to be incurred.

During the period, 30 maintenance hours were worked in production department A. Materials cost £50 while overhead cost £100 to perform maintenance for department A.

Required

What is the correct charge to production department A for its use of the maintenance service department during the period?

Example 3

Billy has a contract with his company that he will use his own 4-wheel car for business journeys and will be reimbursed at a fixed rate per kilometre travelled. After allowing for holidays and time spent in the office it is estimated that he will make 300 daily business journeys in the course of a year with the average journey covering 70 kms. Billy has provided the following details

  • The current price of petrol is £3 per litre and performance is 30kms for every litre.
  • Repair costs £7 per 200kms.
  • Tyres will be renewed every 2,100kms. Each type costs £10.
  • Insurance is £100 per year which the company agrees to pay it in full.
  • License is £200 per year which the company agrees to pay half of the expense.
  • Car cleaning service for every 1,000km-journey costs £8. The company agrees to pay a quarter of the expense.

Required

Calculate an equitable rate per kilometre. (Round up to 2 d.p.).

Solution example 1

Beware that the information shown is for 10 days.

The room servicing cost per occupied room-night:

£24,000 / (40 x 60% x 10)

= £100

Solution example 2

The correct charge is:

(£22,000 / 2,000) x 30 + £50 + £100= £480

Solution example 3



Total
Petrol cost [(300 x 70kms) / 30kms] x £3 £2,100
Repair cost [(300 x 70kms) / 200kms] x £7 £735
Tyres cost [(300 x 70kms) / 2,100kms] x £10 x 4 £400
Insurance £100 £100
License £200 x 1/2 £100
Car cleaning servicing £(300 x 70kms) / 1,000kms] x £8 x 1/4 £42
Total costs
£3,477
An equitable rate per kilometre = £3477 / (300 x 70kms) = £0.17 per kilometre