1. Chapter 6 Service costing
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2. Outline What are service organisations?
Differences between service and manufacturing businesses
Value chains in service firms, retailers and wholesalers
Service production environments
Activity-based costing for services
Case study: Service costing at Adelaide Bank
When should firms estimate their service costs?
Flow of costs in service firms
Costing in retail and wholesale businesses
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3. What are service organisations?
Organisations that deliver help, utility or care, providing an experience, information or other intellectual content where the majority of the value is intangible rather than residing in any physical products
Service organisations dominate many economies
private sector, public sector, not-for profit sector
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4. Differences between service and manufacturing businesses
Most services are intangible
Service outputs are often heterogeneous
Services are often consumed as they are produced
Services are perishable and cannot be stored
Some services entail some minor physical or tangible aspects
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5. Other aspects of services
Retailers and wholesalers are part of the service sector
They have different characteristics to most service firms
Provide tangible goods as well as services
Services are produced outside the service sector
Most manufacturing firms provide a service component to their product
Upstream and downstream segments of the value chain may produce services
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7. The value chain in service firms
Upstream activities and costs
Only large service firms may have research and development (R&D) and design activities
Downstream activities and costs
Marketing and customer support
Production and delivery activities and costs
Production and delivery may occur simultaneously
Direct labour may dominate and materials may not be significant
Upstream and downstream costs may be regarded as overhead costs for service costing purposes
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9. The value chain for retailers and wholesalers
Upstream activities and costs
R&D and design unlikely to be relevant
Purchasing activities important
Production activities and cost
The sales transaction and (sometimes) distribution are included
Sales and distribution may occur at the same time
Downstream activities and cost
Marketing activities, delivery and customer support are important
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11. Service production environments
Professional service firms
Staffed by professional staff who provide individual services to customers
There are relatively few customers, despite having large numbers of staff
The front office is more important than the back office
Service delivery involves people, more than equipment, and the emphasis may be more on the how the service is delivered rather than what is delivered
Examples: medical, legal, accounting, management consulting and architectural businesses
(cont.)
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12. Service production environments (cont.)
Mass service entities
Involve many customers, each one requiring limited staff time and limited customisation
Staff are mainly non-professional
Most of the value is in the back office not the front office
The service may involve equipment, and focus more on what is delivered rather than how
Examples: bus and train companies, airline companies, post offices, electricity suppliers, telecommunications companies and public service organisations
(cont.)
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13. Service production environments (cont.)
Service shops
Fit between professional and mass service businesses in terms of the number of customers, staff time and degree of customisation
Examples: hotel chains, banks, cafés and restaurants, print shops and car repair workshops
Some service entities have aspects of mass service and professional service types
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15. Job costing systems for professional service firms
Professional service firms have limited material or equipment and produce no inventories
Professional firms suit a job costing environment
Few clients and jobs
The production process for each client is unique
Labour cost can be traced directly to individual services in an economic manner
Job billing rather than job costing may be used
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16. Process costing systems for (some) mass services
Services are produced in large quantities, so individual tracking of costs is not feasible
Production processes are repetitive; there is limited room for customisation
Various services consume similar resources
Substantial indirect labour
Costs tracked directly to production processes
Process costing will not provide accurate tracking of costs to services, where the scope for discretion in service delivery is high
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17. Hybrid costing systems for service shops and (other) mass services
Suitable for some service shops and some mass service entities
Varying degrees of customisation, standardisation of processes and traceability of costs
Costing systems will vary on a continuum from job costing to process costing
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18. Activity-based costing for services
Service entities often have high direct labour costs that can be traced directly to services
Overhead costs can be allocated to services using cost drivers
The greater the proportion of overhead costs
the greater the potential for inaccurate service costs
more benefits may be gained from accurate activity-based costing, versus conventional costing systems
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19. Case study: Costing services at Adelaide Bank
Job costing—investment advisory services
Professional labour costs
Traced to jobs using an hourly rate
Hourly rate based on annual salary plus on-costs, divided by billable hours
Overhead costs
Includes upstream and downstream costs
Identify the overhead cost driver, often professional labour
Predetermined overhead rate per dollar of professional labour
(cont.)
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20. Case study: Costing services at Adelaide Bank (cont.)
Why estimate the cost of investment advisory services?
A basis for setting fees
To assess the profitability of each service
To determine which service to promote, refine or withdraw
To control costs
Job billing may be used rather than costing to determine fees
Charge out rates per billable hour; includes an allowance for overheads and required profit margin
(cont.)
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21. Case study: Costing services at Adelaide Bank (cont.)
Process costing—ATM services
Three processes
The provision of ATM service facilities
Initial transaction processing by front-end processor
Back-end processing
Few direct costs for the ATM transaction
Substantial indirect labour costs in front-end and back-end processing
Substantial equipment-related costs
Degree of completion and transferred-in costs not relevant
(cont.)
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22. Case study: Costing services at Adelaide Bank (cont.)
Why estimate ATM services?
To set fees
Assess the profit or loss associated with each transaction
Information for control
The cost per transaction should be used with caution in decision making
Includes a high proportion of indirect costs which do not behave on a per-unit basis
(cont.)
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23. Case study: Costing services at Adelaide Bank (cont.)
Hybrid costing
Some services are a mix of standardised processes and customised features
Which costs should be included in service costs?
Upstream and downstream costs to suit managers’ decision-making needs
Costing systems may cost only some services, based on decision-making needs
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24. When should firms estimate their service costs?
No external reporting requirements to estimate individual service costs
Service costing systems will be implemented where benefits exceed costs
Cost and benefits are influenced by
Complexity of the costing system
Accuracy of the service cost information
Relevance of service cost information to managing resources and creating value
(cont.)
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25. When should firms estimate their service costs? (cont.)
Relevance to creating value and managing resources
Managers can use service costs to assess service profitability, decide what service to produce/offer, set prices/fees, and to plan and control costs
Complexity, accuracy and relevance of service costing will vary across different types of service environments
Service costing may be undertaken infrequently and selectively to meet managers’ needs
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27. Service costing in practice
Job costing is common in professional service firms and some service shops
Costing systems in service firms tend to focus on the costs of responsibility centres
Firms may choose to cost only some services to support management decisions
The benefits of a costing system (or an individual costing exercise) should be compared to the costs of setting up the system
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28. Flow of costs in service firms
No inventory to value, so external reporting requirements not relevant
Individual service costs are usually not accumulated in the general ledger
Costs are shown as line item operating expenses, not cost of goods sold (COGS) in income statements
(cont.)
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29. Flow of costs in service firms (cont.)
Service costs not usually integrated into the accounting ledger, so overapplied or underapplied overhead not relevant
Some service firms do need to account for work-in-process (AASB 102)
Consist of accumulated costs of jobs, where fees are not realised
Only production costs can be included
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30. Costing in retail and wholesale businesses
Two distinct aspects
Tangible goods are sold
There is a wide range of goods
Inventories and COGS are recorded in the accounting ledger
Inventories must be valued at the end of an accounting period at the lower of cost or net realisable value
(cont.)
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31. Costing in retail and wholesale businesses (cont.)
Cost of goods sold
Cost of beginning inventory + purchases – cost of ending inventory
How may managers use COGS?
Assess the profitability of various product lines and responsibility centres
Guide product pricing
Upstream and downstream costs may be included to provide a more comprehensive estimate of COGS for decision making
(cont.)
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32. Costing in retail and wholesale businesses (cont.)
A range of services may also be provided to customers as part of the sales transaction and at other points on the value chain
For accounting purposes, these costs are expensed in the current accounting period
For management decisions, these service costs may need to be identified to help manage resources
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33. Summary
Most service outputs are intangible, heterogeneous, consumed as produced, perishable and cannot be stored
The type of service costing system may depend on the service environment
Job costing may suit professional services
Process costing may suit mass services
Overhead costs may include upstream and downstream costs
Unlike in manufacturing, service costs are solely to support managers’ decision making
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