MANAC Project

Service Costing
Introduction:

Service sector, being a fastest growing sector and having a significant contribution towards the GDP
in India, is a very important sector where the role of the cost and management accounting is
inevitable. The competitiveness of a service entity is very much dependent on a robust cost and
management accounting system for competitive pricing and identification of value adding activities.
Providers of services like transportation, hotels, financial services & banking, insurance, electricity
generation, transmission and distribution etc. are very much cost conscious and thrive to provide
services in a cost-effective manner.

Irrespective of regulatory requirements to maintain cost records and get the records audited, service
costing becomes integral and inseparable part of each service entity. We will be discussing an
overview of how costing is done in service sectors like Transportation, Toll roads, Electricity
generation, transmission and distribution, Hospitals, Canteen & Restaurants, Hotels & Lodges,
Educational institutes, Financial institutions, Insurance, Information Technology (IT) & Information
Technology Enabled Services (ITES).

The applications of service costing could be internal as well as external.

Internal: The service costing is required for in-house services provided by a service cost center to
other responsibility centers as support services. Examples of support services are Canteen and
hospital for staff, Boiler house for supplying steam to production departments, Captive Power
generation unit, operation of fleet of vehicles for transport of raw material to factory or distribution
of finished goods to the market outlets, IT department services used by other departments, research
& development, quality assurance, laboratory etc.

External: When services are offered to outside customers as a Profit Centre in consonance with
organizational objectives as an output like goods or passenger transport service provided by a
transporter, hospitality services provided by a hotel, provision of services by financial institutions,
insurance and IT companies etc.

In both the situation, all costs incurred are collected, accumulated for a certain period or volume,
recorded in the cost accounting system and then expressed in terms of a cost unit of service

Service vs Product Costing:

Service costing differs from product costing (such as job or process costing) in the following ways due
to some basic and peculiar nature

 Unlike products, services are intangible and cannot be stored, hence, there is no inventory
for the services

 Use of Composite cost units for cost measurement and to express the volume of outputs

 Unlike a product manufacturing, employee (labor) cost constitutes a major cost element
than material cost

 Indirect costs like administration overheads are generally have a significant proportion in
total cost of a service as unlike manufacturing sector, service sector heavily depends on
support services and traceability of costs to a service may not economically feasible
Types of Service Costing
The different type of service costing are as follows
 Transport Costing
 Power Generation and Distribution Costing
 Boiler House Costing
 Canteen Costing
 Hospital Costing
 Hotel Costing

Transport Costing

Depending on the type of transportation service a company offers, costing in the transportation
industry achieves a number of goals: :

 Private Transport: When a vehicle is hired for a private tour, service costing is used
to assess the fees that will be charged.

 Passenger Transport: In the case of public or passenger transportation firms, it also

determines the cost of transportation, per passenger, up to a certain distance.

 Goods Transport: When it comes to goods transport systems, service costing

determines the cost of transporting a certain quantity of goods over a certain
distance.

The most popular goals of transportation costing are to compare two separate vehicles or groups of
vehicles, and to determine whether to use an alternative mode of transportation or one's own
vehicle in terms of cost.

Power Generation and Distribution Costing

Water, coal, or sunlight are used to generate electricity in powerhouses. Fixed costs, such as interest
on inventory, depreciation, repairs and maintenance, and administration expenses; and variable
costs, such as steam used, labor salaries, lubricants, gas, and so on, make up the majority of the cost
of power generation services.
Boiler House Costing

The boiler house supplies steam for air conditioning, power generation, and air compression, as well
as supporting services to power and energy generation units.

Fuel (coal, oil), direct and indirect labour, water and its processing, indirect material (tools, service
material), repairs, and fixed costs are all included in the overall cost of boiler services (rent, taxes,
depreciation, administration expenses, etc.).

Canteen Costing

Canteens are located in government organizations, warehouses, businesses, workplaces, universities,

schools, and even hospitals to provide employees, students, and patients with inexpensive foods such
as meals, refreshments, and snacks.

The canteen manager or supervisor maintains cost control and conducts service costing to determine
income for these businesses.

Material, labour, supplies, consumable shops, and miscellaneous overheads are all included in the
cost of canteen services.
Hospital Costing

Health institutions such as hospitals, community centers, nursing homes, medical camps, and clinics
offer programs that include cost analysis, which can be accomplished by service costing.

Fixed charges such as labour wages, maintenance fees, rent, administrative costs, and other
overheads are included in the hospital bill. The overall expense also includes variable costs such as
medications, bed charges, doctor's fees, and so on.

Hotel Costing

Hotels offer lodging as a service to their customers, which entails a high maintenance expense in
addition to the fixed cost. Depreciation, employee wages, capital interest, taxes, and other fixed costs
are included in the fixed expense. Whereas, variable cost involves electricity charges, temporary staff
salary, etc.

Determinants of Service Costing:

To compute the Service cost, it is necessary to understand the unit for which the cost is to be
computed. All the costs incurred during a period are collected and analyzed and then expressed in
terms of a cost per unit of service.

One specific issue with service costing is the difficulty in defining a realistic cost that represents a
suitable measure of the service provided. The cost unit to be applied needs to be defined carefully and
frequently, a composite cost unit may be deemed more appropriate.
For example, Hotels may use the ‘Occupied Room Days’ as an appropriate unit for cost ascertainment
and control.
Other typical cost unit that may be used include:

Service industry Unit of cost (examples)

Passenger- km., (In public transportation)
Transport Services
Quintal- km., or Ton- km. (In goods carriage)
Electricity Supply Service Kilowatt- hour (kWh)
Patient per day, room per day or per bed, per
Hospital
operation etc.
Canteen Per item, per meal etc.
Cinema Per ticket.
Hotels Guest Days or Room Days
Bank or Financial Institutions Per transaction, per services
Educational Institutes Per course, per student, per batch, per lecture etc.
IT & ITES Cost per project, per module etc.
Insurance Per policy, Per claim, Per TPA etc.

For preparing a statement of cost or a cost sheet for service sector, costs are usually collected and
accumulated for a specified period viz. A month, quarter or a year, etc.

The cost statement for services may be prepared either on the basis of functional classification as done
for product costing or on the basis of variability. Cost sheet on the basis of variability is prepared
classifying all the costs into three different heads
 Fixed costs or Standing charges
 Variable costs or Operating expenses
 Semi-variable costs or Maintenance expense

When we talk about services, our mind recalls the multiple intangible products we use on a day to day
basis. But do you know that all these services have different cost units and elements during
computation

Cost Unit in Service Costing

The activities in the Service sector is labor intensive and hence the cost unit is usually difficult to define.
The inputs and output units cannot be stored and is expended as soon as it is generated. Hence to
measure the cost of business operations in the service industry is a complex activity where all the cost
parameters are to be considered while deciding a suitable unit for costing.

Under service costing, following are two kinds of cost units ascertained:

1. Simple Cost Unit

2. Composite Cost Unit

Simple Cost Unit: The cost unit, which uses only one single parameter for measurement of the service
cost, is termed as a simple cost unit.
 Service Organization Type Cost Unit
Water Supply Per Kilometer
Canteen Per Meal / Per Person
Road Maintenance Per Kilometer
Street Lighting Per Lamp

Gas Per Cubic Meter

Private Transport Per Trip
Water Supply Per Kilometer

Composite Cost Unit: Measurement of two parameters is combined to form a single cost unit. It is
the most commonly used cost unit in service costing.

Service Organization Type Cost Unit

Hospital Per Bed – Day
Hotel Per Room – Night
Electricity Per Kilowatt – Hour

Passenger Transport Per Passenger – Kilometer

Goods Transport Per Tonne - Kilometer
Hospital Per Bed – Day

Organization Overview

ABCL’s IT and Business Services (ITBS) segment has a comprehensive and mature suite of end-to-end
offerings to address the traditional and emerging transformation needs of large enterprises. These
constitute the most extensive offerings in the industry and are aligned to the three critical building
blocks of next-gen enterprises—Digital Foundation, Digital Business, and Digital Operations.
Under these building blocks are their key capabilities and service offerings. Hybrid Cloud, Digital
Workplace, Unified Service Management and Cybersecurity/Governance, and Risk and Compliance are
the offerings grouped under Digital Foundation, which is the evolution of their industry-leading
Infrastructure services. Consulting, Applications, Insights, and IoT are the offerings under Digital
Business. IT Operations, Managed Cybersecurity Services (CSFC), and Process Operations are the
offerings under Digital Operations.
These capabilities are supported and complemented by a robust ecosystem of partners and innovation
labs. They are intrinsic components of ITBS that differentiate us and visibly enhance the overall value of
our service to clients.
Services Portfolio of ABCL Ltd.
The digital services include: -
1. Digital consulting
2. Data Analysis
3. IOT Works
4. Integrated IT Ops
5. Process Operation
6. Cyber Security operations

Costing in Information Technology (IT) & ITES:

Information Technology (IT) and Information Technology Enabled Services (ITES) organizations provide
their customers with services or intangible products. These organizations are highly labor intensive.

The services of IT and ITES organizations may be used for – provision of services to outside customers
or provision of services internally (captive consumption)

In this sector employee (labor) cost constitutes a significant portion of the total operating costs. The
direct employee cost is traceable to services rendered
In addition to employee cost, significant overhead costs for offering the services are incurred and are
classified as service overhead. To arrive at the cost incurred for rendering the services, it is necessary
to allocate / apportion such overheads to cost units

Concept of Project

In general – IT & ITES industries, the jobs undertaken are considered as Project. Each project is unique
in nature and varies in size, functionality requirements, duration and staffing requirements

When a project is taken up, a detailed planning is done – by breaking down the project into number of
activities and their dependencies. Based on the above, project scheduling are developed.
Then the skill level requirement for carrying out each of the activities is identified and the duration of
each and every activity would be ascertained. This process is known as effort estimation
Once the skill level and duration is identified, then required man-power is identified for carrying out
the activities
Normally, project scheduling and effort estimation is carried out together. The costs of development
are primarily the costs of the effort involved, so the effort computation is used in both the cost and the
schedule estimate.

Manpower/Labor
The Manpower involved in IT industry could be direct or indirect.
In a typical software implementation project, three to four levels of direct man-power that would be
directly engaged, as mentioned below.

 Software Engineers / Functional Consultants / Business Analysts

 Project Leaders
 Project Manager
 Program Manager, etc

Depending on the nature and complexities of the projects being implemented, the number of persons
engaged, their levels and duration of the engagement varies. For example, in a multi-continental,
multi-time zone software implementation projects, in addition to the above man-power, Customer
Account Manager, Portfolio Manager, etc may be involved.
The costs incurred on the above listed man-power are traceable with a project and hence forming part
of direct costs of the project.

In addition to the above persons, who are directly engaged in project, there could be support persons
or indirect manpower, who are indirectly involved in the project.

For example, Quality Assurance Team, Version Control team, Staffing Manager, etc who are indirectly
support the projects by providing required level of support services over the life of the projects

It is possible that the indirect manpower may be involved in more than one project, simultaneously.
Their time spent, may or may not be traced on any particular project and will be used across multiple
projects. If their time can be identified with a project, they will be treated as direct manpower.
Accordingly, the cost incurred on them will be treated as direct cost. However, if their time is not
traceable with a single project, then it may either be allocated or apportioned to various projects on
some suitable basis. Accordingly, the cost incurred on them will be treated as overhead and the same
will be apportioned to various projects on some suitable basis.

Effort Cost in these types of organizations are calculated on the basis of cost per Person day or cost per
Person week or cost per Person month. That means cost incurred for a person for rendering services
per day or per week or per month

Depending on the requirement of the customer, the periodicity will be defined. For example,
implementation of new software may require eight to twelve person months. In such a case, the cost
will be calculated on Per Person month basis. On the other hand, implementation of one or two new
functionality in already implemented (existing) software may require one to two week’s efforts. In such
a case, the cost will be calculated on per Person week basis

Parameters in Computation of Total Cost

Hardware and software costs involved

  If they are identifiable with a project, then they are directly allocated to the project
 If they are not directly identifiable with a project or not fully allocable to a project, then
they are treated as service overhead

Travel and training costs

 If they are incurred for a project, then they are directly allocated to the
project
 If they are not directly identifiable with a project or allocable over a
number of projects, then they are treated as service overhead. For
example, Java (software language) training provided to the software
engineers, may useful in multiple Java based projects. Hence treated as
overhead costs

Effort Costs

 Effort costs are basically identified with a project. They can be classified as
direct cost, unless otherwise specified.
 Effort costs are not just the salaries of the software engineers or programmers who are
involved in the project. Organizations compute effort costs in terms of overhead costs
where they take the total cost of running the organization and divide this by the number of
productive staff. Therefore, the following costs are all part of the total effort cost
 Costs of providing, heating and lighting office space
 Costs of support staff such as accountants, administrators,
system managers, cleaners and technicians
 Costs of networking and communications
 Costs of central facilities such as a library or recreational facilities
 Costs of Social Security and employee benefits such as pensions and health
insurance, etc.

Analysis of Organizational Costing Data

Budgeting and Quote

ABCL had taken up a project for one of its important clients to implement Hybrid Cloud services in their
internal IT system. A project team was formulated for this purpose for a duration of 90 days which is
also the expected duration of this project.
At the beginning of any project at ABCL, budgeting is done to estimate the resources required and
predict the cost and margin structure for the project. This also helps the company rationalize a quote
that is pitched to the client which is then signed off after some negotiations.
A similar process was carried out with the client for this project. Budgeting was done prior to the
project initiation and the quote was approved by the client. These details are mentioned below –

Budget Cost in ABCL Quote

SKU Summary
SKU Total Cost (AUD)
COM-AE-DS-OPT $ 119,275.44
COM-AE-RS-OPT $ 171,026.11
Total $ 290,301.55
ABCL then uses this budget to identify the markup they charge to the client. Usual practice at ABCL is to
follow a Full Cost-Plus Pricing (FCPP) model in which profit margin is kept between 30% to 50% over
the total estimated cost of the project.
Considering the long-term association that the client has with ABCL along with other factors and
negotiations, it was decided by the management to keep the profit margin at 30% of the total cost.

Budget Revenue $ 415,859.36

Budget Margin 30%
Budget Cost $ 290,301.55

One month into the project, Rohit who is the manger for this project was asked by the senior
management and the finance team to provide an interim report on the costing and how is it faring
against the budget calculated for the project at the beginning.
Considering the current pandemic scenario and the challenges company is facing with resource crunch
and cost cutting, the cost structure is liable to change. Rohit has made appropriate changes in the team
and resource allocation to this affect and hopes that the updated margin statement would reflect these
changes positively.

It is 1st April 2021 and Rohit has a task carved out for the day to work on this exercise and provide a
report by tomorrow EOD. As an MBA from IIM Lucknow, Rohit recollected some of the Service Costing
concepts taught to him by his MANAC professor at IIML Lucknow Dr. A. K. Mishra to approach this
request.

Step 1 – Identification of cost object

Cost object for this project are the resources employed to carry out this project. Details for the same
are consolidated along with the hourly rates in $ and are mentioned below.

S.No. Resource Role Hourly rate

1 Rohit Jindal Project Manager $ 292.02
2 Manpreet Kaur Kohli Lead Network Consulting Engineer $ 226.97
3 Ankit Garg Network Consulting Engineer $ 101.72
4 Antim Kumar Jaiswal Network Consulting Engineer $ 74.71
5 Anubhav Bhatnagar Network Consulting Engineer $ 122.20
6 Deepak Bartwal Network Consulting Engineer $ 111.05
7 Niladri Saha Network Consulting Engineer $ 82.60

One can note that hourly rate is the cost unit in this case.
Depending on designation, role and contribution, different costs are assigned to different resources.

Step 2 - Costs incurred till date

To calculate costs incurred till date, time dedicated by each resource to the project is identified which
is then factored-in to the hourly rates to arrive at the total cost.
 Actual Hours
Role Hourly rate in OP (30th Mar) Actual Cost (30th Mar)
Rohit Jindal $ 292.02 76 $ 22,194
Manpreet Kaur Kohli $ 226.97 130 $ 29,506
Ankit Garg $ 101.72 175 $ 17,802
Antim Kumar Jaiswal $ 74.71 215 $ 16,062
Anubhav Bhatnagar $ 122.20 20 $ 2,444
Deepak Bartwal $ 111.05 80 $ 8,884
Niladri Saha $ 82.60 13 $ 1,074
Total 709 $ 97,965

Till date, total accounted cost has come out to be $ 97,965 for a total of 709 work hours.

Step 3 – Expected EAC cost

The next step in this process is to estimate future course of the project and to calculate total Estimate
at Completion (EAC) cost.
Actual Hours Project Hours (Till PID
Role Hourly rate in OP (30th Mar) Actual Cost (30th Mar) completion) EAC Cost Total Hours
Rohit Jindal $ 292.02 76 $ 22,194 18 $ 27,449.88 94
Manpreet Kaur Kohli $ 226.97 130 $ 29,506 120 $ 56,742.00 250
Ankit Garg $ 101.72 175 $ 17,802 175 $ 35,603.57 350
Antim Kumar Jaiswal $ 74.71 215 $ 16,062 465 $ 50,799.92 680
Anubhav Bhatnagar $ 122.20 20 $ 2,444 41 $ 7,454.32 61
Deepak Bartwal $ 111.05 80 $ 8,884 95 $ 19,433.32 175
Niladri Saha $ 82.60 13 $ 1,074 0 $ 1,073.81 13
Total 709 $ 97,965 914 $ 198,556.81 1623

The total estimated cost which includes costs incurred till date is $ 198,556 for a total of 1623 hours.
Consolidating this by role type and comparing it with the budget gives us –

Budget Hours in ABCL Quote

Work hrs Summary Total Remote Hours
Role Budgeted Actuals Difference
Network Consulting Engineer 1440 1529 89
Project Manager 93 94 1
Total 1533 1623 90
Avgerage Hours 192 203 11
1800
1623
1600 1529 1533
1440
1400
1200
1000

800
600
400
191.63 203
200 89 93 94 90
1 11
0
Network Consulting Project Manager Total Avgerage Hours
Engineer

Budgeted Actuals Difference

This gives us an extra committed time of 90 hours over the entire course of duration of this project.

Step 4 – Consolidation and Conclusion

After calculating both the budgeted and actual costs, the last and final step to this exercise for Rohit is
to consolidate all the costs and identify the margin gap between the budgeted and actual numbers.

Margin Impact
Budget Revenue $ 415,859.36
Budget Cost $ 290,301.55
Budget Margin 30%
EAC Revenue $ 415,859.36
EAC Cost $ 198,556.81
EAC Margin 52%

$450,000.00 $415,859.36 $415,859.36

$400,000.00
$350,000.00
$300,000.00 $290,301.55

$250,000.00
$198,556.81
$200,000.00
$150,000.00
$100,000.00
$50,000.00
$-
Budget Revenue Budget Cost EAC Revenue EAC Cost

Looking at the final numbers, Rohit was a little pleasantly surprised but overall glad to see a positive
margin impact of all the changes, process, and operations optimization that he has brought in the team
to meet the challenges company is facing due to the current pandemic scenario. Rohit was more than
happy to forward this consolidated report with the senior management and the finance team.