Accounting for Cost of Services

The cost of goods sold represents all direct costs incurred on manufacturing a product or acquiring it. Usually, it includes a company’s purchases and other similar expenses that directly contribute to the products. This figure is crucial in calculating gross profits. For service-based firms and companies, however, the cost of goods sold is not applicable. Instead, these firms use the cost of services.

What is the Cost of Services?

The cost of services is similar to the cost of goods sold. Instead of purchase expenses, it includes all direct costs incurred on providing a service. For most firms, these costs will involve direct labour expenses incurred for employees. These include salaries, wages, bonuses, overtime, etc., paid to staff who provide services.

In some cases, the cost of services may also include expenses incurred on direct materials. However, these materials are not for manufacturing physical products. Instead, they consist of items that are essential to the provision of services. Apart from these, they may also include any other expenses that contribute to the rendering of services.

Like the cost of goods sold, the cost of services is crucial in measuring gross profits. Similarly, these do not include any indirect expenses incurred for operation or other purposes. Firms report the cost of services in the income statement and deduct it from their revenues to reach gross profits. Overall, the cost of services is highly crucial for companies and firms involved in rendering services.

What is the Accounting for Cost of Services?

The accounting for the cost of services is similar to the cost of goods. As mentioned, this amount includes any expenses incurred directly toward providing services. Usually, it involves the labour costs incurred for employees who render services. In essence, the cost of services is an expense for firms. However, it is crucial that any item in this heading directly contributes to the services provided.

When firms incur an expense, they must determine whether it is a direct or indirect expense. Once they ensure it directly contributes to the services, they can record it as a cost of services item. The journal entry for cost of services is as follows.

Date Particulars Dr Cr
Material / Labor / Other expenses (Cost of services) XXXX
Cash / Bank / Payables XXXX

In the above journal entry, the debit side will include the account for the expense. Firms will separate these accounts into the cost of services category. The credit side will consist of the source for the expense. Usually, firms pay for them or may also get them on credit. Either way, this entry will increase the firm’s cost of services in the income statement.

Example

A firm, Red Co., provides accountancy services to its clients. During one of its assignments, the firm pays one of its employees $10,000 through a bank account to render accounting services to a client. Since this expense relates directly to the provision of services, Red Co. recorded it as a part of its cost of services. The journal entry for the transaction is as below.

Date Particulars Dr Cr
Salary Expense (Cost of Services)  $  10,000
Bank  $  10,000

During the assignment, Red Co. also purchased stationery items for the employee to help document progress. The firm acquired $1,000 worth of goods for which it paid through cash. These items contributed directly to the provision of services. Therefore, they will be a part of the cost of services. The journal entry is as below.

Date Particulars Dr Cr
Stationery Expense (Cost of Services)  $  1,000
Cash  $  1,000

Overall, Red Co.’s cost of services for the specific client was $11,000 ($10,000 salary expense + $1,000 stationery expense).

Conclusion

Cost of services represents all direct expenses incurred on the provision of services. It includes various items for firms that are in the services industry. The accounting for the cost of services is similar to that of the cost of goods. Firms record any direct expenses in the relative account and treat them as a part of the cost of services.

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