Cost of Services Rendered

Cost of Services Rendered

Service based operations do not use the traditional retail based format for the profit and loss statement which utilizes a ‘Cost of Goods Sold’ section.  Instead, the service industry uses a ‘Cost of Services Rendered‘ segment. The presentation format is very similar though. Below is a comparison of the two formats:

                            Traditional Retail                                                                Service Based
Sales                                                                                              Sales

.   Product                                 $Z,ZZZ,ZZZ                                             Fees                                     $Z,ZZZ,ZZZ
.   Warranty/Protection Plans           ZZ,ZZZ                                             Auxiliary Charges                       ZZ,ZZZ
.   Sub-Total Sales                                           $Z,ZZZ,ZZZ                                                                                          $Z,ZZZ,ZZZ
Cost of Goods Sold                                                                   Cost of Services Rendered
.   
Inventory                                Z,ZZZ,ZZZ                                              Labor                                   $Z,ZZZ,ZZZ

.   Labor                                            ZZ,ZZZ                                              Labor Burden                           ZZZ,ZZZ
.   Supplies                                          Z,ZZZ                                              Travel/Lodging/Meals              ZZZ,ZZZ
.   Warranties                                       Z,ZZZ                                              Compliance                                 ZZ,ZZZ
.   Sub-Total                                                        Z,ZZZ,ZZZ                                                                                              Z,ZZZ,ZZZ
Gross Profit                                                        $ZZZ,ZZZ                                                                                               $ZZZ,ZZZ

Although the two formats are similar in structure, they have different meanings. This article will explain to the reader the various terms used with service based operations within the cost of services rendered section of the income statement (profit and loss statement). There are several different formats that can be used and they are explained too. Finally, I’ll explain how you set this up in the chart of accounts in order to get the results desired.

Terminology with Cost of Services Rendered

Unlike retail which uses terms based on the respective product sold, the service industry uses terms that correlate to the service provided. The key is the person providing the services. For example, with the medical profession (think of large practices or hospitals) they will separate the staff and use terms such as: Professional Practitioners (those that carry Medicare charging identification numbers such as doctors, surgical staff, clinical personnel), Nursing Staff, Housekeeping, Food Service and Other.   Therefore their reports group the entire labor pool to distinguish the costs within the group. Often, this matches the revenue section with the respective sales of the services.

Other industries use different terms for their labor groups. The following chart identifies some service based operations and the terminology customarily used for the labor component of the cost of services rendered.

Law Firms
.     – Partners/Associates
.     – Administrative Support
.     – Outside Services (court reporters, researchers, investigators etc.)

Professional Engineering
.     – Licensed Professionals
.     – Engineers
.     – Ancillary Staff
.     – Subcontractors

Marine
.     – Trades
.     – Shipfitters
.     – Divers
.     – Unskilled

Sometimes, the cost of services rendered section focuses on the type of pay and not the function of the laborer.

Carpet Cleaning Companies
.     – Commissions
.     – Hourly
.     – Management

As illustrated, most service based operations use functions of their staff to identify the respective costs and not the form of pay. Customarily, the less professional the service based organization, the more likely the report is pay based and not functional based.

Another part of the cost of services rendered section identifies the additional costs for the respective personnel. Most companies will pool these additional costs and allocate them based on an objective criterion and call this labor burden. Labor burden includes matching payroll taxes, employee benefits, workers’ compensation insurance, training, human resources and safety. Those smaller service based operations will not pool these costs but utilize a parent-child account structure to assign the expenditures within the Cost of Services section similar to this:

.   – Labor                                           $ZZZ,ZZZ
.   – Labor Overhead:
.      — Payroll Taxes        $ZZ,ZZZ
.      — Benefits                   ZZ,ZZZ
.      — Insurance                 ZZ,ZZZ
.      — Safety/Training          Z,ZZZ
.          Sub-Total Labor Overhead         ZZ,ZZZ

With the service based industries, labor burden will not include those costs to get the employee to the designated workplace.

Those costs related to travel, lodging and support while on the job are commonly separated and grouped as one line item. Terms include the customary Travel or Logistics.   No matter what term is used, this aspect of the employee’s costs is separated from the actual cost of labor associated with the personnel used to earn the revenue for the company.

Understanding the terminology used is essential when reading the reports. There are different kinds of reports and knowledge of the various presentation formats is helpful to appreciate the Cost of Services Rendered.

Presentation Formats for Cost of Services Rendered

When the average person engages a service based company to provide services, they often have to sign a contract. Think of professional based entities such as law and accounting firms. These contracts separate not only the levels of the respective staff members used but also the functions of service provided.  For example, with a law firm, they will specifically separate out office costs such as copying, printing, and supplies in their bills to their clients.  In addition, they will also bill for outside services such as recorders, stenographers, and others.

This separation of functional services is also identified in the cost of services rendered section of the profit and loss statement.  In effect, they are lining up the cost of services section with the revenue section of their income statement.  Here is an example of a medical office profit and loss statement.

  Sunville Medical Practice
   Profit and Loss Statement
Period Ending October 31, 2012

Medical Billings:
.       Medical Practitioners                                                                                               $Z,ZZZ,ZZZ
.       Medical Support (LPN, Physical Therapist)                                                                 ZZZ,ZZZ
.       Sub-Total Medical Billings                                                                                      $Z,ZZZ,ZZZ
Non-Medical Fees:
.        Weight Loss/Diabetic Program Subscriptions                                      ZZ,ZZZ
.        Copy/Fax/Report Fees                                                                                ZZZ
        Sub-Total Non-Service Fees                                                                                           ZZ,ZZZ
Total All Billings/Fees                                                                                                  $Z,ZZZ,ZZZ
Cost of Services Rendered
Direct Cost of Professional Services:
.        Professional Provider Salaries                                    ZZZ,ZZZ
.        Support Staff Salaries & Wages                                 ZZZ,ZZZ
.        Sub-Total Direct Labor                                                                 ZZZ,ZZZ
.        Medical Supplies (Pharmaceutical, kits, bandages)     ZZ,ZZZ
.        Weight Loss/Diabetic Program Supplies                      ZZ,ZZZ
.        Sub-Total Supplies                                                                         ZZZ,ZZZ
Total All Direct Costs of Services Rendered                                      ZZZ,ZZZ
Indirect Cost of Professional Services:
.       Payroll Taxes                                                      ZZZ,ZZZ
.       Medical Billing                                                     ZZ,ZZZ
.       Professional Liability Insurance                           ZZ,ZZZ
.       Gen Liability/Workmen’s Comp                          ZZ,ZZZ
.       Lab/Outside Services (Temp Staff)                      ZZ,ZZZ
.       Payroll Benefits                                                    ZZ,ZZZ
.       Retirement Matching Contributions                    ZZ,ZZZ
.      Training/Accreditation/Compliance                        Z,ZZZ
.       Medical Waste Removal                                         Z,ZZZ
Total Indirect Cost of Professional Services                                   ZZZ,ZZZ
Sub-Total Cost of Services Rendered                                                                          Z,ZZZ,ZZZ
Gross Profit                                                                                                                     $ZZZ,ZZZ

Notice in the revenue section how the professional service is separated from the non medical aspects of the practice?  This is also done within the cost of services rendered section (with this company they use direct cost of services and indirect costs to accumulate total cost of services rendered).

Some industries sell a product and a service together as a package deal. You will see this often with construction, trades and within the auto industry.  Again, just as with the medical practice above, their financial reports are customarily functional based. Sometimes, the company will report in a column format. Here is an example of an RV Dealership report:

.                                                     Units                     Parts                  Service
.  Sales                                      $ZZZ,ZZZ                $ZZ,ZZZ              $ZZZ,ZZZ
. Cost of Sales/Services
.   – Inventory                              ZZZ,ZZZ                  ZZ,ZZZ                    Z,ZZZ
.   – Labor                                      ZZ,ZZZ                     Z,ZZZ                  ZZ,ZZZ
.   – Labor Overhead                        Z,ZZZ                     Z,ZZZ                    Z,ZZZ
.   – Other                                            ZZZ                         ZZZ                    Z,ZZZ
. Gross Profit                              $ZZ,ZZZ                    $Z,ZZZ               $ZZ,ZZZ

Notice that the dealership separated their report based on the respective corporate departments and use a universal cost of sales section that incorporates the traditional retail format and cost of services rendered form?

There is no single required format for any company with the exception of publicly traded companies and their reports are tied to rules as promulgated by both the Securities and Exchange Commission and Generally Accepted Accounting Principles. For everyone else, you are free to present your cost of sales section including cost of services rendered in a format that is best suited to your needs.

To get the reports in a format that you desire, you have to modify the chart of accounts. The next section will explain how this is done.

Modifying the Chart of Accounts

To obtain the presentation format you desire, you simply modify the chart of accounts to match your format wanted. Lay out the format on a piece of paper so you have an idea of what you want. Within your accounting software sits a subroutine program that controls the chart of accounts. Go to this sub program, (commonly called Lists in QuickBooks) and look at your existing chart of accounts. Every chart of accounts has seven types of accounts. The first six are the standard accounting types of accounts and include:

Assets
Liabilities
Equity
Revenue
Cost of Sales
Expenses

The seventh is referred to as non posting type of accounts; this includes purchase orders, work orders and some suspense accounts.

Notice, in the six standard types of accounts is the Cost of Sales section. It is this section that is modified to get the output desired. You may have to group your accounts based on the output desired by using a parent-child structure or even a control account. You can test the outcome by printing a preliminary profit and loss statement to include zero balances.   

One word of caution here.  Every software is different. The lower level accounting programs will not allow you to change the type of account name. This means you can’t change cost of sales to cost of services rendered. You can still create the sub account structure with proper names, but this section will still be called ‘Cost of Sales’.   For those of you that do not know, cost of sales is the universally accepted language for this part of the income statement.  Each business sector uses a different wording stream to identify cost of sales. Here is a short list:

Retail                                        – Cost of Goods Sold
Food Service                            – Cost of Meals Served
Transportation                          – Cost of Transportation
Construction                             – Cost of Construction
Mining/Natural Resources       – Cost of Extraction

The service industry uses ‘Cost of Services Rendered’.

Summary – Cost of Services Rendered

The term ‘Cost of Services Rendered’ is used with the profit and loss statement (income statement) for the cost of sales section of the report. It is customarily associated with service based business operations such as professional firms, human labor providers and the medical profession. There is no one single format that is universal to all human labor service providers. The accountant must modify the chart of accounts to suit the needs of the respective company in order to present a report that makes sense and is easily readable.  ACT ON KNOWLEDGE.

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