TABLE OF CONTENTS

INTRODUCTION......................................................................................................................1

PREPARATION OF COST SHEET UNDER OPERATING COST........................................4

Illustration of Operating cost sheet:-......................................................................................9

Hotel industry.........................................................................................................................9

 Direct Expenses:........................................................................................................10

 Indirect Expenses:.....................................................................................................10

Hospital industry..................................................................................................................11

Transportation industry........................................................................................................17

CASE STUDY.........................................................................................................................18

Adhunik Transport Organization Limited............................................................................18

Introduction:.....................................................................................................................18

Number of vehicles:.........................................................................................................18

No. of Employees:............................................................................................................19

Costs:................................................................................................................................19

CONCLUSION........................................................................................................................21

1
 INTRODUCTION

Operating cost 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. E.g. Maintenance department,
power house, boiler house, canteen, hospital, internal transport.

The information concerning the business enterprise is very helpful to the

management to control it in an efficiently way. As the other branches like
financial accountancy and management accountancy, the cost accountancy also
serves the important information to the management regarding the operating
efficiency of the business. It becomes very easy for management to lay down
management policies, to guide management decisions or evaluate operating
management performance with the information provided by cost accounting.

The term operation in business terminology refers to an activity of the business.

It is very important to study the operations of the business in detail because
depends on the operations, which it performs. The management should always
concentrate on the efficiency of the operation and also the costs associated to
the operations. It is very important to control the costs associated to the

2
operations for the enterprises like manufacturing companies, companies
engaged in the process of extraction of materials from earth like, coal mines etc.

Generally, the above mentioned business enterprises depend on the operation

that it has to be performed in to produce in to produce the final output. The
costs associated with such operations are generally higher. These costs are
called as “operating costs”.

The costs, which are incurred to perform the operation of the enterprise, are
called as operating costs. These costs are to be accounted for in order to arrive
at the total costs of operation or process, which helps in determining the price of
the final product.

“Cost accounting is the classifying, recording and appropriate allocation of

expenditure for the determination of the costs of products or services, and to the
presentation of suitably; arranged data for the purposes of control and
guidance of management.”

It includes the ascertainment of the costs of every process, operation, services or

contrast as may be appropriate. It deals with the cost of production, selling and
distribution. It thus, the provision of such analysis and classification of
expenditure as will enable the total cost of any particular unit of production to
be ascertained with reasonable degree of accuracy and at the same time to
disclose exactly how such total cost is constituted (i.e. the value of material
used, the amount of labour and other expenses incurred) so as to control and
reduce the cost.

Operating Costs are the costs incurred by undertakings which do not

manufacture any product but provide a service. Such undertakings for example

3
are — Transport concerns, Gas agencies; Electricity Undertakings; Hospitals;
Theatres etc. Because of the varied nature of activities carried out by the service
undertakings, the cost system used is obviously different from that followed in
manufacturing concerns.

Essential features of operating costs are as follows:

(1) The operating costs can be classified under three categories. For example in
the case of transport undertaking these three categories are as follows:
(a) Operating and running charges. It includes expenses of variable nature. For
example expenses on petrol, diesel, lubricating oil, and grease etc.
(b) Maintenance charges. These expenses are of semi-variable nature and
include the cost of tyres and tubes, repairs and maintenance, spares and
accessories, overhaul, etc.
(c) Fixed or standing charges. These includes garage rent, insurance, road
licence, depreciation, interest on capital, salary of operating manager, etc.
(2) The cost unit used is a double unit like passenger-mile; Kilowatt-hour, etc.
It can be implemented in all firms of transport, airlines, bus-service, etc., and by
all firms of Distribution Undertakings.

PREPARATION OF COST SHEET UNDER OPERATING

COST
For preparing a cost sheet under operating cost, costs are usually accumulated
for a specified period viz., a month, a quarter, or a year etc.
All of the accumulated costs should be classified under the following three
heads:

4
1. Fixed costs or standing charges:
Which are the same whether the operation is closed or running at 100%
capacity. Fixed Costs include items such as the rent of the building. These
generally have to be paid regardless of what state the business is in.
2. Variable costs or running charges, (Fuel, Driver Wages, Depreciation, oil
etc.):
Which may increase depending on whether more production is done, and how it
is done (producing 100 items of product might require 10 days of normal time
or take 7 days if overtime is used. It may be more or less expensive to use
overtime production depending on whether faster production means the product
can be more profitable). Variable Costs include indirect overhead costs such as
Cell Phone Services, Computer Supplies, Credit Card Processing, Electrical use,
Janitorial Supplies, Office Products, Payroll Services, Telecom, Uniforms,
Utilities, or Waste Disposal etc.
3. Semi-variable costs or maintenance costs. (Supervision salary, Repairs and
Maintenance)
Under operating costing, the per unit cost of service may be calculated by
dividing the total cost for the period by the total units of service in the period.

Overhead costs for a business are the cost of resources used by an organization
just to maintain its existence. Overhead costs are usually measured in monetary
terms, but non-monetary overhead is possible in the form of time required to
accomplish tasks.
Examples of overhead costs include:
 payment of rent on the office space a business occupies
 cost of electricity for the office lights
 some office personnel wages

Non-overhead costs are incremental costs, such as the cost of raw materials
used in the goods a business sells.
5
Operating Cost is calculated by Cost of goods sold + Operating Expenses.
Operating Expenses consist of:
 Administrative and office expenses like rent, salaries, to staff, insurance,
director’s fees etc.
 Selling and distribution expenses like advertisement, salaries of salesmen.
It includes all operating cost such as salary, rent, stationery, furniture etc.

In the case of a device, component, piece of equipment or facility (for the rest of
this article, all of these items will be referred to in general as equipment), it is
the regular, usual and customary recurring costs of operating the equipment.
This does not include the capital cost of constructing or purchasing the
equipment (depending on whether it is made by the owner or was purchased as
a constructed system).Operating costs are incurred by all equipment — unless
the equipment has no cost to operate, requires no personnel or space and never
wears out (any examples? perhaps intangibles, though not equipment, per se). In
some cases, equipment may appear to have low or no operating cost because
either the cost is not recognized or is being absorbed in whole or part by the cost
of something else.

Equipment operating costs may include:

 Salaries or Wages of personnel

 Advertising
 Raw materials
 License or equivalent fees (such as Corporation yearly registration fees)
imposed by a government
 Real estate expenses, including
o Rent or Lease payments
o Office space rent
o furniture and equipment

6
 o investment value of the funds used to purchase the land, if it is
owned instead of rented or leased
o property taxes and equivalent assessments
o Operations taxes, such as fees assessed on transportation carriers
for use of highways
 Fuel costs such as power for operations, fuel for production
 Public Utilities such as telephone service, Internet connectivity, etc.
 Maintenance of equipment
 Office supplies and consumables
 Insurance premium
 Depreciation of equipment and eventual replacement costs (unless the
facility has no moving parts it probably will wear out eventually)
 Damage due to uninsured losses, accident, sabotage, negligence,
terrorism and routine wear and tear.
 Taxes on production or operation (such as subsidence fees imposed on oil
wells)
 Income taxes

Some of these are not applicable in all instances. For example,

 A solar panel placed on one's home for use in generating electric power
generally has only capital costs; once it's running there are no personnel
costs, utility costs or depreciation and it uses no extra land (that wasn't
already part of the place where it is located) so it has no real operating
costs; however there may need to be taken into account costs of
replacement if damaged.
 An automobile or any other item purchased for personal use has no salary
cost because the owner does not charge themselves for operating the
device.

7
  An item which is leased may have some or all of these costs included as
part of the purchase price.

It might be questionable to assert that the cost of ten extra people on the sales
force are an incremental cost or an overhead cost, since the wages for these
people are both overhead and incremental. The staffs needed to keep the shop
operational are mostly considered as overhead.

 formula for operating cost: total cost*no. of weeks

The main features of operating costing are as following:

 The undertaking which adopts service costing does not produce any
tangible goods. These undertakings render unique services to their
customers.

 The expenses are divided into fixed and variable cost. Such a
classification is necessary to ascertain the cost of service and the unit cost
of service.

 The cost unit may be simple or composite. The examples of simple cost
units are cost per unit in electricity supply, cost per liter in water supply,
cost per meal in canteen etc. Similarly cost per passenger kilometers in
transport cost per patient-day in hospital, costs per room-day in hotel etc.
are the examples of composite cost unit.

 Total cost is averaged over the total amount of service rendered.

8
  Costs are usually computed period-wise. However, in the case of
utilization of vehicles, use of road-rollers etc., the costs are computed
order wise.

 Service costing can be used for service performed internally or

externally.

 Documents like the daily log sheet, cost sheet etc. are used for the
collection of cost data.
Examples of the cost units for services

Transport Ton- Kilometer, Passenger KM, KM Travelled

Hotel Bed- nights available, occupied, meals

College/Schools Students hours, full time/part time student hours

Hospitals Patient bed days, occupied, per operation, per visit

Electricity Kilowatt-hours

Swimming pool Bathers attended, Hours of opening

Canteen Meals provided, Ingredients of Dishes

Illustration of Operating cost sheet:-

Particulars Total cost Cost per km
A Standing charges :-
License fees
Insurance Premium
Road tax
Garage rent

9
 Driver’s wages
Attendant-cum-cleaner’s wages
Salaries and wages of other staff
Total
B Running charges :-
Repairs and maintenance
Cost of fuel (diesel, petrol etc.)
Lubricants, grease and oil
Cost of tires, tubes and other spare parts
Depreciation
Total
C Total charges [ (A) + (B) ]

MAIN AREAS OF OPERATING COSTING

Operating costing is further divided in and used in 3 main areas namely
 Hotel industry
 Hospital industry &
 Transport industry

Hotel industry

In the hotel industry, expenses are divided into two main categories:

 Direct Expenses:
These are the expenses that vary with the level of production. For example, in
the Food and Beverage department, the Cost of Food Sales is a direct expense.
For, the more dishes we serve, the more cost of Food Sales the Hotel incurs.
Moreover, in the Telephone Department, the Cost of Calls is a direct expense.

10
For, the more we connect guests to whatever destination wanted, the more cost
of calls the hotel incurs.

 Indirect Expenses:
These are the expenses that do not vary with the level of production, or variable
costs that cannot be feasibly distributed to various Financial Reporting Centers.
In the hotel industry, indirect expenses are, hence, divided into two different
categories:

Fixed Charges:
Examples might include rent, insurance, property taxes, and interest expense.
For, these very expenses are incurred for the benefit of the hotel as a whole not
for the benefit of each single department. To illustrate, if a hotel insures itself
against fire, theft and burglary, and one day some valuable equipment has been
stolen, from any department whatsoever, the insurance company will indemnify
the hotel.

Undistributed Expenses:
Examples might include electricity, energy, and water expenses. For, usually the
hotel receives a total energy bill to be paid. In the old days, some hotels went
for allocating this amount according to certain factors (ex. Surface, Department
Usage…). However, this practice proved to be misleading, since it might under-
allocate energy expenses for some departments and over-allocate it for others.
Nowadays, most of the hotels decide not to allocate such expenses any more.
Rather, hotels report such expenses in separate schedules.
At this stage, departments of a typical hotel would be listed along with their
various related direct expenses. Later, examples of fixed charges and
undistributed expenses would be discussed. Last, a bracket would be opened to

11
discuss one of the most important Direct Expenses in any hotel, which is Payroll
and Related Expenses. For, hotels being described as labor intensive companies
devote a big percentage of their financial resources to such an expense.

Hospital industry

Hospital cost information is derived by relating the inputs of resources in

monetary terms to the outputs of services provided by the hospital. Cost
information is part of the basic information needed by managers and policy
makers for making decisions about how to improve the performance of a
hospital, where to allocate the resources within or among hospitals, or to
compare the performance of different hospitals to one another. Some of the
basic reasons for wanting cost information are to improve efficiency, increase
effectiveness, enhance sustainability, and improve quality.

Cost data can be used for two primary purposes, relative to time: for the present
and for the future. It can be used to assess the current situation of a hospital,
such as for assessing its efficiency, determining the effectiveness of the
hospital, reviewing its priorities, and setting of prices. Cost information may
also be used for the future: making cost projections, budgeting, and scenario
planning with “what if?” situations.
Cost data on a series of hospitals, within an area or country, may be used by
national, regional, and provincial managers to compare the performance of
similar types of hospitals. They may also use such information to establish
standards of performance and efficiency for hospitals.
The managers or administrators of hospitals may also use the cost data on their
individual hospital. This information can be used to
 measure performance of different departments, wards or units within the
hospital;
12
  examine composition of costs: staff, supplies; and
 assess revenue generation to costs of various services

The process of determining the costs of a hospital involves six steps:

The steps in costing of the hospital services are provided in the six sections
below.
Step 1: Defining the major and relevant activity areas of the hospital
Define the relevant areas of hospital operations which need to be costed. Factors
to consider are
(1) The importance of an activity relative to the hospital’s total output or level
of activity,
(2) The Amount of detailed costing information available, and
(3) The amount of detail needed from the Output of this exercise.

Major Cost Areas for Hospital

1. Inpatient
¨ Medical ward
¨ Surgical ward
¨ Maternity
¨ Private ward
2. Outpatient clinic
3. Ancillary services
¨ Pharmacy
¨ Laboratory
¨ Radiology (X-Ray)
4. Outreach services (services provided off-site: mobile MCH clinics, patrols,
etc.)
5. Training school

13
Step 2: Gathering information on the services provided or the output of the
hospital
Information to be gathered for each of these areas will be based on a typical
measure of workload. For inpatient services two outputs are sought: total
inpatient days and total admissions. The reason for two measures is that since
these measures will serve as a denominator and determine the outputs of this
model, it is often useful to have not only the unit cost per day of hospitalization
(total costs/total patient days) but also to have the average cost per admission
(total costs/total admissions). This latter output of the model—total cost per
admission—is especially helpful if attempting to determine the payments or
premiums on a capitation basis.
For outpatient clinics it is typical to use total visits for a time period as a
measure of workload.
Ancillary services will use the number of examinations, procedures, or
prescriptions filled.
Outreach services would use number of visits to the mobile clinic, number of
contacts, or number of surveillance visits. Training schools may be a major
source of resource commitment.
The number of students enrolled would be a useful measure of the workload of
the institution.
Step 3: Determining the labour and other recurrent costs
In this step you must identify the major cost components for the major activities
identified in step
The major components of expenditure are detailed below
Recurrent costs:
 Labour
 Salaries
 Allowances (uniforms, housing, education, home leave, rural or hardship
incentive pay, etc.)

14
  “Free” labour (foreign or missionary health personnel who provide their
services at no cost to the facility). Their services should be costed as the
equivalent of what a national would receive for doing that same job
 Drugs
 Medical Supplies
 Transportation (petrol and maintenance for vehicles and ambulances)
 Maintenance (for all facilities and equipment other than vehicles)
 Food (total food costs incurred for both patients and staff)
 Telecommunications
 Office expenses
 Other
Step 4: Ascertaining the capital costs of the hospital
 Building (construction or modification but not routine maintenance,
which is included in recurrent costs)
 Equipment (major equipment purchased for the facility). Equipment is
considered capital equipment if its cost is higher than some set amount
(such as US$ 200) and it has an expected useful life of more than one
year. If it does not meet these requirements then it is a recurrent cost. For
example, waste cans have a useful life of greater than one year but
because they cost much less than $200 their purchase is considered a
recurrent rather than a capital cost.
 Vehicles
Step 5: Allocating the indirect costs
The model includes a summary chart, constructed from the labour and the other
costs listed, which lists the total cost for each activity area. Because we also
want the unit costs of those areas providing patient care services, the indirect or
administrative costs must be allocated to the inpatient, outpatient, other
ancillary services, and any other activities as defined in the first step.

15
The administrative costs are considered indirect in that they support the care and
ancillary services delivered to patients and are part of the total costs of the
facility. To allocate these indirect costs of administration we must use what is
termed “the step-down allocation method.”
Since the ancillary, inpatient, and outpatient services cannot use a common
workload measure we will use the other direct costs as a basis for allocating the
indirect costs. The assumption is that the indirect costs follow the same
proportional representation that the direct service costs use among these areas.
Step 6: Reviewing and using the hospital cost summary
The resulting information can be used by an individual institution or for
comparing several institutions. The uses, as mentioned in the introduction,
include:
1. Accountability
Using the information to report to the hospital board or the ministry how
financial resources have been used, and that they have been used properly and
efficiently. Budgets may be generated using cost information.
2. Assessing efficiency
Efficiency is achieved when more hospital services (outputs) are produced with
the same amount of resources (staff, finances, equipment) or when the same
output is produced with fewer resources. So when cost profiles of several
hospitals are available for the manager to review, an assessment of their relative
levels of efficiency may be made.
3. Establishing standards
When cost information is available for a cross-section of similar type hospitals,
the comparison can result in setting a standard for what that type of hospital
should be able to produce with a given set of resources.
4. Cost Recovery: Establishing prices

16
Knowing the cost of services allows the managers to set prices for all services
“at cost” plus a small margin, or determine which services will receive cross
subsidies.
5. Cost Projections: Planning for the future
What-if” scenarios may be generated with the service volume and costing
information generated.
This can help in the planning of new services or expanding existing services

Transportation industry
The production of transport services in most modes involves joint and common
costs. A joint cost occurs when the production of one good inevitably results in
the production of another good in some fixed proportion. For example, consider
a rail line running only from point A to point B. The movement of a train from
A to B will result in a return movement from B to A. Since the trip from A to B
inevitably results in the costs of the return trip, joint costs arise. Some of the
costs are not traceable to the production of a specific trip, so it is not possible to
fully allocate all costs nor to identify separate marginal costs for each of the
joint products. For example, it is not possible to identify a marginal cost for an i
to j trip and a separate marginal cost for a j to i trip. Only the marginal cost of
the round trip, what is produced, is identifiable.

Common costs arise when the facilities used to produce one transport service
are also used to produce other transport services (e.g. when track or terminals
used to produce freight services is also used for passenger services). The
production of a unit of freight transportation does not, however, automatically
lead to the production of passenger services. Thus, unlike joint costs, the use of
transport facilities to produce one good does not inevitably lead to the
production of some other transport service since output proportions can be
varied. The question arises whether or not the presence of joint and common

17
costs will prevent the market mechanism from generating efficient prices.
Substantial literature in transport economics has clearly shown that conditions
of joint, common or non-allocable costs will not preclude economically efficient
pricing.

CASE STUDY
Adhunik Transport Organization Limited

Introduction:

Adhunik Transport Organization Limited was established in the year 1988 as an

organization. In 1991, it got the status of a limited company after reaching the
minimum turnover level. The company currently has a turnover of
approximately Rs. 10 Crores. The company is a member of Bombay Goods
Transport Association (BGTA) AND Indian Bank Association (IBA), which is
very essential for the smooth conduct of their business activities. BGTA checks
all business malpractices and IBA is needed for regulating payments within
different states. The company has its 17 branches all over the country, along
with 3 agencies in certain remote areas. The company also provides
warehousing facilities to companies like Philips-India and Colgate. The
company is involved in delivery of goods all over the country.

Number of vehicles:
The company has owned as well as dedicated trucks and trailers.

 Owned Vehicles

8 HCVs- Heavy Commercial Vehicles

4 Trailers

18
  Dedicated Vehicles

25 LCVs- Light Commercial Vehicles

Dedicated Vehicles are delivery trucks, which are made according to certain
specifications, operated under the name of another company for which they give
a minimum amount of business and certain running costs are borne by that
company.

The company has its LCVs dedicated to ELBEE Delivery Services. They are
used for delivering goods given by ELBEE. The driver charges and
maintenance charges are borne by Adhunik Transport. Other expenses are borne
by Elbee. The advantage to Elbee is that its capital is not blocked. The
advantage to the company is that it does not have to look for customers and
keeps getting a minimum amount of business.

No. of Employees:

The Company has on an average 8 office staff members per branch. There are
30 staff members in the head office in Mumbai. The salaries of these employees
vary from Rs. 2,000- Rs. 10,000 depending upon the nature of the job they do.

Measurement of Materials is done in tons.

Costs:

Fixed Costs
Salaries 54,00,000

Insurance 8,00,000

Transport Permits (Every 5 yrs) 1,00,000

Administrative Overheads 2,11,00,000

19
Taxes

Depreciation 30,00,000

Interests 34,00,000

TOTAL 3,38,00,000

Variable Costs
Maintenance (Per Vehicle) :
HCV 10,000
LCV 6,000
TRAILERS 15,000

Wages:

Drivers 2,000
Cleaners 1,200
Transit Expenses 500-1,500
TOTAL 35,000 approx

Notes:

 There are 2 drivers and 1 cleaner for every long journey.

 In case of short journeys, there is only 1 driver and 1 cleaner.
 The maximum distance covered in a day is 300kms. The average distance
covered 225-280kms.
 THE CUSTOMERS ARE CHARGED:
Rs. 1.20 PER KM PER TON (For HVC)
Rs. 1.00 PER KM PER TON (For LVC)
The Profit-Margin is between 10%-20%.

20
 CONCLUSION

After studying the topic in depth and data collection from a firm following are
the findings from the project

 As the subject, important features and advantages of cost accounting are

studied and the project throws light on 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.
 It is applied by transport companies, gas and water works, electricity
supply companies, canteens, hospitals, theatres school etc.
 The costs, which are incurred to perform the operation of the enterprise,
are called as operating costs. These costs are to be accounted for in order
to arrive at the total costs of operation
 Operating Costs are the costs incurred by undertakings which do not
manufacture any product but provide a service.
 The various steps and items of the operating cost sheet is explained in
depth along with illustrative example and cost units for various services
 The three main area namely
o Hotel industry
o Hospital industry &
o Transport industry
In which massive use of this method of costing is used are explained
with illustrations
 Finally, the cost details of adhunik transport organisation limited are
provided herewith which will help us to know more about operating
costing.

21
 REFERENCES
 https://www.accountingnotes.net/cost-accounting/service-costing/service-
costing-7-types-of-service-costing-cost-accounting/16616
 https://www.konceptca.com/blog/operating-costing-cma-inter-syllabus
 https://www.geektonight.com/operating-costing/#google_vignette
 https://chatgpt.com/c/6753a907-8018-800e-82d2-71ac4720154c
 https://www.scribd.com/doc/211458896/Operating-Costing-a-case-study-
on-transport-industry

22