CHAPTER 1

INTRODUCTION

OPERATING COSTING

MEANING
OPERATING COSTING is the method used to ascertain the cost of providing a service
such as transport, hotel, hospital, gas, or electricity. Operating cost denote the cost of
providing a service as opposed to cost of manufacturing a product. CIMA has defined
operating costing as that form of operation costing which applies when standardize service
are provided either by an undertaking or by a service cost centre within an undertaking. Cost
accounting standard -1 by ICWA define operating cost as the cost incurred in conducting a
business activity. Operating cost refer to the cost of undertaking, which do not manufacture
any product but which provide service.

DEFINITION
The day-today expenses incurred in running a business, such as sales and administration, as
opposed to production .Also called operating expenses. These are recurring expenses in
operating the business. The expenses can include property maintenance, taxes, and wages.

[1]

 APPLICATION:
Operating costing is employed in different types of service industries such as

Transport service e.g. truck operator, road transport, railway, air-line etc.
Municipal service like road maintenance, garbage disposal, street lighting etc.
Supply service such as electricity, steam, gas, water etc.
Welfare service e.g. canteen, hospital, library etc.

COST UNIT:
For ascertaining cost it is necessary to decide suitable cost unit for each types of
service industry. Basically, operating costing is a types of process costing. Thus it
used the method of process costing when ascertaining the cost of supply of electricity,
steam etc. however, sometime operating costing may adopt a particular job as a unit
of cost as for example when costing a particular trip by a bus so as to quote the
charger. In such cases operating costing used the method of job costing by treating a
specific trip as a separate job. A cost unit under operating costing may be of two types
(a) simple cost unit (b) costing cost unit. Following is the list of different cost unit
used in different types of service.

SERVICE INDUSTRIES

SIMPLE COST UNIT

[2]

Passenger transport

Per kilometer

Good transport

Per kilometer

Road Maintenance

Per K.M. of road maintained

Water supply

Per kilo liter of water supplied

Canteen

Per meal/ dish

SERVICE INDUSTRIES

COMPOSITE COST UNIT

Passenger transport

Per Passenger K.M.

Good transport

Per Ton K.M

Electricity

Per kilowatt Hour

Steam, Gas

Per K.G. / Cubic Ft.

Hospital

Per Patient Day

Library

Per Member Book

Thus it can be seen that in operating costing in most cases the cost unit is a compound unit. It
refer to both the quantum of service and period of service. Thus a transport charge for
carrying so much weight (Ton) for so much distance (Km) an electricity company charge one
for use of both the quantum (Kilowatt) and the period (Hour) and so on.
[3]

 PROCEDURE:
1) DETERMINE COST UNIT: The first in operating costing is the determination of
the cost unit. This is a complex task as explained in para 1.3.
2) ASCERTAIN COST: The next point to be notes is that operating cost are period
cost. The cost of supplying the service for a period are ascertained in the following
manner(taking the example of a transport)
VEHICLE NO.: Each vehicle is treated as accost centre and given a specific number.
All the cost account against this number. A separate account is opened to record the
cost and income of each vehicle.
VARIABLE COST: Variable cost are the running and operating. This included
expenses of variable nature e.g. petrol, diesel, lubricating oil, grease etc. the material
requisition note and time sheet (or Log) bears the vehicle no. the relevant vehicle
account is debited with it direct material and direct labour cost. Direct expenses such
as a fuel are debited to vehicle account on the basic of log book and the cash /
purchase / journal vouchers.
FIXED COSTS: Fixed cost (fixed charge) included garages rent, insurance, road
license fees etc. the fixed charges are apportioned and absorbed by each vehicle no.
on the basic of overhead absorption rate which may be actual or pre determine. The
fixed cost attributable to the vehicle are debited to the relevant vehicle account.
REVENUE: The revenue from the vehicle is credited to the vehicle account.
PROFIT OR LOSS: the vehicle account at this stage will reveal the profit or loss
made on operating that vehicle. The profit or loss is then transfer to the costing profit
and loss account the total operating cost of a period is divided by the number of cost
unit (KM/Passenger/ Ton)supplied during the period to arrive at the operating cost Per
unit for that period.
3) NO STOCK: In case of a service industry there is no question of any closing stock or
work-in-progress since it is not possible to store a service for future use.

[4]

4) ABNORMAL COST: According to cost accounting standard 5 (transportation

cost)abnormal and non recurring cost shall be directly debited to p&l a/c and shall not
form part of operating cost. Example are penalty, detention charge demurrage and
cost related to abnormal breakdown.

LIMITATIONS
OPERATING COST ACCOUNTING HAS CERTAIN LIMITATIONS

a)Based on estimates: Indirect costs are not charged fully to a product or process. It is
charged to all the products and processes on the basis of estimates. Actual cost varies from
estimated cost. Due to these limitations, all cost accounting results are taken as mere
estimates.

[5]

b)Lack of uniformity: Procedures of cost accounting followed by different organizations are

different for different products. There is no uniformity. There is also possibility of

difference in pricing material issues for production. All these lead to different cost results for
the same operation.

c)Many conventions: There are many conventions for classification of costs, pricing of
material issues, apportionment of indirect costs, adoption of marginal or standard cost, etc.
These create difficulty in determining the exact cost, because no one type of cost is suitable
for all. Purposes and in all circumstances.

d)Expensive: Cost accounting is expensive. It involves lots of clerical won for maintaining
various costing records for different purposes. For medium and small size concern, the
benefit derived from costing system may not justify the cost involved.

e)Result requires reconciliation: Information and results provided b;financial accounting and
cost accounting may be different for the as activity. This requires reconciliation to find out
correctness of the two before taking any decision.

[6]

f)Dependent: It is not an independent system of accounting. It depends on other accounting

systems.

g)Does not include all items of expense and income: Items of purely financial nature such as
interest, financial charges, discount and loss on issue of shares and debentures, etc. are not
taken into consideration in Cost Accounting.

h)Not an exact science: Like other accounting system, it is not an exact] science but an art
that has developed through theories and practices.

RESEARCH METHODOLOGY

[7]

One important aspect of analyzing cost data is the challenge of how to present the
findings in a manner that potential users may be able to apply to their own settings.
Consequently, a key question underlying the development of this report is: who are the
potential users of operating cost information and how will the information be used?
Since this analysis has been motivated by informational needs of provincial Ministries
of health, the analysis below assumes that the primary users of the findings will be provincial
Ministries of health and other significant purchasers of health care services, such as the B.C.
Health Services Purchasing Organization (HSPO).
This analysis assumes that the primary users of the methods and findings regarding
operating costs of hospitalizations will be provincial Ministries of health and other
significant purchasers of health care services.

CHAPTER 2

FEATURES OF OPERATING COSTING

[8]

THE MAIN FEATURES OF OPERATING COSTING ARE AS

FOLLOWING

(1) The undertaking which adopts service costing does not produce any tangible goods.
These undertakings render unique services to their customers.

(2) The expenses are divided into fixed and variable cost . Such a classification is necessary
to ascertain the cost of service and the unit cost of service.

(3) The cost unit may be simple or composite. The examples of simple cost units are cost per
unit in electricity supply , cost per liter in water supply, cost per meal in canteen etc.
Similarly cost per passenger kilometers in transport cost per patient-day in hospital, cost per
room-day in hotel etc. are the examples of composite cost unit.

(4) Total cost are averaged over the total amount of service rendered.

(5) Costs are usually computed period-wise. However, in the case of utilization of vehicles,
use of road-rollers etc., the costs are computed order wise.

(6) Service costing can be used for service performed internally or externally.

(7) documents like the daily log sheet, cost sheet etc. are used for the collection of cost data.

ADVANTAGES & DISADVANTAGES OF OPERATING

COSTING
[9]

 ADVANTAGES OF OPERATING COSTING:

1. Invest in more training for your employees. Wait-isn't this article about reducing
operating expenses? Well, it is. Investing in more training for employees will reduce
the number of errors that are made, which will inevitably save money for the
company. Not only that, but investing more in your employees will show them that
they are valued. In return, they will be more engaged and produce more (and better)
work.

2. Cut office supply expenses. Reducing supply expenses can significantly reduce your
operating expenses and improve your bottom line. This can be done by going from
paper to electronic whenever possible or ordering supplies in bulk in order to obtain
discounts. In addition, if you purchase all of your supplies at the same outlet, you
may be able to negotiate a better price. At the very least, shop around for lower prices
and any loyalty programs offered by potential suppliers.

3. Cut out travel and entertainment expenses. Although T & E expenses are considered a
"perk," during tough times, these are expenses a business can do without. Instead of
traveling to business meetings, hold conference calls or meetings online. Also, try not
to spend funds on company outings, meals, or other entertainment.
[10]

4. Rent or lease equipment as opposed to purchasing new equipment. Leasing business

equipment and tools preserves capital and provides flexibility. According
to Nolo.com, a legal advice website, the primary advantage of leasing business
equipment is that it allows businesses to acquire assets with minimal initial
expenditures. In addition to this, leasing offers the benefits of improved cash flow, tax
advantages, flexible terms, and the ability to easily upgrade equipment.

5. Reduce

marketing

and

advertising

expenses. Business

magazine and

websiteEntrepreneur.com suggests that business owners "split advertising and

promotion costs with neighboring businesses. Jointly promote a sidewalk sale, or take
your marketing alliance further by

sharing mailing lists, distribution channels and

suppliers with businesses that sell complementary goods or services." If you are
advertising via television or radio ads, look for cheaper time slots as another option.

6. Reduce your staff-well, sort of. This doesn't necessarily mean completely laying off
your workers. Instead, consider rehiring your workers on a contract basis as a
temporary employee. This could save you money on salary expenses as well as
employee benefits until the business gets back on track and is able to rehire workers
on a permanent basis.

[11]

7. Outsource

administrative

functions. Consider outsourcing functions

such

as

your

accounting and payroll to help reduce your business expenses. This will give you more time
to focus on building your business and costing projects, while possibly reducing the expense
of these functions if you are able to outsource them for cheaper than performing them within
your business.
While cutting expenses may seem like something to do temporarily to maintain your
business, actually implementing these ideas when revenues are increasing will continue to
help your business generate the most profitability possible.

DISADVANTAGES OF OPERATING COSTING:

Start-up businesses are typically more costly and risky since there is no proven
formula.

In order to obtain capital to fund the business, a lengthy detailed business plan must
be put together.

All of the details of starting the business, including licenses, marketing, naming the
business, finding product sources, etc. are the responsibility of the owner

[12]

CHAPTER 3
COST ANALYSIS

The costs incurred in departments rendering services or service organizations are grouped
under the following heads:
1. Fixed or standard charges
2. Semi-fixed or maintenance charges
3. Variable or running charges

To ascertain the cost per unit, these charges are aggregated and divided by the number of
service units during the specified period.

Cost per unit = total cost during the period

Number of service unit during the period

Determination of cost per unit serves the following purposes:

1. It is used for price fixation.

2. It is used for cost control

[13]

STAFF CANTEEN COSTING

Most of the factories have canteens for staff. They are subsidized either partly or wholly. It is
manned by a supervisor who is responsible for running it. The supervisor is accountable to
the works manager or personnel manager. The major accounting headings are

(i)
(ii)
(iii)
(iv)
(v)

provisions,
services,
labor,
consumable stores and
miscellaneous overheads.

Cost per meal can be calculated on the number of meals served; for other items such as
snacks, on the number of snacks served, and tea/ coffee: no. of tea or coffee served.
A specimen of operating cost statement for a canteen is shown as follow

[14]

HOTEL COSTING

Hotel industry is a service industry and covers various activities as provision for food and
accommodation and providing other comforts like recreation, business facilities, shopping
areas for shopping facilities. In order to provide the service, hotel industry is required to
incur various expenses. Expenses may be fixed or variable. Fixed expenses comprise staff
salaries, repairs and renovations, interior decoration, laundry contract cost, sundries and
depreciation on fixed assets, variable expenses include lighting charges, attendants salaries
and power charges

In order to calculate the room rent to be charged per person, notional profit is added in the
total operating cost and divided by the number of rooms available. The numbers of rooms
available are calculated after taking into consideration various categories of suite, various
seasons and occupancy percentage.

[15]

ELECTRICITY GENERATION
Power houses engaged in electricity generation or steam generation use Power House
Costing. Operating cost statement can be prepared by identifying the costs associated with
the power generation or steam generation. Cost unit is different for electricity generation and
steam generation. For electricity generation, cost unit is cost per kilowatt-hour while for
steam it is lb

EXPENSE ACCOUNT

An expense account typically ties to an item making a company spend money, but

there also are non-cash cost accounts that reduce the organizations income. If you hear
finance people using terms such as cost, expense, charge and outlay, just note theyre
referring to the same thing. Expense accounts run the whole operating gamut, from
merchandise cost and interest to selling, general and administrative outlays. Think of SG&A
outlays as anything from rent and litigation to insurance, office supplies, travel and business
entertainment. Non-cash expense accounts include depreciation, amortization and depletion.

DATA REPORTING

Operating accounts constitute the conceptual fulcrum around which an organization builds its
bookkeeping and financial reporting practices. These accounts help the business publish
accurate, complete financial data summaries at the end of a given period -- say, a month,
[16]

quarter or fiscal year. A full set of accounting reports includes a balance sheet, an income
statement, an equity statement and a cash flow statement.

OPERATING COSTINGMANAGEMENT CONTROL

The operating activity encompasses all the management functions involved in the day-to-day
performance of organizational tasks and missions. As such, it is primarily a lower-echelon
function and is, therefore, of considerable importance to wing/base level managers. In fact, it
can be said that the preponderant portion of a wing/base-level managers efforts are expended
in the operating activity. In this regard, many if not most management actions are concerned
primarily with operational effectiveness, mission accomplishment, and the like
considerations which do not necessarily require cost data. Nevertheless, there are two areas
of operating activity in which managers use cost information: management control and
decision-making.5
In essence, management control is the function of ensuring that management plans and
policies are implemented as intended.6 In performing this function, cost information can help
in three important ways: it can serve as a means of communication; it can be used to
motivate; and it can be used as a yardstick of appraisal.

COMMUNICATION

The communicating role of cost data is inherent in the data themselves. Their very existence
constitutes a record of some activity, and the simple act of transmittal constitutes a report, be
it formal or informal. Perhaps it is this characteristic of cost information that is responsible
[17]

for the interest in cost information for its own sake. A cursory consideration of the
communicating role of cost data could lead to the erroneous argument that, since any and all
cost information by its very nature constitutes a record and/or report, any and all cost
information is of use to management. This argument, however, ignores one of the basic
precepts of communication: to be effective, any communication must convey the intended
thought. In order to be an effective means of communication, then, cost data must be
collected and presented in a fashion suitable for conveying the intended thought. This is
simply another way of stating the introductory premisecost has no meaning unless the type
of cost is specified. From this discussion it follows that no special category of cost data is
required in performing the communicating function. What is required is that the correct type
of cost data be used, depending on the purpose of the communication.

MOTIVATION
Cost information can be used as an important tool for motivating subordinates. If nothing
else, the mere collection of cost data indicates that management is concerned about costs, and
this fact alone will serve to motivate subordinates to comply with management plans and
policies that can be measured in terms of cost.
At this point it would be appropriate to digress for a moment and consider the importance of
motivation. Motivation, really, is the only way that management can ever accomplish
anything. Mr. Robert Anthony expressed this idea most succinctly:
An obvious and fundamental fact about organizations is that they are made up of human
beings. The management control process in part consists of inducing the people in an

[18]

organization to do certain things and to refrain from doing others. Although for some
purposes an accumulation of the costs of manufacturing a product is useful, management
literally cannot control a product or the costs of making a product. What management does
or at least attempts to dois control the actions of the people who are responsible for
incurring these costs.8
Regardless of how it is attained, cost control is certainly one of the most important
management objectives.9 But, to repeat, this objective can only be realized by motivating
people. However, . . . costs can be controlled only on the basis of accurate, comprehensive,
well-coordinated knowledge of their nature, amount, and reason for existence . . .10 The
logical consequence of these arguments is that, for management control purposes, costs must
be collected and people must be motivated. This twofold requirement can be satisfied by
measuring costs incurred and categorizing them in terms of the person or persons responsible
for incurring the costs. This process will fix responsibility for costs with those individuals
who have control over the costs.11 This concept of measuring and categorizing costs as either
controllable or uncontrollable serves a dual purpose: to collect the required cost data and to
motivate responsible individuals toward cost control and other management objectives,
thereby satisfying the need of cost data for management control.

APPRAISAL
Closely associated with the function of motivation is the appraisal or evaluation function. As
far as people are concerned, the two functions are practically inseparablea man will be
motivated to perform to the extent that he will be evaluated on his performance. Evaluation,
per se, must be based on much more than just cost performance. Nevertheless, since cost
[19]

performance, or efficiency, is a management objective, it must enter into evaluation to some

extent. The other half of the evaluation coin is effectivenesshow well the job was done. In
the military, effectiveness is rightfully considered to be more important than efficiency, and it
should therefore be given primary consideration in evaluation. The problem, then, is to
motivate toward efficiency and evaluate efficiency without jeopardizing effectiveness. This
may be accomplished by evaluating efficiency in terms of extremesthe very good and the
very bad being identified and evaluated accordingly, and all those in between being evaluated
entirely on effectivenss.12 At any rate, the same cost concepts are applicable to the appraisal
of people as were developed in the preceding discussion on motivationcontrollable costs
and uncontrollable costs.
A further application of the appraisal function concerns the evaluation of decisions.
Decisions are often based at least in part on cost considerations. In order to evaluate such
decisions it is necessary to measure results in terms of the cost parameters used in the
decision process.13 It is evident, then, that the same cost considerations and categories will be
used in evaluating decisions as were used in making them, and these will be considered in
succeeding paragraphs.
Suffice it to say in summary that cost information is used in the management control function
of the operating activity in order to communicate, to motivate, and to evaluate, and that these
uses of cost information require that costs be categorized as controllable or uncontrollable. At
any rate, the same cost concepts are applicable to the appraisal of people as were developed
in the preceding discussion on motivationcontrollable costs and uncontrollable costs

[20]

 OPERATING COSTINGDECISION-MAKING

Theres more than one way to skin a cat is a homespun adage which expresses one of the
most basic and most generally accepted truisms of human activitythat there is more than
one way to do anything. One of managements most basic and most frequently performed
tasks is selecting the best way to do something. This, of course, is the essence of
management decision-makingchoosing among alternatives. Moreover, the decisionmaking process is one of comparing the relative effects of the various possible alternatives.
Any course of action may be thought of or measured in terms of change, based on the
situation existing before and after the implementation of that course of action. The more a
given course of action improves a given situation (or the less it degrades the situation), the
better is that alternative. Or, in the words of Haynes and Massie, . . . decisions are based on
measuring the benefits to be derived . . . against the sacrifices (costs) incurred.14
One of the most important aspects of cost information in the decision-making process is
futurity. Decisions are concerned with the impact of alternatives on future events, not with
past history. It follows, then, that only those costs not yet incurred are important to a . . .
[management] decision, and unavoidable costs should never even be considered in the
decision-making process.

COST FOR DECISION-MAKING

The effective communication of cost information for decision-making depends, in large part,
on categorization of costs to reflect those aspects illustrated in the automobile example. The
[21]

first requirement is to separate the costs incurred as a direct result of performing a given task
from those only indirectly related to the task. These aspects may be identified as direct and
indirect costs respectively.16 All the costs listed in Table I are direct costs associated with
owning and operating an automobile. Indirect costs would be incurred for such things as
upkeep of garage and driveway, utilities for the garage, etc.
A further distinction must be made between costs that vary in direct proportion to output and
those that do not, termed variable and fixed costs respectively.17 In the illustration,
gasoline and lubricants and tire replacements are examples of variable costs, and their
magnitude is determined solely by the number of miles driven. Costs such as depreciation,
registration, garage rent, insurance, etc., are fixed and they remain essentially the same
regardless of how much the car is driven.
Of even more interest in decision-making is the distinction between costs that will be
affected by a particular decision and those that will not, termed incremental and sunk
costs respectively.18 Returning to our example once more, if the family lives in a house that
has a garage and driveway, the costs of these facilities are sunk costs. They have been
incurred and cannot be reduced by any decision concerning the use of the family car.
Finally, a manager must consider opportunity costs (or opportunity losses). He must consider
that any gain which might have resulted from employing his resources in a manner other than
the one being considered must be foregone if the alternative is selected and is therefore part
of the cost (sacrifice) incurred by choosing the first course of action. This aspect of cost data
has been termed implicit cost, as opposed to explicit costs, which represent the resources
actually consumed by the alternative selected.19 All the costs listed in Table I, for example,
are the explicit costs of owning and operating the family automobile for one year.

[22]

DESIGNING THE SYSTEM Designing the system begins with product development.
Product development involves determining the characteristics and features of the good (or
service if engaged in a service-oriented industry) to be sold. It should begin with an
assessment of customer needs and eventually grow into a detailed product design. The
facilities and equipment that will produce the product, as well as the information systems
needed to monitor and control performance, are part of this system design process. In fact,
manufacturing process decisions are integral to a system's ultimate success or failure. "Of all
the structural decisions that the operations manager faces, the one with the greatest impact on
the manufacturing operation's success is the process/technology choice, " said Thomas S.
Bateman and Carl P. Zeithaml in Management: Function and Strategy. "This decision
addresses the question 'How will the product be made?' " Product development should be a
cross-functional decision-making process that relies on teamwork and communication to
install the marketing, financial, and operating plans needed to successfully launch a product.

PLANNING THE SYSTEM Planning the system describes how management expects to
utilize the existing resource base created as a result of the production system design. One of
the outcomes of this planning process may be to change the system design to cope with
environmental changes. For example, management may decide to increase or decrease
capacity to cope with changing demand, or rearrange layout to enhance efficiency.
Decisions made by production planners depend on the time horizon. Long-range decisions
could include the number of facilities required to meet customer needs or studying how
technological change might affect the methods used to produce services and goods. The time
horizon for long-term planning varies with the industry and is dependent on both complexity

[23]

and size of proposed changes. Typically, however, long-term planning may involve
determining work force size, developing training programs, working with suppliers to
improve product quality and improve delivery systems, and determining the amount of
material to order on an aggregate basis. Short-term scheduling, on the other hand, is
concerned with production planning for specific job orders (who will do the work, what
equipment will be used, which materials will be consumed, when the work will begin and
end, and what mode of transportation will be used to deliver the product when the order is
completed).

MANAGING THE SYSTEM Managing the system involves working with people to
encourage participation and improve organizational performance. Participative management
and teamwork are an essential part of successful operations, as are leadership, training, and
culture. In addition, material management and quality are two key areas of concern.
Material management includes decisions regarding the procurement, control, handling,
storage, and distribution of materials. Material management is becoming more important
because, in many organizations, the costs of purchased materials comprise more than 50
percent of the total production cost. Questions regarding quantities and timing of material
orders need to be addressed here as well when companies weigh the qualities of various
suppliers.

A budget provides a roadmap for the financial management of the organization including
controlling costs. Historical results along with the effects of current revenue and cost trends
[24]

provide the basis for a budget and can help predict the future financial health of the
organization. It will also provide the benchmark for reporting future financial results.
Monthly reviews of actual financial results compared to budgeted amounts will provide the
information necessary to react quickly to variances to the plan.

CHAPTER 4

CONCLUSION

[25]

Our detailed analysis of operating cost structures leads us to conclude that although the Big4
Indian IT companies offer similar services and operate in same geographies, each of them has
control over and manages their operating costs differently. And this naturally has varying
effects on their operating profits.

We further conclude that the timeless essence of studying each company closely holds true
even when companies are in the same sector.

CHAPTER 5

BIBLIOGROPHY

[26]

www.managementparadise.com
www.wikipedia.com
www.icai.com
www.investopedia.com

[27]