Service items are created for a couple of uses usually involving items that do not involve inventory.
Primary uses are:
Gift Cards - a gift card is sold using a service item
Services such as repairs, alternations, manicures
Service items are created similar to a Store item, except there is not a quantity used for the item (you do not have a supply of the service item and do not need to receive it once it is created).
Service items still require a vendor (Mandatory field), often the merchant will just create a vendor named "Service" depending on their use of the service item
Sales of service items are included on all sales reports (but are not on the inventory reports)