Operating Costing: Meaning, Definitions, Features, Objectives, Cost Sheet, Examples

Operating costing method is one designed to ascertain and control the costs of the undertakings which do not produce products but which render services.

Operating costing is also known as service costing. It is that form of operation costing which applies where standardised services are provided either by an undertaking or by a service cost center within an undertaking.

The object of service costing is to find the operating cost, i.e., cost of servicing. The costs ascertained are useful for a number of purposes, e.g., comparing the cost of using alternative forms of transport, deciding the price to be charged from the internal and external users, and determining the cost of maintenance of vehicles/carriages.

Contents

Introduction to Operating Costing
Meaning and Definitions of Operating Costing
Features of Operating Costing
Characteristics of Operating Costing
Objectives of Operating Costing
Classification of Operating Cost as per the Accounting Policy
Areas of Operating Costing
How to Ascertain and Control the Costs in Operating Costing?
How to Select a Unit of Cost in Operating Costing?
Unit of Cost
Difference between Operating Costing and Operation Costing
Maintenance of Log Book in Transport Services
Log Sheets
Transport Costing
Operating Cost Sheet
Power House Costing
Boiler House Costing
Canteen Costing
Hotel Costing
Hospital Costing
Ascertaining the Cost of Operating a Cinema Theatre

Operating Costing: Meaning, Definitions, Features, Objectives, Areas , Difference, Log Sheets, Transport Costing, Cost Sheet, Examples and More

Operating Costing – Introduction

Operating costing method is one designed to ascertain and control the costs of the undertakings which do not produce products but which render services. Operating costing is also known as service costing. It is that form of operation costing which applies where standardised services are provided either by an undertaking or by a service cost center within an undertaking.

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Operation costing is the cost of rendering services. It is the cost of producing and maintaining a service. Industries using operating costing do not produce tangible products; but useful service is rendered; for example, transport services, utility services like hospitals, canteens etc., distribution services like supply of electricity, gas etc. There is internal as well as external service.

Service rendered in the same organisation is known as internal service, for example, repairs and maintenance department or canteen in a factory. Services rendered to consumers are known as external service; for example, hospitals, transport companies, electricity companies etc. The operating cost per unit is calculated by dividing the total cost by the number of service units produced or rendered.

Meaning and Definitions of Operating Costing

Operating costing is a method of ascertaining cost of providing or operating a service. In this method, cost is determined in the same way as in the unit costing method or output costing method by preparing a cost sheet. Operating costing method is applied in undertakings which provide service or fall in the category of public utilities. The method is also called service costing.

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This method of costing is employed in those undertakings which are engaged in providing or operating services rather than in manufacturing tangible products. This method is applicable to road transport undertakings, railways, tramways, airways, shipping companies, electricity companies, gas companies, hospitals, cinemas, hotels, canteens, water works etc.

Operating costing is characterised by a form of unit costing. The product produced is only one but it is some service. The service being provided is standardised, or is regarded as such. These may be for sale to the general public, or within the organisation itself. In fact, every manufacturing entity has some service centres, else service departments which act as ancillaries to the production departments.

Operating costing is a method of costing designed to ascertain and control the costs of services. Those industries or organisations which do not produce any product but render some service to customers can use this method.

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According to Wheldon – “operating costing actually is unit costing as applied to the cost of services.”

According to CIMA, London, “Operating Costing is that form of operation costing which applies where standardized services are rendered either by an undertaking or by a service cost centre within an undertaking.”

Both the definitions make it clear that operating costing is confined to costing of services. However the method can also be used for non-standardised services in a restricted way e.g., hiring a bus for a private trip.

Operating Costing – 8 Basic Features

The basic features of operating costing are listed below:

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1. Uniformity of service to all the customers.

2. Involves fixed and variable costs. The distinction is necessary to ascertain the cost of service and the unit cost of service.

3. Service undertakings do not produce physical articles for stock and sale. But services are sold to consumers.

4. It is not concerned with accounting for inventories, other than those for miscellaneous supplies. There is nothing like finished services inventory similar to finished goods inventory.

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5. The cost unit may be simple in certain cases, and composite or compound in other cases like transport undertakings.

6. Total costs are averaged over the total amount of service rendered.

7. It can be applied to the services within the organisation as well as extending services to the community at large.

8. Documents like the daily log sheet, operating cost sheet, boiler house cost sheet, canteen cost sheet etc. are used for the collection of cost data.

Operating Costing Characteristics

The undertakings where operating costing is applied, generally possess the following characteristics:

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(i) These undertakings are engaged in rendering services of unique nature to their customers.

(ii) These undertakings are required to invest a large proportion of their total capital in fixed assets e.g., trucks, buses, ships, aircrafts, railway engines, wagons, railway lines, etc.

(iii) The amount of working capital required to meet out the day-to-day expenses, is comparatively less.

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(iv) In the case of these undertakings, a proper distinction between fixed and variable cost is of utmost importance since the economies and scale of operations considerably affect the cost per unit of service rendered. For example, in case of a transport company if the buses run capacity packed, the fixed cost per passenger shall be lower.

(v) Unlike in other methods of costing, selection of cost unit is difficult in operating costing.

(vi) Operating costs are mostly period costs.

(vii) This system requires a more detailed but simpler statistical data for proper costing.

Operating Costing – 7 Important Objectives

The important objectives of operating costing are as follows:

i) To calculate the cost of uniform service rendered to the customers.

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ii) To ascertain cost of all services produced within an undertaking viz., internal and external services.

iii) To keep the operating cost at the optimum level.

iv) To make a comparative analysis of operating cost incurred for different periods.

v) To make proper evaluation of different alternatives available.

vi) To determine whether to produce a service or buy it from outside.

vii) To ascertain whether the cost incurred on maintenance is excessively incurred or not.

Classification of Operating Cost as per the Accounting Policy

As far as the classification of Operating Cost is concerned, it is very difficult to state clearly whether a particular item of cost falls into one category or the other. Because, it depends upon the accounting policy. For instance, vehicles depreciate due to both the passage of time and the usage of the vehicles.

1. If the Depreciation is computed on the basis of the time factor, it (i.e., Depreciation) falls into the category of Fixed Operating Costs.

2. On the other hand, if Depreciation is calculated on the basis of the utilization of the vehicles, it (i.e., Depreciation) falls into the category of Variable Operating Costs.

3. Further, there are a large number of State Road Transport Corporations in India which compute the annual depreciation on their passenger vehicles on the basis of both the time and usage, and whichever is higher is taken as Annual Depreciation for computing the Operating Costs.

Remuneration to the crew members (viz., Drivers and Conductors) and other staff members such as Cleaners, Mechanics, etc., provides another good example as to how the classification of costs into two or more categories is a difficult task. Because,

1. If the employees are paid on the basis of time (say, monthly), then salary of the employees is an item of fixed cost as the salary is not influenced by the quantum of work done by them (i.e., by the employees) or the quantum of work extracted from the employees by the employer companies. Most of the companies are following this policy of paying remuneration on monthly basis.

2. On the other hand, if the employees are paid on the basis of the work, then salary of the employees falls into the category of variable cost as the salary payable to the employees depends upon the quantum of work done by them (i.e., by employees).

3. Besides, one can find a number of organizations which are remunerating their employees on the basis of both the time and output. For instance, a good number of State Road Transport Corporations in India are rewarding their crew members on the basis of monthly salary plus commission at a specific percentage of the traffic revenue earned. In this type of situations, labour remuneration falls into the category of semi-variable or semi-fixed costs.

Areas of Operating Costing

Operating costing is applied in those areas which provide services and not producing consumable or industrial goods.

These organisations can be mainly:

1. Transport Services – Bus, car, trucks, railways, airways, ships, cargo, tramways, steamer etc.

2. Entertainment Services – Cinema, club, circus, drama, etc.

3. Welfare Services – Hospitals, libraries, canteens, hotels, educational institutions, creches, etc.

4. Supply Services – Gas supply, electricity supply, water supply.

5. Communication Services – T.V., radio, telephone, mobile, Internet computer services etc.

6. Municipal Services – Street lighting, road maintenance, sewerage system, water supply, etc.

How to Ascertain and Control the Costs in Operating Costing?

In its broadest sense, wherever a service is rendered, the principles and method of operating costing can be applied.

Ascertaining and controlling the costs of the following types of services is usually carried on through operating costing:

1. Internal Services:

Services rendered by time keeping, canteen, boiler, etc., to other departments within the same firm.

2. External Services:

Services to outside customers at a charge or even freely to the members of the general public.

(a) Consumer supply services like electricity, water and gas.

(b) Transport services like Air, Sea, Rail and Road.

(d) Public welfare services like hospitals, street lamps, garbage clearing.

(e) Miscellaneous commercial services like lodging houses, banks insurance, etc.

How to Select a Unit of Cost in Operating Costing?

The main problem in operating costing is the selection of a unit of cost. In case of some of the operating undertakings, the unit of cost is simple and obvious.

For instance,

But in case of other undertakings, a composite unit of cost is used. For example, in case of transport undertakings, it will be per passenger kilometre or per ton kilometre.

The calculation of the composite unit of cost in case of a transport undertaking can be illustrated with the help of the following example –

Suppose:

Operating Costing – Unit of Cost (With Important Undertakings)

A proper unit of cost must be selected in order to ascertain the cost per unit of service provided. The selection of a proper unit is a difficult task and it depends upon the nature of work and the purpose for which cost has to be computed.

The unit may be simple as under unit costing, e.g., per bed in case of hospitals, per 1,000 litres in case of waterworks, per child in case of schools, per km. of road maintained in case of a road maintenance undertaking, per cup of tea or per dish in case of canteen service etc.

But, in certain cases, a composite unit of cost is used, e.g., per passenger-kilometre in case of bus companies, which means the cost of carrying one passenger for a distance of one kilometre.

Similarly, cost per quintal-kilometre in case of motor transport means cost of carrying the load of one quintal for one kilometre. For electricity supply undertakings, the unit of cost may be kilowatt-hour which signifies the cost of one kilowatt of electricity generated during an hour.

The following is a list of some of the simple and composite units in certain important undertakings:

Difference between Operating Costing and Operation Costing

Difference # Operating Costing:

1. It refers to the cost of those undertakings which do not produce any tangible product but render services. It is the costing of specific services or functions.

2. It usually uses a composite cost unit.

3. The methods of classification, collection and allocation of operating costs to cost units are different from that of manufacturing units as well as for different services.

Difference # Operation Costing:

1. It refers to the determination of cost of operations. It is a special type of process costing where an operation is a cost centre instead of a process.

2. It uses simple cost unit.

3. Costing procedures are similar for all operations.

Operating Costing – Maintenance of Log Book in Transport Services

For collection of expenses specially in transport service, a book known as log book is maintained for each vehicle. In the log book all the expenses and activities of the vehicle during that specified period are recorded for cost calculation purpose, maintenance purpose and control on cost purpose.

The maintenance of the log book helps in the following matters:

(i) Number of trips (run kilometer) by the vehicle during a day.

(ii) Number of passengers travelled during journey.

(iii) Weight carried during the journey by the vehicle.

(iv) Period and timing of no use of the vehicle and reasons thereof like repair, non-availability of passengers or goods to be carried etc.

(v) Consumption of petrol, diesel, and average rate of consumption of fuel.

Operating Costing – Log Sheets (With Format)

Log sheets are prepared for collection of costs. A log sheet is maintained for each vehicle to record the details of trip, running time, and distance covered, running cost i.e., petrol and diesel, loading or uploading time etc. These log sheets help the management to ascertain the operating cost, to avoid idleness of vehicle and to exercise control.

Transport Costing – Meaning, Objectives, Cost Classification and Advantages

Transport Costing refers to the determination of the cost per unit of services rendered by a vehicle. Its include Water, Air, Road and Railways. Motor transport includes Buses, Taxies, Private Cars, Carriers and Lorries etc. E.g. The cost/passenger/km or cost/ton/km.

Objects of Transport Costing – In Brief

i. It helps in controlling, operating and maintenance costs.

ii. Cost of using own vehicle and hired vehicle can be compared.

iii. Operating costs of different vehicles can be compared and thus efficiency can be improved.

iv. Comparison of oil consumption and time taken for a trip with other trips is possible.

v. Proper apportionment of costs to different departments which use the service is possible.

vi. It provides information for giving quotation and fixing the rates.

Objectives of Transport Costing

1. To find cost per unit of operating a vehicle and to fix the rate for the carriage of passengers or goods.

2. The control of the cost of operating each vehicle.

3. To compare the cost per unit of one means of transport with that of another, and to find out the profitable means of transport.

4. To compare the cost per unit of operating one vehicle, with another vehicle, and to ascertain the efficiency of each vehicle.

5. To help to fix the hire charges of a vehicle where a vehicle is given on hire.

Cost Classification

The expenses incurred by a transport concern can be classified into three categories.

They are –

1. Fixed charges or Standing charges.

2. Maintenance charges.

3. Operating or Running charges.

1. Fixed Charges or Standing Charges

It includes expenses, which remain fixed, whatever may be the distance covered, or trips made. The vehicle may be idle, but these expenses have to be met. Therefore they are called as fixed charges.

Example: Garage rent, insurance premium, road license fee, interest on capital, vehicle tax, establishment expenses of the work shop, head office expenses, depreciation of the vehicle (based on time), wages of drivers, conductors etc (based on amount to be paid on a fixed rate, regardless of distance covered).

2. Maintenance Charges

These expenses are incurred on the repairs and maintenance of the vehicle, so as to keep the vehicle in proper condition. They are semi-variable or semi-fixed in nature.

Example: Repairs and maintenance, spares and accessories, wear and tear of tyres and tubes, supervision expenses, painting charges, overhaul expenses.

3. Operating Charges

These expenses are incurred on the actual running of the vehicle. They vary with the distance covered or the trips made. They are variable in nature.

Example: Petrol or diesel expenses, lubricating oil and grease, salaries and wages of drivers, conductors etc. (if it depends upon the distance covered, or by the number of trips made), depreciation of vehicles (based on the mileage run) etc.

Advantages:

The usefulness of transport costs becomes apparent when we consider the following advantages:

(a) Choosing between alternative means of transport. A transport company- owning Lorries may compare the cost of using a lorry with the prevailing railway rates and decide to make use of the alternative if that appears to be cheaper.

(b) Comparing the cost of maintaining one vehicle with the cost of another vehicle of the same type.

(d) Determining the price at which a vehicle should be hired out.

(e) Comparison between owned transport and hired transport to decide whether it is economical to go in for a hired one.

Operating Cost Sheet (With Specimen)

It is said that, “a well-designed cost sheet is the heart of transport costing”. For collecting and controlling costs, costs are classified and accumulated under the three heads, suitably analysed and presented periodically in the form of an operating cost sheet.

A specimen of operating cost sheet is given as follows:

Power House Costing – Cost Sheet Specimens and Illustration

Power House Costing is concerned with the ascertainment of cost per unit of steam or electricity produced. The costs of producing steam used in power house for the generation of electricity is also included in the power house costs.

The specimen of cost sheet prepared by power-house may be given as follows –

Specimen No. 2:

(Power-house using steam for generating electricity)

Illustration:

From the following data pertaining to the year 2002-03, prepare a Cost Sheet showing the cost of electricity generated per unit of kwh. by Chambal Thermal Power Station –

Total units generated 20,00,000 kwh.

Boiler House Costing (With Cost Sheet Format)

Operating Costing is also applied in those undertakings engaged in steam production. In large firms, a boiler house is a service department providing services to production departments. The total costs are obtained for producing steam. A cost unit is generally in terms of pounds.

Canteen Costing – Classification of Expenses, Illustration and Solution

The object of canteen costing is to ascertain the cost per meal, cost per cup of tea etc.

In a canteen, the expenses are generally classified as follows:

i. Wages and salaries of staff e.g., cooks, helpers, waiters and supervisors.

ii. Provisions like meat, fish, fruits, flour, oil, milk, sugar, cream, tea, coffee, and soft drinks.

iii. Services like steam, gas, electricity, power, water etc.

iv. Consumable stores like cutlery, crockery, glassware, table linen, mops and washing up clothes, drying up clothes, cleaning materials, dust pans and brushes.

v. Miscellaneous overheads like rent, rates, depreciation and insurance.

A monthly operating cost statement is usually prepared to ascertain the total cost and cost per meal. As most factory canteens are subsidised by the employer to some extent, the amount of subsidy is deducted from the total cost.

Illustration:

Progressive Enterprises Ltd., runs a canteen for the benefit of its workmen and provides subsidy of Rs.15,000 per month to the canteen. During the month of May, 2007, the following purchases were made –

Solution:

Hotel Costing – Ascertaining Cost per Room or Cost per Man, Illustration and Statement of Cost

A hotel is engaged in providing food, accommodation and other comforts to its customers. Costs incurred by a hotel may be fixed or variable. Fixed costs may include salaries of staff, depreciation of fixed assets etc., while variable costs may comprise lighting and power charges, wages of room attendants etc. The object of hotel costing is to ascertain the cost per room or cost per man.

Illustration:

Following is the information given by the owner of hotel. You are required to advise him what rent should be charged from customers per day so that he is able to earn 25 profit on cost other than interest.

(1) Staff salaries Rs.80,000 per annum.

(2) Room Attendant’s salary Rs.2 per day. The salary is paid on daily basis and services of room

attendant are needed only when the room is occupied. There is one attendant for one room.

(3) Lighting, Heating and power – The normal lighting expenses for a room if it is occupied for the whole month is Rs.50 per room. Power is used only in winter and normal charge per month, if occupied, for a room is Rs.20.

(4) Repairs to Buildings – Rs.10,000 per annum.

(5) Linen etc. – Rs.4,800 per annum.

(6) Sundries – Rs.6,600 per annum.

(7) Interior decoration and furnishing – Rs.10,000 per annum.

(8) Cost of Building Rs.4,00,000 rate of depreciation is 5%

(9) Other Equipment Rs.1,00,000, Rate of depreciation is 10%

(10) Interest @ 5% may be charged on its investments of Rs.5,00,000 in the buildings and equipments.

(11) There are 100 rooms in the hotel and 80% of the room are normally occupied in summer and 30% of the rooms are occupied in winter.

You may assume that period of summer and winter is six months each. Normal days in a month may be assumed to be 30.

Hospital Costing – Departments, Illustration and Cost Sheet

A hospital is engaged in providing various medical services to the patients and hospital costing is applied to determine the cost of these services.

A hospital may have the following departments on the basis of functions performed by them:

(i) Outdoor Patient Department (O.P.D.).

(ii) Indoor Patient Department (Medical Wards).

(iii) Medical Service Departments e.g., X-Ray Department, Scanning Centre, Pathology Laboratory etc.

(iv) General Service Departments e.g., Boiler House, Power House, Catering Department, Laundry Room, Administrative Office, Works Maintenance Department etc.

(v) Miscellaneous Service Departments i.e., the departments engaged in providing services to the above four departments such as transport department, dispensary, general porting etc.

The operating costs of Outdoor Patient Department, Indoor Patient Department, Medical Service Departments and General Service Departments are determined with reference to the suitable unit of cost and in doing so the costs of miscellaneous service departments are apportioned to them on some suitable basis.

The common units of cost of various departments in a hospital are follows:

(a) Outdoor Patient Department Per Out-patient attended.

(b) Indoor Patient Department Per Room-day.

(d) Scanning Centre per Case

(e) Pathology Laboratory per 100 Requests

(f) Laundry Department per 100 items laundered

(g) Catering Department per Patient per Week.

The costs of a hospital are divided into fixed and variable costs. Fixed costs may comprise salaries of administrative staff, depreciation of building, rent of building, depreciation of surgical and medical equipments etc., while variable costs may comprise light and power, water, laundry charges, food supplied to patients etc.

The preparation of cost sheet can be explained with the help of the following illustrations:

Illustration:

Dr. Sanjeev Sharma and Dr. (Mrs.) Sharma hire a building to run a nursing home. The building has 8,000 square feet of area consisting of 40 rooms of 150 square feet each. The rest is general area. The monthly rent has been agreed at Rs.10 per square feet. Lighting and heating expenses come to Rs.10,000 per month.

The staff would consist of the following –

i. 5 doctors @ Rs.20,000 p.m.

ii. 10 nurses @ Rs.8,000 p.m.

iii. 6 general helpers @ Rs.2,500 p.m.

It is expected that 90% of the rooms will always remain occupied. If a margin of 25% on total takings is desired, ascertain the rent to be charged per day assuming a month of 30 days.

Solution:

Operating Costing – Ascertaining the Cost of Operating a Cinema Theatre

The object of Cinema house costing is to ascertain the cost of operating a cinema theatre. In case of a cinema house the unit of cost is “a man-show”.

Illustration:

A cinema hall has seating capacity of 800. It runs daily 4 shows on all 30 days of a month. It is generally full to the extent of 80% of its capacity. Find out the number of man-shows during the month.

Solution:

Total man-shows = Number of shows per day x Number of days during the month x Number of Persons per show

= 4 shows x 30 days x 800 x (80/100) = 76,800 man-shows.