Question 10.5.3: As you read through this example, notice that we are applyin...
As you read through this example, notice that we are applying all of the principles of cost analysis that you have already learned about in this Learning System. The only difference is that the principles are being applied to determine the cost of intangible services, rather than of tangible products.
Mr G and Mrs H have recently formed a consultancy business and they wish to establish the following rates to
charge clients:
● an hourly rate for productive client work;
● an hourly rate for time spent travelling to/from the clients ’ premises;
● a rate per mile for expenses incurred in travelling to/from the clients ’ premises.
Pricing policy
Mr G and Mrs H have decided that their pricing policy will be based on the cost per hour plus a 5 per cent profit mark-up. Travelling time will be charged to clients at one-third of the normal hourly rate. Travelling expenses will be charged to clients at cost.
Activity estimates
Mr G and Mrs H each expect to work for 8 hours per day, 5 days per week, 45 weeks per year. They refer to this as ‘available time ’.
● Twenty-five per cent of the available time will be spent dealing with administrative matters relating to the general running of the business.
● In the first year, 22.5 per cent of the available time will be idle, that is, no work will be done in this time.
● The remainder of the available time is expected to be chargeable to clients.
● Travelling time will amount to 25 per cent of the chargeable time, during which a total of 18,000 miles will be travelled. Cost estimates
● Mr G and Mrs H each wish to receive a salary of £25,000 in the first year of trading.
● Other costs to be incurred in the first year of trading
£
Electricity 1,200
Fuel for vehicles 1,800
Depreciation of vehicles 6,000
Insurance – professional liability and office 600
Vehicle insurance and road tax 1,080
Office rent and rates 8,400
Telephone expenses 3,000
General office expenses 8,900
Servicing and repair of vehicles 1,200
Requirement
Prepare a summary report for Mr G and Mrs H which states the client charge rates that they wish to establish.
If you look back to Section 10.5.2 you will be reminded that we need to know two things in order to establish the cost per unit of service:
(1) the total costs incurred in the period;
(2) the number of units of service supplied in the period.
We need to classify the costs provided to determine the total cost associated with travelling, and that associated with providing consultancy services.
Consultancy Travelling
£ £
Salaries 50,000
Electricity 1,200
Fuel 1,800
Depreciation 6,000
Insurance 600
Vehicle insurance, etc. 1,080
Office rent and rates 8,400
Telephone expenses 3,000
General office expenses 8,900
Servicing vehicles, etc. _ 1,200
72,100 10,080
Now we need to determine the number of units of service by which each of these cost totals is to be divided. The calculation of the rate per mile for travelling expenses is relatively straightforward:
Rate per mile = \frac{Total travelling expenses}{Miles travelled} = \frac{£10,080}{18,000} = £0.56 per mile
The calculation of the hourly rate for productive work and travelling time is a little more complicated. The first step is to determine the number of units of service supplied, that is, the chargeable hours. We need to look at the activity estimates provided in order to analyse the available time
| Hours | |
| Total available hours for the first year = 2 people × 8 hours × 5 days × 45 weeks | 3,600 |
| Less: administration time 25.0% | |
| idle time 22.5% | |
| 47.5% × 3,600 | (1,710) |
| Time chargeable to clients | 1,890 |
| Productive time spent with clients (75%) | 1,417.5 |
| Travelling time (25%) | 472.5 |
Travelling time will be charged at one-third of the normal hourly rate, therefore we need to calculate a ‘ weighted’ figure for chargeable time
Weighted chargeable time = 1,417.5 + \frac{472.5}{3} = 1,575 hours
Now we can combine the consultancy services costs and the weighted chargeable time to determine an hourly rate for each type of work
Cost per chargeable hour = \frac{£72,100}{1,575} = £45.78
Hourly rate for productive client work = £45.78 + 5% profit mark-up = £48.07 per hour, say £48 per hour
Hourly rate for travelling time = \frac{£48.07}{3} = £ 16.02 per hour , say £ 16 per hour
Summary report: client charge rates
To: Mr G and Mrs H
From: AN Other
Date: xx.xx.xx
Subject: Client charge rates
REPORT
In response to your request, in accordance with the cost and activity data provided, I detail below the required charge rates to clients.
Hourly rate for productive client work £48
Hourly rate for travelling time £16
Rate per mile for travelling expenses £0.56