Operating Costing

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.

For example, maintenance department; power house; boiler house; canteen; hospital; internal transport.

Operation Costing

It represent a refinement of process costing. In this each operation instead of each process of stage of production is separately costed. This may offer better scope for control. At the end of each operation, the unit operation cost may be computed by dividing the total operation cost by total output.

It is defined as the refinement of process costing. It is concerned with the determination of the cost of each operation rather than the process. In those industries where a process consists of distinct operations, the method of costing applied or used is called operation costing. Operation costing offers better scope for control. It facilitate the computation of unit operation cost at the end of each operation by dividing the total operation cost by total input units. It is the category of the basic costing method, applicable, where standardized goods or services result from a sequence of repetitive and more or less continuous operations, or processes to which costs are charged before being averaged over the units produced during the period. The two costing methods included under this head are process costing and service costing.

Role of Operating Cost Accounting

Balance sheets and profit and loss statements do not reveal how profitable one product is versus another, or whether one plant produces more efficiently than another. Although the stockholder or investment analyst may care little about details of efficiency and cost since to them the overall profit of the business is sufficient, management must take a different point of view. Naturally, management is interested in maintaining the overall position of the company. The overall position of a company can include such measures as how successfully it competes, how it is perceived by its customers, competitors, and investors, and its capacity for future growth.

In cost accounting the total expenditures in operating a business are broken down on per item or per unit basis, as for example the cost of producing a gallon of gasoline, a ton of coal, a dozen shirts, or a refrigerator. The same idea can be extended to cost per production order, as when a special product is made for a customer, or extended to cost per activity or operation, such as the cost of drilling ½ inch holes, or plating sheet metal of a certain size and quality.

Cost accounting provides information for the following purposes:

1. Cost determination The costs and expense of a business are recorded, classified, and allocated to various jobs,

departments, products, or services.

2. Costs for pricing Once costs are determined, the information also serves as a guide regarding prices to be quoted

to customers. Even though selling prices are governed only partly by the costs of production, in the long run the selling price must at least equal the costs of production, or there will be serious consequence to the profit and loss statement.

3. Cost for managerial decision In a sense, both cost determination and cost for pricing provide bases for managerial decisions.

Although managerial decision making actually becomes much more complex than the statement above implies, cost information may be helpful in making decision that have to do with (a) whether to add a new product, or to drop one that is now being produced (b) Whether to manufacture a certain unit, or buy it on the outside, and (c) whether to add certain sales terrories and drop others.

4. Cost control One of the more essential purposes of cost accounting is control of expenditures. Such control

leads to efficiency in the use of labor, materials machines and plants. Although to a large extent selling prices are determined by competition, the profit-making capacity of a business is guided by the efficiency with which costs are controlled.

Introduction of Transportation cost

The cost accounting principles for tracing/ identifying an element of cost, its allocation /apportionment to a product or service are well established. Transportation cost is an important element of cost for procurement of materials for production and for distribution of product for sale. Therefore, cost accounting records should present transportation cost separately from the other cost of inward materials or cost of sales of finished goods. The Finance Act 2003 also specifies the certification requirement of transportation cost for claiming deduction while arriving at the assessable value for excisable goods cleared for home consumption / export. There is a need to standardize the record keeping of expenses relating to transportation and computation of transportation cost.

Economic Impacts refer to costs and benefits. Costs (benefits) reduce (increase) scarce resources such as money, time, land, health, environmental quality, or any other item of value. Costs and benefits have a mirror image relationship: a cost can be defined as a reduction in benefits and a benefit can be defined as a reduction in costs. Transportation benefits are often measured in terms reduced transportation costs. For example, congestion reduction benefits consist of reductions in travel time and vehicle operating costs. Calculating costs is therefore the basis for calculating benefits.

 Economists have developed estimates of many transportation costs for use in economic

analysis, including vehicle expenses, travel time costs, road and parking facility costs, crash costs and environmental costs. This chapter summarizes these cost estimates and describes how to obtain additional information on individual costs.

 This Encyclopedia evaluates TDM strategies based on effectiveness in achieving various

transportation improvement objectives (i.e., benefits), including congestion reduction, road and parking facility savings, consumer savings, road safety, and environmental protection (Evaluating TDM). These benefits are usually measured in terms of cost reductions, so this chapter primarily describes transportation costs. However, focusing on costs does not ignore transportation benefits.

Transport systems face requirements to increase their capacity and to reduce the costs of movements. All users (e.g. individuals, enterprises, institutions, governments, etc.) have tonegotiate or bid for the transfer of goods, people, information and capital because supplies, distribution systems, tariffs, salaries, locations, marketing techniques as well as fuel costs are changing constantly. There are also costs involved in gathering information, negotiating, and enforcing contracts and transactions, which are often referred as the cost of doing business. Trade involves transactions costs that all agents attempt to reduce since transaction costs account for a growing share of the resources consumed by the economy.Frequently, enterprises and individuals must take decisions about how to route passengers or freight through the transport system. This choice has been considerably expanded in the context of the production of lighter and high value consuming goods, such as electronics, and less bulky production techniques. It is not uncommon for transport costs to account for 10% of the total cost of a product. This share

also roughly applies to personal mobility where households spend about 10% of their income for transportation, including the automobile which has a complex cost structure. Thus, the choice of a transportation mode to route people and freight within origins and destinations becomes important and depends on a number of factors such as the nature of the goods, the available infrastructures, origins and destinations, technology, and particularly their respective distances. Jointly, they define transportation costs.

Transport costs are a monetary measure of what the transport provider must pay to produce transportation services. They come as fixed (infrastructure) and variable (operating) costs, depending on a variety of conditions related to geography, infrastructure, administrative barriers, energy, and on how passengers and freight are carried. Three major components, related to transactions, shipments and the friction of distance, impact on transport costs.

Transport costs have significant impacts on the structure of economic activities as well as on international trade. Empirical evidence underlines that raising transport costs by 10% reduces trade volumes by more than 20%. In a competitive environment where transportation is a service that can be bided on, transport costs are influenced by the respective rates of transport companies, the portion of the transport costs charged to users.

Rates are the price of transportation services paid by their users. They are the negotiated monetary cost of moving a passenger or a unit of freight between a specific origin and destination. Rates are often visible to the consumers since transport providers must provide this information to secure transactions. They may not necessarily express the real transport costs.

The difference between costs and rates either results in a loss or a profit from the service provider. Considering the components of transport costs previously discussed, rate setting is a complex undertaking subject to constant change. For public transit, rates are often fixed and the result of a political decision where a share of the total costs is subsidized by the society. The goal is to provide an affordable mobility to the largest possible segment of the population even if this implies a recurring deficit (public transit systems rarely make any profit). It is thus common for public transit systems to have rates that are lower than costs.  For freight transportation and many forms of passenger transportation (e.g. air transportation) rates are subject to a competitive pressure. This means that the rate will be adjusted according to the demand and the supply. They either reflect costs directly involved with shipping (cost-of-service) or are determined by the value of the commodity (value-of-service). Since many actors involved in freight transportation

are private rates tend to vary, often significantly, but profitability is paramount.

2. Costs and Time Components

Transportation offers a spectrum of costs and level of services. The price of a transport service does not only include the direct out-of-the-pocket money costs to the user but also includes time costs and costs related to possible inefficiencies, discomfort and risk (e.g. unexpected delays). However, economic actors often base their choice of a transport mode or route on only part of the total transport price. For example, motorists are biased by short run marginal costs. They might narrow down the price of a specific trip by car to fuel costs only, thereby excluding fixed costs such as depreciation, insurance and vehicle tax. Many shippers or freight forwarders are primarily guided by direct money costs when considering the price factor in modal choice. The narrow focus on direct money costs is to some extent attributable to the fact that time costs and costs related to possible inefficiencies are harder to calculate and often can only be fully assessed after the cargo has arrived. Among the most significant conditions affecting transport costs and thus transport rates are:

Geography. Its impacts mainly involve distance and accessibility. Distance is commonly the most basic condition affecting transport costs. The more it is difficult to trade space for a cost, the more the friction of distance is important. It can be expressed in terms of length, time, economic costs or the amount of energy used. It varies greatly according to the type of transportation mode involved and the efficiency of specific transport routes. Landlocked countries tend to have higher transport costs, often twice as much, as they do not have direct access to maritime transportation. The impact of geography on the cost structure can be expanded to include several rate zones, such as one for local, another for the nation and another for exports.

Type of product. Many products require packaging, special handling, are bulky or perishable. Coal is obviously a commodity that is easier to transport than fruits or fresh flowers as it requires rudimentary storage facilities and can be transshipped using rudimentary equipment. Insurance costs are also to be considered and are commonly a function of the value to weight ratio and the risk associated with the movement. As such, different economic sectors incur different transport costs as they each have their own transport intensity. With containerization the type of product plays little in the transport cost since rates are set per container, but products still need to be loaded or unloaded from the container. For passengers, comfort and amenities must be provided, especially if long distance travel is involved.

Economies of scale. Another condition affecting transport costs is related to economies of scale or the possibilities to apply them as the larger the quantities transported, the lower the unit cost. Bulk commodities such as energy (coal, oil), minerals and grains are highly suitable to obtain lower unit transport costs if they are transported in large quantities. For instance, moving a barrel of oil over 4,000 km would cost $1 on a 150,000 deadweight tons tanker ship and $3 on a 50,000 deadweight tons tanker ship. A similar trend also applies to container shipping with larger containerships involving lower unit costs.

Energy. Transport activities are large consumers of energy, especially oil. About 60% of all the global oil consumption is attributed to transport activities. Transport typically account for about 25% of all the energy consumption of an economy. The costs of several energy intensive transport modes, such as air transport, are particularly susceptible to fluctuations in energy prices.

Trade imbalances. Imbalances between imports and exports have impacts on transport costs. This is especially the case for container transportation since trade imbalances imply the repositioning of empty containers that have to be taken into account in the total transport costs. Consequently, if a trade balance is strongly negative (more imports than exports), transport costs for imports tend to be higher than for exports. Significant transport rate imbalances have emerged along major trade routes. The same condition applies at the national and local levels where freight flows are often unidirectional, implying empty movements.

Infrastructures. The efficiency and capacity of transport modes and terminals has a direct impact on transport costs. Poor infrastructures imply higher transport costs, delays and negative economic consequences. More developed transport systems tend to have lower transport costs since they are more reliable and can handle more movements.

Mode. Different modes are characterized by different transport costs, since each has its own capacity limitations and operational conditions. When two or more modes are directly competing for the same market, the outcome often results in lower transport costs.Containerized transportation permitted a significant reduction in freight transport rates around the world.

Competition and regulation. Concerns the complex competitive and regulatory environment in which transportation takes place. Transport services taking place over highly competitive segments tend to be of lower cost than on segments with limited competition (oligopoly or monopoly). International competition has favored concentration in many segments of the transport industry, namely maritime and air modes. Regulations, such as tariffs, cabotage laws, labor, security and safety impose additional transport costs, particularly in developing countries.

Surcharges. Refer to an array of fees, often set in an arbitrary fashion, to reflect temporary conditions that may impact on costs assumed by the transporter. The most common are fuel surcharges, security fees, geopolitical risk premiums and additional baggage fees. The passenger transport industry, particularly airlines, has become dependent on a wide array of surcharges as a source of revenue.

The transport time component is also an important consideration as it is associated with the service factor of transportation. They include the transport time, the order time, the timing, the punctuality and the frequency. For instance, a maritime shipper may offer a container transport service between a number of North American and Pacific Asian ports. It may take 12 days to service two ports across the Pacific (transport time) and a port call is done every two days (frequency). In order to secure a slot on a ship, a freight forwarder must call at least five days in

advance (order time). For a specific port terminal, a ship arrives at 8AM and leaves at 5PM (timing) with the average delay being two hours (punctuality).