Cost of Services for Service Businesses

Brief introduction

The cost of services for a service sector organization mainly constitutes the human resources of the entity which is providing services to its clients and customers.

The human resource of the service organization provides services, the human resource of such service organization contains mainly highly qualified experts who provide their highly judgemental opinion.

Examples of service sector organizations are hospitals, audit and assurance services, IT services, legal consultancy services, the hospitality industry, airline services, cleaning and maintenance services, etc.

The cost of goods sold in the service industry mainly contains the payroll of the service organization that is directly involved in providing service to the clients but excluded the supporting staff.

Calculation of cost of services for service businesses

The cost of services for a service sector organization is quite different than other sectors, the cost of services in a service organization mainly contains the payroll of the highly qualified human resources of the organization that is directly involved in providing services to the client and customers.

For example, the services provided by a doctor, lawyer, and legal consultants can be calculated on an individual basis however the audit and assurance, hospitality, airlines, and maintenance services can be calculated at a group level.

The calculation of cost service for service businesses mainly depends on the nature of services provided and based on the terms and conditions set between the service provider and receiver of the services.

The cost of service for a service sector also includes the direct material cost, depreciation, and amortization of the equipment used in providing services as well as the direct manufacturing overheads.

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Costs that cannot be included in the cost of services

The cost of services for service sector organizations should not include indirect material, indirect labor, and overheads not directly involved in the provision of services.

Thus the payroll of a service business should be apportioned into two parts, the payroll of those employees directly involved in providing services should be charged into the cost of sales and the payroll of those services that are not directly related to providing services should be charged as operating expenses.

For example, a hospital must charge its payroll related to medical and paramedical staff to its cost of providing services, and the payroll related to human resources, procurement department, and research and development should be charged as operating expenses.

Nature of cost of services for service businesses

The core product of a service organization constitutes the services created by highly qualified staff. The employer in return pays high remunerations to its highly qualified and highly experienced employees, this cost is the major portion of cost service.

Costs related to employees whose job description requires providing services in core products as well as in administration must be apportioned in a logical manner.

Information for decision-makers

The main resource of a service business mostly contains its human resource, and the human resource differs in terms of quality, efficiency, speed of providing service, and the judgemental capacity of the employee.

In order to keep intact hardworking employees within the organization, it is important to evaluate and reward employees based on their performance.

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Thus it provides data regarding employees and helps the employer in evaluating and rewarding proficient and highly motivated employees.

Types of service businesses

There are many types of service businesses and the number is increasing with the advent of new sectors or new lines of businesses.

The concept of the service sector is a very vast subject it ranges from services provided on a household basis to the highly qualified decision-making authority of multinational companies (MNCs) as well as global entities.

Taxes on service sector entities

Taxes on service providers have mainly been levied at the source i.e the taxes on services provided are deducted by the employer and the same is deposited to the authorities however in some sectors tax exemptions are provided, such as services provided in IT and IT-enabled services are exempted in Pakistan if provided outside the country.

Impact of cost of service on financial statements

Like in any other business the increased profit margin depends on the size of the cost of service. The higher the cost of service the lower the profit margin and vice versa, this ultimately decides the financial health of the service business.


In order to increase the profit margin and strengthen the financial position and financial performance of the organization, one should keep an eye on the size of the cost of service and try to minimize it to the possible extent.