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Life Cycle Costing

Compiled by Bhupendra Jain; 9811255704 Life-cycle costing offers a different way to look at overall product costs than other types of costing such as job-order, process, and activity-based costing. While many costing methods seem very similar, life-cycle costing stands out from the crowd. Life-cycle costing takes an entirely different view on product costing than other types of costing methods such as job-order and process costing. Finding the right product costing method is essential for a business to stay competitive in todays cost-conscious world.

What Is Life-Cycle Costing? CIMA defines life costing as the practice of obtaining over their life time, the best use of
physical assets at the lowest cost of activity. Life cycle costing is different to traditional cost accounting system which report cost object profitability on a calendar basis i.e. monthly, quarterly and annually. In contrast life cycle costing involves tracing cost and revenues on product by product bases over several calendar periods.
Costs and revenue can be analyzed by time period, but the emphasis is on cost revenue accumulation over the entire life cycle of each product.

Life-cycle costing is a method of costing that looks at a products entire value chain from a cost perspective. Other types of costing generally look only at the production process, whereas lifecycle costing tracks and evaluates costing from the research and development phase of a products life, through to the decline and eventual conclusion of a products life. This approach to costing makes sense for several reasons. First of all, most of a products costs are committed before the product is in the production phase. This means that the majority of control management can exert over production and other costs is during the design phase of the products life-cycle. Life-cycle costing also looks at product costs post-sale. Examples of this type of cost are warranties, customer service, marketing, and distribution costs. Where most types of costing systems focus on cost control, life-cycle costing focuses on reducing costs throughout a products life.

Life-Cycle Costing and Value Engineering

Life-cycle costing is also heavily associated with value engineering. Value engineering is a process used by businesses to reach target cost goals. This process touches all aspects of a product. It is designed to eliminate activities that do not add value, and increase efficiency in activities that are necessary and do add value.

Life-Cycle Costing Procedures

In its standard form, life-cycle costing cannot be used for financial reporting and in and of itself is not consistent with Generally Accepted Accounting Principles (GAAP). However, life-cycle costing is perhaps the best form of costing from a planning standpoint, and is a great tool that can be used by product managers throughout the life-cycle of a product. In order to use life-cycle costing to its fullest, costs must be calculated from the point of the initial idea for the product, until the product is no longer made. These costs are then divided by the total number of expected units to be sold throughout the lifetime of the product to come to a total cost per unit. This process can help product managers to get a realistic view of the total cost of a product, so they can design and adjust accordingly.

When Is Life-Cycle Costing Appropriate?

Life-cycle costing is most appropriate when a product is in the design, or pre-design stages. This will allow management to gain the most benefit from the process, as opposed to attempting to use life-cycle costing after a product is already in the marketplace. Q. 1: activates have been identified and the budget quantifies for the three month ended 31st March 2009 as follows. Activities Product design Purchasing Production Packing Distribution Cost driver unit basis Design hours Purchasing order Machine hours Volume (Cu. M) Weight (Kg) Units of cost driver 8,000 4,000 12,000 20,000 1,20,000 Cost (Rs. 000) 2,000 (See note no -1) 200 1,500 (See note no -2) 400 600

Note no. 1: This include all design costs for new products released this period. Note no. 2: This includes a depreciation provision of Rs. 3, 00,000 of which Rs. 8,000 applies for 3 month depreciation on a SLM basis for a new product (NPD). The remainder applies to other products. New products NPD is included in the above budget. The following additional information applies to NPD. (i) Estimated total output over the product life cycle : 5,000 units (4 years life cycle) (ii) Product design requirement : 400 design hours (iii) Output in quarter ended 31st March, 2009 : 250 units (iv) Equivalent batch size per purchase order : 50 units (v) Other product unit data : production time 0.75 machine hours; volume 0.4 cu. Meters; weight : 3 kg. Required: Prepare a unit overhead cost for product NPD using an activity based approach which include an appropriate share of life cycle cost using the information provided in above.

Q.2: Destine products make digital watches. Destine is preparing a product life-cycle budget for a new watch MX3. Development on the new watch is to start shortly. Estimates for MX3 are as follows: Life-cycle units manufactured and sold Selling price per watch Life Cycle Cost R & D and Design cost Manufacturing - Variable cost per watch - Variable cost per batch - Watches per batch - Fixed Cost Marketing - Variable cost per watch - Fixed cost Distribution - Variable cost per batch - Watches per batch - Fixed cost - Customer service cost per watch 4,00,000 Rs. 40

Rs. 10,00,000

Rs. 15 Rs. 600 500 Rs. 18,00,000

Rs. 3.2 10,00,000 Rs. 280 160 Rs. 7,20,000 Rs. 1.5

Required: 1. Calculate the budgeted life-cycle operating income for the new watch. 2. What percentage of the budgeted total product life cycle costs will be incurred by the end of the R&D and design stage? 3. Destins market research department estimates that reducing MX3s price by Rs. 3 will increase life cycle unit sales by 10%. If unit sales increase by 10% Destin plans to increase manufacturing and distribution batch sizes by 10% as well. Assuming that remaining cost will be the same. Should Destin reduce MX3 price by Rs. 3. Show your calculation.