MEASURING COSTS IN THE SERVICE INDUSTRIES:
NEW CHALLENGES IN A CHANGING ECONOMY
An Honors Thesis (ID 499)
by
Janet S. Howe
Dr. Barnhart, Thesis Director
Ball State University
Muncie, Indiana
March, 1987
Expected Date of Graduation:
Spring Quarter 1987
-
Sr C <'1i
111(-::) .
l.- "L./
,-'il P
.,
~,
'
INTRODUCTION
Today
economy
jobs
the
United
States is moving from
to a service economy.
created
an industrial
Four out of every
presently are service jobs,
five
new
and services
now
1
account for almost 70% of the Gross National Product.
examples
utilities,
communication,
medicine,
many
the
of
services
transportation,
are
retail and wholesale trade,
entertainment,
education,
Some
banking,
law,
insurance,
advertising, and accounting.
The
shift from manufacturing to services has
implications
for
the
and
movement
is causing much concern to people both in
the
causing
more unemployment and low-paying jobs,
Barry Bluestone. 2
economist
important,
the
to
service
economy
out
is
according to
How we plan for it is extremely
The President and some politicians
preserve
industry
government
and
and Congress has responded by holding hearings on
matter.
trying
The growth of the service
government.
This
future.
economic
of
social
explosive
high-paying manufacturing jobs
grows.
should
have
Other politicians feel
not resist the change,
but
been
as
the
that
the
should
help
enter
the
can
find
workers adapt to it.
ENTRY INTO THE SERVICE SECTOR
Although
service
-
growth,
expansion
manufacturers
sector,
profit,
in
once
and
are
they
reluctant
have done so,
even
happiness
to
"they
- particularly
mature manufacturing areas becomes
1
harder
as
to
.-
3
achieve."
Entry
Usually
is
it
not as difficult as some
is just putting to work the
experience
providing
with
assets,
believe.
resources,
Most manufacturers have had
and knowledge they already have.
some
companies
because
services
they
have
them free for years as part of their sales
been
or
to
improve customer relations.
According to Irving D.
ways to
enter
following
field.
a
into
Canton, there are many different
the service
paragraphs. 4
as
sector,
in
the
One way is to go into the financial
Any company whose customers have to borrow money from
financial institution to buy its products
establishing
deriving
a credit subsidiary.
added profits,
firms for years.
that
seen
has
allows
could
consider
This is a proven way
and one that has been used by
of
some
General Motors is an example of one company
done this.
It finances dealer
inventories,
its customers to receive installment
loans
and
entirely
through the GMAC subsidiary.
Another
opportunity
for
firms to
capitalize
on
the
services economy is for a company to take over a service from
the
public sector.
products
that
are used in a government service may be able to come up
with
some
Control
this
-
Any company that manufactures
cost-saving ways to provide the
service
itself.
Data provides an example of a company that has
successfully.
disadvantaged,
It
conducting
is
involved
international
educational and small business programs,
for former prison inmates.
in
training
barter,
done
the
operating
and financing
cars
The company firmly believes that
2
unmet
"every
opportunity
need
of
society
is
and that corporations,
a
potential
not
business
should
government,
take the lead in finding new ways to solve unemployment,
run
public schools and prisons, and redevelop inner cities." 5
Many
manufacturing companies could consider
national
some
opening
Also,
service chain to repair their own products.
companies
might enhance profits by
For
example,
management
and
processing
systems
could
operate the systems properly,
not
shared services.
offering
contract
many
suppliers realized that their
data
customers
so they
staff,
offer management contracts to equip,
a
began
and manage
to
the
customers' systems.
Companies
operations
that have underused capacity in any of
could
explore
the
possibility
of
their
furnishing
services to other companies, as is illustrataed by KimberlyClark.
The
aircraft
firm
many
began
years
operating
ago.
fleet
a
These
aircraft
of
corporate
required
a
maintenance staff which kept growing in size and proficiency,
so
Kimberly-Clark
corporate
plane
decided
owners.
to offer its services
Now
it is
one
of
the
to
other
leading
companies in the maintenance of corporate aircraft.
A
of
company that provides free service with the
its
product
separately,
as
could
consider
marketing
the
purchase
service
Sears does with its maintenance contracts on
appliances.
The above illustrations are just a few of the many
to
enter
the
service
sector.
3
Long
range
planners
ways
of
manufacturing companies should carefully identify and examine
the
many
opportunities available in the service
sector
to
enhance profits by expanding in that direction.
THE PROBLEM OF MEASURING COSTS
Service innovation and increased competition have made it
extremely
important
accounting
system
accurately
and
that
that
providers
allows
of
them
services
many
an
costs
measure
to
Unfortunately,
quickly.
have
service
organizations typically have had either no cost system or one
that
firms
in
service
accounting
the
One of the problems has been that
is very inadequate.
industries have tried to
tool in measuring costs.
manufacturer's
the
wrong
They have tried
using
which is
cost system,
use
designed
for
a
different type of operation.
In
has
manufacturing industries,
four
main uses:
control,
(3)
profitability
inventory
(1)
term
short
analysis. 6
product cost
planning,
The
information
(2 )
valuation,
(4 )
and
techniques used
to
cost
product
develop
information regarding the first three do not provide relevant
information to service organization managers,
as illustrated
in the following paragraphs.
Inventory Valuation
In traditional
,-
product costing,
the costs have to
separated
into period and product costs for the
inventory
valuation.
purpose
be
of
Product costs are costs that directly
or indirectly change the physical form of the product and are
accumulated
as inventory.
All other costs are
4
treated
as
period
costs
In a service industry,
costs.
because
there
are
traditional
Therefore,
no
all costs are period
inventories
product
to
valued.
be
costing techniques
do
not
apply when trying to determine the cost of a service.
Manufacturing Cost Control
For controlling manufactuing costs,
used
mostly
elements
of
the
found only sparingly
be
and
direct
organization
controlled
Most
would
by
using
be
Overhead
as overhead in a standard cost system.
better
labor,
in service industries.
costs incurred in a service
classified
can
to control direct material
standard costs are
budget
traditional
procedures than a standard cost system; hence a standard cost
system has limited applicability in a service industry.
Short Term Planning
Cost accounting
information is used
financial
managerial decisions that
impact
of
volume of sales in the short run.
financial impact,
with production.
7
to
estimate
the
affect
the
In order to calculate the
the accountant must know which costs
vary
In manufacturing, the majority of costs, 60
to 90 per cent, are variable costs.
In the service industry,
however, variable costs are typically only a small portion of
total costs.
costs
Therefore,
between
to divide a service organization's
variable costs and fixed costs
would
be
of
limited benefit.
The
above
illustrations
demonstrate
that
standard
costing techniques used in short term planning, cost control,
and
inventory
valuation
are
service industries.
5
virtually
worthless
in
the
MATCHING COSTS AND REVENUES
of
Instead
techniques
system
to
that
to
adapt
is
tailored to
system
the
should
the
be
able
to
we
must
be
able to assign the
cost
properly
If
industry.
determine
the
To be able to
profitability of each individual service.
this,
costing
standard
we should design a
a service industry,
the
designed,
trying
relevant
costs
do
and
revenues to each type of service offered.
profitability
the
costs
only
The
that
are
relevant
are those that can be uniquely
production
and sale of the
particular
costs
that
eliminated.
they
could
be
attributed
.
8
serVlce.
to
All
Unique costs are defined
other costs are called joint costs.
as
analyzing
in
eliminated
if
the
service
was
Joint costs are not assigned to the service, as
remain unchanged whether or not the product is produced
and sold.
The technique used to separate these costs is
by
John
Deardon
Business Review.
a
in
the September 1978
issue
described
of Harvard
"You start from the broadest definition
product line and separate the unique costs from the
costs
line
for the product line,
into product groups,
and then subdivide the
of
joint
product
repeating the process down to the
smallest unit of service available."
After
determined,
the profitability of different services has
they must be ranked.
return on investment.
the
been
One way to rank them is by
To do this, the accountant must divide
profit by the investment for each service and rank
6
them
in
The investment is defined as
order of high to low.
amount that is uniquely attributable to the product.
way
to
rank
them
and
investment
multiply
cost
For
profitability.
in
it
by
the
of
marginal
company's
The last ranking method is called
borrowing rate.
These
the
Another
In this method, the accountant would calculate the
interest.
ranked
is by profit in excess of
the
order
methods
this
the services
method,
of their total
contribution
but
may be time consuming,
obtained is extremely
absolute
should
to
the
be
profits.
information
valuable.
MEASURING COSTS IN THE BANKING INDUSTRY
One
of
the most pervasive services in our
banking.
In
recent
years,
pressured
to
design
accounting systems
profitability
installment
factors
of
loans,
are
margins,
each
the banking
service;
certificate
causing
e.g.
of
the pressure,
society
is
industry has been
to
determine
checking
deposits,
like
the
accounts,
etc.
shrinking
Many
profit
expansion of service, changes in customer needs and
perceptions,
increased
the
requirements of regulatory
competition
among
banks
and
from
agencies,
and
outside
the
traditional banking community. 9
Banks
have
techniques.
One
always had
trouble
using
reason is because banks have traditionally
charged a set cash fee for some services.
service was usually free,
certain level.
product-costing
Checking
account
as long as a deposit remained at a
In some NOW accounts, the bank paid interest
when the average balance or lowest monthly balance
7
was above
some prescribed minimum.
to
Cost accountants agree that the way
match costs and revenues is to determine the cost of
the
service and the revenue corning from the deposit.
Banks
have
also
had trouble measuring the
effort required to provide a service.
involved in providing many services,
amount
Usually an employee is
not just one.
Another
complication arises when a customer has many different
of
accounts.
of
providing one service independently of
determining
of
types
It becomes very difficult to measure the cost
how
much
revenue comes
others,
all
from
each
and
individual
account.
The
be
a
concept of responsibility accounting has proven
valuable
structuring
guide
responsibility
profitability
recent
times
in
One writer stat.es, "The principles of
is
accounting
are
met
if
determination
matches revenues with those costs
exercised. " 10
responsibility
revenues,
in
an accounting system which provides relevant and
reliable information.
control
for many banks
to
The
information
over
and
the
which
obtained
accounting helps the bank management
costs,
of
from
predict
volume of deposits and loans
to
expect from a service or territory.
Determination
of
specific
responsibility accounting system,
service industries,
and
indirect
Indirect
costs
costs
under
a
whether for banks or other
necessitates an identification of direct
costs.
interest costs,
service
Some
examples of
direct
costs
are
computer operation costs and employee wages.
must
be
further
8
divided
into
service
..-
costs
department
purchasing
printing,
like
training,
personnel
some general bank
and mail processing;
overhead
costs are advertising, top management salaries and directors'
Recognizing
fees.
the
direct
costs
as
controllable
is
central to the idea of responsibility accounting;; determining
the full costs of services for profit analysis or for pricing
new
services
costs
of
necessitates a cost structure based on
a service plus the allocation
of
direct
indirect
costs
determined on some logical basis.
MANAGEMENT ACCOUNTANT'S ROLE
Management
designing
revenues
have
and
accountants
operating
must
the
play a
systems
central
used
crucial
part
in
"data
definition,
and reporting."
analysis,
accountants
must take an active role in the
where
must
also
registration,
11 Service management
processing,
process
in
determine
They
and costs in service industries.
a
to
role
commercial services are
decision-making
involved,
introducing a new service or service contract,
such
as
a new branch,
a new line of business or a new market segment.
An
making
effective tool to assist the accountant's
process
consultant.
reasoning
ana 1 yze
would
the
is called an expert system,
a
decision-
computerized
Expert systems ask a series of questions and use
and decision-making processes of human experts
answers
an d rna k e
·
12
recommen d a t ,lons.
The
probably even be able to tell you how it came up
recommendations.
To
solve
the
problems,
systems use a knowledge base and heuristics.
9
the
to
system
with
expert
Heuristics is a
method
of
decision-making
13
intuition.
uses a
set
of
inductive
past experience,
judgement and logic,
and
that
rules
inference,
be effective in designing the
To
of
expert
systems, management accountants must be familiar with current
controlling and use of
technology concerning the processing,
The
information.
expert systems can also be used to
train
and educate new management accountants.
In
whatever
service business
context
information takes on a new importance.
that
management
his role as a supplier of relevant
accountant finds himself,
only
the
It is imperative not
the accountant know his "craft",
but that he
able to communicate relevant information to managers who
be
operating
accountant
becomes
this
may
end,
the
a teacher and a "silent partner" in
the
in unfamiliar territory.
To
is
decision-making process.
CONCLUSION
As the economy changes from a manufacturing economy to a
economy,
service
Manufacturers
industry;
accountants,
costs
are
being
are
many
challenged to
new
enter
challenges.
the
service
government is being challenged to regulate it; and
accountants
role
there
are being challenged to measure the
we
costs.
As
must accept this challenge and take a major
in designing and utilizing systems which
meaningfully
will
to determine the profitability
service.
10
measure
of
each
ENDNOTES
~.
Erich
Heinemann,
"Why
Not Have
Economy?,"Dun's Business Month, April 1985, p.64 .
2
a
Service
Ibid.
3Irving D.
Canton,
"Learning to Love the Service
Economy," Harvard Business Review, v.62, May-June 1984, p.89.
4Ibid , pp.90-97.
51 bid, p . 96 .
6
John Deardon,
"Cost Accounting Comes to
Service
Industries," Harvard Business Review, September-October 1978,
p. 133.
7Ibid , p.134.
8Ibid , p. 136.
9
Susan Alou and Roger A.
Roemmich,
"Responsibility
Accounting for Banks, " Management Accounting, May 1977,
p.35.
lOIbid, p.36.
llD.
Jordan, "Accountant's Role in Management of Service
Industries", Accountancy, March 1986, p.109.
12Michael D. Akers et al., "Expert Systems for Management
Accountants," Management Accounting, March 1986, p. 30.
131 bid, p . 3 1 .
11
BIBLIOGRAPHY
Akers,
Michael D.,
et al.
"Expert Systems for Management
Accountants," Management AccountinK, pp. 30--34.
Alou,
Susan,
and Roemmich,
Roger A.
"Responsibility
Accounting for Banks," Management Accountin~,
May 1977,
pp. 35-38.
Canton,
Irving D.,
"Learning to Love the Service Economy,"
Harvard Business Review,
v. 62, May-June, 1984, pp. 8997.
Deardon, John, "Cost Accounting Comes to Service Industries."
Harvard Business Review September-October 1!}78, pp. 132140.
Heinemann, H. Erich, "Why Not Have a Service Economy?"
Business Month, v.125, April, 1985, pp. 64-65,68.
Dun's
Johnson,
Frank P. and Charles F.
Muenzberg,
"Can Cost
Analysis Improve Your Mortgage Loan Function'?" Management
Accounting, v. 61, February, 1980, pp. 22-25.
Jordan,
D.,
"Accountant's Role in Management of Service
Industries" Accountancy, v. 97, March 1986, pp. 108-110.
Sandretto,
Michael J.,
"What Kind of Cost System Do You
Need?" Harvard Business Review,
Jan-Feb.
1985, pp. 3642.
12