Service costing

Chapter 6Service costing6-1Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithOutlineWhat are service organisations?Differences between service and manufacturing businessesValue chains in service firms, retailers and wholesalersService production environmentsActivity-based costing for servicesCase study: Service costing at Adelaide BankWhen should firms estimate their service costs?Flow of costs in service firmsCosting in retail and wholesale businesses6-2Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithWhat 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 economiesprivate sector, public sector, not-for profit sector6-3Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithDifferences between service and manufacturing businessesMost services are intangibleService outputs are often heterogeneousServices are often consumed as they are producedServices are perishable and cannot be storedSome services entail some minor physical or tangible aspects6-4Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithOther aspects of servicesRetailers and wholesalers are part of the service sectorThey have different characteristics to most service firmsProvide tangible goods as well as servicesServices are produced outside the service sectorMost manufacturing firms provide a service component to their productUpstream and downstream segments of the value chain may produce services6-5Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith6-6Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithThe value chain in service firmsUpstream activities and costsOnly large service firms may have research and development (R&D) and design activitiesDownstream activities and costsMarketing and customer supportProduction and delivery activities and costsProduction and delivery may occur simultaneouslyDirect labour may dominate and materials may not be significantUpstream and downstream costs may be regarded as overhead costs for service costing purposes6-7Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith6-8Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithThe value chain for retailers and wholesalersUpstream activities and costsR&D and design unlikely to be relevantPurchasing activities importantProduction activities and cost The sales transaction and (sometimes) distribution are includedSales and distribution may occur at the same timeDownstream activities and costMarketing activities, delivery and customer support are important6-9Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith6-10Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithService production environmentsProfessional service firmsStaffed by professional staff who provide individual services to customersThere are relatively few customers, despite having large numbers of staffThe front office is more important than the back officeService delivery involves people, more than equipment, and the emphasis may be more on the how the service is delivered rather than what is deliveredExamples: medical, legal, accounting, management consulting and architectural businesses6-11Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Service production environments (cont.)Mass service entitiesInvolve many customers, each one requiring limited staff time and limited customisationStaff are mainly non-professionalMost of the value is in the back office not the front officeThe service may involve equipment, and focus more on what is delivered rather than howExamples: bus and train companies, airline companies, post offices, electricity suppliers, telecommunications companies and public service organisations6-12Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Service shopsFit between professional and mass service businesses in terms of the number of customers, staff time and degree of customisationExamples: hotel chains, banks, cafés and restaurants, print shops and car repair workshopsSome service entities have aspects of mass service and professional service types6-13Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithService production environments (cont.)6-14Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithJob costing systems for professional service firmsProfessional service firms have limited material or equipment and produce no inventoriesProfessional firms suit a job costing environmentFew clients and jobsThe production process for each client is uniqueLabour cost can be traced directly to individual services in an economic mannerJob billing rather than job costing may be used 6-15Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithProcess costing systems for (some) mass servicesServices are produced in large quantities, so individual tracking of costs is not feasibleProduction processes are repetitive; there is limited room for customisationVarious services consume similar resourcesSubstantial indirect labourCosts tracked directly to production processesProcess costing will not provide accurate tracking of costs to services, where the scope for discretion in service delivery is high6-16Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithHybrid costing systems for service shops and (other) mass servicesSuitable for some service shops and some mass service entitiesVarying degrees of customisation, standardisation of processes and traceability of costs Costing systems will vary on a continuum from job costing to process costing6-17Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithActivity-based costing for servicesService entities often have high direct labour costs that can be traced directly to services Overhead costs can be allocated to services using cost driversThe greater the proportion of overhead coststhe greater the potential for inaccurate service costsmore benefits may be gained from accurate activity-based costing, versus conventional costing systems6-18Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithCase study: Costing services at Adelaide BankJob costing—investment advisory services Professional labour costsTraced to jobs using an hourly rateHourly rate based on annual salary plus on-costs, divided by billable hoursOverhead costsIncludes upstream and downstream costsIdentify the overhead cost driver, often professional labourPredetermined overhead rate per dollar of professional labour6-19Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Case study: Costing services at Adelaide Bank (cont.)Why estimate the cost of investment advisory services?A basis for setting feesTo assess the profitability of each serviceTo determine which service to promote, refine or withdrawTo control costsJob billing may be used rather than costing to determine feesCharge out rates per billable hour; includes an allowance for overheads and required profit margin6-20Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Case study: Costing services at Adelaide Bank (cont.)Process costing—ATM servicesThree processesThe provision of ATM service facilitiesInitial transaction processing by front-end processorBack-end processing Few direct costs for the ATM transactionSubstantial indirect labour costs in front-end and back-end processingSubstantial equipment-related costsDegree of completion and transferred-in costs not relevant6-21Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Case study: Costing services at Adelaide Bank (cont.)Why estimate ATM services?To set fees Assess the profit or loss associated with each transactionInformation for controlThe cost per transaction should be used with caution in decision makingIncludes a high proportion of indirect costs which do not behave on a per-unit basis6-22Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Case study: Costing services at Adelaide Bank (cont.)Hybrid costingSome 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 needsCosting systems may cost only some services, based on decision-making needs6-23Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithWhen should firms estimate their service costs?No external reporting requirements to estimate individual service costsService costing systems will be implemented where benefits exceed costsCost and benefits are influenced by Complexity of the costing systemAccuracy of the service cost informationRelevance of service cost information to managing resources and creating value6-24Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)When should firms estimate their service costs? (cont.)Relevance to creating value and managing resourcesManagers can use service costs to assess service profitability, decide what service to produce/offer, set prices/fees, and to plan and control costsComplexity, accuracy and relevance of service costing will vary across different types of service environmentsService costing may be undertaken infrequently and selectively to meet managers’ needs6-25Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith6-26Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithService costing in practiceJob costing is common in professional service firms and some service shopsCosting systems in service firms tend to focus on the costs of responsibility centresFirms may choose to cost only some services to support management decisionsThe benefits of a costing system (or an individual costing exercise) should be compared to the costs of setting up the system6-27Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithFlow of costs in service firmsNo inventory to value, so external reporting requirements not relevantIndividual service costs are usually not accumulated in the general ledgerCosts are shown as line item operating expenses, not cost of goods sold (COGS) in income statements6-28Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Flow of costs in service firms (cont.)Service costs not usually integrated into the accounting ledger, so overapplied or underapplied overhead not relevantSome service firms do need to account for work-in-process (AASB 102)Consist of accumulated costs of jobs, where fees are not realisedOnly production costs can be included6-29Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithCosting in retail and wholesale businessesTwo distinct aspectsTangible goods are soldThere is a wide range of goodsInventories and COGS are recorded in the accounting ledgerInventories must be valued at the end of an accounting period at the lower of cost or net realisable value6-30Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)Costing in retail and wholesale businesses (cont.)Cost of goods soldCost of beginning inventory + purchases – cost of ending inventoryHow may managers use COGS?Assess the profitability of various product lines and responsibility centresGuide product pricingUpstream and downstream costs may be included to provide a more comprehensive estimate of COGS for decision making6-31Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith(cont.)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 chainFor accounting purposes, these costs are expensed in the current accounting periodFor management decisions, these service costs may need to be identified to help manage resources6-32Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-SmithSummaryMost service outputs are intangible, heterogeneous, consumed as produced, perishable and cannot be storedThe type of service costing system may depend on the service environmentJob costing may suit professional servicesProcess costing may suit mass servicesOverhead costs may include upstream and downstream costsUnlike in manufacturing, service costs are solely to support managers’ decision making6-33Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-SmithPrepared by Kim Langfield-Smith