LIFE CYCLE COSTING

TOPIC: STRATEGIC MANAGEMENT ACCOUNTING

TECHNIQUES

Contemporary Strategic Management

Accounting Techniques

Introduction

At the start of any project, it is important to understand the costs involved

Traditional methods simply look at start up costs, cash flow and profit or loss

Focused primarily on the manufacturing stage of product life cycle

Pre & post – manufacturing are treated as expenses costs

LIFE CYCLE COSTING

Definition Life cycle costing is defined as the total cost

throughout its life including planning, design, acquisition & support costs & any other costs directly attributable to owning / using the asset.

Category of LCC Capital assets :

• Initial costs

• Operating costs

• Disposal costs

LIFE CYCLE COSTING

Simple Formula: Capital

+

lifetime operating costs

+

lifetime maintenance costs

+

disposal costs

–

residual value

LIFE CYCLE COSTING

LCC =

A company is planning a new product. Market research information suggests that the product should sell 10,000 units at RM21/unit. The company seeks to make a mark-up of 40% product costs. It is estimated that the lifetime costs of the product will be as follows : 1. Design and development costs RM50,000 2. Manufacturing costs RM10/unit 3. End of life costs RM20,000 Required : What is the original lifecycle costs per unit? LCC/unit = RM50,000 + ( 10,000 units x RM10 ) + RM20,000 / 10,000 units = RM 17

• Assists management to smartly manage total cost throughout product’s life cycle.

• To identify areas in which cost reduction efforts are likely to more effective.

• To estimate the cost impact of various designs and support options.

LIFE CYCLE COSTING

Life-cycle costing concept

Help management to understand the cost consequence of developing and making a product and to identify areas which cost reduction efforts are likely to be most effective.

The process of LLC fundamentally involves :

Assessing cost arising from an assets over its life cycle

Evaluating alternatives that have impact on this cost ownership

Life-cycle costing concept

Useful apply to low-technology issues, such as repair versus replace decisions

Eg-the New York State Throughway Authority uses life cycle concept to determine the point at which it is more expensive to repair than to replace bridges (Morse, Davis & Hartgraves third edition)

Aspects of Life Cycle Costing

There are 2 important point :

The focus on the product cost

The inclusion of all upstream and downstream cost

A Product Life Cycle (PLC) may be classified into 3 broad stages, namely :

Planning and Design

Manufacturing and Sales

Service and abandonment

Research & Development

Design Production Marketing Distribution After Sales Service

PRODUCT PLANNING &

DESIGN STAGE

MANUFACTURING &

SALES STAGE

SERVICE &

ABANDONMENT STAGE

LIFE CYCLE COSTING

Stages of Product Life Cycle

Planning and design stage

Manufacturing stage

Research and development cost, costs of product design, etc

Witnesses both growth and maturity in sales. All the manufacturing, marketing, selling and distribution costs are incurred at this stage

Service and abandonment stage

• This stage signified by a decline in a sales volume

• The demand for the product declines at this stage. The producers may be required to provide after sales service for the already sold products

• Costs that are incurred in this stage include all costs relating to after sales service including provision of spares and expert services and costs of abandonment and disposal of the product

Stages of Product Life Cycle

Costs Committed and Cost Incurred

Cost that have not yet been incurred but will be incurred in the future on the basis of decision already been taken are

termed committed costs

Cost incurred when a resource is used or sacrificed. The actual cost of product is built up mostly in the growth stage and

matured stage.

Costs incurred vis-à-vis the costs committed at different stages of the product life-cycle are compared in the following diagram.

Comparison of costs committed and cost incurred in product life-cycle stage

Advantages of LCC

Improve forecasting

• the application of LCC technique allows the full cost associated with a procurement to be estimated more accurately.

Improved awareness

• Provide management with an improved awareness of the factors that drive cost and the resources required by the purchase.

Performance trade-off against cost

• LCC technique not only focus on cost but also consider other factors like quality of the goods and level of service to be provided.

Disadvantages of LCC

Time Consuming

• Life cycle costing analysis is too long because of changes of new technology.

Costly

• The longer the project life time, the more operating cost will be incurred.

Technology

• Technology always change day to day.

Pricing

Performance

Management

Decision

Making

•Knowing life cycles ensures appropriate price of the products.

•Highlights the cost consequences of developing and making a product.

•To identify areas in which cost reduction efforts are likely to be most effective.

•Provides premises for decision-making regarding product introduction, product mix, discontinuation of products.

Implications of Life-Cycle Costing

Life-cycle estimates and accumulates costs over a product entire life-cycle.

To determine whether the profits earned during the introduction and growth phase will cover the costs incurred during the pre and post matured stage.

To estimate the life-cycle costs it is essential to identify the cost incurred through different stage of life-cycle product.

Only on knowing the life cycle costs of a product can one appropriately decide on its price.

If viewed from the angel of customer life-cycle costs, the life cycle costs provide input for pricing across the lifecycle.

Help management to understand the cost consequences of developing and making a product and to identify areas in which cost reduction efforts are likely to be most effective

LCC forms an input to evaluation processes such as value management, economic appraisal and financial appraisal

The management of time is immensely important if the profit of a product is to be maximized.

LCC provides a long-term picture of product profitability, feedback on the effectiveness of initial planning and cost data to clarify the economic impact of alternatives like design.

It also considered a way to enhance the control of manufacturing costs.

When viewed as a whole, cost reduction and minimization opportunities as well as revenue extension opportunities

It provide premises for decision-making regarding product introduction, product mix and regarding discontinuation of the products.

The management can know whether the revenue earned by the product is sufficient to cover the costs incurred during its life-cycle

There are opportunities for cost reduction and minimization (and thereby scope for profit maximization)

We will find out about the costs involved at different stages of the life-cycle and the implications of life-cycle costing on pricing, performance management and decision making.