Life Cycle Costing Finding
In management accounting, there are various costing methods applicable to use in practice. Some of practitioners are familiar with job order costing, process costing and activity based costing. The key idea is to apply the right costing method in the right situation. Life cycle costing (LCC) offers another choice to the user. It is usually found in manufacturing, construction, software companies and product development. As we know, consumer and manager need to make decision on the cost of acquisition and cost of ongoing use of many different assets like equipment, motor vehicle, plant and other.
As it seems, the key factor to influence the decision of acquisition on assets is the initial capital cost. In addition, the unrealized cost such as ongoing operation and maintenance cost should be considered before the decision making is made. Life cycle Costing is a process to determine the sum of all the costs related with an asset throughout its life which include acquisition, installation, operations, maintenance, renovation and disposal costs.
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For example, if the managers want to buy the motor vehicle for the purpose of company.
They are needed to consider the whole life cycle costing such as their maintenance, their operation, their initial acquisition, and other factor which can give more information to decision maker to make the better decision. This report sets out to address what LCC, why LCC, when LCC, how LCC use on the manufacturing industry. The aim is to provide a clear understanding toward life cycle costing in theory and practise. FINDINGS 1. ) Life Cycle Costing
Life cycle costing is estimates and accumulated costs over a product’s entire life cycle in order to determine whether the profits earned during the manufacturing phase will cover the cost incurred during during the pre- (upstream) and post- (downstream) stage. By understand on how to identifying the cost incurred during the different stage of product life cycle, it might help the manager to manage the total costs incurred throughout its life cycle. In addition, life cycle costing is also helps managements deeply understanding the cost consequences of developing and making a product and
to identify area in which may cost reduction effective. 1. 1) Life Cycle Costing Concepts The process of Live Cycle Costing involves: I. Assessing costs arising from an asset over its life cycle. Asset life cycle consist of various phase which are planning, acquisition, managing, distribution, and disposition. Though the asset life cycle, all the cost arising from each phase must be estimated at the earlier stage to facilitate in the cost reduction. The acquirer should consider all relevant cost because it is not only about the initial investment and acquisition cost, but all cost occurred over the anticipated life cycle of the assets.
II. Evaluating alternative that have an effect on the cost of ownership. The comparisons of asset alternative whether it is at the concept or detailed design level should be evaluate in order to achieve better outcomes from the assets. Each alternative may have different pros and cons. Selecting unfriendly alternative may affect all the cost incurred during the period of ownership. Therefore, a thorough evaluation shall be made to avoid unwanted circumstances. For example, the mobile phone industry such as Nokia, Samsung, HTC and other is a fast moving product.
Life cycles are short, mobile phone manufacturers spent lots of money on R&D and they have to recover these costs in a short period of time. This explains why newly released mobile phones are sold at such high prices. 1. 2) Reason for use Life Cycle Costing I. Comparison of asset alternatives to achieve better outcome from asset. Each asset alternatives should be evaluated so that it will assess the risk and benefit on every alternatives. A strategize development and implementation of plans and programs for the assets should be done to ensure that the assets operational objectives are achieved at optimum cost.
II. Essential in determination of cost in the asset management process. It is important to identifying the cost in the asset management process whether the asset should be acquired, upgraded, maintained, or disposed of. It will serve a framework on how the asset will be acquired; planning for the upgrade and maintenance and disposal process will be managed. III. As managers’ tools in asset. An effective asset manager’ tools will help in delivering company objective effectively and efficiently.
In addition, the manager’s tools will be helps by systematic tools like economic appraisal, financial appraisal, value management, risk management and demand management in weighing up the costs and benefits, risks, objective, revenues and expenditures. IV. Enables the decision maker to balance the performance, reliability, maintain abilities and other goals against life cycle costs. In order to achieve the outcomes that reflect performance, reliability and ability, the proper planning, allocation of resources and evaluation of the performance should relate each other and fit together. 1.
3) It can be used in three stages Life cycle costing should be applied when there are three stages: I. The conceptual stage: This is the stage when the initial proposal for investments is being considered. It is to estimate the future cost and provision to be made over the life of the assets. For example, the different type and designs of machine to increase the sales production for the manufacturing industry. II. The acquisition stage. This is the stage where the supplier for the assets is being assessed. It is to assist in the selection of the most cost-effective option. III. The service stage.
The stage of decision making on whether to maintain, improve or dispose of the assets. It is to improve the cost effectiveness of the production as well as to improve the specification of future assets. For example, when automotive manufacturing products their car product, they are improving their quality of car. So that to ensure the customer still keeps loyalty to buy their car for future. 1. 4) Estimate Life Cycle Costing The formula to calculate the life cycle costing: Life Cycle Costing = Capital Cost + Life Time Operating Cost + Life Time Maintenance Costs + Disposal Cost – Residual Value
1. 4. 1) Product life cycle: relationship between costs committed and costs incurred Product Life Cycle Phases Figure 1 illustrates the relationship between costs committed and costs incurred in the life cycle costing. It involves three stages of a product’s life cycle, the planning and design stage, the manufacturing stage and the service and distribution stage. Committed or locked-in costs are costs have not been incurred currently but that will be incurred in the future after the decision basis has been made. Costs are incurred when a resource is sacrificed or used.
A system of costing is the record cost only had been done when they have been incurred. Furthermore, the costs that have been committed are difficult to be alter. The pattern of cost commitment and incurrence will vary based on the industry and specific product introduced. During the planning and design stage, the cost management can be most effectively exercised compared to the manufacturing stage when the product design and processes have already identified and costs have been committed. At the post sales service and distribution phase, its focus more on cost containment than cost management. 1. 4.
2) Life Cycle Costing Model The information should be obtained before selecting a model. This is to ensure that the analysis can be made. Evaluation should be made in considering the applicability of all cost factors, empirical relationship, constants, elements and variables. Life cycle costing model should: I. Represent the characteristic of the asset being analyzed. It includes the intended use environment, maintenance concept, operating and maintenance support scenarios and any constraints and limitations. II. Comprehensive to include and highlight the relevant factors to the Life Cycle Costing asset.
III. Easy to understand in order to permit timely decision making, future updates and modification. IV. Evaluate the specific Life Cycle Costing elements independently of other costing elements. 1. 4. 3) Life Cycle Costing Breakdown into Asset Cost Some element need to be identified in Life Cycle Costing. This is because it requires the breakdown of the asset into its part of cost elements over time. The elements that should be considered are: I. Significant amount of cost that generate components of activity. II. Time in the life cycle when conducting the activity. III.
Resources cost categories that relevant such as material, labor, overhead, transportation and others. 1. 4. 4) Benefits of Life Cycle Costing The benefits the manager can gain from Life cycle costing are: I. Planning and analysis of alternative solutions. It is to serve a framework to document and compare the alternatives to achieve significant cost benefits. Life cycle costing concept will give earlier actions to produce revenue or to lower costs. II. Selection of preferred alternatives. The decision maker can use the information for the selection process with the life cycle costing analysis.
Better decision should follow from more realistic and accurate assessment of cost and revenue. III. Securing funding. The comparison between the alternatives that have different cash flow patterns over time is important. This is because there are corporate cash flows issues that need to be considered. Life cycle costing analyses provide a basis for projecting cash requirements. IV. Review. The life cycle costing can serve confirmation of the reliability of the life cycle costing model. Besides, the credibility of future life cycle costing plans can be achieved. 1. 4.
5) Life Cycle Costing Process Life cycle costing involves six stages which are: Stage 1: Plan Life Cycle Costing The documentation of the plan needs to be done at the beginning to serve a framework of life cycle costing. This plan must be review to ensure the plan has been interpret correctly and address clearly. Stage 2: Select or Develop Life Cycle Costing Model All relevant categories of cost that will happen in phases of life cycle should be identified. Select a method for estimating the associated cost and develop the estimates. Stage 3: Apply Life Cycle Costing Model
Life cycle costing model need to be validated and obtain the model results from each relevant combinations and support scenarios defined in the analysis plan. Stage 4 : Document and Review Life Cycle Costing Results The documentation of the results should be done to ensure the users understand clearly the results and affects of the analysis along with the constraints and uncertainties associated with the result. Stage 5 : Prepare Life Cycle Costing Analysis Life cost analysis used to control and manage the ongoing costs of assets or part thereof.
It involves review and development of the life cycle costing model as a cost control mechanism. Stage 6 : Implement and Monitor Life Cycle Costing Analysis Life cycle costing should have a continuous monitoring of the actual performance of an asset during its operations and maintenance and to provide feedback for future reference. 1. 4. 6) Application to industry For pharmaceutical products, the product life cycle is becoming shorter and shorter as new products keep being developed for the market demand purposes. It is not surprising that new drugs are being sold at very high prices.
For example, drugs which are used to fight cancer in targeted therapy can cost a patient on average RM 20,000 to RM 200,000 per month. Again, the life cycle is short (or uncertain), and pharmaceutical companies need to pay back the initial costs in R&D in a short period making high prices necessary. You can imagine how much the companies need to pay for a team of top tier scientists who have been working in the laboratory day and night for many years while developing the drug. Finally, as a short revision on life cycle costing, suppose a new cancer curing drug XXX is expected to have sales of 100,000,000 units in the coming 10 years.
The selling price is targeted at RM 1,000 per unit. R&D is RM 10,000,000,000, design cost is RM 500,000,000, manufacturing cost is RM 1,000,000,000, marketing RM 100,000,000, distribution costs another RM 100,000,000 and finally customer service RM 50,000,000. Find the life cycle profit for XXX as follow: RM Millions XXX Sales 100,000 R&D (10,000) Design (500) Manufacturing (1000) Distribution (100) Marketing (100) Customer service (50) Life cycle profit 88,250 The life cycle profit is RM 88,250 million (or RM 88,250,000,000).
It is for 10 years and thus on average every year the profit is RM 8,825 million which is quite normal for leading pharmaceutical companies. It can be seen that the total life cycle cost is RM 11,750 million and RM 10,000 million (or 85. 1%) spent on R&D. CONCLUSION Life Cycle Costing can be conclude as key asset management tool which takes into account the whole of life implication on the asset starting from the cost planning, acquiring, operation maintaining and disposing. It assist in analyse not only the cost of acquiring an asset but also the costs over an asset’s life like long-term operational and maintenance costs.
In addition, it will be the guidance on how long term strategic planning process, analysis, evaluation and decision making process towards the asset managements. The best expected outcome can be managed if all the relevant cost and benefits over life span of an asset is taking into account. Lastly to overall cost involve in owning, operating and maintaining an asset from the initial planning up till disposal. Thus, selecting the best alternative in order to minimize the possible cost incurred and maximizes the potential savings that can be made.