## Operating Costing

### Definition

Operating Costing is the method of ascertaining the cost of providing a service to customers, rather than manufacturing a tangible product. It is used exclusively in service industries.

Examples: Transport companies, cinema halls, hospitals, hotels, power utilities, internal service departments within a manufacturing firm.

### Features of Operating Costs

1. Costs are classified into three categories (illustrated for transport):

Operating/Running charges (variable nature): petrol, diesel, lubricating oil, grease
Maintenance charges (semi-variable nature): tyres, tubes, repairs, overhaul, spares
Fixed/Standing charges: garage rent, insurance, road licence, depreciation, operating manager's salary

2. The cost unit used is composite — combines two dimensions into one unit.

### Cost Units in Operating Costing

Industry	Simple Cost Unit	Composite Cost Unit
Passenger Transport	Per km	Per passenger-km
Goods Transport	Per km	Per tonne-km
Power/Electricity	—	Per kilowatt-hour (kWh)
Hotel	—	Per room-day
Hospital	—	Per patient-day
Steel	Per tonne	—
Bricks	—	Per 1,000 bricks
Sugar	—	Per quintal (100 kg)

### Absolute vs. Commercial Tonne-km

Both compute the composite cost unit for goods transport, but differently:

	Absolute Tonne-km	Commercial Tonne-km
Concept	Weighted average (per trip)	Simple average (total)
Formula	Σ (Weight carried × Distance) for each trip	Total Distance × (Sum of all loads ÷ Number of trips)
Precision	More precise	Simpler but less precise
When used	Different loads on different trips	When a uniform average load is assumed

### Operating Costing vs. Operation Costing

Feature	Operating Costing	Operation Costing
Applies to	Service industries	Manufacturing (refinement of Process Costing)
Cost unit	Composite service unit (passenger-km, room-day)	Cost per operation performed
Focus	Entire service delivery	Each discrete operation in the production sequence
Cost computation	Total cost ÷ Total service units delivered	Total operation cost ÷ Total output at that operation

Worked example

### Example 1

Absolute vs. Commercial Tonne-km:

A goods truck makes 3 trips:

Trip 1: 100 km, carrying 5 tonnes
Trip 2: 200 km, carrying 3 tonnes
Trip 3: 150 km, carrying 4 tonnes

Absolute Tonne-km = Σ (Weight × Distance)

= (5 × 100) + (3 × 200) + (4 × 150)

= 500 + 600 + 600 = 1,700 tonne-km

Commercial Tonne-km = Total Distance × Average Load

= (100 + 200 + 150) × [(5 + 3 + 4) ÷ 3]

= 450 × 4 = 1,800 tonne-km

Key insight: Absolute tonne-km weights each trip separately (more accurate); Commercial tonne-km uses an average load across all trips (simpler).

### Example 2

Identify the appropriate cost unit:

(i) Steel manufacturing → Per Tonne

(ii) Brick making → Per 1,000 bricks

(iii) Sugar production → Per quintal (100 kg)

(iv) Power/electricity generation → Per kilowatt-hour (kWh)

(v) Hospital → Per patient-day

(vi) Hotel → Per room-day

(vii) Passenger bus service → Per passenger-km

⚠️ Common exam mistakes

Confusing Operating Costing (service industry — entire service) with Operation Costing (manufacturing — one operation at a time) — the names are nearly identical but contexts are entirely different
Using simple cost units for transport — always use composite units (passenger-km, tonne-km) that capture both load and distance simultaneously
Confusing Absolute and Commercial tonne-km calculation — Absolute uses weighted sum per trip; Commercial uses total distance × simple average load
Thinking Operating Costing only applies to external service businesses — internal service departments (in-house hospital, internal transport fleet) also use Operating Costing
Misclassifying semi-variable maintenance charges as either purely fixed or purely variable — maintenance costs (tyres, repairs) are semi-variable, distinct from running (variable) and standing (fixed) charges

Reference:

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Operating Costing — Concepts, Features, Cost Units, and Absolute vs. Commercial Tonne-km

Worked example

⚠️ Common exam mistakes