Job Costing In The Service Industry

Feb 06, 2015

Most of our assignments in job costing relate to manufacturing companies and assisting them in getting their job cost systems in order. In many of those businesses, a large portion of their product cost is variable and can be specifically assigned to a specific product. The fixed overhead portion is generally a much smaller portion of the total cost to be recovered. Although it presents numerous problems associated with properly computing methods of recovery, it generally does not represent the majority of the cost to be recovered.

What about job costing in an environment where virtually all the costs are fixed? Our latest assignment has to do with computing job cost in a service industry where there is a group of highly paid, highly technical employees all working on fixed salaries; as well as a large amount of other fixed overhead that all has to be recovered in some fashion on an hourly rate basis.

Although this seems like just another cost assignment with somewhat rearranged components, I believe that it is significantly different in the theory that must be applied to accurately recover cost and determine billing rates.

I have seen some professional literature that questioned the validity of developing hourly rates where so much of the actual cost to perform the assignment is really related to the capacity of the individual and available work. That is to say, that an individual on salary working at 80% utilization would have a very different cost per hour as compared to the same individual working at a 40% utilization. In the case of highly paid individuals, the actual cost per hour difference could be huge, and may not be dependent at all on the individuals proficiency or availability for work, but rather the work available to the individual. I believe that in a stable environment with consistent work hours and available work, normal job costing hourly rate computations can be valuable and reliable. However, those same rate calculations could be misleading if the company is in a strong growth phase with constantly expanding hours and/or personnel, or in a radically changing environment where work is high one month and low the next.

The other important considerations for considering hourly rate computations in a fixed cost environment has to do with a change in focus as to management’s benchmarks in controlling operations and seeking to achieve the highest profitability. The ability to convert some of the labor costs to variable so that crew sizes or hours worked can be fluctuated based on available work and pay to those individuals adjusted accordingly could be an important factor in times of radical fluctuations in volume. If those tools are unavailable due to the nature of the work or the individuals involved, then business managers must focus on continuous new work development so as to provide a reliable stream of volume to keep costs as low as possible, while constantly monitoring overall profitability. There are numerous other factors that are relevant to rate development in a service industry that does make it radically different compared to rate development in an industry that has a huge component of its cost structure as variable.

Categories: Cost Accounting