GROUP MEMBERS:

Mitch T. Minglana
Bambie Y. Montilla
Bamboo Y. Montilla

CHAPTER 8: REVIEW QUESTIONS AND PROBLEMS

1. What is life-cycle costing, and why it is used?

ANSWER: Life-cycle costing is a management technique used to identify and monitor the
costs of product or service throughout its life cycle. It provides a long-term perspective of
product costs and product or service profitability. Life-cycle costing is used throughout the
cot cycle to minimize overall cost.

2. Do cost management practices change over the product’s sales life cycle? Explain how

ANSWER: Together with the change in strategy and pricing, there is a change in the cost
management system. At the Introduction and into the growth phases, the primary need is for
value chain analysis, to guide the design of products in a cost-efficient manner. Master
budgets are also used in these early phases to manage cash flows; there are large
developmental costs at a time when sales revenues are still relatively small. As the strategy
shifts to cost leadership in the Latter phases, the goal of the cost management system is to
provide the detailed budgets and activity-based costing tools for accurate cost information.

3. For what types of firms is life-cycle costing most appropriate and why?

ANSWER: Life cycle costing is more heavily used by businesses that place an emphasis
on long-range planning, so that their multi-year profits are maximized. An organization
that does not pay attention to life cycle costing is more likely to develop goods and
acquire assets for the lowest immediate cost, not paying attention to the heightened
servicing costs of these items later in their useful lives.

4. Explain the difference in intended application between sales life-cycle analysis and life-
cycle costing.

ANSWER: Sales life cycle is the sequence of phases in the product’s or service’s life in the
market – from the introduction of the product or service to growth in sales and finally
maturity, decline and withdrawal from the market. While the Life-cycle costing is a
management technique used to identify and monitor the costs of product or service throughout
its life cycle.
5. What are the different methods of product engineering used in product design and life-
cycle costing?

ANSWER: There are four common design methods namely:

 Basic Engineering, this is a method in which product designers work independently
from marketing and manufacturing to develop a design from specific plans ad
specifications.

 Prototyping, this is a method in which functional models of the product are developed
and tested by engineers and trial customers.

 Templating, this is a design method in which an existing product is scaled up or down to

fit the specifications of the desired new product.

 Concurrent Engineering, or simultaneous engineering, is an important new approach in

which product design is integrated with manufacturing and marketing throughout the
product’s life cycle.

6. What is meant by the sales life-cycle? What are the phases of the sales life cycle? How
does it differ from the cost life cycle?

ANSWER: The Sales Life-cycle is the sequence of phases in the product’s or service’s life in
the market from the introduction of the product or service to growth in sales and finally,
maturity, decline and withdrawal from the market. And Sales Life-cycle is different from cost
life cycle because Cost life cycle is the sequence of activities within the firm that begins with
research and development, followed by design, manufacturing, marketing / distribution and
common service. The cost life cycle has no phases just like the Sale life-cycle because it only
focuses merely on the development or research about the product or services and it does not
undergo any phases.

There are four Phases of the Sales Life Cycle namely:

 Phase 1: Product Introduction, in the first phase there is little competition, and sales
rise slowly as customers become aware of the new product or service.
 Phase 2: Growth, sales begin to grow rapidly and product variety increases. The product
continues to enjoy the benefits of differentiation. There is increasing competition and
prices begin to soften.
 Phase 3: Maturity, sales continue to increase but at a decrease rate, there is a reduction
in the number of competitors and of product variety.
 Phase 4: Decline, sales begin to decline, as do the nuber of competitors. Prices stabilize.
7. Do pricing strategies change over the different phases of the sales lifecycle? Explain
how?

ANSWER: The strategic pricing approach changes over the life cycle of the product or
service. In the FIRST PHASE, pricing is set relatively high to recover development costs and
to take advantage of product differentiation and the new demand for the product. I the
SECOND PHASE, pricing is likely to stay relatively high as the firm attempts to build
profitability in the growing market. Alternatively, to maintain or increase market share at this
time, relatively low prices (penetration pricing) might be used. In the LATTER PHASES,
pricing becomes more competitive, and target costing and life-cycle costing methods re used,
as the firm becomes more of a price taker rather than a price settler and makes efforts to
reduce upstream (for product enhancement) and downstream costs.

8. What is target costing, and what type of firms use it?

ANSWER: Target Costing is a technique in which the firm determines the desired cost for
the product or service, given a competitive market price so the firm can earn a desired profit.
Many Firms employ both methods-operational controls to achieve productivity gains and
target costing to determine low-cost design. Target Costing is particularly popular among
Japanese firms such as Toyota, Nissan, Toshiba, and dalhatsu motor in various industries
such as automobile manufacturing, electronics, machine tooling, and precision machine
manufacturing.

9. For what type of firms is target costing appropriate and why?

ANSWER: Target costing is most applicable to companies that compete by continually

issuing a stream of new or upgraded products into the marketplace (such as consumer goods).
For them, target costing is a key survival tool. Conversely, target costing is less necessary for
those companies that have a small number of legacy products that require minimal updates,
and for which long-term profitability is more closely associated with market penetration and
geographical coverage (such as soft drinks).
The target costing concept has limited application in a services business where labor
comprises the primary cost.
Target costing is an excellent tool for planning a suite of products that have high levels of
profitability. This is opposed to the much more common approach of creating a product that is
based on the engineering department’s view of what the product should be like, and then
struggling with costs that are too high in comparison to the market price.

10. What is meant by the concept of value engineering? How is it used in target costing?

ANSWER: Value engineering is a systematic, organized approach to providing necessary

functions in a project at the lowest cost. Value engineering promotes the substitution of
 materials and methods with less expensive alternatives, without sacrificing functionality. It is
focused solely on the functions of various components and materials, rather than their
physical attributes. Value engineering is also called value analysis.

Value Engineering is used in target costing to reduce product cost by analyzing the trade-offs
between (1) different types and levels of products functionality and (2) total product cost.

11. Explain the two methods for reducing total product costs to achieve a desired target cost.
Which is most common in the consumer electronics industries? In the specialized equipment
manufacturing industries?

There are two methods for reducing the total product costs:
 Integrate new manufacturing technology using advanced cost management techniques
such as activity-based costing and seeking higher productivity through improved
organization and labor relations. This method of cost reduction is common in
Specialized Equipment Manufacturing Industries.
 Redesign the product or service. This approach is more common that n the first one
because it recognizes that design decisions for much of the product life cycle cost. This
approach to target costing is associated primarily with Japanese manufactures, especially
Toyota, which is credited with developing the method in the mid-1960s. This method of
cost reduction is common in Consumer Electronics Industries.

12. What is the main difference between activity-based costing and the theory of constraints?
When it is appropriate to use each one?

ANSWER: Activity-based costing is a method that recognizes the causal relationship of

cost drivers to cost activities by measuring the cost and performance of process-related
activities and cost objects. Costs are assigned to activities based on resource consumption
and then assigned to cost objects based on activity consumption.
The theory of constraints was developed by Goldratt and Fox in the 1980’s and has since
evolved. Goldratt developed a scheduling approach known as optimized production
technology (OPT) that used TOC principles. This method was coined "synchronous
manufacturing" in 1984 and became the theory of constraints in 1987.

When comparing ABC with the TOC it becomes clear that the cost paradigms are based on
different time horizons - ABC has a long run horizon, while the TOC has a short-run horizon.
The concept of short-run versus long run looks at whether the capacity of the production
facility can be expanded or contracted.

When comparing ABC with the TOC it becomes clear that the cost paradigms are based on
different time horizons - ABC has a long run horizon, while the TOC has a short-run horizon.
 The concept of short-run versus long run looks at whether the capacity of the production
facility can be expanded or contracted.

It is assumed that in the short-run production capacity is fixed and cannot be readily changed.
This creates bottlenecks or constraints. This context brings the assumptions of the TOC to
life. In the long run, however, more costs become variable, especially when spending and
consumption are brought into alignment. This reinforces the assumptions underlying ABC.

These methods are based on different sets of assumptions with separate time horizons; thus,
claims that one approach is superior over the other should be abandoned. There is room for
both approaches when they are used appropriately. Accountants need to understand each tool
and how they work in order to know when one is appropriate and the other is not.

13. What is the role of the network diagram in the theory of constraints analysis?

ANSWER: A Network Diagram is a flowchart of the work done that shows the sequence of
processes and the amount of the time required for each. The purpose of the network diagram
is to help the management accountant look for signs of bottleneck.

14. What is meant by a binding constraint in the theory of constraint analysis? A non-binding
constraint?

ANSWER: If an inequality constraint holds with equality at the optimal point, the constraint
is said to be binding, as the point cannot be varied in the direction of the constraint even
though doing so would improve the value of the objective function.

If an inequality constraint holds as a strict inequality at the optimal point (that is, does not
hold with equality), the constraint is said to be non-binding, as the point could be varied in
the direction of the constraint, although it would not be optimal to do so. If a constraint is
non-binding, the optimization problem would have the same solution even in the absence of
that constraint.

15. Name the five steps of the theory of constraints and explain the purpose of each. Which is
the most important steps and why?

ANSWER: The five steps in Theory of Constraints Analysis are:

 Step 1: identify the Binding Constraint(s). In the first step in the management accounts
work with manufacturing managers and engineers to identify binding constraints by
developing network diagram of the flow of production. A Network diagram is a flowchart
of the work done that shows the sequence of processes and the amount of the time
required for each.
  Step 2: Determine the Mostly Efficient Utilization for Each Binding Constraint. In this
step, the management accountant determines how to most effectively utilize the firm’s
resources. The approach differs somewhat depending on whether there is one product, or
two or more (as SPI has). If there is one product, the management accountant looks for
ways to maximize the flow of production through the constraint.
 Step 3: Manage the Flows Through the Binding Constraint. In step 3, the objective is to
manage the flow of production in and out of the binding constraint to smooth the flow of
production throughout the plant. The orderly scheduling of production prevents the
building of materials or work-in-process inventory at various processes. An important tool
for managing product flow in this context is the Drum-Buffer-rope system, which is a
system for balancing the flow of production through a binding constraint.
 Step 4: Add Capacity to the Constraint. As longer-term measures to relive the constraint
and improve cycle time, management should consider adding capacity to the constraints
by binding new or improved machines and/or additional labor.
 Step 5: Redesign the Manufacturing Process for Flexibility and Fast Cycle time. The
most complete strategic response to the constraint is to redesign the manufacturing
process, including the introduction of new manufacturing technology, deletion of some
hard-to-manufacture products, and redesign of some products for greater ease of
manufacturing. Simply removing one or more minor features on a given product might
speed up the production process significantly.

Among the five steps of theory of Constraints, the Step one is the most important because
this tells us where to focus our improvement efforts, since we know that only an
improvement at the constraint makes a difference.

16. For what types of firms is the theory of constraints analysis most appropriate and why?

ANSWER: The theory of constraints is very apt for manufacturing and supply chain
logistics. But, because it is used to identify and improve methods and systems, it can be
applied to any area of the business.

Whatever business processes you have, where you have bottlenecks, you can use the theory of
constraints to find effective solutions to a business issue.

For example, your recruitment processes may suffer from hindrances such as: not attracting
enough suitable candidates for vacancies; or management not reviewing CVs quickly; or there
being slow reference-checking processes. 

And in any project management situation - whatever its focus - there are all kinds of activities
going on, all of which aim to converge to produce the final result.  Any bottlenecks in the
system will delay or hinder the outcome and the theory of constraints can be applied to solve
the issues. 
 To achieve your organisation’s or your department’s full potential and to perform to the
maximum, the theory of constraints can be a useful tool to eliminate the business stresses that
bind and choke efficiency.

PROBLEM 1 (Matching Market Characteristics with Sales Life-Cycle Stages)

Activities and Market Characteristics Sales Life-Cycle Stage

 Decline in sales Decline
 Advertising Introduction and can also be in Growth
 Boost in production Growth
 Stabilized profits growth
 Competitor’s entrance into market Introduction
 Market research Growth
 Market saturation Maturity
 Start production Introduction
 Product testing Introduction
 Termination of product Decline
 Large increase in sales growth

Required: insert the appropriate life-cycle stage in the space provided after each activity

PROBLEM 2 (Life-Cycle Costing)

The following revenue and the cost data are for Round Manufacturing’s to radial saws. The
RM 200 is for the commercial market and the RM 800 is for industrial customers. Both
products are expected to have three-year life cycles.

RM200
YEAR 1 YEAR 2 YEAR 3
Revenue Costs P 500,000 P 2,000,000 P 2,500,000
Research and development 1,000,000 -0- -0-
Prototypes 300,000 50,000 -0-
Marketing 60,000 320,000 475,000
Distribution 80,000 120,000 130,000
Manufacturing 20,000 800,000 1,000,000
Customer service -0- 60,000 85,000
Income
P (960,000) P 650,000 P 810,000

RM800
YEAR 1 YEAR 2 YEAR 3
Revenue Costs P 900,000 P 1,800,000 P 2,000,000
Research and development 1,150,000 -0- -0-
Prototypes 550,000 30,000 10,000
Marketing 124,000 200,000 260,000
Distribution 170,000 300,000 410,000
Manufacturing 85,000 600,000 700,000
Customer service -0- 20,000 10,000
Income
P (1,179,000) P 650,000 P 610,000

Required:
1. How would a product life-cycle income statement differ from this calendar year income
statement?
2. Prepare a three-year life-cycle income statement for both products. Which product
appears to be more profitable?
3. Prepare a schedule showing each cost category as a percentage of total annual costs. Pay
particular attention to the research and development and customer service categories. What
do you think this indicates about the profitability of each product over the three-year life
cycle?

PROBLEM 3 (Target Costing in a Service Firm)

TARA alarm systems installs home security systems. Two of TARA’s systems, the MCU
100 and the MCU 900, have these characteristics: