## **Learning Outcomes**

After reading this article, you will be able to describe how service and operation costing is used in organisations that provide services rather than goods, distinguish the unique features of service environments, select and justify suitable cost units (including composite units), and calculate a cost per service unit. You will also be able to explain the advantages and limitations of different cost measures, and apply definitions and calculations to real-world situations for exam questions.

## **ACCA Management Accounting (MA) Syllabus**

For ACCA Management Accounting (MA), you are required to understand service and operation costing in the context of management accounting for non-manufacturing organisations. When studying this area, focus on:

- Defining the characteristics of service organisations relevant to costing
- Identifying situations where service or operation costing should be used
- Explaining the role and selection of cost units, including composite cost units
- Calculating total and unit costs in service operations
- Analysing cost per unit for performance measurement and control purposes

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which of the following is a composite cost unit typical for the transport industry?
   a) Vehicle
   b) Kilometre
   c) Passenger-kilometre
   d) Staff hour

2. List two ways in which service/operation costing differs from costing in a manufacturing environment.

3. Explain when it would be more appropriate to use a composite cost unit rather than a simple cost unit, and give a relevant example.

4. True or false? In service costing, all overheads can be easily and directly allocated to each cost unit.

## **Introduction**

Service and operation costing is a method applied to organisations providing services—such as transport, healthcare, hospitality, public utilities, or education. The nature of service output creates specific challenges for costing, particularly in the selection of cost units and the allocation of shared costs. Correctly identifying the service cost per unit is essential for pricing, internal control, and comparing performance.

> **Key Term: service costing**
> A costing method for determining total and per-unit costs in organisations that provide intangible outputs, such as services performed for users or customers.

## Service Organisations: Characteristics and Costing Implications

Service environments differ fundamentally from manufacturing, which influences how costs are recorded and managed.

- **Intangibility:** The output is non-physical (e.g. accommodation, medical treatment, a delivered journey).
- **Variability:** The quality of services may differ depending on time, staff, or customer needs.
- **Simultaneous production and consumption:** Most services are consumed as they are provided, so they cannot be stored in inventory.
- **Perishability:** Unused capacity (such as an empty hotel room or unoccupied train seat) cannot be stored for later use.

These features create unique difficulties in linking costs to output, especially for overheads and shared costs.

> **Key Term: cost unit**
> The unit of output or service to which costs are related for purposes of calculation, control and comparison.

## Cost Units in Service and Operation Costing

The central step in service costing is the identification of an appropriate cost unit, which forms the basis for measurement and control.

### Simple Cost Units

A simple cost unit captures a single output dimension. Examples:

- Room-night (hotel)
- Patient-day (hospital)
- Meal served (food service)
- Call handled (contact centre)

This approach works when the service is homogeneous and output easily counted.

### Composite Cost Units

When both volume and a second variable (such as distance or time) are significant, a composite cost unit combines two elements to better reflect cost causation. Examples:

- Tonne-kilometre (haulage)
- Passenger-kilometre (public transport)
- Patient-day (where both number of patients and number of days in care matter)

> **Key Term: composite cost unit**
> A unit of output that incorporates two or more measures (e.g., number of items multiplied by distance or time), used where a single measure would be misleading.
>
> **Key Term: operation costing**
> A costing method applied to continuous or uniform services and processes, focusing on the average unit cost of each operation or batch.

### Choosing an Appropriate Cost Unit

The cost unit should represent the main output in a way that enables fair allocation of costs and meaningful comparison. Composite cost units are especially useful where both the scale and the nature of service matter (e.g. weight and distance for haulage).

#### Common Service Cost Units

| Industry/Service  | Simple Unit       | Composite Unit      |
| ----------------- | ----------------- | ------------------- |
| Hotel             | Room-night        | Guest-night         |
| Hospital          | Case treated      | Patient-day         |
| Airline/Bus/Train | Passenger journey | Passenger-kilometre |
| Haulage           | Delivery/load     | Tonne-kilometre     |
| Restaurant        | Meal served       | -                   |
| Utilities (water) | m³ supplied       | -                   |

## Calculating Unit Costs in Service Organisations

Unit costs are required for pricing, performance monitoring, and financial control. The calculation involves identifying the total relevant costs for a period and dividing them by the number of cost units delivered.

### Categories of Service Costs

| Type of cost   | Examples                                        |
| -------------- | ----------------------------------------------- |
| Direct costs   | Staff wages, direct supplies, fuel, consumables |
| Indirect costs | Support staff, administration, utilities, rent  |
| Fixed costs    | Salaries, depreciation, building costs          |
| Variable costs | Food ingredients, fuel, disposable items        |

Most service organisations have a high proportion of fixed and overhead costs relative to variable costs, making the allocation or apportionment of costs to units especially important.

### **Worked Example 1.1**

**A mid-size hospital incurs total costs of \$120,000 in April. In that month, it provides 2,400 patient-days. What is the cost per patient-day?**

> **Answer:**  
> Cost per patient-day = \$120,000 ÷ 2,400 = \$50.00

### **Worked Example 1.2**

**A road haulage company delivers 200 consignments per week, each with an average load of 3 tonnes for 150 km. Total weekly cost is \$18,000. Find the cost per tonne-kilometre.**

> **Answer:**  
> Total tonne-kilometres per week = 200 × 3 × 150 = 90,000  
> Cost per tonne-kilometre = \$18,000 ÷ 90,000 = \$0.20

### Using Composite Units

Composite cost units provide a more accurate basis for cost per service unit when both quantity and another factor impact costs significantly.

### **Worked Example 1.3**

**A coach company carries 900 passengers on trips averaging 100 km each during a week. Weekly operating costs are \$27,000. Calculate the cost per passenger-kilometre.**

> **Answer:**  
> Total passenger-kilometres = 900 × 100 = 90,000  
> Cost per passenger-kilometre = \$27,000 ÷ 90,000 = \$0.30

## Allocating and Apportioning Overheads

In service organisations, indirect and fixed costs are often significant. These costs must be apportioned fairly across cost units. Typical bases include:

- Floor area for rent
- Staff numbers for supervision
- Machine hours for utilities or maintenance

> **Key Term: overhead apportionment**
> The process of sharing indirect costs between cost units using a logical and fair basis.

### **Exam Warning**

> It is essential to clearly state the basis for allocating or apportioning overheads. Arbitrary choices or inconsistent application may result in errors and loss of marks.

## Interpreting and Comparing Service Unit Costs

Regular calculation of unit costs enables service organisations to:

- Review efficiency trends over time
- Compare branches or departments
- Monitor the effect of cost control efforts
- Benchmark against external competitors (where similar cost units are used)

Consistent use of the same cost unit is essential for valid comparison.

### **Revision Tip**

> Always define the cost unit at the start of any calculation or report—whether it is simple or composite. Be specific, e.g. "cost per patient-day" or "cost per passenger-kilometre."

## Advantages and Limitations of Service Costing

**Advantages:**

- Provides a systematic method for measuring and controlling service costs
- Facilitates informed pricing and tendering for service contracts
- Promotes standardisation of measurement and performance evaluation

**Limitations:**

- Difficulties arise in apportioning overheads fairly, especially with multiple services
- Some services are hard to quantify or standardise (e.g., consultancy)
- Output quality and variability may not be fully reflected in a quantitative cost unit
- Use of an inappropriate cost unit can lead to misleading conclusions

## **Summary**

Service and operation costing methods apply to environments where output is intangible, variable, and not storable. The central challenge is choosing and applying a suitable cost unit—simple or composite—so that costs can be linked to output reliably. Most service organisations face high fixed and overhead costs, which must be apportioned using logical bases. Correctly calculated unit costs support pricing, control, benchmarking, and management decision making.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Service and operation costing applies to service organisations with intangible or non-storable outputs
- Unique features of services require careful selection of cost units
- Simple and composite cost units allow for meaningful cost measurement
- High fixed and overhead costs are typical in service industries
- Accurate cost per service unit calculation requires fair allocation of all costs
- Regular use of unit costs enables control, comparison, and informed pricing decisions

## **Key Terms and Concepts**

- service costing
- cost unit
- composite cost unit
- operation costing
- overhead apportionment

Costing methods - Service/operation costing and unit measures