Chapter 6
Service Costing
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
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
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
2
Service vs. 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
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
3
Other aspects of services
 Retailers and wholesalers are part of the
service sector
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 parts of the value
chain may produce services
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
4
Cost classifications in
service firms
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
5
The value chain in service
firms
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
6
The value chain in service
firms
 Upstream activities and costs
 Only large firms may have 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 material not significant
 Upstream and downstream costs may be regarded
as overhead costs for service costing purposes
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
7
The value chain of 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 often distribution
included
 Downstream activities and cost
Marketing activities, delivery and customer
support important
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
8
Types of service entities
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
9
Professional services
 Staffed by professional staff who provide
personal services and serve relatively few
customers
 The front office is more important than the
back office
 Examples: medical, legal, accounting,
management consulting, and architectural
businesses
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
10
Mass services
 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
 Examples: bus and train companies, airline
companies, post offices, electricity supplies,
telecommunications companies, public
service organisations
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
11
Service shops
 Fit between professional and mass service
businesses in terms of number of
customers, staff time and degree of
customisation
 Examples: hotel chains, banks, cafés and
restaurants, print shops and car repair
workshops
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
12
Costing systems for service entities
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
13
Job costing for professional
service firms
 Professional service firms have limited
material or equipment, 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
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
14
Process costing for (some)
mass service firms
 Services are produced in large quantities, so
individual tracking of costs is not feasible
 Production processes are repetitive, 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
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
15
Hybrid costing systems
 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
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
16
Activity-based costing for
services
 Service entities often have high direct
labour cost that can be directly traced 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, and more benefits
may be gained from activity-based costing
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
17
Case study: 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
Will include upstream and downstream costs
Identify the overhead cost driver, often professional
labour
Predetermined overhead rate per dollar of professional
labour
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
18
Case study: Adelaide bank
 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
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
19
Case study: Adelaide bank
 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 of 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
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
20
Case study: Adelaide bank
 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
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
21
Case study: Adelaide bank
 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
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
22
When do firms estimate
service costs?
 No external reporting requirements to
estimate individual service costs
 Service costing systems will be used where
benefits exceed costs
 Cost and benefits influenced by
Complexity of the costing system
Accuracy of the service cost information
Relevance of service cost information to the
firms’ strategy and competitive environment
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
23
Factors affecting the decision
to implement service costing
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
24
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 from a costing system must
exceed the costs of setting up the system
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
25
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 COGS, in statements of
financial performance
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
26
Flow of costs in service firms
 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-progress (AASB1019)
Consist of accumulated costs of jobs, where
fees are not realised
Only production costs can be included
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
27
Costing in retail and
wholesale businesses
 Two distinct aspects
Tangible goods are sold
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
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
28
Costing in retail and
wholesale businesses
 Cost of good 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
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
29
Costing in retail and
wholesale businesses
 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
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
30