1. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-1 Chapter 6 Service costing

2. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-2 What 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

3. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-3 Differences between service and 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 Some services entail some minor physical or tangible aspects

4. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-4 Other aspects of services Retailers and wholesalers are part of the service sector –They have 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

5. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-5 Cost classifications in service organisations

6. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-6 The value chain in service firms continued

7. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-7 The value chain in service firms Upstream activities and costs –Only large service 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 materials may not be significant Upstream and downstream costs may be regarded as overhead costs for service costing purposes

8. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-8 The value chain for 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 (sometimes) distribution are included –Sales and distribution may occur at the same time Downstream activities and cost –Marketing activities, delivery and customer support are important

9. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-9 Service production environments

10. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-10 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

11. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-11 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 suppliers, telecommunications companies, public service organisations

12. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-12 Service shops Fit between professional and mass service businesses in terms of the number of customers, staff time and degree of customisation Examples: hotel chains, banks, cafés and restaurants, print shops and car repair workshops Some service entities have aspects of mass service and professional service types

13. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-13 A continuum of costing systems for service entities

14. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-14 Job costing systems for professional service firms Professional service firms have limited material or equipment and 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 in an economic manner –Job billing rather than job costing may be used

15. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-15 Process costing systems for (some) mass services Services are produced in large quantities, so individual tracking of costs is not feasible Production processes are repetitive; there is 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

16. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-16 Hybrid costing systems for service shops and (other) mass services 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

17. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-17 Activity-based costing for services Service entities often have high direct labour costs 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

18. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-18 Case study: Costing services at 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

19. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-19 Case study: Costing services at 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 Job billing may be used rather than costing to determine fees –Charge out rates per billable hour; includes an allowance for overheads and required profit margin continued

20. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-20 Case study: Costing services at 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 for 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

21. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-21 Case study: Costing services at 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

22. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-22 Case study: Costing services at 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

23. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-23 When should firms estimate their service costs? No external reporting requirements to estimate individual service costs Service costing systems will be used where benefits exceed costs Cost and benefits are 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

24. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-24 Factors affecting the decision to implement service costing

25. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-25 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

26. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-26 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 income statements continued

27. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-27 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- process (AASB 102) –Consist of accumulated costs of jobs, where fees are not realised –Only production costs can be included

28. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-28 Costing in retail and wholesale businesses Two distinct aspects –Tangible goods are sold –There is 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

29. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-29 Costing in retail and wholesale businesses Cost of goods 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

30. Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 6-30 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