What is Operating Costing?
Operating costing is a method of cost calculation primarily applicable to businesses and industries engaged in providing continuous services. This form of costing is used to determine the actual cost of producing a service which helps in tracking efficiency, controlling expenditure, and ensuring profitability.
In industries like electricity generation, transportation, and healthcare, operating costing helps in determining the total and per-unit operational costs. The aim is to allocate all relevant expenditures—such as wages, fuel, maintenance, and other operational expenses—appropriately to measure accurate service delivery costs.
Examples
-
Electricity Generation: A power generation company would use operating costing to determine the cost per kilowatt-hour (kWh) of electricity it produces, taking into account costs relating to fuel, maintenance of machinery, labor, and administrative expenses.
-
Healthcare Services: A hospital would apply this costing method to ascertain the cost per patient day care, incorporating costs for medical staff salaries, medicines, utilities, and other overheads.
-
Transportation Services: A bus company might use operating costing to calculate the cost per kilometer of each bus route, including expenses like driver salaries, fuel, maintenance, and depreciation of buses.
Frequently Asked Questions
Q1. Why is operating costing important?
A1. Operating costing is crucial for service-oriented businesses as it helps them ascertain the cost of the services they provide, thereby enabling effective cost control, pricing decisions, and financial planning.
Q2. How does operating costing differ from job costing?
A2. Unlike job costing, which is applied to specific jobs or batches, operating costing is used for activities that are continuous and repetitive in nature. Job costing breaks down costs per project, while operating costing aggregates expenses over a period.
Q3. What are the key components of operating costing?
A3. Key components include direct costs (e.g., materials, labor) and indirect costs (e.g., overheads like utilities, rent, equipment depreciation).
Q4. Can operating costing be applied to both public and private sectors?
A4. Yes, operating costing is applicable in both public and private sectors where continuous service provision needs to be accounted for financially.
1. Absorption Costing: A costing method that allocates all manufacturing costs to the product, whether those costs are variable or fixed.
2. Direct Costs: Costs that can be directly attributed to a specific activity or service, such as direct labor and direct materials.
3. Overheads: Indirect costs of running a business that cannot be charged directly to any specific job or product, e.g., rent, utilities.
4. Job Costing: A cost allocation method used to calculate costs for specific jobs or batches, more applicable for customized or non-repetitive production environments.
Online References
Suggested Books for Further Studies
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan: This book covers comprehensive cost accounting techniques and includes sections on operating costing.
- “Managerial Accounting” by Ray H. Garrison, Eric Noreen, and Peter C. Brewer: Provides detailed insights into cost management, including service and operating costing methods.
- “Cost and Management Accounting” by Colin Drury: An in-depth look at various cost accounting methodologies, including operating costing, with practical examples.
Accounting Basics: Operating Costing Fundamentals Quiz
### What is the primary purpose of operating costing?
- [x] To determine the cost of delivering continuous services within an organization
- [ ] To calculate the one-time production cost of a specific product
- [ ] To estimate future expenses for new product development
- [ ] To identify potential areas for budget cuts
> **Explanation:** Operating costing is primarily used to ascertain the costs associated with delivering ongoing services, such as electricity generation or transportation, over a period.
### Which of the following industries would most likely use operating costing?
- [x] Electricity generation
- [ ] Automotive manufacturing
- [ ] Custom furniture making
- [ ] Agricultural farming
> **Explanation:** Operating costing is particularly relevant to industries involved in continuous operations, such as electricity generation, which requires ongoing cost calculation.
### How does operating costing benefit service-oriented businesses?
- [x] It helps them ascertain the cost of the services they provide.
- [ ] It enables the calculation of batch production costs.
- [ ] It simplifies tax filing procedures.
- [ ] It reduces the need for managerial oversight.
> **Explanation:** Operating costing assists service-oriented businesses in determining the precise cost of service delivery, enabling better pricing and cost control.
### What type of costs are included in operating costing?
- [ ] Only fixed costs
- [ ] Only variable costs
- [ ] Direct costs and not indirect costs
- [x] Both direct and indirect costs
> **Explanation:** Operating costing includes both direct costs (like labor and materials) and indirect costs (like overheads) associated with providing a service.
### Can operating costing be used in both public and private sectors?
- [x] Yes
- [ ] No
- [ ] Only in the public sector
- [ ] Only in the private sector
> **Explanation:** Operating costing is applicable to both public and private sectors, wherever continuous service provision necessitates financial accounting.
### Which costing method is typically contrasted with operating costing?
- [ ] Marginal Costing
- [x] Job Costing
- [ ] Process Costing
- [ ] Standard Costing
> **Explanation:** Operating costing differs primarily from job costing, which is used for specific projects or batches rather than continuous operations.
### What is the primary difference between job costing and operating costing?
- [ ] Job costing is used for continuous operations.
- [ ] Operating costing breaks down costs by project.
- [x] Job costing is used for specific jobs, while operating costing is used for continuous operations.
- [ ] There is no difference.
> **Explanation:** Job costing is designed for specific jobs or projects, while operating costing applies to continuous, repetitive operations.
### In the context of operating costing, what are ‘direct costs’?
- [ ] Costs related to administration and management
- [x] Costs attributable directly to a specific service, like labor and materials
- [ ] Long-term asset costs
- [ ] Costs related to financial auditing
> **Explanation:** Direct costs refer to costs that can be directly attributed to the production of a specific service, such as labor and materials.
### What is the primary component not included in operating costing?
- [ ] Labor costs
- [ ] Maintenance expenses
- [x] Development costs for new products
- [ ] Utility costs
> **Explanation:** Development costs for new products are generally not included in operating costing, which focuses on the ongoing costs of delivering current services.
### What role does overhead play in operating costing?
- [x] It represents the indirect costs of business operations.
- [ ] It accounts for the direct material costs.
- [ ] It calculates the profit margin.
- [ ] It measures only fixed expenses.
> **Explanation:** Overheads in operating costing represent the indirect costs necessary for the business's continuous operation, such as utilities and administrative expenses.
Thank you for exploring our in-depth look at operating costing, a vital component of accounting for organizations providing continuous services. We hope this article and accompanying quiz have enriched your understanding and application of this essential concept!
