8.2 Costing Services: Calculating Costs in Service Organisations

AAT Level 2 Principles of Costing PCTN

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1 Introduction

About the AAT Principles of Costing (PCTN) Assessment

2 Chapter 1: The Cost Accounting Framework

1.1 Purpose and Role of Cost Accounting 1.2 Cost Accounting versus Financial Accounting 1.3 Responsibility Accounting and Cost Centres

3 Chapter 2: Cost Recording, Sourcing, and Coding

2.1 Cost Units and Cost Objects 2.2 Cost Coding Systems and Principles 2.3 Source Documentation and Cost Data Collection

4 Chapter 3: Cost Classification, Behaviour and the Manufacturing Account

3.1 Cost Classification by Element, Nature, and Function 3.2 Cost Behaviour Patterns and Analysis 3.3 Product Costs, Period Costs and the Manufacturing Account

5 Chapter 4: Inventory Valuation and Control

4.1 Inventory Records and Control Procedures 4.2 FIFO and LIFO Inventory Valuation 4.3 AVCO Inventory Valuation and Method Comparison

6 Chapter 5: Labour Costing and Remuneration

5.1 Labour Remuneration: Time Rates, Basic Pay, and Overtime 5.2 Piecework Systems and Incentive Schemes 5.3 Labour Cost Accounting, Idle Time, and Payroll On-Costs

7 Chapter 6: Overheads and Overhead Absorption

6.1 Overheads: Collection, Allocation and Apportionment (Background) 6.2 Overhead Absorption Rates: Per Unit, Per Labour Hour and Per Machine Hour

8 Chapter 7: Budgeting and Variance Analysis

7.1 Budgetary Planning, Principles, and Functional Budgets 7.2 Fixed versus Flexed Budgets 7.3 Calculating Variances: Totals, Adverse or Favourable, and Percentages 7.4 Variance Investigation, Causes, and Management by Exception

9 Chapter 8: Product and Service Costs, and Spreadsheet Tools

8.1 Product Cost Build-Up and Mark-Up versus Margin 8.2 Costing Services: Calculating Costs in Service Organisations 8.3 Entering and Formatting Data in Spreadsheet Tasks 8.4 Writing Costing Formulas the Way AAT Credits Them

8.2 Costing Services: Calculating Costs in Service Organisations

Key Takeaways Explain This Topic AI

A service cost unit is a unit of service delivered, such as one treatment, one meal, one parcel delivered or one chargeable hour.

The full cost of a service equals direct materials (consumables) plus direct labour plus overheads absorbed, usually per labour hour.

In a service business, fixed cost per unit falls as volume rises while variable cost per unit stays constant, exactly as in manufacturing.

Service businesses often cost jobs using budgeted rates so that work can be priced immediately, then compare with actual costs for control.

Service organisations do not prepare a manufacturing account because they hold no raw materials, work in progress or finished goods inventory.

Last updated: September 2026

8.2 Costing Services: Calculating Costs in Service Organisations

Key Concept: Service organisations still need to know what each unit of service costs. The method is the same as for a product: add the direct materials (consumables), direct labour and a share of overheads. The differences are that labour is usually the largest cost, there is little or no inventory, and the cost unit is a unit of service, such as a treatment, a meal, a delivery or a chargeable hour.

The PCTN specification requires you to be able to calculate the costs of products in service organisations (learning outcome 2.5.6). AAT's delivery guidance suggests familiar examples, such as a hair salon or takeaway food, to show how materials, labour and overhead costs are determined. That is exactly the style of scenario to expect.

How Service Costing Differs from Manufacturing

Feature Manufacturing organisation Service organisation
Output Tangible products that can be stored Services that are consumed as they are delivered
Inventory Raw materials, work in progress and finished goods Usually only small stocks of consumables
Largest cost Often materials or overheads Usually staff time (labour)

Typical cost unit One chair, one batch of 500 bricks One haircut, one meal, one parcel delivered, one chargeable hour, one patient-day

Manufacturing account? Yes No

Overhead absorption base Units, labour hours or machine hours Usually labour hours (staff time) or units of service

The cost unit must be something the organisation can count and that reflects how resources are consumed. A courier firm might use "per parcel delivered", a hotel "per occupied room-night" and a training company "per student-day".

Worked Example 1: The Cost of a Salon Treatment

Calder Hair Studio wants to know the full cost of its "cut and colour" treatment so that it can review its price.

Direct materials: colour products used £6.50 per treatment
Direct labour: 1.5 stylist hours at £14.00 per hour

Overheads: budgeted salon overheads (rent, rates, power, reception wages, laundry) are £54,000 for the year, and budgeted stylist hours are 6,000. Overheads are absorbed per stylist hour.

Step 1: Calculate the overhead absorption rate OAR = £ 54 , 000 6 , 000 stylist hours = £ 9.00 per stylist hour \text{OAR} = \frac{£54,000}{6,000 \text{ stylist hours}} = £9.00 \text{ per stylist hour} OAR = 6 , 000 stylist hours £54 , 000 = £9.00 per stylist hour

Step 2: Build up the cost of one treatment

Cost element Working £
Direct materials Colour products 6.50
Direct labour 1.5 hours × £14.00 21.00
Direct cost 27.50
Overheads absorbed 1.5 hours × £9.00 13.50
Total cost per treatment 41.00

If the salon charges £60 for the treatment, each one covers its full cost and leaves £19 of profit. Using labour hours as the absorption base makes sense here, because a longer treatment occupies a chair, a basin and the salon's facilities for longer.

Worked Example 2: Cost per Meal at Different Volumes

Ribble Kitchen is a takeaway. Its weekly costs are:

Ingredients: £3.20 per meal (variable)
Packaging: £0.40 per meal (variable)

Kitchen staff wages: £4,200 per week (staff are paid a time rate for a fixed rota, so this is fixed for the week)

Rent, rates and utilities: £1,800 per week (fixed)

Weekly meals sold 1,500 meals 2,000 meals
Variable costs (£3.60 per meal) £5,400 £7,200
Fixed costs (£4,200 + £1,800) £6,000 £6,000
Total cost £11,400 £13,200
Cost per meal £7.60 £6.60

This is the cost-behaviour rule from Section 3.2 applied to a service. Variable cost per meal stays at £3.60, while fixed cost per meal falls from £4.00 (£6,000 ÷ 1,500) to £3.00 (£6,000 ÷ 2,000) as volume rises. PCTN tasks often ask you to calculate total and unit costs at two or three activity levels in exactly this way.

Worked Example 3: Costing a Client Job in an Accountancy Practice

An accountancy practice prepares a set of year-end accounts for a client. It costs jobs using budgeted hourly rates, so that each job can be costed when it is finished rather than at the year-end.

Partner time: 3 hours at £60 per hour
Trainee time: 10 hours at £18 per hour
Practice overheads are absorbed at a budgeted £25 per chargeable hour

Cost element Working £
Partner time 3 × £60 180
Trainee time 10 × £18 180
Direct labour cost 360
Overheads absorbed 13 chargeable hours × £25 325
Total cost of the job 685

Note the use of budgeted rates. PCTN learning outcome 1.4 expects you to know that costing systems use actual or budgeted costs to determine the cost of a unit, job or batch. Budgeted rates let the practice cost and price a job straight away. Actual costs are compared with the budget later for control.

Common Exam Traps

Choosing an input as the cost unit. "The salon", "the van fleet" and "stylist wages" are cost centres or costs, not cost units. The cost unit is the unit of service delivered.

Forgetting overheads. A service cost built from labour and consumables alone understates the true cost, often by a large amount.

Treating time-rate staff as a variable cost per unit. If staff are paid for a fixed rota regardless of how many customers are served, their wages behave as a fixed cost for that period.

Absorbing on the wrong base. Use the base the task gives you. If none is given, the base should reflect what drives the cost, which for most services is staff time.