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 a question on how to do costing in a service-based business. Currently, I am working for a firm that manufactures various products used in pipelines (torque wrenches, flange pullers, bolts and flanges, grinding machines, etc.). Five years ago we began servicing pipelines in refineries, offshore/onshore platforms, nuclear plants, etc. Our services include joint integrity, leak sealing, and leak-free bolted connections. Our service technicians go to customers to service their pipelines and charge the customers an hourly fee. In servicing these customers, our technicians often sell these customers our various manufactured products. The company is organized around functions and not as separate profit centers.
Currently, our cost accounting system only calculates the costs of physical products we manufacture, not the cost of our servicing side of the business. While we charge our customers a fee for our various services, our accounting system does not track the actual costs of providing these services, nor does it track the products our customers purchase because our technicians require these products to complete their servicing functions. Rather, the cost of field technicians is "overhead," and hence our profitability is all over the place. In slack periods, the utilization of our field technicians is low and our profitability is low, while in peak periods the utilization of our technicians is high and our overall profitability rises. We should (but we don't) account for time and utilization rate of technicians, cost and utilization of tools used, training costs, and the revenues of the products sold during the servicing. These latter revenues are treated as revenues to the entire corporation, not revenues to the servicing end of the business. We don't know the profitability of our servicing business, although we are confident it is very profitable.
Before jumping to any conclusions, I would like to know how to proceed about possible changes in our accounting systems and any advice you might offer regarding how to better evaluate the profitability of our new (and growing) service business. Thank you for your time.
Best Regards
Suresh Batik
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What advice/guidance would you offer Suresh?