Professional Documents
Culture Documents
INTRODUCTION TO TOPIC
It is a method of costing applied by undertakings which provide service rather than
production of commodities. Like unit costing and process costing, operating costing is thus a
form of operation costing.
The emphasis under operating costing is on the ascertainment of cost of rendering services
rather than on the cost of manufacturing a product. It is applied by transport companies, gas
and water works, electricity supply companies, canteens, hospitals, theatres school etc.
Within an organisation itself certain departments too are known as service departments which
provide ancillary services to the production departments. E.g. Maintenance department,
power house, boiler house, canteen, hospital, internal transport.
The information concerning the business enterprise is very helpful to the management to
control it in an efficiently way. As the other branches like financial accountancy and
management accountancy, the cost accountancy also serves the important information to the
management regarding the operating efficiency of the business. It becomes very easy for
management to lay down management policies, to guide management decisions or evaluate
operating management performance with the information provided by cost accounting.
The term operation in business terminology refers to an activity of the business. It is very
important to study the operations of the business in detail because depends on the operations,
which it performs. The management should always concentrate on the efficiency of the
operation and also the costs associated to the operations. It is very important to control the
costs associated to the operations for the enterprises like manufacturing companies,
companies engaged in the process of extraction of materials from earth like, coal mines etc.
Generally, the above mentioned business enterprises depend on the operation that it has to be
performed in to produce in to produce the final output. The costs associated with such
operations are generally higher. These costs are called as operating costs.
The costs, which are incurred to perform the operation of the enterprise, are called as
operating costs. These costs are to be accounted for in order to arrive at the total costs of
operation or process, which helps in determining the price of the final product.
Cost accounting is the classifying, recording and appropriate allocation of expenditure for
the determination of the costs of products or services, and to the presentation of suitably;
arranged data for the purposes of control and guidance of management.
It includes the ascertainment of the costs of every process, operation, services or contrast as
may be appropriate. It deals with the cost of production, selling and distribution. It thus, the
provision of such analysis and classification of expenditure as will enable the total cost of any
particular unit of production to be ascertained with reasonable degree of accuracy and at the
same time to disclose exactly how such total cost is constituted (i.e. the value of material
used, the amount of labour and other expenses incurred) so as to control and reduce the cost.
Operating Costs are the costs incurred by undertakings which do not manufacture any
product but provide a service. Such undertakings for example are Transport concerns, Gas
agencies; Electricity Undertakings; Hospitals; Theatres etc. Because of the varied nature of
activities carried out by the service undertakings, the cost system used is obviously different
from that followed in manufacturing concerns.
5. Finally it involves the preparation of right information to the right person at the right
time so that it may be helpful to management for planning, evaluation of performance,
control and decision-making
Overhead costs for a business are the cost of resources used by an organization just to
maintain its existence. Overhead costs are usually measured in monetary terms, but nonmonetary overhead is possible in the form of time required to accomplish tasks.
Examples of overhead costs include:
Non-overhead costs are incremental costs, such as the cost of raw materials used in the goods
a business sells.
Operating Cost is calculated by Cost of goods sold + Operating Expenses. Operating
Expenses consist of:
Administrative and office expenses like rent, salaries, to staff, insurance, directors
fees etc.
In the case of a device, component, piece of equipment or facility (for the rest of this article,
all of these items will be referred to in general as equipment), it is the regular, usual and
customary recurring costs of operating the equipment. This does not include the capital cost
of constructing or purchasing the equipment (depending on whether it is made by the owner
or was purchased as a constructed system).Operating costs are incurred by all equipment
unless the equipment has no cost to operate, requires no personnel or space and never wears
out (any examples? perhaps intangibles, though not equipment, per se). In some cases,
equipment may appear to have low or no operating cost because either the cost is not
recognized or is being absorbed in whole or part by the cost of something else.
Advertising
Raw materials
investment value of the funds used to purchase the land, if it is owned instead
of rented or leased
Maintenance of equipment
Insurance premium
Depreciation of equipment and eventual replacement costs (unless the facility has no
moving parts it probably will wear out eventually)
Damage due to uninsured losses, accident, sabotage, negligence, terrorism and routine
wear and tear.
Income taxes
A solar panel placed on one's home for use in generating electric power generally has
only capital costs; once it's running there are no personnel costs, utility costs or
depreciation and it uses no extra land (that wasn't already part of the place where it is
located) so it has no real operating costs; however there may need to be taken into
account costs of replacement if damaged.
An automobile or any other item purchased for personal use has no salary cost
because the owner does not charge themselves for operating the device.
An item which is leased may have some or all of these costs included as part of the
purchase price.
It might be questionable to assert that the cost of ten extra people on the sales force are an
incremental cost or an overhead cost, since the wages for these people are both overhead and
incremental. The staffs needed to keep the shop operational are mostly considered as
overhead.
The undertaking which adopts service costing does not produce any tangible goods.
These undertakings render unique services to their customers.
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.
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, costs per room-day in hotel etc. are the examples of composite cost unit.
Documents like the daily log sheet, cost sheet etc. are used for the collection of cost
data.
Hotel
College/Schools
Hospitals
Electricity
Kilowatt-hours
Swimming pool
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Canteen
Total cost
Cost per km
License fees
Insurance Premium
Road tax
Garage rent
Drivers wages
Attendant-cum-cleaners wages
Salaries and wages of other staff
Total
Running charges :-
Hotel industry
Hospital industry &
Transport industry
Hotel industry
In the hotel industry, expenses are divided into two main categories:
Direct Expenses:
These are the expenses that vary with the level of production. For example, in the Food and
Beverage department, the Cost of Food Sales is a direct expense. For, the more dishes we
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serve, the more cost of Food Sales the Hotel incurs. Moreover, in the Telephone Department,
the Cost of Calls is a direct expense. For, the more we connect guests to whatever destination
wanted, the more cost of calls the hotel incurs.
At this very stage a bracket would be opened to explain that there is a primordial difference
between revenue generator departments. In fact, revenue generator departments are classified
into two: Service Type departments versus merchandising departments. Service type
departments are revenue generators making money from solely providing services (Ex.
Rooms Division department). On the other hand, merchandising departments ensure revenue
by getting use of certain raw material, processing it, and then sell the final product (Ex. F&B
department, Telephone department). Therefore, only merchandising departments have a
direct expense called Cost of Sales.
Indirect Expenses:
These are the expenses that do not vary with the level of production, or variable costs that
cannot be feasibly distributed to various Financial Reporting Centers. In the hotel industry,
indirect expenses are, hence, divided into two different categories:
1. Fixed Charges:
Examples might include rent, insurance, property taxes, and interest expense. For, these very
expenses are incurred for the benefit of the hotel as a whole not for the benefit of each single
department. To illustrate, if a hotel insures itself against fire, theft and burglary, and one day
some valuable equipment has been stolen, from any department whatsoever, the insurance
company will indemnify the hotel.
2. Undistributed Expenses:
Examples might include electricity, energy, and water expenses. For, usually the hotel
receives a total energy bill to be paid. In the old days, some hotels went for allocating this
amount according to certain factors (ex. Surface, Department Usage). However, this
practice proved to be misleading, since it might under-allocate energy expenses for some
departments and over-allocate it for others. Nowadays, most of the hotels decide not to
allocate such expenses any more. Rather, hotels report such expenses in separate schedules.
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At this stage, departments of a typical hotel would be listed along with their various related
direct expenses. Later, examples of fixed charges and undistributed expenses would be
discussed. Last, a bracket would be opened to discuss one of the most important Direct
Expenses in any hotel, which is Payroll and Related Expenses. For, hotels being described as
labor intensive companies devote a big percentage of their financial resources to such an
expense.
Rooms
Telephone
Gift Shops
2. Support Centers those departments that have minimal Guest Contact and do not produce
Sales. Yet, they do provide services to Revenue Centers, which, in turn, provide Services to
Guests
Marketing
Data Processing
Human Resources
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3. Other Financial Reporting Centers include Energy Costs and Fixed Charges (Rent
Expense, Property Taxes, Insurance Expense, Interest Expense, Depreciation and
Amortization Expenses)
Each Financial Reporting Center should be assigned an Identification Number. To
illustrate, consider the following Example:
Financial Reporting Center
Rooms
Food and Beverage
Telephone
Administrative & General
Marketing
Property Operation and Maintenance
Energy Costs
Fixed Charges
Identification Number
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15
17
31
36
38
41
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Responsibility Accounting:
Aim provides Financial Information useful in evaluating the effectiveness of Managers
and Department Heads. That's why only Direct Expenses should be charged to Specific
Departments
1. Expenses include the day-to-day Costs of Operating the Business, the Expired Costs of
Assets through Depreciation and Amortization, and the "write-off" of pre-paid items.
Expenses are classified as Direct expenses (Cost of Sales and Operating Expenses), Indirect
Expenses (Fixed Charges and Undistributed Expenses) and Income Taxes
a) Direct Expenses they are Costs incurred solely for the benefit of a particular
Department
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Cost of Sales
Payroll Expenses
Payroll-related Expenses
Operating Supplies
b) Indirect Expenses They are incurred for the benefit of the Hotel as a whole, and cannot
be identified with any particular Department
Property Insurance
Interest Expense
Property Taxes
| FIXED CHARGES
Rent Expense
Marketing Expense
| UNDISTRIBUTED EXPENSES
Energy Costs
c) Income Taxes it is neither a Direct Expense, nor an Indirect Expense. It should appear
as a separate Line Item on a Hotel's Summary Income Statement
2-Departmental Expense Accounting:
Separate Expenses versus one Lump-sum Amount of Expenses
Hospital industry
Hospital cost information is derived by relating the inputs of resources in monetary terms to
the outputs of services provided by the hospital. Cost information is part of the basic
information needed by managers and policy makers for making decisions about how to
improve the performance of a hospital, where to allocate the resources within or among
hospitals, or to compare the performance of different hospitals to one another. Some of the
basic reasons for wanting cost information are to improve efficiency, increase effectiveness,
enhance sustainability, and improve quality.
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Cost data can be used for two primary purposes, relative to time: for the present and for the
future. It can be used to assess the current situation of a hospital, such as for assessing its
efficiency, determining the effectiveness of the hospital, reviewing its priorities, and setting
of prices. Cost information may also be used for the future: making cost projections,
budgeting, and scenario planning with what if? situations.
Information on the costs and outputs of hospitals can provide considerable information for
managers of hospitals, regional coordinators of health services, and policy makers overseeing
the issues of the national health system. The information can be used to assess the internal
operations and performance of a single hospitalsuch as helping assess the utilization of
health personnel in different departments of the hospital in providing servicesand to make
comparisons of the operations and efficiency of different hospitals. Some of the specific
potential uses of cost information for a health care administrator are:
Comparison across facilities to identify those that are efficient from those those are
not,
comparison of costs with fees,
development of a cross-subsidization strategy,
evaluation of the financial requirements of a new program, or
Analysis of the effect of changing the use of staff, equipment, and supplies in
providing services in an existing program.
When the cost data (the financial cost of the resource inputs) can be related to information
about the outputs (the type and quantity of services provided) assessments of efficiency of the
input output relationship can be made.
Cost data on a series of hospitals, within an area or country, may be used by national,
regional, and provincial managers to compare the performance of similar types of hospitals.
They may also use such information to establish standards of performance and efficiency for
hospitals.
The managers or administrators of hospitals may also use the cost data on their individual
hospital. This information can be used to
Step 1: Defining the major and relevant activity areas of the hospital
Define the relevant areas of hospital operations which need to be costed. Factors to consider
are
(1) The importance of an activity relative to the hospitals total output or level of activity,
(2) The Amount of detailed costing information available, and
(3) The amount of detail needed from the Output of this exercise.
Major Cost Areas for Hospital
1. Inpatient
Medical ward
surgical ward
Maternity
Private ward
2. Outpatient clinic
3. Ancillary services
Pharmacy
Laboratory
Radiology (X-Ray)
4. Outreach services (services provided off-site: mobile MCH clinics, patrols, etc.)
5. Training school
Step 2: Gathering information on the services provided or the output of the hospital
Information to be gathered for each of these areas will be based on a typical measure of
workload. For inpatient services two outputs are sought: total inpatient days and total
admissions. The reason for two measures is that since these measures will serve as a
denominator and determine the outputs of this model, it is often useful to have not only the
unit cost per day of hospitalization (total costs/total patient days) but also to have the average
cost per admission (total costs/total admissions). This latter output of the modeltotal cost
per admissionis especially helpful if attempting to determine the payments or premiums on
a capitation basis.
For outpatient clinics it is typical to use total visits for a time period as a measure of
workload.
Ancillary services will use the number of examinations, procedures, or prescriptions filled.
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Outreach services would use number of visits to the mobile clinic, number of contacts, or
number of surveillance visits. Training schools may be a major source of resource
commitment.
The number of students enrolled would be a useful measure of the workload of the institution.
Step 3: Determining the labour and other recurrent costs
In this step you must identify the major cost components for the major activities identified in
step
The major components of expenditure are detailed below
Recurrent costs:
Labour
Salaries
Allowances (uniforms, housing, education, home leave, rural or hardship incentive
pay, etc.)
Free labour (foreign or missionary health personnel who provide their services at
no cost to the facility). Their services should be coasted as the equivalent of what a
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Transportation industry
Price, cost and investment issues in transportation garner intense interest. This is certainly to
be expected from a sector that has been subject to continued public intervention since the
nineteenth century. While arguments of market failure, where the private sector would not
provide the socially optimal amount of transportation service, have previously been used to
justify the economic regulations which characterized the airline, bus, trucking, and rail
industries, it is now generally agreed, and supported by empirical evidence, that the move to a
deregulated system, in which the structure and conduct of the different modes are a result of
the interplay of market forces occurring within and between modes, will result in greater
efficiency and service.
Many factors have led to a reexamination of where, and in which mode, transportation
investments should take place. First and perhaps most importantly, is the general move to
place traditional government activities in a market setting. The privatization and
corporatization of roadways and parts of the aviation systems are good examples of this
phenomenon. Second, there is now a continual and increasing fiscal pressure exerted on all
parts of the economy as the nation reduces the proportion of the economys resources which
are appropriated by government. Third, there is increasing pressure to fully reflect the
environmental, noise, congestion, and safety costs in prices paid by transportation system
users. Finally, there is an avid interest in the prospect of new modes like high speed rail
(HSR) to relieve airport congestion and improve in environmental quality. Such a major
investment decision ought not to be made without understanding the full cost implications of
a technology or investment compared to alternatives.
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There are many types of costs. Key terms and brief definitions are below.
Variable costs: The costs which change as output levels are changed. The
classification of costs as variable or fixed is a function of both the length of the time
horizon and the extent of indivisibility over the range of output considered.
Marginal (or incremental) cost: The derivative (difference) of Total Cost with respect
to a change in output.
Social cost: The cost the society incurs when its resources are used to produce a given
commodity, taking into accounts the external costs and benefits.
Private cost: The cost a producer incurs in getting the resources used in production
Sunk costs: These are costs that were incurred in the past. Sunk costs are irrelevant for
decisions, because they cannot be changed.
Indivisible costs: Do not vary continuously with different levels of output or must
expenditures, but be made in discrete "lumps". Indivisible costs are usually variable
for larger but not for smaller changes in output
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Escapable costs (or Avoidable costs): A cost which can be avoided by curtailing
production. There are both escapable fixed costs and escapable variable costs. The
escapability of costs depends on the time horizon and indivisibility of the costs, and
on the opportunity costs of assets in question
The production of transport services in most modes involves joint and common costs. A joint
cost occurs when the production of one good inevitably results in the production of another
good in some fixed proportion. For example, consider a rail line running only from point A to
point B. The movement of a train from A to B will result in a return movement from B to A.
Since the trip from A to B inevitably results in the costs of the return trip, joint costs arise.
Some of the costs are not traceable to the production of a specific trip, so it is not possible to
fully allocate all costs or to identify separate marginal costs for each of the joint products. For
example, it is not possible to identify a marginal cost for an i to j trip and a separate marginal
cost for a j to i trip. Only the marginal cost of the round trip, what is produced, is identifiable.
Common costs arise when the facilities used to produce one transport service are also used to
produce other transport services (e.g. when track or terminals used to produce freight services
is also used for passenger services). The production of a unit of freight transportation does
not, however, automatically lead to the production of passenger services. Thus, unlike joint
costs, the use of transport facilities to produce one good does not inevitably lead to the
production of some other transport service since output proportions can be varied. The
question arises whether or not the presence of joint and common costs will prevent the
market mechanism from generating efficient prices. Substantial literature in transport
economics has clearly shown that conditions of joint, common or non-allocable costs will not
preclude economically efficient pricing.
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The statistical data regarding costs, maintenance and performance are helpful in preparing a
performance in respect of each vehicle.
In order to compare the operating efficiency for each period, the total costs thus arrived at are
divided by the bases such as number of hours or days, number of kilometres run, number of
commercial ton-kilometres, etc. Costs per unit thus obtained are compared with the past
result. A monthly Vehicle Cost Sheet and Performance Statement are generally used in many
transport undertakings.
Cost control is always possible by means of comparison of actual performance with the
budgeted performance. Various control measures, viz., securing the optimum use of vehicles,
regular maintenance as a planned operation, avoidance of loading and unloading delays
prevention of overlapping and duplicated journeys, planned replacement of vehicles, etc.,
may be instituted.
Where transport department is treated as service department all costs are collected and
apportioned to other departments on the basis of commercial ton-kms. The haulage of
incoming material might be charged as an addition to cost of raw material, and the haulage of
fabricated
goods
to
customers
becomes
part
of
distribution
overhead.
Generally, commercial ton-km is obtained by multiplying the total tonnage carried by the
kilometres travelled and dividing the product by two. This is done where the vehicles return
empty as is found in most cases.
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Number of vehicles:
The company has owned as well as dedicated trucks and trailers.
Owned Vehicles
8 HCVs- Heavy Commercial Vehicles
4 Trailers
Dedicated Vehicles
25 LCVs- Light Commercial Vehicles
Dedicated Vehicles are delivery trucks, which are made according to certain specifications,
operated under the name of another company for which they give a minimum amount of
business and certain running costs are borne by that company.
The company has its LCVs dedicated to ELBEE Delivery Services. They are used for
delivering goods given by ELBEE. The driver charges and maintenance charges are borne by
Adhunik Transport. Other expenses are borne by Elbee. The advantage to Elbee is that its
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capital is not blocked. The advantage to the company is that it does not have to look for
customers and keeps getting a minimum amount of business.
No. of Employees:
The Company has on an average 8 office staff members per branch. There are 30 staff
members in the head office in Mumbai. The salaries of these employees vary from Rs. 2,000Rs. 10,000 depending upon the nature of the job they do.
Measurement of Materials is done in tons.
COSTS:
FIXED COSTS
Salaries
54,00,000
Insurance
8,00,000
1,00,000
Administrative Overheads
2,11,00,000
Taxes
Depreciation
30,00,000
Interests
34,00,000
TOTAL
3,38,00,000
VARIABLE COSTS
Maintenance (Per Vehicle)
HCV
10,000
LCV
6,000
TRAILERS
15,000
Wages
Drivers
2,000
Cleaners
1,200
Transit Expenses
500-1,500
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TOTAL
35,000 approx
Notes:
The maximum distance covered in a day is 300kms. The average distance covered
225-280kms.
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Chapter 5 Findings
After studying the topic in depth and data collection from a firm following are the findings
from the project
As the subject, important features and advantages of cost accounting are studied and
of operation
Operating Costs are the costs incurred by undertakings which do not manufacture any
Finally , the cost details of Adhunik transport organisation limited are provided
herewith which will help us to know more about operating costing
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