Not every business makes things. Hotels, hospitals, bus companies, telecoms operators, law firms and schools sell services. They have costs just like a factory, and managers need to know what a service costs, but there is no product to count and often no stock. The cost unit is more awkward too: what exactly is one unit of a bus service or of a hospital stay?
This topic explains the nature of services and how they differ from products, how service costing differs from manufacturing costing and from job costing, the idea of composite cost units such as cost per passenger-kilometre or per room per day, and how to calculate the cost per unit of service. A transport route example matches the style of recent examination questions.
In 30 seconds
A service is an intangible activity that benefits another party and leaves no ownership behind. Services are intangible, inseparable (produced as they are consumed), variable in standard, perishable (cannot be stored) and give no ownership. Service costing has no production overhead, usually small materials, little or no stock, and often large general overheads.
Because units are hard to define, a composite cost unit built from two measures is used: cost per room per day, per passenger per kilometre, per tonne per kilometre, per patient per day or per man per day. Cost per unit of service = total cost of the service ÷ number of service units. Non-standard services are better costed as jobs.
The nature of services and operations
A service is an activity carried out by one party for the benefit of another. It is essentially intangible and does not result in anyone owning anything. Examples are hotel services, consultancy, legal and accounting services, telecoms, broadcasting, entertainment, postal services and medical services.
| Characteristic | Meaning | Example |
|---|---|---|
| Intangibility | A service has no physical substance. It cannot be held or seen | An audit, a flight, a medical consultation |
| Inseparability | Creating and consuming the service cannot be separated. It does not exist until the customer receives it | A haircut is produced while the customer sits in the chair |
| Variability | It is hard to keep the standard consistent. Goods can be made to a specification, services much less easily | Two meals in the same restaurant on different nights |
| Perishability | A service cannot be stored. An unused seat or room is lost for ever | An empty hotel room tonight earns nothing, and cannot be sold tomorrow |
| Lack of ownership | The customer gets only a temporary benefit, not property | A bus ticket gives a ride, not the bus |
Operations are activities that, like services, do not result in a finished product for sale. Examples are a customer service centre handling calls and emails, and a staff canteen serving meals to employees. They can be costed in a similar way.
How service costing differs from manufacturing
The cost of a service is the sum of direct materials, direct labour, direct expenses (if any) and a share of operational overheads. The differences from costing a manufactured product are these.
- There is no production system, so no production overheads.
- Direct materials are often a small part of total cost. A telecoms company’s materials cost of providing a call is tiny.
- In some services direct labour is a large part of cost, as in film-making, accountancy and investment banking.
- General overheads can be a very high proportion of total cost.
- Inventory is usually very small, so absorption costing, which exists mainly to value stock, has little value for management information.
Service costing or job costing?
The purpose of service costing is to give management information about the cost of the different services and the profitability of each. It suits services that are fairly standard. If the services are not standard, job costing is more sensible.
| Service costing | Job costing in a service business |
|---|---|
| A hospital recording the cost of treating a patient for a particular condition, with each case treated in much the same way | A firm of accountants or solicitors, where the cost of each job depends mainly on the professional time spent on it, usually charged at a standard hourly rate |
Composite cost units
The main difficulty in service costing is choosing a cost unit. A composite cost unit combines two variables, such as a cost per “man per day”. The two variables are the number of men and the number of days.
| Composite cost unit | What it measures | Used by |
|---|---|---|
| Cost per room per day | Average cost of maintaining one room for one day | Hotels |
| Cost per passenger per kilometre (or mile) | Average cost of carrying one passenger one kilometre | Bus and train operators |
| Cost per tonne per kilometre (or mile) | Average cost of carrying one tonne of goods one kilometre | Freight and delivery firms |
| Cost per patient per day, or per bed per day | Average cost of treating a patient, or maintaining a bed, for a day | Hospitals |
| Cost per man per day | Average cost of one person’s professional time for a day | Audit, legal and consultancy firms |
Composite units can be used alongside job costing. A firm of accountants may cost each job for a client, to monitor the profit on each job, and also calculate an average cost per man per day, to monitor the general level of its costs.
Calculating the cost per unit of service
Cost per unit of service = total costs of the service ÷ number of units of service
Total costs are direct materials, direct labour and direct expenses plus a charge for overheads (unless marginal costing is used).
The hard part is counting the service units correctly.
Hotel example
A hotel has 60 rooms and opens 300 days a year. Total annual cost is ₦18,000,000. Room-days available = 60 × 300 = 18,000. Cost per room per day available = ₦18,000,000 ÷ 18,000 = ₦1,000. If the occupancy rate is 70%, room-days occupied = 18,000 × 70% = 12,600, and the cost per occupied room-day = ₦18,000,000 ÷ 12,600 = ₦1,428.57. Both figures are useful. The first measures the cost of keeping capacity ready and the second the cost of what is actually sold.
Because rooms cannot be stored, the gap between them is the cost of unused capacity.
Transport example
A bus company runs a service between two towns 150 km apart. Over a year, 80,000 passengers travel from Town A to Town B and 60,000 from B to A. Total cost of the service is ₦126,000,000. Passenger-kilometres = (80,000 + 60,000) × 150 = 21,000,000. Cost per passenger-kilometre = ₦126,000,000 ÷ 21,000,000 = ₦6.00. A passenger who travels the whole route therefore costs the company 150 × ₦6 = ₦900.
Professional services: cost per man-day
An audit firm’s total annual cost of professional staff and overheads is ₦240,000,000. Its staff work 4,000 productive man-days in the year. Cost per man-day = ₦240,000,000 ÷ 4,000 = ₦60,000. A job that needs 25 man-days has a cost of 25 × ₦60,000 = ₦1,500,000, and the firm can compare that with the fee it can charge.
A transport route question
Examination questions on transport usually give several cost items per vehicle, some fixed and some depending on distance, plus seats, trips, fares and occupancy rates. The method is: work out the annual cost per vehicle, work out the revenue per vehicle, and compare profit per route.
Kano Express has buses with 50 seats and operates 300 days a year. The company has two routes.
| Route 1: Kano to Kaduna (200 km one way) | Route 2: Kano to Wudil (100 km one way) | |
|---|---|---|
| Trips per bus per day | 2 (one round trip) | 6 (three round trips) |
| Fare per passenger | ₦1,200 | ₦600 |
| Occupancy | 80% outward, 70% return | 85% each way |
Costs per bus per year, the same on both routes: insurance ₦1,200,000, depreciation ₦3,000,000 and licence ₦300,000 (standing charges of ₦4,500,000); driver and conductor pay ₦3,600,000; running costs (fuel, tyres, maintenance) ₦120 per kilometre.
| Per bus per year | Route 1 | Route 2 |
|---|---|---|
| Distance (km) | 400 km × 300 = 120,000 | 600 km × 300 = 180,000 |
| Running costs at ₦120 per km | ₦14,400,000 | ₦21,600,000 |
| Standing charges | ₦4,500,000 | ₦4,500,000 |
| Staff pay | ₦3,600,000 | ₦3,600,000 |
| Total cost | ₦22,500,000 | ₦29,700,000 |
| Passengers per day | (50 × 80%) + (50 × 70%) = 40 + 35 = 75 | 6 × (50 × 85%) = 6 × 42.5 = 255 |
| Passengers per year | 75 × 300 = 22,500 | 255 × 300 = 76,500 |
| Revenue | 22,500 × ₦1,200 = ₦27,000,000 | 76,500 × ₦600 = ₦45,900,000 |
| Profit per bus | ₦4,500,000 | ₦16,200,000 |
| Passenger-kilometres | 22,500 × 200 = 4,500,000 | 76,500 × 100 = 7,650,000 |
| Cost per passenger-km | ₦22,500,000 ÷ 4,500,000 = ₦5.00 | ₦29,700,000 ÷ 7,650,000 = ₦3.88 |
| Revenue per passenger-km | ₦6.00 | ₦6.00 |
Route 2 is more profitable, even though its fare is lower, because the buses carry far more passengers in a day and the standing charges and pay are spread over more passenger-kilometres.
Background: the earlier papers refer to “running charges” in service costing. Costs that depend on how far or how long the vehicle runs (fuel, tyres, maintenance) are running charges. Costs that are incurred whether or not it runs (insurance, licence, depreciation, often driver pay) are standing charges. Separating them helps when comparing routes or deciding whether an extra trip is worthwhile.
The ideas in more depth
Choosing the right measure of activity
The best composite unit reflects both the volume and the size of the service. A hotel measures rooms and days. A bus company measures passengers and distance. A hospital measures patients and days. Counting only passengers, or only kilometres, would misrepresent the work, because a 5 km trip and a 500 km trip cost very different amounts.
Capacity and utilisation
Services are perishable, so unused capacity is permanently lost. In most service businesses a large part of cost is fixed (the building, the vehicles, the permanent staff). The cost per unit of service therefore falls sharply as utilisation rises. In the hotel example, the cost per occupied room-day falls from ₦1,428.57 at 70% occupancy to ₦1,250 at 80% (₦18,000,000 ÷ 14,400). This is why occupancy, load factor and utilisation are the key performance measures.
Using cost per unit
- Pricing. The cost per unit shows the minimum price needed to break even at the expected utilisation.
- Control. Compare the cost per unit with budget, with previous periods and with similar branches.
- Decisions. Compare routes, services or departments on a common basis.
Overheads in service costing
Because there is no production overhead, general overheads form a large proportion of the cost of a service. They may be shared on a fair basis, such as the number of rooms, or beds, or professional hours, or left unabsorbed if the aim is to study the marginal cost of providing the service.
Worked example: a hospital ward
Scenario. A hospital ward has 30 beds and is open 365 days. Annual costs: nurses’ pay ₦65,700,000; doctors’ time charged to the ward ₦36,500,000; drugs and consumables ₦15,330,000; catering ₦11,000,000; building and equipment costs allocated to the ward ₦40,000,000; general hospital overhead share ₦19,970,000. The ward is occupied 80% of the time. Calculate the cost per bed per day and the cost per patient per day.
- Total cost.
₦65,700,000 + ₦36,500,000 + ₦15,330,000 + ₦11,000,000 + ₦40,000,000 + ₦19,970,000 = ₦188,500,000. - Bed-days available.
30 × 365 = 10,950. - Cost per bed per day.
₦188,500,000 ÷ 10,950 = ₦17,215 (to the nearest naira). - Patient-days.
10,950 × 80% = 8,760. - Cost per patient per day.
₦188,500,000 ÷ 8,760 = ₦21,518. - Comment. The cost per patient-day is higher than per bed-day because 20% of the bed capacity is unused. If occupancy rose to 90%, patient-days would be 9,855 and the cost per patient-day would fall to ₦19,127.
Types of service organisation and their cost units
| Organisation | Typical cost unit | Direct costs | Main overheads |
|---|---|---|---|
| Hospital | Patient-day, bed-day, or a procedure | Nurses and doctors on the ward, drugs and consumables | Building costs, administration, catering, laundry |
| School | Student-term, or cost per student per year | Teaching staff, books and materials | Premises, administration, security |
| Hotel | Occupied room-night | Housekeeping and front-desk labour, laundry, supplies | Building, energy, marketing, management salaries |
| Bank branch | Transaction, or cost per account | Tellers and relationship officers | Branch premises, head office, technology |
| Courier | Parcel delivered, or tonne-kilometre | Riders and drivers, fuel | Vehicles’ depreciation, insurance, depot costs |
| Audit firm | Chargeable hour or man-day | Staff time on the engagement, travel | Office rent, training, technology, partners’ time |
In every case, the first step is to choose a measure of output that reflects what the customer receives. The second is to find the total cost of the service and divide by the number of units.
Using service costs to set prices
Service prices are often set by adding a margin to the cost per unit of service. The hotel with 60 rooms, a cost of ₦18,000,000 a year, and 70% occupancy (12,600 occupied room-nights) has a cost of ₦1,428.57 per occupied room-night. A mark-up of 40% gives a room rate of ₦1,428.57 × 1.40 = ₦2,000. Revenue = 12,600 × ₦2,000 = ₦25,200,000, and profit = ₦25,200,000 − ₦18,000,000 = ₦7,200,000.
The price depends on the assumed occupancy. If occupancy were only 50% (9,000 room-nights), the cost per occupied night would rise to ₦2,000, and a 40% mark-up would need a rate of ₦2,800 to earn the same margin. Because most of the cost is fixed, the break-even occupancy at a ₦2,000 rate is ₦18,000,000 ÷ ₦2,000 = 9,000 room-nights, or 50% of capacity.
Performance measures in service businesses
- Occupancy rate or load factor: the proportion of capacity used. For the hotel, 70%; for a bus, the percentage of seats filled.
- Average daily rate: revenue per occupied room. Here ₦2,000.
- Revenue per available room (RevPAR):
average daily rate × occupancy = ₦2,000 × 70% = ₦1,400.
Compare it with the cost per available room-night (₦1,000): the margin per available room-night is ₦400, or ₦7,200,000 over 18,000 room-nights. - Utilisation of professional staff: chargeable hours as a percentage of available hours. A consultant with 1,600 chargeable hours out of 2,000 available is 80% utilised.
- Cost per unit of service, compared with budget, last year and competitors.
Job costing in professional services
Where each engagement is different, costs are built up by job. An audit firm records the time of each grade of staff on each assignment and charges at a rate per hour. Suppose an audit used 20 manager hours at ₦8,000, 60 senior hours at ₦5,000 and 120 junior hours at ₦3,000, plus travel and other direct expenses of ₦90,000. Overhead is recovered at ₦1,500 per professional hour (200 hours).
| ₦ | |
|---|---|
| Manager 20 × ₦8,000 | 160,000 |
| Senior 60 × ₦5,000 | 300,000 |
| Junior 120 × ₦3,000 | 360,000 |
| Direct expenses | 90,000 |
| Overhead 200 × ₦1,500 | 300,000 |
| Total cost of the engagement | 1,210,000 |
| Fee with a 30% mark-up | 1,573,000 |
The average cost per chargeable hour is ₦1,210,000 ÷ 200 = ₦6,050. Because this is a composite unit (hours of mixed grades), it can be used alongside the job cost to monitor the firm.
Break-even occupancy in transport
In the Kano Express route example, each bus has 50 seats and makes 2 one-way trips a day for 300 days: 600 trips and 30,000 seat-trips a year. At ₦1,200 a passenger the revenue at 100% occupancy would be 30,000 × ₦1,200 = ₦36,000,000. The annual cost is ₦22,500,000, so the break-even occupancy = ₦22,500,000 ÷ ₦36,000,000 = 62.5%. Actual average occupancy was 75% (75 passengers on 100 seats per day), which is a margin of safety of 12.5 percentage points.
Managers use the break-even load factor to judge how much demand can fall before a route loses money.
Controlling service costs
- Manage capacity. Fixed costs are high, and unused capacity is lost. Match staff rosters and vehicle schedules to expected demand.
- Raise utilisation. Fill empty seats and rooms through promotions in slack periods.
- Price by demand. Charging more in peak periods and less in slack ones raises revenue from the same capacity (often called yield management).
- Control the variable costs such as fuel, consumables and supplies, by monitoring cost per unit.
- Maintain quality. Because services are variable, standards and training protect customer satisfaction while costs are cut.
Common mistakes in the exam
- Using only one measure of activity (such as passengers) instead of a composite unit (passenger-kilometres).
- Dividing total cost by the number of passengers on one trip instead of by the annual passenger-kilometres.
- Forgetting that outward and return trips may have different occupancy rates.
- Mixing up capacity (room-days available) with usage (room-days occupied).
- Applying production overhead in a service business.
- Treating non-standard professional work as a standard service rather than a job.
- Forgetting to convert monthly costs to annual costs when the activity data is annual.
- Listing the characteristics of services without explaining them.
Quick revision
- Service characteristics: intangibility, inseparability, variability, perishability, lack of ownership.
- Service costing: no production overhead, small materials, little stock, high general overhead.
- Standard services: service costing. Non-standard professional work: job costing.
- Composite units: room-day, passenger-km, tonne-km, patient-day or bed-day, man-day.
- Cost per unit = total cost ÷ service units. Count units carefully, including occupancy.
Practice questions
These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.
Section A style: multiple choice
Question 1. Which is a characteristic of a service?
- It can be stored
- It is perishable
- It gives ownership of goods
- It has physical substance
Show the answer
B. Services cannot be stored.
Question 2. Production overhead is usually absent from service costing because:
- Services have no production system
- Services are free
- Overheads are always variable
- Services use only direct materials
Show the answer
A. There is no production process.
Question 3. A suitable composite cost unit for a bus company is:
- Cost per room per day
- Cost per passenger per kilometre
- Cost per patient per day
- Cost per tonne
Show the answer
B. It combines passengers and distance.
Question 4. A hotel has 50 rooms and opens 360 days a year. Annual cost is ₦21,600,000. The cost per room-day available is:
- ₦900
- ₦1,000
- ₦1,200
- ₦4,320
Show the answer
C. Room-days = 18,000. ₦21,600,000 ÷ 18,000 = ₦1,200.
Question 5. Total cost is ₦120,000,000 and passenger-kilometres are 30,000,000. The cost per passenger-kilometre is:
- ₦3
- ₦4
- ₦5
- ₦6
Show the answer
B. ₦120,000,000 ÷ 30,000,000 = ₦4.
Question 6. A firm of accountants is best costed using:
- Process costing
- Job costing, with cost per man-day as a composite unit
- Batch costing
- Joint product costing
Show the answer
B. Each job depends on the time spent by professional staff.
Question 7. Inventory in a service business is usually:
- Very large
- Very small
- Equal to sales
- Equal to overheads
Show the answer
B. Services cannot be stored.
Question 8. The cost per patient-day is higher than the cost per bed-day when:
- Occupancy is below 100%
- Occupancy is 100%
- There are no beds
- Costs are zero
Show the answer
A. Fewer patient-days than bed-days share the same cost.
Question 9. A bus with 50 seats is 80% full on a trip. The passengers carried are:
- 30
- 35
- 40
- 45
Show the answer
C. 50 × 80% = 40.
Question 10. Services are said to be inseparable because:
- They cannot be sold
- Creation and consumption occur together
- They are always standard
- They can be stored
Show the answer
B. A service does not exist until it is consumed.
Section B style: written questions
Question 11 (10 marks). Explain the five characteristics of services and state how service costing differs from costing a manufactured product.
Question 12 (20 marks). Abuja Coaches Ltd runs five buses, each with 40 seats, on a 120 km route. Each bus makes 4 one-way trips a day for 25 days a month. The fare is ₦600 per passenger and the average occupancy is 75%. Costs per bus per month: running costs ₦95 per km; driver’s pay ₦180,000; insurance and depreciation ₦400,000.
(a) State and explain the characteristics of services. (5 marks)
(b) Explain what a composite cost unit is and give three examples. (4 marks)
(c) Calculate for one bus per month: the total cost, the revenue, the profit and the cost per passenger-kilometre. (8 marks)
(d) Calculate the profit for the fleet and comment on the effect of occupancy. (3 marks)
A further written question
Question 13 (10 marks). A hotel has 80 rooms, opens 360 days a year and has total costs of ₦21,600,000. Occupancy is 65%. (a) Calculate the cost per room-day available. (3 marks) (b) Calculate the cost per occupied room-day. (3 marks) (c) Calculate the cost per occupied room-day if occupancy rises to 80%. (2 marks) (d) State why a composite cost unit is used. (2 marks)
Model answers
Show the model answer to Question 11
Characteristics of services. Intangibility: services have no physical substance. Inseparability: creation and consumption happen together, so the service does not exist until it is consumed. Variability: it is difficult to keep the standard of service consistent. Perishability: services cannot be stored, so unused capacity is lost. Lack of ownership: the customer gets only a temporary benefit, not ownership of anything.
Differences from manufacturing costing. There is no production system, so no production overheads. Direct materials are often a small part of the total cost. In some services direct labour is a high share of cost. General overheads can be a very large proportion of total cost. Inventory is usually very small, so absorption costing is of little value for management information.
A composite cost unit, such as cost per passenger-kilometre, is often needed because the output has no natural physical unit.
Show the model answer to Question 12
(a) Intangibility: services cannot be seen or held. Inseparability: they are created and consumed together. Variability: the standard is hard to keep consistent. Perishability: they cannot be stored, so unused seats are lost. Lack of ownership: the customer gets a temporary benefit only.
(b) A composite cost unit is a unit of cost made up of two variables, used where a service has no single natural unit. Examples: cost per room per day (hotels), cost per passenger per kilometre (bus operators), cost per patient per day (hospitals), cost per tonne per kilometre (freight) and cost per man per day (professional firms).
(c) Per bus per month.
- Distance = 120 km × 4 trips × 25 days = 12,000 km.
- Running costs.
12,000 × ₦95 = ₦1,140,000. - Driver ₦180,000.
- Insurance and depreciation ₦400,000.
- Total cost = ₦1,720,000. Passengers per trip = 40 × 75% = 30.
- Trips per month.
4 × 25 = 100. - Passengers = 3,000.
- Revenue = 3,000 × ₦600 = ₦1,800,000. Profit = ₦80,000. Passenger-kilometres = 3,000 × 120 = 360,000.
- Cost per passenger-km = ₦1,720,000 ÷ 360,000 = ₦4.78.
(d) Fleet profit = 5 × ₦80,000 = ₦400,000 a month. The margin is thin. Because most costs are standing costs or depend on distance, not on the number of passengers, extra passengers cost almost nothing to carry, so each extra point of occupancy adds directly to profit. If occupancy rose from 75% to 80%, passengers would rise to 3,200 per bus, revenue to ₦1,920,000 and profit per bus to ₦200,000.
Show the model answer to Question 13
(a)
- Room-days available.
80 × 360 = 28,800. - Cost per room-day available.
₦21,600,000 ÷ 28,800 = ₦750.
(b)
- Occupied room-days.
28,800 × 65% = 18,720. - Cost per occupied room-day.
₦21,600,000 ÷ 18,720 = ₦1,153.85.
(c)
- Occupied room-days at 80% = 28,800 × 80% = 23,040.
- Cost per occupied room-day.
₦21,600,000 ÷ 23,040 = ₦937.50.
(d) A service has no single natural unit, so a measure combining two variables, here rooms and days, reflects both the size and the duration of the service provided. It lets managers compare hotels of different sizes and track the cost of the service over time.
Pathfinder on Service costing
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
A bus company with two routes asks which route is more profitable, from weekly and monthly operating costs, annual fixed charges, fares that differ by day, and occupancy rates. This is a service costing calculation with composite units.
Revise first: A transport route question
From the previous syllabus. Asks which item is not a composite cost unit used in service costing.
Revise first: Composite cost units
From the previous syllabus. Asks which costing method usually makes use of a composite cost unit: service costing.
Revise first: Composite cost units
From the previous syllabus. Asks which item is NOT an example of a composite cost unit.
Revise first: Composite cost units
From the previous syllabus. Asks for the term used for the running charges in service costing.
Revise first: A transport route question
Source: ICAN Pathfinder, Management Accounting. Diets covered: May Diet, 2026, November Diet, 2018, May Diet, 2021, May Diet, 2022 and May Diet, 2019 (earlier ones from the previous syllabus). May Diet, 2025 and November Diet, 2024 are not covered here.
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