The service industry is a highly competitive one. As a result, service providers are always seeking more efficient ways of operating, which will reduce their overall costs.
Determining the cost in any service industry is fundamental, as every service organisation must ascertain its business overheads. This is because, in this industry, companies provide services and intangible products.
The kind of service provided by the service sector is diverse and has its requirements and peculiarities. In this blog, we will discuss costs and costing methods in the service industry.
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What is service costing?
Service costing can be defined as a kind of operation costing used by organisations that create and provide services instead of producing goods.
All costs incurred during the production of a service are added together in this cost accounting method. This is then divided by the total number of service units rendered.
Finally, the total cost has to be divided by the total units to reach the per-unit cost.
Need for service costing
Service costing is not the same as standard costing. Service costing is dependent on the rate instead of the price. Rate is the price per unit of the service which has been delivered.
The rate is determined by several factors such as equipment, machinery cost, labour wages, licenses, etc. Service costing is essential for service industries such as hospitality, aviation and transport as it helps determine the organisation's revenue, profit and targets.
Costing methods used in the service sector
The service industry adopts one of the following basic costing methods for assigning costs to their services. These costing methods are as follows:
- Job costing method: In this type of costing method, the cost of any particular service is obtained by giving costs to a distinct, identifiable service. A job costing method is employed in service industries such as advertising companies, accounting firms, etc.
Activity Based Costing (ABC) can be used to assign overheads or indirect costs. There are two steps in ABC. Firstly, figuring out the cost of resources and assigning them to activities. And secondly, giving output to each action.
- Process costing method: This type of cost accounting is employed when a business is constantly producing the same service. Processing units can also be assigned costs, which become inputs in the chain step or the product’s final value. Credit cards, postal delivery, etc., use process costing methods.
- Hybrid costing method: Several service industry companies use a costing method, which is neither a job nor a process costing method. These companies employ a hybrid costing method, which combines elements from both these costing methods.
Ways for calculating costs
How is the cost used for cost accounting calculated? There are three primary ways - direct tracing, cause and effect and allocation.
Direct tracing: In this method, the cost is directly traced from the inputs to the outputs. This is the most challenging way of estimation as it takes a lot of time, patience and observation.
Cause and effect: In this method, the activities are linked with the resources spent. For instance, a manager cannot have their salary related to specific deliveries under his watch. This is because these individuals oversee several deliveries at once. However, if they participate in a particular delivery, a part of their salary could be attributed to the specific delivery.
Allocation: In this method, the costs are distributed according to common factors. In the previous scenario, the salary of a manager can be distributed evenly among the number of deliveries that took place under their watch.
Cost unit types in service costing
It is a complex process to calculate the cost of business operations in the service industry. This is because all the cost parameters must be considered when deciding on a suitable costing unit.
Listed below are the two types of cost units ascertained with survive costing:
Simple cost unit
A simple cost unit can be defined as employing only one parameter when measuring the service cost. Some of the service organisations and their simple cost units are:
Nature of organisation with Cost unit
Road maintenance - Per kiloliter
Water supply - Per kiloliter
Gas - Per cubic metre / per kilogram
Canteen - Per person / per meal / per staff
Boiler house - Per 1000 lbs
Street lightingv - Per lamp / per point
Private transport - Per unit / per kilometre / per passenger / per trip
Composite cost unit
Composite cost units are the service industry's most commonly used cost units. This method combines two parameters to create a single cost unit.
Here are the various kinds of service organisations and the composite cost units:
Nature of organisation with Cost unit
Hotel - Per room-night / per room-day / per bed-day
Hospital - Per patient-day / per bed-day
Passenger transport - Per quintal-kilometre / per tonne-mile
Electricity - Per kilowatt-hour
Boiler house - Per cubic centimetre-liter
Goods transport - Per quintal-kilometre / per tonne-mile
Theater or cinema - Per ticket-show
The formula of cost per unit
The formula for calculating the cost per unit is:
Cost per service unit = Total costs for the period / Number of service units in the period
Limitations of cost accounting
There are several benefits of cost accounting. Using this method, management can get a clear picture of the resources being used in the company by associating the costs with the outputs.
On the other hand, there are some drawbacks as well. It is a tedious process which demands a lot of time and resources. Also, this method is ideal for some service sectors, such as banks and hospitals. In contrast, cloud computing companies will find implementing a little more challenging.
Service costing is very important as every service industry has to ascertain its business overheads. With this, companies can ensure proper pricing of services as well as keep control over the fixed and variable costs.
Cost accounting deals with establishing the connection between inputs' costs and the outputs resulting from them.
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