CIMA - C1 Fundamentals of Management Accounting
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14: Service costing ⏐ Part D Costing and accounting systems
During a slack week, only six journeys were made.
Journey Tonnes carried (one way) One-way distance of journey
Kilometres
1 5 100
2 8 20
3 2 60
4 4 50
5 6 200
6 5 300
The expected average full cost per tonne-kilometre for the week is $
.
Answer
The expected average full cost per tonne-kilometre for the week is $
0.304
Workings
Variable costs
Journey 1 2 3 4 5 6
$ $ $ $ $ $
Loading labour 10 16 4 8 12 10
Petrol (both ways) 20 4 12 10 40 60
Repairs (both ways)
10
2
6
5
20
30
40
22
22
23
72
100
Total costs
$
Variable costs (total for journeys 1 to 6) 279
Loading equipment depreciation 80
Loading supervision 80
Drivers' wages 200
Vehicles depreciation 160
Drivers' supervision 120
Other costs
200
1,119
Journey One-way distance
Tonnes Kilometres Tonne-kilometres
1 5 100 500
2 8 20 160
3 2 60 120
4 4 50 200
5 6 200 1,200
6 5 300
1,500
3,680
Cost per tonne-kilometre
3,680
$1,119
= $0.304
Note that the large element of fixed costs may distort this measure but that a variable cost per tonne-kilometre of
$279/3,680 = $0.076 may be useful for budgetary control.
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Part D Costing and accounting systems ⏐ 14: Service costing
341
Question
Hourly rates
Mr G and Mrs H have recently formed a consultancy business, and have sought your advice concerning costs and fees.
Both wish to receive a salary of $20,000 in the first year of trading. They have purchased two cars at a cost of $13,000
each and expect to use them for three years. At the end of this time each of the cars has an expected resale value of
$4,000. Straight-line depreciation is to be applied.
Mr G and Mrs H expect to work for eight hours per day, five days per week for 45 weeks per year. They refer to this as
available time. 25% of the available time is expected to be used for dealing with administrative matters related to their
own business, and in the first year it is expected that there will be idle time which will average 22.5% of the available
time. The remainder of the available time is expected to be chargeable to clients.
Mr G and Mrs H agreed that their fee structure should comprise the following.
• An hourly rate for productive client work
• An hourly rate for travelling to/from clients
• A rate per mile travelled to/from clients
They expect that the travelling time will equal 25% of their chargeable time, and will amount to a total of 18,000 miles.
They have agreed that this time should be charged at one-third of their normal hourly rate.
Apart from the costs referred to above, Mr G and Mrs H have estimated their other costs for the first twelve months as
follows.
$
Electricity 1,200
Fuel for vehicles 1,800
Insurance – professional liability and office 600
Insurance – vehicles 800
Mobile telephones 1,200
Office rent and rates 8,400
Office telephone/facsimile 1,800
Postage and stationery 500
Secretarial costs 8,400
Servicing and repairs of vehicles 1,200
Vehicle road tax 280
The consultancy business should break even after paying the required salaries.
If costs are classified as either professional services costs or vehicle costs, then, on the basis of the above data and
costs,
(a) the hourly rate for productive client work is $
(b) the hourly rate for travelling to/from clients is $
(c) the rate per mile travelled to/from clients is $
Answer
(a) The rate is $
39.43
(b) The rate is $
13.14
(c) The rate is $
0.56
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14: Service costing ⏐ Part D Costing and accounting systems
Workings
Cost analysis
Professional
Vehicle
services costs
costs
$
$
Electricity
1,200
Fuel for vehicles
1,800
Insurance: professional liability and office
600
vehicles
800
Mobile telephones (note 1)
1,200
Office rent and rates
8,400
Office telephone/fax
1,800
Postage and stationery
500
Secretarial costs
8,400
Servicing and repairs of vehicles
1,200
Vehicle road tax
280
Vehicle depreciation (note 2)
6,000
Salaries
40,000
62,100
10,080
Notes
1 It is assumed that mobile telephones are used in providing professional services and that their use is not
consequent on travelling.
2 Annual depreciation =
3
000,4$000,13$ −
× 2 cars = $6,000
Analysis of available time
Total hours per annum
(8 × 5 × 45) × 2 people =
3,600 available hours
Less: administration
25.0%
idle time
22.5%
47.5% × 3,600 =
(1,710
) hours
1,890
hours
Travelling time (25%) 427.5 hours
Productive time (75%) 1,417.5 hours
Rates
Travelling time is to be charged at one third of the normal hourly rate.
'Weighted' chargeable time = 1,417.5 + (472.5/3)
= 1,575 hours
∴ Rate per productive hour
= $62,100/1,575
(a) Hourly rate for productive client work = $39.43
(b) Hourly rate for travelling (÷ 3)
= $13.14
(c) Rate per mile travelled = $10,080/18,000
= $0.56
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Part D Costing and accounting systems ⏐ 14: Service costing
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1.6 Job costing and services
Remember that job costing applies where work is undertaken to customers' special requirements. An organisation may
therefore be working in the service sector but may supply one-off services which meet particular customers' special
requirements; in such a situation job costing may be more appropriate than service costing. For example, a consultancy
business, although part of the service sector, could use job costing.
2 Management reports
Management reports based on cost accounting information should be formatted to aid management to cost products
and services, and to plan, control and make decisions.
We finish this Study Text by referring you back to the very first sections of the very first chapter.
Cost accounting provides information for management to enable them to cost products or services, and to plan, control
and make decisions.
The format of cost accounting reports is entirely at management discretion. Each organisation can devise its own
management accounting system and format of reports.
So, whatever the type of organisation, be it production or service, commercial or not-for-profit, private sector or public
sector, the cost accounting management reports should be formatted in the most appropriate way so as to provide
information to management to enable them to cost products/services, plan, control and make decision.
As you have worked through this part of the Study Text in particular you should have noticed the sort of information
management of organisations in job, batch, process and service industries need.
2.1 Information for management
For example, suppose a private hospital has three main revenue earning departments – maternity, surgical and
orthopaedic. These departments are supported by many other departments, some of which also earn revenue by
charging for services undertaken for external customers.
The radiology department is one of these departments. In addition to undertaking x-ray work for the above three hospital
departments, it charges for external work involved in carrying out x-rays on patients who have been referred to it by
doctors in general practice. After this work has been done, patients may continue their treatment within the hospital.
Let's have a think about the type of information which ought to be provided within the hospital for operational control
and for making proper charges for services.
2.1.1 Information for operational control
(a) Responsibility centres
For effective operational control each department within the hospital should be a separate cost or profit
centre with a manager responsible for the performance of each centre.
Those centres which have a measurable output, such as the maternity, surgical, orthopaedic and radiology
departments, can be designated as profit centres since it is possible to determine their revenue and
therefore their profit. Other departments would operate as cost centres, responsible for the control of
their own costs.
FA
S
T F
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RWAR
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14: Service costing ⏐ Part D Costing and accounting systems
(b) Coding systems
The information system should contain an efficient coding system to ensure that all costs and revenues
are charged and credited to the correct responsibility centre.
(c) Control reports
The costs and revenues collected for each centre should be reported to the manager of the centre on a
regular basis, at least monthly.
The reports should show separately controllable and uncontrollable items. For example the costs directly
incurred by the department, which are under the control of the responsibility centre manager, should be
separated from the uncontrollable costs. The latter would include items such as central administration
charges. Although there is an argument for excluding these charges altogether, it can be useful to show
them on the control reports so that managers are aware of the cost of providing them with administrative
support services.
(d) Establishing a basis for comparison
The most effective way of achieving operational control is to compare each department's costs, and
revenues if appropriate, with some form of yardstick.
The best basis of comparison is a budget, which should be divided into time periods according to the
frequency with which control reports will be prepared.
Variances can then be calculated and analysed. A system of exception reporting should be adopted so
that the busy manager's attention is drawn to those areas where management action is most urgently
needed.
(e) Determining appropriate cost units
For those departments with measurable activity a suitable cost unit or a series of cost units should be
established. This is particularly applicable where output can be standardised, or where activities can be
analysed into a series of standard tasks such as taking an x-ray.
The cost units can be used to control costs by establishing a standard cost and providing mangers with
information which compares actual unit cost with standard and which identifies any variances.
(f) Flexible budgets
Control information can be improved if it is based on a system of flexible budgets. This is particularly
relevant if activity levels fluctuate and a significant proportion of costs is variable.
Once a cost unit has been established the budget cost allowance for the period can be determined based
on the actual activity achieved. This will enable a more realistic budget comparison for more effective
operational control.
(g) Ad hoc reports and future projections
As well as routine reports, the hospital information system should be capable of providing ad hoc advice
for managers on the cost and revenue affects of proposed activities. For example it should be possible to
project future costs for the purpose of tendering for work.
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Part D Costing and accounting systems ⏐ 14: Service costing
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2.1.2 Information for charging for services
A well designed information system will provide the basis for making proper charges for services.
Once a suitable cost unit has been established the system should be capable of accurately measuring the units of
activity so that the correct charge is made for services provided.
For tendering and quotation purposes it will be necessary to be able to project costs in order to determine a reasonable
price to be charged. This will require an understanding of the cost behaviour pattern for each department.
The standard cost used for operational control could provide the basis for charging for services. An activity based
analysis may provide a better understanding of the cost of services provided. For example the process of taking an x-ray
could be broken down into a series of activities with a separate cost driver for each (the cost per patient transported to
x-ray, and the cost per film processed for example).
Once a realistic standard cost has been established, management can decide on the required margin to be added to
achieve a price for the service provided.
2.2 Figures for management
Here are some figures that might be highlighted in some (or many) management reports.
(a) Gross revenue is income (at invoice values) received for goods and services over some given period of
time. It is used as an indicator of the level of demand for the organisation’s product or services.
(b) Value-added is sales less cost of bought-in materials and services, and represents the wealth or value
created by an organisation’s operations. It is affected only by costs incurred internally, such as labour, and
is therefore useful as a target. (Sometimes value added is calculated as profit plus interest plus all
conversion costs).
(c) Contribution is the difference between sales revenue and variable costs of sale. It is used in decision
making as fixed costs are not relevant to many business decisions.
(d) Gross margin is the ratio of gross profit to sales revenue and is used to look into the relationship between
production/purchasing costs and sales revenues and to analyse the pure trading activities of an
organisation. It can be increased by raising prices and/or by negotiating lower prices with suppliers. It is
calculated as ((sales – cost of sales)/sales for the period) × 100%.
(e) Marketing expense may be compared to revenue on a period by period basis to see whether the
expenditure has produced the desired increase in sales and in which areas.
(f) General and administrative expenses need to be carefully controlled in order to keep net profit margins
at an acceptable level. They may be targeted as an area for cost reduction if the organisation is trying to
improve its profitability.
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14: Service costing ⏐ Part D Costing and accounting systems
Chapter Roundup
• Service organisations do not make or sell tangible goods.
• Specific characteristics of services
– Intangibility
– Simultaneity
– Perishability
– Heterogeneity
• One main problem with service costing is being able to define a realistic cost unit that represents a suitable measure of
the service provided. If the service is a function of two activity variables, a composite cost unit may be more appropriate.
• Average cost per unit of service =
Total costs incurred in the period
Number of service units supplied in the period
•
The success of not-for-profit organisations
cannot be judged in terms of profitability, nor against competition.
•
Management reports
based on cost accounting information should be formatted to aid management to cost products
and services, and to plan, control and make decisions.
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Part D Costing and accounting systems ⏐ 14: Service costing
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Quick Quiz
1 With many services the cost of direct materials will be relatively high.
True
False
2 Match up the following services with their typical cost units
Service Cost unit
Hotels Patient-day
Education Meal served
Hospitals Full-time student
Catering organisations Occupied bed-night
3 What are the specific characteristics of services.
I Intangibility
II Heterogeneity
III Perishability
IV Consistency
V Regularity
VI Simultaneity
A I, III, V and VI
B II, III, IV and V
C I, II, III and VI
D II, IV, V and VI
4 Average cost per unit of service =
...........................
...........................
5 Value added is:
A Sales less cost of materials and services
B Sales less labour cost
C Sales less internally generated costs
D Sales less cost of bought-in materials and services
6 Which two of the following might be characteristic of a hospital?
Use of composite cost units
Use of equivalent units
High levels of indirect costs as a proportion of total cost
Calculation of profit per patient
?
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14: Service costing ⏐ Part D Costing and accounting systems
Answers to Quick Quiz
1 False. Labour, direct expenses and overheads will be a greater proportion of total cost.
2 Service Cost unit
Hotels Patient-day
Education Meal served
Hospitals Full-time student
Catering organisations Occupied bed-night
3 C
4 Average cost per unit of service =
period the in supplied units service of Number
periodthein incurredcostsTotal
5 D
6 Service costing characteristics include composite cost units and high levels of indirect costs as a proportion of total
cost. Not-for-profit organisations such as hospitals would not measure performance on profit so profit per patient would
be inappropriate. Equivalent units are used in process costing, not service costing.
Now try the questions below from the Question Bank
Question numbers Page
87–92 371
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Question bank
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