Life cycle costing
Content
Identify the costs involved at different
01
stages of the life cycle
02 Derive life cycle cost in manufacturing
and service industry
03 Identify the benefits of life cycle costing
(1) Development stage
Sales volume: None
A high level of set-up costs
Research & development costs
Product design and production facilities
(2) Introduction stage
Sales volume: Very low level
High marketing and promotion costs
High business risk (negative cash flow)
(3) Growth stage
Sales volume: Rapid increase
Sales revenue increase dramatically
Marketing and promotion cost will continue through this
stage
Costs decrease as fixed costs are recovered over greater
sales volumes
(4) Maturity stage
Sales volume: Stable high volume
Initially profits will continue to increase as initial set-up
and fixed costs are recovered
Marketing and distribution economies are achieved
Price competition and product differentiation will start to
erode profitability as new customers are limited
(5) Decline stage
Sales volume: Falling demand
Product is phasing out, production economies may be
lost and marketing costs are cut in this stage
A replacement product needs to have been developed
(R&D)
Additional development costs may be incurred to
refine the model or function to extend the life cycle
Discommisioning cost
Maximizing return over the product life cycle
1) Design costs out of products
almost 70-90%of a product's life cycle costs are determined
early in the life cycle, at the design or development stage.
Careful design of the product and manufacturing and other
processes will keep cost to a minimum over the life cycle.
2) Minimize the time to market
The quicker a company can get a product to the market
place, the longer the product will be established in the
market place without competitors’rival product increases
3) Maximize the length of the life cycle itself.
other use? other market?
Maximizing return over the product life cycle
4) Minimize break-even time
A short BET is very important in keeping an organization liquid.
The sooner the product is launched the quicker the research and
development costs will be repaid.
Implications
True costs of product are identified
All costs relating to the product including R&D are
associated with the product. This enables true assessment
of a product’s profitability.
Price will change according to demand
Given that there will be different levels of demand for a
product over its expected life, it will not be appropriate to
set one price for the product’s entire life.
Assess profitability over product life not by period
Advantages of life cycle costing
Consider external factors throughout a product’s expect life.
Consider all costs incurred on a product, and therefore lead to
cost reduction.
Very useful in the modern competitive environment, in which
products often have a short life cycle and when a large
portion of costs will be committed prior to product
commencing.
Life cycle thinking can promote long-term rewarding in
contrast to short-term profitability rewarding.
Promotes maximization of return over the product life cycle.
Lecture Example
The following costs arise in relation to production of
a new product:
(i) Research and development costs
(ii) Design costs
(iii) Testing costs
(iv) Advertising costs
(v) Production costs
In calculating the lifetime costs of the product,
which of the above items would be EXCLUDED?
A (i),(ii), and (iii) only
B (ii) and (iii) only
C (iv) and (v) only
D None of the above
Question
The following statements have been made about life cycle
costing:
(i) It focuses on the short-term by identifying costs at the
beginning of a product’s life cycle
(ii) It identifies all costs which arise in relation to the
product each year and then calculates the product’s
profitability on an annual basis
(iii) It accumulates a product’s costs over its whole life time
and works out the overall profitability of a product
(iv) It allocates costs to each stage of a product’s life cycle
and writes them off at the end of each stage
Question
Which of the above statements is/are correct?
A. (i) and (iii)
B. (iii) only
C. (i) and (iv)
D. (ii) only
Question
A manufacturing company which produces a range of products
has developed a budget for the life-cycle of a new product, P.
The information in the following table relates exclusively to
product P:
Lifetime total Per unit
Design costs $800,000
Direct manufacturing costs $20
Depreciation costs $500,000
Decommissioning costs $20,000
Machine hours 4
Production and sales units 300,000
Question
The company’s total fixed production overheads are budgeted to
be $72 million each year and total machine hours are budgeted
to be 96 million hours. The company absorbs overheads on a
machine hour basis.
What is the budgeted life-cycle cost per unit for product P?
A. $24·40
B. $25·73
C. $27·40
D. $22·73
