Accounting for Cost of Services for a Service Business

Cost of Goods Sold, cost of sales, cost of revenue, or cost of services are referred to all the direct costs associated with services rendered to the customer for the business provides companies.

It includes all the direct costs involved in running or performing services. The typical expenses included in the category of direct costs are the cost of material, cost of labor or cost of salaries in a service industry, and all other costs which can be linked directly to the manufacturing of products or rendering of services.

However, materials are usually not significant compared to direct labor costs but we still need to include all of those materials that are used to the cost of services.

Other costs that do not directly contribute to rendering service should not include in the cost of services when presented in the income statement.

The cost of services is reported in the entity income statement similar to the cost of sales for the manufacturing or trading company. The costs are records are they are incurred complying with accrual basis as well as matching principle.

Examples of Service Business:

Service businesses provide different types of intangible products performed by individuals or a team of experts.

Services business includes accounting firms, law firms, consulting firms, medical treatment, transportation, hospitality, etc.

For example, an accounting firm generates revenues by providing accounting services to its clients such as bookkeeping and auditing services.

And the revenue that the firm generates during the year is

  • Bookkeeping = USD500,000
  • Audit = USD800,000

Then the total revenue is USD1,300,000

Related article  Cost of Goods Sold for a Merchandising Company - Explained

The firm incurred direct labor costs ( Salaries for the professional staff) during the period are USD700,000.

So that salary for the professional staff here considers as the costs services during the period.

Then the extract P&L should be,

Revenue = USD,1300,000

Cost of services = USD700,000

Gross profit = USD600,000

Cost of services journal entry:

Cost of services are considered as the expenses element of the financial statements and the double tries are the same as expenses or cost of goods sold.

Following the example above, the salaries of the professional staff are considered as the costs of services since the professional staff is involved directly with the services.

The double entry for the cost of services are as follow:

Cost of servicesDr

Difference between COGS and Cost of Services:

The term cost of goods sold is mostly associated with the manufacturing industry while services or skill-based industry cost of revenue is used to express their cost of services.

Another difference between the two is the calculation and maintenance of inventory.

The cost of inventory plays a major part in the calculation of COGS while there is no such thing when we calculate the cost of revenue or services.

 Accounting for Cost of Services:

In a broader view, the cost of services includes all the direct costs involved in performing the task or activity and excluding all the indirect costs.

Cost of Services/Revenue = Sum of All Direct Costs


Raw material + Direct labor + Shipping cost + Other Direct Costs

The cost of services or revenue is charged to the company’s income statement to calculate the gross profit.

Related article  Cost of Goods Sold for a Grocery Store - Explained

Cost of services includes:

  1. Raw Material:  In the services industry mostly there is not any raw material as they do not manufacture any product. But businesses have to consider the cost of any material used in performing their services.
  2. Direct Labor or Salaries Expense: The cost of direct labor or salaries of experts should be included while calculating the cost of services. For example, if a repairing company takes a contract for repairing a house in 3 days. The company has done the job with the help of 1 labor who works for 30 hours at a rate of $5 per hour.

So the cost of labor charge to the cost of services will be

= 30 * $ 5 = $ 150

  • Transportation or Shipping Cost: All the costs incurred on the transportation of skilled labors or professionals for the given job will be included in the cost of services.

Suppose a law firm sends a team of experts from one city or state to another city or state to represent their client.

The cost of a train, bus, or plane ticket will be included as a cost of services and will charge to the company’s income statement.

  • Cost not to be included in Cost of Services: All the indirect expenses which are not directly related to the performance of activity are not included in the cost of sales.

The common examples of indirect costs for a services business are:

  • Salaries of marketing staff
  • Rent of premises or office
  • Utility Bills
  • Phone Bills
  • Any other overhead expense.