}ACC4206Topic 2 (v)Life Cycle Costing (LCC)(vi)Value Chain Analysis (VCA)}Topic 2 (v)Life Cycle Costing (LCC)}}(v) Life Cycle Costing (LCC)1.Life cycle costing (LCC) tracks and accumulates actual costs and revenues attributable to each product (service, customer or projects) over the entire product’s life cycle, i.e. from their design stage through development to market launch, production an
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}ACC4206
Topic 2
(v)Life Cycle Costing (LCC)
(vi)Value Chain Analysis (VCA)
}Topic 2 (v)
Life Cycle Costing
(LCC)
}
}(v) Life Cycle Costing (LCC)
1.Life cycle costing (LCC) tracks and accumulates actual costs and revenues attributable to each product (service, customer or projects) over the entire product’s life cycle, i.e. from their design stage through development to market launch, production and sales, and their eventual withdrawal from the market. The components of the cost elements that a product can incur over its life cycle includes:
}Design & Legal costs – i.e. Patenting
}Research, Development and Testing costs
}Cost of buying any technical data (if necessary)
}Recruitment & Training costs
}Production/Manufacturing costs
}Marketing, Sales and Distribution costs
}Inventory, storage, obsolescence costs
}Retirement and Disposal costs.
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2.Life cycle costing differs from the traditional management accounting because LCC looks at all costs (production and non-production costs), through-out its entire life cycle. Where-else, under the traditional cost accumulation system, costs of a product are accumulated based on financial years and thus tend to dissect a product’s life cycle over a series of 12-month periods. This means that traditional management accounting system, do not accumulate the costs of a product over its life cycle and do not assess a product’s profitability over its entire life. Rather, all cost accumulation and profit assessment is done on a periodic basis, i.e. yearly.
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3.The problem with traditional cost accumulation systems is that they do not tend to relate a particular product’s research and development costs (R&D) to the product itself, rather they usually write it off on an annual basis (i.e. as a period charge) against the revenue generated by existing products. This will make the existing products less attractive in terms of profitability and the ‘true’ profitability of a product may not be known for sure.
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4.In comparison to traditional management accounting system, using the life cycle costing technique, the total profitability of any given product over its life cycle can be determined. This enables an organization to obtain more accurate feedback information on the organization’s success or failure in developing new products.
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5.In an advanced manufacturing environment, where products have low labour content, and are designed to make use of standard components and minimize wastage, rectification and warranty costs, thus the direct unit cost is relatively low and overhead costs will be higher. Moreover, due to advanced manufacturing technology, we find that the product’s life cycle tends to be shorter then those traditionally produced products.
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•A very high proportion of the total costs over the product’s life cycle will be in the form of initial development, design and production set-up costs.
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•In globally competitive market, product life cycles are decreasing, making initial costs even more disproportionate in the early stages.
6.The commitment of a high proportion of a product’s life cycle costs at the very early stages of the cycle has led to the need for accounting systems that compare the revenues from a product with all the costs incurred over the entire PLC.
PRODUCT LIFE CYCLE (PLC)
7.All product goes through a life cycle – product life cycle model suggest that products goes through stages with the period which begins with the initial product specification, and ends with the withdrawal from the market of both the product and its support. It is characterized by defined stages including;
Ø Development,
Ø Introduction,
Ø Growth,
Ø Maturity,
Ø Decline &
Ø Senility (Abandonment or Withdrawal)
The PLC Graph
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}Research & Development - The product is in a research & development stage where costs are incurred but no revenue generated.
}Introduction - Product is launched. Success depends of awareness and trial of product by customers. Extensive marketing and promotional costs incurred. Pre-production costs already incurred. (R&D, product design, etc).
}Growth - Product is accepted at introduction stage. Sales volume increases rapidly. Unit costs falls as LOA increases. (FC per unit falls).
Marketing and promotions to continue.
}Maturity - Market saturation is approaching. Sales growth is slowing down as product enters maturity stage. Initial profits will continue to increase due to FC recovered and marketing and distribution economies achieved. Price competition and product differentiation to start as firms compete for limited new customers remaining.
}Decline - Product moves to obsolescence and is replaced by new alternative. Product is removed when profits fall to an unacceptable level. New product is developed with new R & D.
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8.Characteristics of each stage of PLC:
9.Life cycle and Long Term Survival
}The returns expected from a product will depend on where that product is in its life cycle. The chart below gives an indication:
10.Thus, an organization should have a number of products at different stages in the life cycle. A product portfolio should also contain products with life cycles of different lengths.
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Implications of LCC:
10.Life cycle costing has implications on pricing, performance management & decision-making. One area of interest is the ‘non-production costs’ – in LCC, these costs are tracked and attributed to individual products over complete life cycles. The benefits of such an act is:
i.The total of these costs for each individual product can therefore be reported and compared with revenues generated in the future.
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ii.The visibility of these costs are much greater as they are not aggregated as a period charge.
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iii.Individual product profitability can be better understood by attributing all costs to products.
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iv.As a result, more accurate feedback information is available on the organization’s success or failure in developing new or modified versions of products.
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