Life Cycle Costing

It is a modern approach for planning of Capital Assets with the objective of

minimization of cost and maximization of profit. It is a method which is used to set
the cost of a product. In this method of costing we look at the accumulated cost
over the entire product lifecycle, which includes cost right from the start from R&D
to removal of the product from the market. So here we dont include periods of time,
splitting up or cost in that period of time, we include cost of the product over its
lifecycle right through to the end.
Lifecycle of the product can be split into five different phases:
1)
2)
3)
4)
5)

Development
Introduction
Growth
Maturity
Decline

This life cycle will be different for all products, not all products will have the same
lifecycle. Some products may have a short lifecycle; some might have a long one.
The key concept behind Life cycle costing is that we are no longer looking at
accounting periods, we dont talk about periods of month or a year we take into
consideration the entire product lifecycle, it may last as long as possible. Hence
when we look at the entire life cycle it will enable us to set a better price for our
product.
For e.g.: If we look at a product, produced by a manufacturing company with 4 year
lifecycle and we are given various costs over the lifecycle of that product. Suppose
we have 6 costs as mentioned below and these costs are mentioned at different
periods of the lifecycle of the product. So we have to add the total cost over the
lifecycle of the product.

So from the example we see that the R&D cost is only included in year 1, while the
product is included in all the rest of the three years. The total cost over the 4 years
for different phases amounts to 1044.
Phases of Lifecycle:

This shows the 5 stages as mentioned earlier in the document. Half way up th
diagram we have the zero point. The red line depicts the sales and the blue line,
the profit.

1) R&D Stage:
a) The sales at this point are zero because product is not the market yet and
the profit is going down, this is because the money is spent on R&D but
there are no sales yet so the product is loss making.
b) Cost Involved: costs for R&D, for testing of the product and some capital
investment would also be required to buy new equipment or machinery to
do testing or do research and develop the product. It may or may not
sometimes include the training costs of employees.
c) This phase can take up large percentage of total costs of the product; it
may be as large as 90%. So we would have to try and minimize this to a
large extent.

2) Introduction Stage: At this stage we see that the sales begin but we are
still making a loss. The point where the profit (blue line) crosses the zero line
that is the breakeven point.

3) Growth Phase: Sales continues to increase and we start making profit.

4) Maturity Stage: Still we see growth in both the sales and profit but the
percentage increasein profit has declined.

5) Decline: Further the sales continue to decrease and the company starts
making loss.

After this stage we choose the take the product back from the market.

Calculation of Lifecycle Costing:

Allocate the total costs of the lifecycle to the units of the product produced. Here is
an illustration to explain this.

Here the total costs are allocated to the different phases and then this total cost is
allocated to the product and the cost per unit is determined.
Advantages:
1) Over Traditional Costing:
In traditional costing we write off the R&D costs in the period which they are
incurred, this means that we write the new R&D costs over the revenue that we
generate from the old products. So we are generating the revenue from the old
products and writing off the costs from the new products against that revenue
and this can make the old products look less profitable.
2)
3)
4)
5)

Product is priced up to cover the lifecycle costs.

It enables companies to track costs through the lifecycle of the product.
It also enables the business to focus on early decisions.
It also minimizes the time to reach the product.