The calculation of the cost of a service with similar service centers or functions and cost units that are an appropriate measure of the service provided is a form of Activity Based Costing (ABC).
ABC identifies activitiies which cause costs (known as cost drivers) and puts costs into cost pools.
ABC attempts to overcome problems associated with traditional approach to product costing.
The traditional approach absorbs overheads on production volume as measured by labor or machine hours.
What this means is that, products with high volume standards are charged with most overheads while short run production are charged with lower overheads.
The overhead absorption associated with the traditional volume tends to overcost products made in long runs and undercoat products made in short run.
ABC solves this problem by relating associated overheads by cost drivers and not by production volume.
With ABC, a product or service cost is made up of it’s direct costs and an appropriate share of overheads related to the number of cost units the production causes.
After a service company has determined the appropriate cost unit, the cost per service unit could be calculated.
An example will be given presently but first, what is service costing?
What is service (function) costing?
Service costing is a cost accounting for clearly specified services or functions, which may be service centers or functions.
Another definition is; Service costing is the process of identifying all costs associated with building, supporting, and delivering your service (Stanford).
What is the formula for calculating cost per service unit?
Cost per service unit = Total costs per period/Number of service units supplied in the period.
If in a particular financial year, the records of a hotel showed the following information;
- Number of rooms = 500,
2. Guests. = 100,000
3. Average stay. = 1 day
4. 90% occupancy.
5. Total costs (food, drinks, laundry and lodging) = $2,000,000
The cost per guest per day would be = 2,000,000/100,000 = $20.
There is often a difficulty to define and agree on a realistic cost unit that is an appropriate measure of the service provided. It’s because of this difficulty that a composite cost unit is often used.
Also, the unit cost has limitations. The major problem is that it is a summary figure that ignores quality of performance.