Email from Suresh Batik

I received the following email from a former student.

I hope you are doing well.

I took your Managerial Accounting class ten years ago and have aquestion on how to do costing in a service-based business.Currently, I am working for a firm that manufactures variousproducts used in pipelines (torque wrenches, flange pullers, boltsand flanges, grinding machines, etc.). Five years ago we beganservicing pipelines in refineries, offshore/onshore platforms,nuclear plants, etc. Our services include joint integrity, leaksealing, and leak-free bolted connections. Our service techniciansgo to customers to service their pipelines and charge the customersan hourly fee. In servicing these customers, our technicians oftensell these customers our various manufactured products. The companyis organized around functions and not as separate profitcenters.

Currently, our cost accounting system only calculates the costsof physical products we manufacture, not the cost of our servicingside of the business. While we charge our customers a fee for ourvarious services, our accounting system does not track the actualcosts of providing these services, nor does it track the productsour customers purchase because our technicians require theseproducts to complete their servicing functions. Rather, the cost offield technicians is “overhead,” and hence our profitability is allover the place. In slack periods, the utilization of our fieldtechnicians is low and our profitability is low, while in peakperiods the utilization of our technicians is high and our overallprofitability rises. We should (but we don’t) account for time andutilization rate of technicians, cost and utilization of toolsused, training costs, and the revenues of the products sold duringthe servicing. These latter revenues are treated as revenues to theentire corporation, not revenues to the servicing end of thebusiness. We don’t know the profitability of our servicingbusiness, although we are confident it is very profitable.

Before jumping to any conclusions, I would like to know how toproceed about possible changes in our accounting systems and anyadvice you might offer regarding how to better evaluate theprofitability of our new (and growing) service business. Thank youfor your time.

Best Regards

Suresh Batik