Topic 3. COSTING OF PRODUCTS AND SERVICES

Topic 3. COSTING OF PRODUCTS AND SERVICES

Vera Butkouskaya

Content

1. Cost accumulation2. Cost tracing and cost allocation.3. Costing systems (Job costing systems;

Process costing systems, others)4. Cost allocation: Allocation base, OH rate

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3.1. Cost accumulation

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Operating and support departments

▰ Operating department (or Profit center)▻ adds value to a product or service that is observable by a customer,▻ For ex. F&B department

▰ Support department (or Cost center) ▻ provides service which maintains other internal departments (both

operating departments and other support department) in the organization

▻ For ex. Engineer/Computer departmentThe costs from support departments can be allocated to both operating and other support departments.

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Cost accumulation

Hotel cost objects / units/ departments for cost accumulation.

▰ Profit centers:▻ main operating departments (those that have

contact with the customer and thus generate not only revenues, but also expenses)

▰ Cost centers:▻ support departments (those that have

minimal contact with the costumer and do not generate revenues).

▰ Rooms▰ Others 5

Hotel Organizational Chart

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Which one are main departments and which ones are supporting?

Profit/ Revenue centers, Example

The most common Profit centers in a Hotel:1. Rooms Department (100%), 2. Food and Beverage (100%),3. Golf and Health Club/SPA (54.8%),4. Reservations5. Housekeeping (laundry services)6. Others

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Cost centers, Examples

The most common Cost centers in a Hotel:1. Front office

▻ Staff is responsible for selling and up-selling room, maintaining balanced guest accounts, offering services like handling mail, faxes, messages, and local and hotel information.

2. Housekeeping (cleaning activities)▻ There is the largest number of staff in hotel and they are responsible for the cleanliness

activities in the public areas.3. Guest services

▻ The staff needs to greet the guests when they arrive at the hotel, escort the guests to the front desk, personally allocate the room, and take the guest and luggage to the room.

4. Security▻ It provides guest safety and loss prevention.

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Allocation from the support departments

Example, Main departments use the services of support departments. For example, economist in “Accounting department” is responsible to calculate the salary for the cooks in “F&B” department and for the receptionists in “Front office” department.

The total cost accumulated in the support department should be allocated between user departments. But how much of the total cost should be allocated to each department? 9

Accounting Department

Food and Beverages

Front office Department

Main/User departmentSupport department

X?

Y?TC = X+Y

Cost accumulation and assignment

A costing system accounts for costs in two stages:1. Cost accumulation is the collection of cost data in

some organized way through an accounting system (recording and grouping of actual costs).

2. Cost assignment is both (1) tracing (of direct) and (2) allocating (of indirect) accumulated costs to cost objects

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3.2. Cost tracing and cost allocation

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Cost tracing and cost allocation

Cost tracing is the assigning of direct costs to the chosen cost object. Cost allocation is the assigning of indirect cost to the chosen cost objects.

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Direct and indirect costs

Direct costs are costs that are related to the particular cost object and can be assigned to it

(the salary of the housekeeper is direct cost for the Housekeeping department).

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Indirect costs are costs that are related to various cost objects and cannot be assigned to one particular cost object

(the salary of the housekeeper is indirect cost for Room Department).

© Vera Butkouskaya, PhD | www.verapetrovna.com

Direct costs

A direct costs are:

▰ Are mainly variable by nature (will change based on sales) ▰ Are charged to a particular operating department or division▰ Are responsibility to control by the department or division

manager.Examples of these types of costs for Housekeeping department are:

▰ wages and salaries of cleaning personnel, ▰ operating supplies and services, ▰ linen and laundry,▰ etc

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Indirect costs

Indirect costs:

▰ cannot be charged to any specific department or division, ▰ Thus are not controlled by department/division managers▰ Also called cost undistributed costs or overhead costs▰ Can be allocated between departments/divisions.

Examples,

▰ General building maintenance▰ Annual audit ▰ Wifi or internet connection, ▰ Etc.

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The same cost can be direct and indirect with the respect to different cost objects. 16

©2017 Vera Butkouskaya www.verapetrovna.com

Factory Depreciation Cost

Cost objects

Finished car

Factory

IndirectAllocated

DirectTraced



Hotel Depreciation Cost

Cost objects

Room

Hotel

IndirectAllocated

DirectTraced



Total cost of the Food purchased

Cost objects

A dish

Restaurant

IndirectAllocated

DirectTraced

But how much of the total cost of the food should be allocated to each dish?

“Managers prefer to make decisions based on the direct costs (?).

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3.3. Costing systems

Job costing, process costing, ….

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Costing systems

Costing systems aim to report cost numbers that indicate the manner in which particular cost objects - such as products or services - use the resources of the organization.Management accounting provides information for:

1 Planning and control – management accounting systems accumulate costs by department to compare actual costs with budgeted costs for performance evaluation.

2 Product/service costing – management accounting requires many choices to determine the costs of services and products.

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Job-costing

Job is a task or piece of work, especially one that is paid.For example, cleaning the room, preparing menu, selling a room, etc.

Individualized cost are normally the costs which can be applied only to the one single unique job (service, product, action, etc.).For example, renting a hotel for organizing a wedding ceremony.

Or, The cost of the personalized dinner menu.

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A process-costing system

▰ A process-costing system is a costing system in which ▻ the costs of products or

service is obtained by ▻ assigning costs to masses of

like or similar units.Common for hotels with a number of standard rooms or to a restaurant that serve standard menu.

23Unit (standard) cost = total costs / number of units

Job Costing vs. Process Costing

Audit by an accounting firm.

Linens for a particular bed size.

(individualized costs)

The cost of standard room cleaning.

Furniture for 1 single room.

(standard costs)


Costs are assigned to

Most companies combine 2 systems...

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In a job-costing,▰ individual jobs ▰ use different quantities

of production resources.

Specific dish.

In Process-costing▰ averages production

costs▰ over all units

produced.Standard lunch menu.

Hybrid-costing system

A Hybrid-costing system blends characteristics from both job-costing systems and process-costing systems.Example,

Lunch menu - the choice of dishes from the standard list and individualized cost for drinks

Hotel - standard cost per room and additional individual cost for each additional bed

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3.4. Cost allocation

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How to allocate the costs?

▰ Costs incur in different parts of the organization.▰ The same cost can be direct for one cost object

and indirect for another cost object. ▰ Different cost should be used differently when

costing products, services, customers or contracts▻ (refer to job-costing OR process-costing)

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Cost pool (Overhead)

The indirect costs may include:(1) Costs incurred at corporate headquarters (top

management)(2) Costs incurred at the individual level (each

individual support department) Cost pool (Overhead OH) is a grouping of individual indirect cost items (for example, fixed and variable because of their different behaviour).

▰ Broad: A company-wide total-cost pool for electricity.▰ Narrow: Cost of the food in the kitchen. 29

Allocation Base

An allocation base is the basis upon which an company allocates its overhead (indirect) costs. It takes the form of a quantity.

Allocation based quantity on

▰ Non-financial merits:▻ square footage occupied

▰ Financial▻ Working hours (per hour salary of

the personnel)


Which area on the floor spends more electricity? - rooms, corridor, bar?

Which area on the floor spends more working hours (salary) of the cleaning personnel? - rooms, corridor, bar?

Allocation (Overhead) rate (OH rate)

An indirect cost rate (OH rate) is a tool for determining the proportion of indirect costs in the indirect cost pool each cost object should bear.▰ The OH rate is

▻ the total of indirect costs pool (overhead OH) for a specific reporting period,

▻ divided by total quantity allocation base. OH rate = OH/(total quantity of the allocation base)

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Allocation Base

▻ Given: Total cost of Cleaning services (Housekeeping department) 1000 euro per month. Rooms 70 sq.m. - 13 rooms, Bar - 20 sq.m., Corridor - 10 sq.m.

▻ Calculate: ▻ How much was spent on cleaning rooms (the cost will be

allocated to Room department)? ▻ And how much was spent on cleaning common areas

(Administrative costs)?▻ How much was spent on cleaning the bar (F&B department)?

▻ Allocation base▻ square m.

▻ OH rate▻ = total indirect costs / total square m.

▻ Allocated cleaning cost from Housekeeping department:▻ Cost allocated = OH rate*units

32© Dr. Vera Butkouskaya www.verapetrovna.com

Housekeeping department - main or user? Room, F&B departments - main or user?

Allocation Base

▻ Given: Manager knows that the more direct cleaning materials used, the more time cleaning personnel hours are spend. Total cost of Cleaning services (Housekeeping department) 1000 euro per month. 1 room - direct cost of cleaning materials - 1$ (13 rooms), Bar - 4$, Corridor - 2$.

▻ Calculate: ▻ How much was spent on cleaning rooms (the cost will be

allocated to Room department)? ▻ And how much was spent on cleaning common areas

(Administrative costs)?▻ How much was spent on cleaning the bar (F&B department)?

▻ Allocation base▻ $

▻ OH rate▻

▻ Allocated cleaning cost from Housekeeping department:▻ 33

© Dr. Vera Butkouskaya www.verapetrovna.com

Housekeeping department - main or user? Room, F&B departments - main or user?

“But, can be one particular cost both direct and indirect (?).

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Cost object: A dish Food used to prepare this dish

Cost object: A dishElectricity used extractor hood during all day

Cost object: A dishSalary of the cook

Cost object: A dishSalary of the Chef


Cost object: A trip Airline tickets and hotel reservation

Cost object: A trip

Cost object: A tripSalary of the cook

Cost object: A tripSalary of the Chef

Single-rate and dual-rate methods

▰ A single-rate cost-allocation method ▻ pools all costs in 1 (one) cost pool▻ allocates them to cost objects using the same (single) allocation

base ( same OH rate per unit )▰ A dual-rate cost-allocation method

▻ first classifies costs from one cost pool into 2 (two) subpools (variable and fix)

▻ each sub-pool has a different allocation base ( different OH rate)

37For each method, company previously decide weather to

single-rate method

Given:▰ Total costs in indirect cost pool (TiC) = TiFC+TiVC▰ TFC - total fixed costs ▰ TVC - total variable costs▰ Labour Hours used by Department 1(Lh1)▰ Labour Hours used by Department 2 (Lh2) ▰ Total labour hours used by all departments (TLh)

Calculate: how many from Total costs should be allocated to Department 1Solution: Allocation base - LhOH rate under single-base method = TiC / TLh Cost allocated to Department 1 = = OH rate * Lh 1 38

dual-rate method

Given:▰ Total costs in indirect cost pool (TiC) = TiFC+TiVC▰ Labour Hours used by Department 1 and 2 (Lh1 and Lh2)▰ Direct materials used by Department 1 and 2 (DM1 and DM2)▰ Total labour hours used by all departments (TLh)▰ Total materials used by all departments (TDM)

Calculate: how many from Total costs should be allocated to Department 1Solution: Allocation base fixed costs - Lh, allocation rate variable costs - DMOH rate fixed costs = TiFC / TLh ; OH rate variable costs = TiVC/DMCost allocated to Department 1 = = OH rate fixed costs * Lh 1 + OH rate variable costs * DM1 39

Single-rate vs. dual-rate + / -

▰ Single-rate method ▻ + has lower cost of implementation▻ - can create mistakes in decision-making

▰ Dual-rate method▻ + demonstrate the different behaviour of fix and variable costs

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“Questions

[email protected]

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Activity-based costing (ABC)

Activity-based costing (ABC) is an accounting method that identifies the activities that a firm performs and then assigns indirect costs to products/service.It assigns indirect costs to products/services in a more logical manner than the traditional approach of simply allocating costs on the basis of operating/support departments or rooms.

▻ For example, using customer groups (individuals, business travelers or families) as cost objects. CPA - customer performance analysis

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Documents

Topic 3. COSTING OF PRODUCTS AND SERVICES