Ch4 LifeCycle

 

Chapter 4 Product Life Cycle Costing 1.

Objectives

1. 1.1 1

Expl Explai ain n the the conc concep eptt of li life fe cycl cyclee co cost stin ing. g.

1.2 1.2

Des escr crib ibee tthe he ph phas asee of of lif lifee cycl cyclee cos costi ting ng..

1.3 1.3

Desc Describ ribee how how to maxim maximize ize the retur return n of over over the the produ product ct life life cy cycle cle..

1. 1.4 4

den denti tify fy the the ben benef efit itss of of lif lifee cyc cycle le cost costin ing. g.

1.!

Explain Explain the implicat implications ions of using using life cycle cycle costi costing ng eespec speciall ially y in in as assist sisting ing manageme management nt with decisions.

$ife %ycle %osting

&eaning

'tages of  life cycle

(ow to maximize return

mplications of using life cycle

1. Development stage

Design costs

*enefits of life cycle

2. ntroduction stage

&inimise time to mar+et

(ow to assist management decision

3. )rowth stage

&aximise the length of life span

4. &aturity stage

&inimise brea+even time

!. Decline stage

 "4#1

 

2.

The N Na ature of L Liife Cy Cycle Costing !un 12" !un 1#$

2.1

Life Cycle Costing

$ife cycle costing trac%s and accu&ulates costs and revenues  attributable to each  product over the entire product life cycle .

2.2 2.2

, prod produc uctt-ss llif ifee cycl cyclee cost costss are are incu incurr rred ed fro& its design stage through develop&ent to &ar%et launch" production and sales" and finally to its eventual 'ithdra'al fro& the &ar%et.

2. 2.3 3

, prod produc uctt li life fe cyc cycle le can can be div divid ided ed int into o fiv fivee phas phases es.. a/

Deve Develop lopme ment nt 0 he he produ product ct has has a rese resear arch ch and and deve develop lopme ment nt sta stage ge w whe here re cost costss are incurred but no revenue is generated. (ere target costing may be used in combination with life cycle costing.

b/ b/

ntr ntrod oduc ucti tion on 0 he he pr prod oduc uctt is intr introd oduc uced ed to the mar+ mar+et et.. oten otenti tial al cust custom omer erss will be unaware of the product or service and the organization may have to spend further on advertising to bring the product or service to the attention of  the mar+et. hen h en a produc productt is ne' to the &ar%et and a co&petitor  has not  already established a rival product in the mar+et a company may be able to choose

its pricing strategy for the new product. i/

f a &ar%et penetration  市場滲透/ strategy is chosen the aim should  be to sell the product at a lo' price in order to obtain a large share of  the mar+et as 5uic+ly as possible. his pricing strategy is therefore

ii/

based on lo' prices and high volu&es. f a &ar%et s%i&&ing 市場刮脂策略/ strategy is chosen the aim is to sell at a high price in order to &a(i&i)e the gross profit  per unit sold. *ales volu&es 'ill be lo'  and the product will be purchased only by

customers who are willing to pay a high price to obtain a 6uni5ue7 item. )radually the selling price will be reduced although it will be +ept as high as possible for as long as possible. his approach is often used with high technology products. c/ c/

)rowt rowth h 0 he prod produc uctt gains gains a bi bigg gger er mar+ mar+et et as dem demand and build buildss up. 'ale 'aless revenues increases and the product begins to ma+e a profit.

d/ d/

&atu &aturi rity ty 0 Event Eventua uall lly y the the growt growth h in deman demand d for the the produ product ct will will slow slow do down wn and it will enter a period of relative maturity. t will continue to profitable. he  "4#2

 

 product may be modified or improved i mproved as a means of sustain sustaining ing its demand. e/ e/

Dec ecli line ne 0 he he mar+e mar+ett will will have have bough boughtt enoug enough h of the the produ product ct and and it will will therefore reach saturation point. Demand will start to fall. Eventually it will  become a loss#ma+er and this is the time when the organization should decide to stop selling the product or service.

2.4

he horizont horizontal al axis axis measur measures es the the durati duration on of of the the life life cycle cycle which which can can last last from from say 18 months to several hundred years. %hildren-s crazes or fad products have very short lives while some products such as binoculars invented in the eighteenth eighteenth century/ can last a very long time.

2.!

+(a&ple 1

,*% %o specializes in the manufacture of solar panels. t is planning to introduce a new slimline solar panel specially designed for small houses. Development of the new panel is to begin shortly and 'olaris is in the process of determining the price of  the panel. t expects the new product to have the following costs. 9ear 1

9ear 2

9ear 3

9ear 4

2;;;

1!;;;

2;;;;

!;;;

<

<

<

<

1?;;;;;

1;;;;;

1;;;;;

@!;;;

!;;;;

1;;;;

roduction cost per unit

!;;

4!;

4;;

4!;

%ustomer service costs per unit

!;

4;

4;

4;

:nits manufactured and sold =>D costs &ar+eting costs

 "4#3

 

Disposal of specialist e5uipment

3;;;;;

he &ar+eting Director believes that customers will be prepared to pay <!;; for a solar panel but the Ainancial Director believes this will not cover all of the costs throughout the lifecycle. ,e-uired

%alculate the cost per unit loo+ing at the whole life cycle and comment on the suggested price. *olution

$ifecycle cost <;;; =>D 1?;; B 1;;/

2;;;

&ar+eting 1;; B @! B !; B 1;/

23!

roduction 1;;; B C@!; B 8;;; B 22!;/

18;;;

%ustomer service 1;; B C;; B 8;; B 2;;/

1@;;

Disposal

3;;

otal lifecycle costs

2223!

otal production ;;; units/

42

%ost per unit

!2?.4;

he total lifecycle costs are <!2?.4; per solar panel which is higher than the price  proposed by the mar+eting director. 'olaris will either have to charge a higher price or loo+ at ways to reduce costs. t may be difficult to increase the price if customers are price sensitive and are not  prepared to pay more. %osts could be reduced by analysing each part of the costs throughout the life cycle and actively see+ing cost savings. Aor example using different materials using cheaper staff or ac5uiring more efficient technology.

 "4#4

 

#.

/a /a(i (i& &is isin ing g tthe he ,e ,etu turn rn ov over er th thee Pr Pro oduct duct Li Life fe Cy Cycl clee

0$

esi esig gn co cost stss ou out of of pr produc ducts

3.1 3.1

*etw *etween een @; @; to ?; ?; of a produ product ct-s -s li life fe cycle cycle cost costss are dete determ rmine ined d by decis decision ionss made made early in the life cycle at the design or development stage. he following figure illustrates illustra tes a typical pattern of cost co&&it&ent and cost incurrence during the three stages of a product-s life cycle 0 the planning and design stage the manufacturing stage and the service and abandonment stage.

3.2 3.2

9ou will will see from from the the fi figu gure re that that appro approxi xima mate tely ly 8; 8;  of a pr prod oduc uctt-ss costs costs are co&&itted or loc%ed in during the planning and design stage. ,t this stage product

designers determine the product-s design and the production process. n contrast the maFority maF ority of of costs are incurred  at the &anufacturing stage but they have already  become loc%edin at the planning and design stage  and are difficult to alter.

3$

/ini&is &ise th the ti ti&e to to &a &ar%et

3.3 3.3

%omp %ompeti etitor torss watch watch each each othe otherr very car carefu efully lly to to determ determine ine wha whatt types types of prod product uct thei their  r  rivals are developing. f an organization organization is launching a new product it is vital to get it to the mar+et place as soon as possible. his will give the product as long a period as  possible without a rival riv al in the mar+et place plac e and should mean increased incr eased mar+et share in the long run.

3.4

Aurthermore the life span may not proportionally lengthen if the products products launch is delayed and so sales may be per&anently lost. t is usual for the product-s overall overall  "4#!

 

 profitability to fall by 2! if the launch is delayed by six months. his means that th at it is usually worthwhile incurring extra costs to +eep the launch on schedule or to speed up the launch. C$$ C

/a(i /a(i&i &ise se th thee len lengt gth h of of tthe he life life sp span an

3.! 3.!

rodu roduct ct life life cycle cycless are not not pred predete eterm rmine inedG dG they they are are set set by the the actio actions ns of mana managem gement ent and competitors. competitors. Hnce developed some products lend the&selves to a nu&ber of  different usesG this is especially true of materials such as plastic I% nylon and

other synthetic materials. he life cycle of the material is then a series of individual  product curves nesting nes ting on top of each other as a s shown below.

3.C

*y entering different national or regional &ar%ets  one after another an organisation may be able to &a(i&ise revenue. his allows resources to be better applied and sales in each mar+et to be maximised. Hn the other hand in todayJs fast moving world an organisation could lose out to a competitor if it failed to establish an early presence in a particular mar+et.

$

/ini&is &ise br brea%even ti ti&e

3.@

, short short brea+e brea+even ven time time is very importa important nt in in +eeping +eeping an orga organisa nisation tion li5uid. li5uid. he sooner  sooner  the product is launched the 5uic+er the research and developm development ent costs will be repaid  providing the organisation organisatio n with funds to develop further products.

 "4#C

 

4.

5& 5&pl pliica cati tion onss o off 6 6si sing ng Life Life Cyc yclle C Cos osti ting ng

4.1 4.1

radit raditio ional nal cost costing ing syste systems ms do not not attem attempt pt to mea measur suree the prof profita itabil bility ity o off a produc productt over its entire life.

4.2 4.2

$ife $ife cycle cycle cost costing ing com compar pares es the the revenu revenues es and and costs costs of the the produ product ct over over its its entire entire lif life. e. his has many benefits . a/

he potential profitability profitability  of products can be asse assessed ssed before before &ajor &ajor develop&ent  of th thee produ product ct is carried carried out and costs costs incurr incurred. ed. Nonprofit

be abandoned   at an earl early y stag stagee be befo fore re co cost stss ar aree &a%ing &a%in g product productss  can be committed. b/

Techni-ues can be used to reduce costs over the life of the product.

c/

Pricing strategy can be deter&ined before the product enters production.

his may lead to better control of mar+eting and distribution costs. d/

0ttention can be focused on reducing the research research and develop&ent phase

to get the product to mar+et as 5uic+ly as possible. he longer the company can operate without competitors entering the mar+et the more revenue can be earned and the sooner the product will reach the brea+even point. e/

*y &onitoring the actual perfor&ance of products against plans  lessons can be learnt to i&prove the perfor&ance of future products . t may also be

 possible to improve the estimating es timating techni5ues used. u sed. 4.3 4.3

,n under understa standi nding ng of the the produ product ct life life cycle cycle can can also also assis assistt man manag ageme ement nt with with deci decisi sions ons withK

4.4

a/

ricingG

b/

erforma rmanc ncee manag nagementG

c/

Decision#ma+ing

Pricing. ,s a product moves from one stage in its life cycle to the next a change in pricing strategy &ight be necessary necessary to &aintain &ar%et share. Aor example prices might be reduced as a product enters its maturity phases and annual sales volume

stops rising/. 4.!

Perfor&ancee &anage&ent. ,s a product moves from one stage of its life cycle to Perfor&anc

another its financial performance will change. /anage&ent should understand that an i&prove&ent or decline in perfor&ance could be lin%ed to changes in the life cycle and should therefore to some extent at least/ be expected.

4.C

ecision&a%ing. n addition to helping management with decisions on pricing an

understanding of life cycle costing can also help 'ith decisions about &a%ing ne' invest&ents in the product   new capital capital expenditure expenditure// or 'ithdra'ing a product fro& the &ar%et.

 "4#@

 

+(a&ination *tyle 7uestions 7uestion 1 8 Life Cycle Costing and target costing

raditional cost control systems focused on cost containment rather than cost reduction. oday cost management focuses on process improvement and the identification of how  processes can be more effectively effectiv ely and efficiently perfor performed med to result in cost reductions. reductio ns. ,e-uired

Discuss how the cost management techni5ues of target costing and life cycle costing differ  from the traditional cost containment approach and how each see+s to achieve cost reduction. 1; mar+s/ 7uestion 2 8 Life Cycle Costing and 03C

$es 'aturniens ', ma+es digital watches. $es 'aturniens is preparing a product life cycle  budget for a new watch &L3. Development on the new watch with features such as a calculator and a daily diary is to start shortly. $es 'aturniens expects the watch to have a  product life cycle of 3 years. yea rs. Estimates about &L3 are as follows followsKK 9ear 1

9ear 2

9ear #

!;;;;

2;;;;;

1!;;;;

<4!

<4;

<3!

?;;;;;

1;;;;;

#

Iariable cost per watch

<1C

<1!

<1!

Iariable cost per batch

<@;;

<C;;

<C;;

4;; C;;;;;

!;; C;;;;;

!;; C;;;;;

<3.C;

<3.2;

<28;

<4;;;;;

<3;;;;;

<3;;;;;

Iariable cost per watch

<1

<1

<1

Iariable cost per batch

<12;

<12;

<1;;

atches per batch

2;;

1C;

<12;

<24;;;;

<24;;;;

<24;;;;

<2

<1.!;

<1.!;

:nits manufactured and sold rice per watch =>D and design costs &anufacturing

atches per batch Aixed costs &ar+eting Iariable cost per watch Aixed costs Distribution

Aixed costs %ustomer service costs per watch

 "4#8

 

,e-uired

a/

%alculat %alculatee the budgeted budgeted life cycle cycle operat operating ing profi profitt for the new new watc watch. h.

b/

hat perc percenta entage ge of the the budgeted budgeted produ product ct life life cycle cycle costs costs will will be incurr incurred ed at the the end of  the =>D and design stagesM

c/

,n analy analysis sis reveal revealss that 8; of the total total produc productt life life cycle cycle costs costs of the the new watch watch will will  be loc+ed in at the end of the =>D and design stages. hat implications would this finding have on managing &L3-s costsM

d/

$es 'aturn 'aturniens iens-- &ar+e &ar+ett =esearch =esearch Depart Departmen mentt estimates estimates that that reducin reducing g &L3-s &L3-s price price by <3 each year will increase sales by 1; each year. f sales increase by 1; $es 'aturniens 'aturnie ns plans to increase manufacturing manufacturing and distribution batch sizes by 1; as well. ,ssume that all variable costs per watch variable costs per batch and fixed costs will remain the same. 'hould $es 'aturniens reduce &L3-s price by <3M

7uestion # 8 Life Cycle Costing and 3udgeting

argrin designs develops and sells many % games. )ames have a short lifecycle lasting around three years only. erformance of the games is measured by reference to the profits made in each of the expected three years of popularity. argrin accepts a net profit of 3! of  turnover as reasonable. , rate of contribution sales price less variable cost/ of @! is also considered acceptable. argrin has a large centralised development department which carries out all the design wor+   before it passes the completed game to the sales and distribution department to mar+et and distribute the product. argrin has developed a brand new game called 'tealth and this has the following budgeted  performance figures. figures . he selling price of 'tealth will be a constant <3; per game. ,nalysis of the costs show that at a volume of 1;;;; units a total cost of <13;;;; is expected. (owever at a volume of 14;;; units a total cost of <1!;;;; is expected. f volumes exceed 1!;;; units the fixed costs will increase by !;. 'tealth-s budgeted volumes are as followsK 'ales volume

9ear 1

9ear 2

9ear #

8;;; units

1C;;; units

4;;; units

n addition mar+eting costs for 'tealth will be <C;;;; in year one and <4;;;; in year two.  "4#?

 

Design and development costs are all incurred before the game is launched and has cost <3;;;;; for 'tealth. hese costs are written off to the income statement as incurred i.e.  before year 1 above/. ,e-uired

a// a

Expl Explai ain n the the pr prin inci cipl ples es be behi hind nd li life fecy cycl clee co cost stin ing g an and d br brie iefl fly y stat statee why why arg rgri rin n in  particular should shou ld consider these lifecycle lifec ycle principles.

b/ b/

4 mar+s/

r rod oduc ucee the the bu budg dget eted ed resu result ltss fo forr th thee ga game me ' 'te teal alth th-- and br brie iefl fly y asse assess ss the the ga game me--s expected expe cted perform performance ance ta+in ta+ing g iinto nto account account the whole whole lifecyc lifecycle le of of tthe he game game..

c/

Explain Explain why increme incremental ntal budget budgeting ing is a commo common n method method of budget budgeting ing and and outline outline the the main problems with such an approach.

d/

? mar+s/ mar+s/ C mar+s/

Discuss Discuss the the extent extent to which which a meaning meaningful ful standa standard rd cost can can be set for for games games produced produced  by argrin. argrin. 9ou 9ou should consider each of the cost classifications cla ssifications mentioned above. C mar+s/ otal o tal 2! mar+s/ mar+ s/ ,%%, A! erformance &anagement December 2;;8 N4/

 "4#1;

 

7uestion 4 8 Life Cycle Costing

, compan company y manuf manufact acture uress &3 &3 pl play ayers ers.. t is planni planning ng to intro introduc ducee a new model model an and d development will begin very soon. t expects the new product to have a life cycle of 3 years and the following costs have been estimated. 9ear ; :nits manufactured and sold rice per unit =>D costs

<8!;;;;

9ear 1

9ear 2

9ear3

2!;;;

1;;;;;

@!;;;

<?;

<8;

<@;

<?;;;;

#

#

<3;

<2!

<2!

<!;;;;;

<!;;;;;

<!;;;;;

<!

<4

<3

<3;;;;;

<2;;;;;

<2;;;;;

<1

<1

<1

<1?;;;;

<1?;;;;

<1?;;;;

<3

<2

<2

 Production costs costs

Iariable cost per unit Aixed costs  Marketing costs

Iariable cost per unit Aixed costs  Distribution costs

Iariable cost per unit Aixed costs %ustomer service costs per unit ,e-uired

a/ a/

Exp xpla lain in life life cycl cyclee cost costin ing g and and stat statee wh what at dist distin ingu guis ishe hess it fr from om mor oree trad tradit itio iona nall management accounting techni5ues.

b/

1; mar+s/

%alculat %alculatee the cost cost per unit unit loo+in loo+ing g at the whole whole lifec lifecycl yclee and commen commentt on the price price to to be charged.

@ mar+s/ otal o tal 1@ mar+s/ mar+ s/

 "4#11

 

7uestion : 8 Life Cycle Costing

 has recently completed the development and testing of a new product which has cost <4;;;;;. t has also bought a machine to produce the new product costing <1!;;;;. he  production machine is capable of producing 1;;; units of the product per month and is not expected to have residual value due to its specialized nature. he company has decided that the unit selling prices it will charge will change with the cumulative numbers of units sold as follows. %umulative sales units

'elling price < per unit in this band

; to 2;;;

1;;

2;;1 to @;;;

8;

@;;1 to 14!;;

@;

14!;1 to !4!;;

C;

!4!;1 and above

4;

*ased on these selling prices it is expected that sales demand will be as shown below. &onths

'ales demand per month units/

1 0 1;

2;;

11 0 2;

!;;

21 0 3;

@!;

31 0 @;

1;;;

@1 0 8;

8;;

81 0 ?;

C;;

?1 0 1;; 1;1 0 11;

4;; 2;;

hereafter

"il

:nit variable costs are expected to be as follows. < per unit Airst 2;;; units

!;

 "ext 12!;; units

4;

 "ext 2;;;; units

3;

 "ext 2;;;; units

2!

 "4#12

 

hereafter

3;

 operates a Oust#in#time O/ purchasing and production system and operates its business on a cash basis. , columnar cash flow statement showing the cumulative cash flow of the product after its introduction and growth stages has already been completed and this is set out below. ntroduction

)rowth

&onths

1 0 1;

11 0 2;

21 0 3;

 "umber of units produced and a nd sold

2;;;

!;;;

@!;;

'elling price per unit

<1;;

<8;

<@;

:nit variable cost

<!;

<4;

<4;

:nit contribution

<!;

<4;

<3;

otal contribution

<1;;;;;

<42!;;;

< <4!;;;;/

<2!;;;/

%umulative ,e-uired

a/

%omplet %ompletee the cash cash flow flow statem statement ent for for each of the the remaini remaining ng two two stages stages of the the product product-s -s life cycle. Do not copy the introduction and growth stages in your answer. gnore the time value of money.

b/

! mar+s/

Explain Explain using using your answe answerr to a/ above above and and the data data provide provided d the the possible possible reason reasonss for  the change changess in costs costs and and sell sellin ing g pric prices es duri during ng the the life life cy cycle cle of the the prod product uct..

! mar+ mar+s/ s/

otal o tal 1; mar+s/ mar+ s/

 "4#13