Life Cycle Costing identifies the costs at the different stages of the life-cycle, how to derive a life cycle cost in manufacturing and service industries and how to identify the benefits of life cycle costing.
Life Cycle Costing
Life cycle costing is a cost accounting technique that accumulates costs over a product’s entire life. It is used primarily for planning and calculating lifetime costs and profitability.
a) Identify the costs involved at different stages of the life-cycle.
The product life cycle has five phases:
- Development – Usually includes research and development.
- Introduction – The Product is introduced to the market
- Growth – The Product gains a bigger market share as its demand grows
- Maturity – Profitable stage when sales reach a peak and are stable
- Decline – A saturation point where there is more than enough on the market
Life cycle costs are all of the costs attributable to product over its life from concept to withdrawal from the market.
The costs at different stages of the life cycle include:
- Design costs
- Cost of making models and prototypes
- Testing costs – Model testing
- Equipment costs – Development and investment
- Technical data and research costs – Information needed for analysis
- Training – Employee training
- Production – Costs to make the product
- Distribution – Transportation and logistics
- Marketing – Advertising, customer service, branding
- Inventory – Costs of holding inventory, include warehouse fees
- Retirement and Disposal – Costs at the end of the product’s life
b) Derive a life cycle cost in manufacturing and service industries.
Life cycle costing is used in manufacturing and service industries to estimate returns over the life of a product or service. In these industries, the majority of the life cycle costs are made “early in the life cycle.”
Therefore, business in these industries try to maximize the returns of the product over the life cycle by:
- Carefully designing the product to reduce design costs
- Minimising the time it takes to get the product on the market
- Minimising the time it takes for revenue to cover incurred costs
- Maximising the length of the life span
c) Identify the benefits of life cycle costing.
The benefits of life cycle costing are:
- The profitability of a product or service over its lifetime can be calculated. This allows management to decide whether to continue with the development.
- The sales volumes and prices of products with short lives can be estimates
- Allows for advanced planning to generate more revenue or lower costs
- Encourages better decision making because of realistic assessments of revenues and costs
- Encourages long-term and strategic planning and provides more useful information
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