The Cost Equation

Sensitivity: Internal Management Accounting

Service Costing
Service costing is used when an organization or department provides a service. There are
four main differences between the ‘output’ of service industries and the products of
manufacturing industries.

1. Intangibility – output is in the form of ‘performance’ rather than tangible (‘touchable’)

goods.
2. Heterogeneity – the nature and standard of the service will be variable due to the high
human input.
3. Simultaneous production and consumption – the service that you require cannot be
inspected in advance of receiving it.
4. Perishability – the services that you require cannot be stored.

Examples of service industries include the following:

• hotel
• college
• hairdressers
• restaurant.

Sensitivity: Internal Management Accounting

Service Costing
Unit cost measures for service costing
One of the main difficulties in service costing is the establishment of a suitable cost unit. In
some situations it may be necessary to calculate a composite cost unit.

A composite cost unit is more appropriate if a service is a function of two variables.

Examples of composite cost units are as follows:

– tonne-miles for haulage companies
– patient-days for hospitals
– passenger-miles for public transport companies
– guest-days for hotel services.

What can be cost unit for a:

1. Restaurant
2. Financial Consultant
3. Travel Agent
4. Lawyer

Sensitivity: Internal Management Accounting

Service Costing - Example

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 Ordering and Accounting for Inventory

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Ordering, purchasing and receiving

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Accounting for inventory - the material account

Sensitivity: Internal Management Accounting

Inventory Valuation
There are three main inventory valuation methods:
– FIFO
– LIFO
– Weighted average cost.

First In First Out – FIFO assumes that materials are issued out of stock in the order in which
they were delivered into inventory.

Last In First Out – LIFO assumes that materials are issued out of inventory in the reverse
order to which they were delivered into inventory.

Weighted average cost – AVCO values all items of inventory and issues at an average price.
The average price is calculated after each receipt of goods. The average price is calculated by
dividing the total purchase costs to date by the total units received to date.

Sensitivity: Internal Management Accounting

Stocktaking
Periodic stocktaking involves checking the balance of every item of inventory on the same
date, usually at the end of an accounting period.

Continuous stocktaking involves counting and valuing selected items of inventory on a

rotating basis. Specialist teams count and check certain items of inventory on each day. Each
item is checked at least once a year with valuable items being checked more frequently.

Any items which are identified as being slow-moving or obsolete should be brought to the
attention of management as soon as possible.

Slow-moving items are those inventory items which take a long time to be used up.

Obsolete items are those items of inventory which have become out of date and are no
longer required.

Sensitivity: Internal Management Accounting

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Ahmed Jawad Syed Ahmed Jawad Hussaini

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Sensitivity: Internal Management Accounting