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Cost of Services Calculation

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Seeking advice on classifying costs as 'cost of services' for a small business:

  • that utilises supplies and equipment to provide services;
  • where the labour involved in providing the services are salaried and paid regardless of the level of activity

Can these costs be allocated directly to 'cost of services'?

 

 

 

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RLI
By lionofludesch
08th Aug 2017 21:57

If you like.

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By tom123
09th Aug 2017 09:01

Presumably this is a management accounts question?
In which case, the business can choose to classify it's costs in the most appropriate way - within reason.

You may well choose to have direct costs (for the supplies) and a category of production overheads (for the static labour) prior to arriving at your definition of gross profit.

This will help with monitoring percentages over time.

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By vcatterall
09th Aug 2017 11:00

Hi Tom,

Thanks for your reply.

It is a management accounts question, however, I am interested in your view on where these expenses should reflect on the income statement?

I have been thinking along these lines:
1. Supplies & Tools used in providing services allocated directly to COS (although there will be inventory on hand, I believe the business is too small to warrant a monthly count)
2. Depreciation of Equipment used in providing services allocated to COS based on the hours utilised whilst providing the service.
3. Variable portion of the production salaries allocated to COS based on the hours spent providing the service.

Then the balance of the depreciation and production salaries included with administrative overheads below gross profit.

I'm not sure if this is the most accurate way to handle this.

Vanessa

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By tom123
10th Aug 2017 14:19

Where possible, I would tend to include fixed costs on one line, and then have a line below it (which could well be a credit) representing the amount allocated to areas - rather than splitting out the original posting.

I would tend to leave depreciation on it's own somewhere - as it is not really a controllable cost in the medium term.

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RLI
By lionofludesch
09th Aug 2017 09:13

The point is that you need to produce the information which is useful to your business and not worry about what other businesses do.

And, above all, be consistent. Don't chop and change.

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Replying to lionofludesch:
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By vcatterall
09th Aug 2017 11:03

Hi there,

Thanks for your reply.

I couldn't agree more. I am just interested to hear how other companies in similar industries handle this.

Vanessa

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By Duggimon
09th Aug 2017 12:36

I would tend to put variable costs like your first option in cost of sales (or services if you like) and fixed or less variable costs like salaries elsewhere so GP levels remain consistent over varying levels of activity.

As others have said though, it doesn't matter so long as you keep it consistent period after period.

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By Leonard Brown
10th Aug 2017 13:39

Hi Vanessa

The question you raise is one faced by many, many organisations in which the ‘resource’ used to generate / provide / produce the billable product or service (in your case, employment costs) is NOT directly variable.

As I see it, how you decide to state the different elements ultimately depends upon WHAT USE you are going to make of the information you produce.

My preference is to use a technique which, as best as can, attributes to a sale (what I find helps to describe as) the ‘Truly Variable Costs’: in other words those costs which would NOT have been expended had that specific product, service or sale not occurred.

Perhaps for your organisation, those would be the ‘supplies and tools’ you refer to – plus several other costs?

Your ‘Truly Variable Costs’ might also include identifiable elements of ‘overtime’ cost which would not have been incurred had that sale not been made/service not been provided.

So, in a statement that starts with your Sales Turnover, you would deduct your ‘Truly Variable Costs’, leaving your Contribution.

All other costs (those that aren’t ‘truly variable’) would be listed and deducted from the Contribution to determine your Operating Profit.

The real key, of course, is that not all sales will generate an equal contribution ‘per-hour’ (or whatever the measure is for your sector). But by understanding the relevant measures around this, an organisation can identify the ‘better’ (higher contribution yielding) uses of its resources and can study those that yield poor rates of contribution per unit of resource consumed. (And then decide whether it’s possible to ‘improve’ them)

If this methodology sounds of any interest – and you’d like a bit more information about it, let me know and I’ll provide it.

Leonard

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Replying to Leonard Brown:
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By vcatterall
10th Aug 2017 16:03

Hi Leonard,

Thanks for your comprehensive reply.

To answer your question, I am trying to determine the true contribution/GP of the company.

I think I'm struggling to get my head around the costs that are direct but not variable. e.g. Production Software used for editing and processing aerial surveys/reports; Depreciation costs of equipment used in performing aerial surveys; Parts purchased for equipment used in performing aerial surveys.

What are your thoughts on these?

Kind Regards,
Vanessa

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paddle steamer
By DJKL
10th Aug 2017 15:06

Reminds me why my Bigg's "Cost Accounting" is in near pristine condition ,despite having been bought secondhand in 1984, whilst my very old Carters is just hanging together and no more-I hated Management Accounting at university and the intervening years have not helped improve my opinion- now to just work out where to post the cost of those oily rags .

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By tom123
10th Aug 2017 16:24

They need to be apportioned according to square feet ;)

In all seriousness, 25 years on from Uni, and with CIMA quals, I haven't used a lot of the rather complex apportionments.

Users (in my case department heads) really don't want to see apportioned costs over which they have no control.

If a cost is fixed (such as salaries) it is fixed. Doesn't really matter if, in the old days of hourly pay etc, the theories say it is variable.

What You Measure is What You Get.

or

Keep It Simple Stupid

are my maxims.

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By Leonard Brown
11th Aug 2017 11:57

Hi Vanessa

OK. Remember, there is a difference between “Contribution” and “Gross Profit”. So the constituent elements depend upon WHICH of the two you are trying to calculate.

If you check the definitions, you’ll find Contribution defined something like…

Contribution = Sales Turnover less Direct Materials, Direct Labour, Variable Production Overhead and Variable Selling and Distribution Overhead.

And Gross Profit defined something like…

Gross Profit = Sales Turnover less Direct Materials, Direct Labour and TOTAL Production Overhead.

If it’s Gross Profit (and NOT Contribution) you are trying to calculate (as I see it) – “variable” isn’t a factor.

But as I mentioned earlier, when I calculate ‘Contribution’, I tend to go further than the standard definition – and look to identify a business’ ‘TRULY Variable Costs’. But that’s because of the use I intend to make of the information.

So it perhaps returns to ‘WHY’ you are “trying to determine the true contribution/GP of the company”:
- what you are hoping to learn from it, and
- what use you are hoping to put it to?

As clear as 'mud'? Leonard

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Replying to Leonard Brown:
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By vcatterall
11th Aug 2017 13:32

Hi Leonard,

Thanks. I am trying to calculate the GP to determine if the company's earnings adequately cover its overheads. Would you just allocate the items in query to a line called 'Production Overheads' then? I still have an issue with this as we will still incur monthly production software costs, for instance, but could quite easily have not used it at all to generate the sales in that month. Alternatively, these costs can be allocated below the GP line?

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Replying to vcatterall:
RLI
By lionofludesch
11th Aug 2017 13:47

As Leonard says, it's not Gross Profit you need to look at, so much as Contribution.

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