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SERVICE SECTOR COSTING In case of manufacturing industries, the selling price of a product is decided by adding the variable cost involved for the product, the fixed cost to be absorbed by the product and the desired profit but a question arises about how do service industry who do not give any product to the customers but give only services, decide the charge for their services?
For this purpose, there are 3 different methods available as given below:
1) Job Costing Method
This method is generally adopted by those business firms who give services to the customers as per their requirement. Hence, these business firms decide the charges for each and every customer individually depending upon the time and effort which will be required for each and every customer.
E.g. Garages, accounting firms, audit firms, advertisement firms, etc.
2) Process Costing Method
This method is adopted by those business firms who give same kind of service to all the customers and hence these business firm are able to decide the charges in advance.
E.g. Goods transport company, Passengers transport company, Hotel industry, etc.
Under this method, the charges are decided in advance using the following techniques:
i) Estimate the total cost to be incurred for any particular future period bifurcating the cost into variable & fixed cost.
ii) To the estimated total cost, add the desired profit in order to get the total collection for that particular period.
iii) Estimate the total quantity of service to be given in that particular period in terms of composite units.
E.g. Goods Transport Company – Tonne km
Passenger Transport Company – Passenger km
Hospitals – Bed days
Hotel Industry – Room days etc.
iv) Divide the total collection required by the total number of composite units in order to give the charge per composite unit.
v) At this common rate, all the customers will be charged but the amount chargeable to each customer will differ depending upon the quantum of service taken by each customer.
3) Hybrid Method
This method is useful to those business firms who give common service to all the customers and additional services to desiring customers.
For common services, a common rate will be decided in advance and for additional services, the amount will be charged additionally on a case to case basis.
For e.g. Hotel Industry
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Q.1. A transport company has a fleet of three trucks of 10 tonnes capacity each plying in different directions for transport of customer’s goods. The trucks run loaded with goods and return empty. The distance travelled, number of trips made and the load carried per trip by each truck are as under:
Truck No. One way Distance
(Kms.) No. of trips
per day Load carried per
trip (tonnes)
1 16 4 6
2 40 2 9
3 30 3 8
The analysis of maintenance cost and the total distance travelled during the last two years is as under:
Year Total kilometers travelled Maintenance Cost
1 1,60,200 ₹ 46,050
2 1,56,700 ₹ 45,175
The following are the details of expenses for the year under review:
Diesel : ₹ 60 per litre. Each litre gives 4 kms. on an average.
Driver’s salary : ₹ 2,000 per month
Licence and taxes : ₹ 5,000 per annum per truck
Insurance : ₹ 5,000 per annum for all the three vehicles.
Purchase price per truck : ₹ 3,00,000. Life 10 years. Scrap value at the end of life is ₹ 10,000.
Oil and sundries : ₹ 25 per 100 kms. run.
General overhead : ₹ 11,084 per annum
The vehicles operate 24 days per month on an average.
Required:
(i) Prepare an Annual Cost Statement covering the fleet of three vehicles.
(ii) Calculate the cost per km. run.
(iii) Determine the freight rate per tonne km. to yield a profit of 10% on freight charges.
Solution:
Working Note:
1) Calculation of total RMS for the year
= Kms. per round trip × Round trips per day × Days per month × Month per annum
Truck 1 = (16 × 2) × 4 × 24 × 12 36,864
2 = (40 × 2) × 2 × 24 × 12 46,080
3 = (30 × 2) × 3 × 24 × 12 51,840
1,34,784
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2) Calculation of total tonne RM for the year
= Tonne RM per round trip × Round trips per day × Days per month × Month per annum
Truck 1 = [(6 × 16) + (0 × 16)] × 4 × 24 × 12 1,10,592
2 = [(9 × 40) + (0 × 40)] × 2 × 24 × 12 2,07,360
3 = [(8 × 30) + (0 × 30)] × 3 × 24 × 12 2,07,360
5,25,312
3) Break-up of maintenance cost (semi-variable cost)
Variable cost per RM = Difference in Amts.
Difference in RM
= 46,050−45,175
1,60,200−1,56,700=
875
3,500 = ₹ 0.25/RM
Fixed Cost = Semi Variable Cost – VC
= 46,050 – (0.25 × 1,60,200) = ₹ 6,000
i) Statement showing the total cost for the year for all the 3 vehicles together
Particulars ₹
I) Variable Cost
Maintenance Cost (0.25 × 1,34,784) 33,696
Diesel Cost 20,21,760
Km Cost
4 60
1,34,784 ?
Oil & Sundries 33,696
Km Cost
100 25
1,34,784 ?
20,89,152
II) Fixed Cost
Maintenance Cost (WN 3) 6,000
Driver’s Salary [(2,000 × 12) × 3] 72,000
Licence & Taxes [5,000 × 3] 15,000
Depreciation [(3,00,000 – 10,000/10) × 3] 87,000
General Overhead 11,084
1,96,084
III) Total Cost (I + II) 22,85,236
ii) Cost per RM run
= Total Cost
Total RMS run =
22,85,236
1,34,784 = ₹ 16.94 per truck per RM
iii) Freight Rate per tonne RM
Particulars ₹
Cost per tonne RM [22,85,236/5,25,312] 90 4.35
+ Profit per tonne RM 10 0.48
Freight rate per tonne RM 100 4.83
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Q.2. A manufacturing company runs its boiler on furnace oil obtained from X oil company and Y oil company whose depots are situated at a distance of 24 kms and 16 kms from the factory site.
Transportation of furnace oil is made by company’s own tank lorries of 8 tonne capacity each. Onward trips are made only with full load and the lorries return empty. The filling time takes an average of 40 minutes for X oil company and 30 minutes for Y oil company. The emptying time in the factory is 40 minutes for each. The average speed of lorries works out to 24 kms. per hour.
The varying operating charges average 80 paise per km covered and fixed charges gives an incidence of ₹ 7.50 per hour of operation.
a) Calculate the transportation cost of furnace oil per ton-km for each source.
b) Also suggest which source is more economical for the company.
Solution:
1) Calculation of total RMS for one complete operation for the two sources available X Oil Co. = 24 RMS × 2 = 48 km.
Y Oil Co. = 16 RM × 2 = 32 km.
2) Calculation of total minutes required for one complete operation for the 2 sources available
Particulars X Oil Co. Y Oil Co.
Filling time 40 30
Emptying time 40 40
Travelling time
Source Km Cost
X Oil 24 60
48 ?
Y Oil 24 60
32 ?
120
80
200 150
3) Calculation of total tonne RM for a complete operation for the 2 sources available
Tonnes × RM
X Oil [(8 × 24) + (0 × 24)] = 192 Tonne/RM
Y Oil [(8 × 16) + (0 × 16)] = 128 Tonne/RM
a) Statement showing the transportation cost of furnace oil per tonne RM for each source
Particulars X Oil Co. Y Oil Co.
Variable Cost
X Oil = 48 × 0.8)
Y Oil = 32 × 0.8)
38.4
25.6
Fixed Cost
X Oil Co. = 200/60 × 7.5
Y Oil Co. = 150/60 × 7.5
25
18.75
Total Cost 63.4 44.35
Tonne RM 192 128
Cost per tonne RM 0.33 0.35
b) Since the cost of transporting 8 tonnes of furnace oil from Y Oil Co. is only ₹ 44.35 as compared to ₹ 63.4 with X Oil Co. Hence, Y Oil Co. is more economical for transportation of furnace oil.
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Q.3. Modern Airways has a single jet aircraft and operates between EXETOWN and WYETOWN. Flights leave EXETOWN on Mondays and Thursdays and depart from WYETOWN on Wednesdays and Saturdays. Modern Airways cannot afford any more flights between EXETOWN and WYETOWN. Only tourist class seats are available on its flights. An analyst has collected the following information:
Seating capacity of aircraft 360
Average passengers per flight 200
Flights per week 4
Flights per year 208
Average one way fare ₹ 5,000
Variable fuel cost ₹ 1,40,000 per flight
Food service to passengers (not charged to passengers) ₹ 200 per passenger
Commission paid to travel agents on each ticket
booked on Modern Airways (Assume all Modern
Airways tickets are booked by travel agents) 8% of fare
Fixed annual lease cost allocated to each flight ₹ 5,30,000
Fixed ground services cost allocated to each flight
(maintenance, check-in, baggage handling) ₹ 70,000
Fixed salaries of flight crew allocated to each flight ₹ 40,000
For the sake of simplicity, assume that fuel cost are unaffected by the actual number of passengers on a flight.
Required:
(a) What is the operating income that Modern Airways makes on each one-way flight between EXETOWN and WYETOWN?
(b) The market research department of Modern Airways indicates that lowering the average one-way fare to ₹ 4,800 will increase the average number of passengers per flight to 212. Should Modern Airways lower its fare?
(c) Zed Tours and Travels, a tour operator, approaches Modern Airways to charter its jet aircraft twice each month, first to take Zed’s international tourists from EXETOWN to WYETOWN and then bring the tourists back from WYETOWN to EXETOWN. If Modern Airways accepts the offer, it will be able to offer to its customers only 184 (208 minus 24) of its own flights each year. The terms of the charter are:
(i) For each one-way flight Zed will pay Modern ₹ 7,50,000 to charter its plane and to use its flight crew and ground service staff.
(ii) Zed will pay for fuel costs.
(iii) Zed will pay for all food costs.
On purely financial consideration, should Modern Airways accept the offer from Zed Tours and Travels? What other considerations should Modern Airways consider in deciding whether or not to charter its plane to Zed Tours and Travels?
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Solution:
a) Statement showing the operating income per flight between EXETOWN & WYETOWN
Particulars ₹
I) Total Revenue (200 × 5,000) 10,00,000
II) Total Cost
a) Variable Cost
Fuel Cost 1,40,000
Food Cost (200 × 200) 40,000 Commission to Travel Agent (8% of 10,00,000) 80,000
2,60,000
b) Fixed Cost
Lease Cost 5,30,000
Ground Service Cost 70,000
Salaries of Flight Crew 40,000
6,40,000
c) Total Cost (a + b) 9,00,000
III) Net Operating Income (I + II) 1,00,000
b) Statement showing the additional profit/reduction in profit with a revised fair
Particulars ₹
I) Additional Revenue [(4,800 × 212) – 10,00,000] 17,600
II) Additional Cost Food Cost (12 × 200) 2,400
Commission to Agents (8% of 17,600) 1,408
3,808
III) Additional Profit (I – II) 13,792
Since, lowering the fare increases the profit, hence the fare should be lowered.
c) i) Statement showing the total profit per flight if chartered to Zed Tours & Travels
Particulars ₹
I) Total Collection 7,50,000
II) Total Cost
Fixed Cost 6,40,000
III. Profit (I – II) 1,10,000
Since the profit per flight is only ₹ 1,10,000 as against ₹ 1,13,792 which can be earned when the aircraft is used for the general customers hence, the aircraft should not be chartered to Zed Tours & Travels on financial considerations.
ii) Other points to be given importance before a final call –
a) If the arrangement is a long term arrangement, only then the company should give a thought of chartering the aircraft.
b) The revenue of 1,13,792 is based on the market research which can even go wrong whereas 1,10,000 will be a fixed income without any contingency from this angle the scheme seems favourable.
c) By reducing the flights for regular customers, the co. may lose some regular customers permanently. From this angle, the scheme seems unfavourable.
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Q.4. Asha Road Carriers is a transporting company that transports goods from one place to another. It measures quality of service in terms of:
(i) Time required to transport goods
(ii) On-time delivery
(iii) Number of lost or damaged cartons
To improve its business prospects and performance the company is seriously considering to install a scheduling and tracking system, which involves an annual outlay of ₹ 1,50,000, besides equipments costing ₹ 2,00,000 needed for installation of the system. The company proposes to utilise the proceeds of the fixed deposit maturing next month to purchase the equipment. The rate of interest at present on deposit is 10%. The company furnishes the following information about its present and anticipated future performance:
Current Expected
On-time delivery 85% 95%
Variable cost per carton lost or damaged ₹ 50 ₹ 50
Fixed cost for cartons lost ₹ 9,000 ₹ 9,000
Number of cartons lost or damaged 3,000 1,000
The company expects that each per cent point increase in on-time performance will result in revenue increase of ₹ 18,000 per annum. Contribution margin is 45%. Should Asha Road Carriers acquire and install the new system?
Solution:
Statement showing the increase/(decrease) in the profit by installing the new system
Particulars ₹
I) Increase in profit due to
a) Increase in contribution (18,000 × 10 × 45%) 81,000
1% 18,000
10% ?
b) Reduction in the variable cost [(3,000 – 1,000) × 50] 1,00,000
1,81,000
II) Decrease in profit due to
a) Annual outlay 1,50,000
b) Loss of Interest on FD (2,00,000 × 10%) 20,000
1,70,000
III) Net increase in profit (I – II) 11,000
Since, installing the new system increases the profit by ₹ 11,000 hence the new system should be installed.
Note:
Depreciation information for the equipment is not given in question and hence it is not considered in the above statement. However, before taking a final decision the company should think about the same.
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Q.5. A hospital operates a 40 bed capacity special health care department. The said department levies a charge of ₹ 425 per bed day from the patient using its services. The data relating to fees collected and cost for the year 2017-2018 are as under:
₹
Fees collected during the year 34,95,625
Variable cost based on patient bed days 13,57,125
Departmental fixed cost 6,22,500
Apportioned cost of the hospital administration charge 10,00,000
Besides the above, nursing staff were employed as per the following scale at ₹ 48,000 per annum per nurse.
Annual Patient Bed Days No. of nurses required
Less than 5,000 3
5,000 & less than 7,000 4
7,000 & less than 9,000 6
9,000 & above 8
The projections for the year 2018-2019 are as under:
The cost other than apportioned cost will go up by 10%.
The apportioned cost will increase by ₹ 2,50,000 per annum.
The salary of the nursing staff will increase to ₹ 54,000 per annum per nurse.
The occupancy of the bed capacity is not likely to increase in 2018-2019 and consequently the management is actively considering a proposal to close down the department. In that event, the departmental fixed cost can be avoided.
Required:
(i) Present statement to show the profitability of the department for the year 2017-2018 and 2018-2019.
(ii) Calculate the:
Break-even bed capacity for the year 2018-2019.
Increase in fee per bed day required to justify continuance of the department.
Solution:
Calculation of the patient bed days for the year 2017-18
= Total fees collected
Fees per patient bed day =
34,95,625
425 = 8,225
Note:
a) In 2018-19 the patient bed days will remain the same.
b) 8,225 patient bed day require 6 nurses.
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i) Statement showing the profit for the year 2017-18 & 2018-19
Particulars 2017-18 2018-19
I. Total Revenue 34,95,625 34,95,625
II. Total Cost
a) Variable Cost [2018-19 = 13,57,125 + 10%] 13,57,125 14,92,838
b) Fixed Cost
Dept. FC [2018-19 = 6,22,500 + 10%] 6,22,500 6,84,750
Apportioned FC 10,00,000 12,50,000
Nurses salary 2,88,000 3,24,000
2017-18 = 6 × 48,000
2018-19 = 6 × 54,000
19,10,500 22,58,750
Total Cost (a + b) 32,67,625 37,51,588
III. Profit/(Loss) (I – II) 2,28,000 (2,55,963)
ii) a) BEP(Bed Capacity) = Fixed Cost
Contribution per bed day
= 22,58,750
243.15*
= 9,276 bed days
* The above BEP is improper because in the above fixed cost, 6 nurses salary has been considered whereas above 9,000 bed days, 8,000 nurses are required.
Final BEP (bed capacity) = Revised FC
Cont. per bed day
= 22,58,750+(54,000 ×2
243.5
= 23,66,750
243.5 = 9,720 bed days
b) Increase in the fee required per bed day with 8,225 patient bed days to achieve break even point in 2018-19
= Loss Amt.
Patiend bed days =
2,55,963
8,225 = ₹ 31.12
Q.6. A public company responsible for the supply of domestic gas has been approached by several prospective customers in a rural area adjacent to a high-pressure main. As a condition of its license to operate as a utility, the company is obliged to respond positively to current needs provided the financial viability of the company is not put at risk. New customers are charged ₹ 250 each for connection to the system. Once a meter is installed, a standing charge of ₹ 10 per quarter is billed. Charges for gas are levied at ₹ 400 per 1,000 metered units. A postal survey of the area containing 5,000 domestic users, elicited a 40% response rate. 95% of those who responded confirmed that they wished to become gas users and expressed their willingness to pay the connection charge. Although it is recognized that a small percentage of those willing to pay for connection may not actually choose to use gas, it is expected that the average household will burn 50 metered units per month. There will be some seasonal differences. The company’s marginal cost of capital is 17% pa and supplies of bulk gas cost the company ₹ 0.065 per metered unit. Wastage of 15% has to be allowed. Determine what the maximum capital project cost can be to allow the company to provide the service required.
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Solution:
Statement showing the recurring income p.a. for the company
Particulars Amt.
I. Recurring Revenue
Standing Charge (1,900* × 10 × 4) 76,000
Charges for Gas (1,900 × 50 × 12 × 0.4) 4,56,000
(400/1,000)
5,32,000
II. Recurring Cost
Cost for Gas purchased
(1,900 ×50 ×12 ×0.065
85%)
15% is loss
87,176
III. Profit/(Loss) (I – II) 44,48,224
The above profit should give 17% on the investment made by the company.
Total investment which can be made by the company towards capital cost.
= 4,44,824
17% = ₹ 26,16,612
Total capital cost of profit will be the company’s investments + The customers contribution
= 26,16,612 + (1,900 × 250)
= 26,16,612 + 4,75,000
= 30,91,612
* (5,000 × 40%) × 95% = 1,900
Q.7. XY Hotel has 40 bed rooms with a maximum occupancy of 490 sleeper nights per week. Average occupancy is 60% throughout the year.
The average food cost per person per day is as follows: (₹)
Breakfast 72.00 Lunch 220.00 Dinner 268.00
560.00 Direct wages and staff meals per week are as under:
Housekeeping 39,040.00 Restaurant and Kitchen 68,600.00 General 35,200.00
Direct expenses per annum are ₹ 9,15,200 for house -keeping and ₹ 10,40,000 for restaurant. Indirect expenses amount to ₹ 68,22,400, which should be apportioned on the basis of floor area. The floor areas are as follows:
Sq. Mt. Bed Rooms 3,600 Restaurant 1,200 Service Area 600
A net profit of 10% must be made on the restaurant taking and also on accommodation takings. Calculate what amount per person should be charged per day and also show the split between accommodation and meal charges.
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Solution:
Statement showing the total collection required per person per day towards accommodation and meal charges
Particulars Accommodation Meal
Cost per week
- Food Cost (294* × 560) - 1,64,640
- Direct wages & staff meal cost 39,040 68,600
General direct wages & staff meal charged to Acc. & Meal in the ratio of their respective cost
12,767 22,433
[Acc. 35,200 × 39,040/1,07,640]
[Meal 35,200 × 68,600/1,07,640]
- Direct Expenses [9,15,200/52] 17,600 20000
[10,40,000/52]
- Indirect Expenses in the ratio of 36 : 12[68,22,400/52] 98,400 32,800
Total cost per week 90 1,67,807 3,08,473
Add: Profit 10 18,645 34,275
Total collection 100 1,86,452 3,42,748
Sleeper nights per week 294 294
Charge per person per day 634.19 1,165.81
1,800
Q.8. Elegant Hotel has a capacity of 100 single rooms and 20 double rooms. It has a sports centre
with a swimming pool, which is also used by persons other than residents of the hotel. The hotel has a shopping arcade at the basement and speciality restaurant at the roof top. The following information is available:
(i) Average occupancy: 75% for 365 days of the year (ii) Current cost are:
Variable cost per day Fixed cost per day Single room ₹ 400 ₹ 200 Double room ₹ 500 ₹ 250
(iii) Average sales per day of restaurant is ₹ 1,00,000. Contribution is at 30%. Fixed cost ₹ 10,00,000.
(iv) The sports centre/swimming pool is likely to be used by 50 non-residents daily. Average contribution per day per non-resident is estimated at ₹ 50.Fixed cost is ₹ 5,00,000 per annum.
(v) Average contribution per month from the shopping arcade is ₹ 50,000. Fixed cost is ₹ 6,00,000 per annum.
You are required to find out: (a)(i) Rent chargeable for single and double room per day, so that there is a margin of safety of
20% on hire of rooms and that the rent for a double room should be kept at 120% of a single room.
(ii) The hotel intends to reserve the normal occupancy of 12 single rooms for one of its valued corporate customers at a discount of 10% of the rent. What increase in the occupancy of the remaining single room days is required to compensate the loss arising from the discount?
(b) Evaluate the profitability of restaurant, sports centre and shopping arcade separately.
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Solution:
Working Notes:
Calculation of total occupied room days p.a.
= (Rooms × Occupancy %) × days
= (100 × 75%) × 365 = 27,375
= (20 × 75%) × 365 = 5,475
a) i) Statement showing the total collection required for the year
Particulars Amt.
I. Variable Cost
Single Rooms (27,375 × 400) 1,09,50,000
Double Rooms (5,475 × 500) 27,37,500
1,36,87,500
II) Fixed Cost
Single Rooms (27,375 × 200) 54,75,000 Double Rooms (5,475 × 25) 13,68,750
68,43,750
III. Total Cost (I + II) 80 2,05,31,250 IV. Margin of Safety/Profit 20 51,32,813
V. Collection 100 2,56,64,063
Let the rent chargeable per single room day = x
Rent chargeable per double room day = ₹ 1.2x
Forming an equation for the total collection period, we get
(27,375 × x) + (5,475 × 1.2x) = 2,56,64,063
27,375x + 6,570x = 2,56,64,063
33,945x = 2,56,64,063
x = 2,56,64,063
33,945
x = 756.05
Rent chargeable per single room day = ₹ 756.05
Rent chargeable per double room day
= 1.2 × 756.05
= ₹ 907.26
ii) Calculation of total discount amount
= 12 × 75% × 365 × (756.05 × 10%)
= 2,48,362
Additional single room days to be occupied to compensate the loss on account of discount.
= Discount Amt.
Contribution per single room day
= 2,48,362
(756.05−400)
= 2,48,362
356.05
= 698 (Approx.)
V.C.
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b) Statement showing the profitability of restaurant, sports centre & shopping arcade
Particulars ₹
I. Restaurant
Total Contribution (1,00,000 × 30% × 365) 1,09,50,000
Less: Fixed Cost (10,00,000)
Profit 99,50,000
II. Sports Contribution
Total Contribution (50 × ₹ 50 × 365) 9,12,500
Less: Fixed Cost (5,00,000)
Profit 4,12,500
III. Shopping Arcade
Total Contribution (50,000 × 12) 6,00,000
Less: Fixed Cost (6,00,000)
Profit 0