RELEVANT COST&COST PLANNING FOR PRODUCT LIFE CYCLE

A relevant cost (also called avoidable cost or differential cost) is a cost that differs between
alternatives being considered.In order for a cost to be a relevant cost it must be:

 Future
 Cash Flow
 Incremental
It is often important for businesses to distinguish between relevant and irrelevant costs when
analyzing alternatives because erroneously considering irrelevant costs can lead to unsound business
decisions. Also, ignoring irrelevant data in analysis can save time and effort.

Types of irrelevant costs are:

 Sunk costs
 Committed costs
 Notional or Non cash costs (e.g depreciation and amortization)

A construction firm is in the middle of constructing an office building, having spent $1 million on it so
far. It requires an additional $0.5 million to complete construction. Because of a downturn in the real
estate market, the finished building will not fetch its original intended price, and is expected to sell
for only $1.2 million. If, in deciding whether or not to continue construction, the $1 million sunk cost
were incorrectly included in the analysis, the firm may conclude that it should abandon the project
because it would be spending $1.5 million for a return of $1.2 million. However, the $1 million is an
irrelevant cost, and should be excluded. Continuing the construction actually involves spending $0.5
million for a return of $1.2 million, which makes it the correct course of action.

A managerial accounting term for costs that are specific to management's decisions. The concept of
relevant costs eliminates unnecessary data that could complicate the decision-making process

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 RELEVANT COST&COST PLANNING FOR PRODUCT LIFE CYCLE

Cost Planning for the Product Life Cycle: Target-Based Costing, Constraint Theory, and Strategic
Pricing
The cost life cycle is a series of activities within a company that begins with research and
development followed by design, production (or service provision), marketing/distribution, and
customer service. The sales life cycle is a series of stages in the web of a product or service in the
market environment from the introduction of the product or service to the market environment,
sales growth, and finally maturity, sales decline, and product withdrawal from the market.
Target-Based Costing

Target cost= Competitive price–Desired profit

The company has two options for reducing costs to a target cost level:
1.By incorporating new production technologies, using more advanced cost management techniques
such as activity-based financing, and seeking higher productivity.
2.By redesigning a product or service.
Implementing a target-based costing approach involves the following five stages:
1.Determination of market prices.
2.Determination of the desired profit.
3.Making the calculation of the target cost at the market price minus the desired profit.
4.Use of value engineering to identify ways to save product costs.
5.Use of kaizen financing and operational control for better cost savings.

Value Engineering
Value engineering is used intarget costing to reduce product costs by analyzing trade-off between
different types of product functionality (different types of product features) and the total cost of the
product. A common type of value engineering applied in these companies is the functional analysis,
the process of examining the performance and cost of each major function or product feature.
Design analysis is a general form of value engineering for products in the second group, industrial
and specialty products. Cost tables are computerized databases that include comprehensive
information about a company's cost drivers. Group technology is a method for identifying similarities
in product components produced so that the same component can be used in two or more products
thereby reducing costs. Combined engineering, or continuous engineering, is a new development in
the product design process that replaces the basic engineering approach in which product designers
work in isolation for specific components of the overall design project.

Target-Based Costing and Kaizen

The fifth step in target-based costing is to use continuous improvement
(kaizen)
and operational control to reduce costs. Kaizen occurs at the stage of production where the effects
of value engineering and the design that have been developed have already occurred. The role of
cost reduction at this stage is to develop new production methods and use new management
techniques such as operational control, total quality management, and constraint theory to further
reduce costs.

Advantages of Target-Based Costing

1. Targeted costing can be advantageous because of the following:
2. Improve customer satisfaction, partially customer value-focused design
3. Reducing costs, through more effective and efficient designs.
4. Helping companies to achieve desired profits on new or redesigned products.
5. Can reduce the total time required for product development, through improved
coordination of design, production, and marketing managers.

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 RELEVANT COST&COST PLANNING FOR PRODUCT LIFE CYCLE

6. It can help provide a competitive edge in times of economic recession.

7. It can improve the overall product quality, as the design has been carefully improved and
production issues taken into account at the design stage.

Constraint Theory
One of the key methods used to increase speed is the theory of constraints (TOC). The measurement
is interpreted in different ways by different companies, depending on the nature of the company's
operations. For example, production cycle time (or production lead time or output time) is usually
defined as:
Cycle time = Amount of time between receipt of a customer order and delivery of the order Another
useful measure is the efficiency of the production cycle
(manufacturing cycle efficiency—MCE)
: MCE= processing time/Total cycle time

Constraints are activities that slow down the total product cycle time. TOC has turned attention to
increasing speed on constraints, leading to a favorable reduction in overall cycle time and inventory.
TOC can be compared against on-time production
(just-in-time — JIT) both of which are aimed at reducing cycle times and reducing inventory levels.

Activity-based financing and constraint theory

TOC ABC
The main purpose Short term focus; output limit Long term focus; analysis on
analysis is based on the cost the overall cost of the
of raw materials and related product, including raw
raw materials materials, labor and expenses
Constraints and resource Strictly included; a major Not expressly included except
capacity focus of the TOC as indicated on time-driven
ABC
Time Driver No direct utilization of cost Build an understanding of cost
drivers drivers at the unit, batch,
product and facility levels
Main Use Short-term optimization of Strategic Pricing and Profit
production and product planning
composition

Life Cycle Costing

Typically, the cost of a product or service is measured and reported for a relatively short period of
time, such as a month or a year. Life cycle costing provides a long-term perspective because it
considers the entire life cycle cost of a product or service. Therefore, this financing provides a more
complete perspective of the cost of the product and the profit opportunity of the product or service.
The Importance of Design
Important success factors at the design stage include the following:

1. Marketing time savings.

2. Reducing expected service costs.
3. Suppress the influence of the product environment.
4. Increase the ease of production.
5. The planning and design process.

Strategic Pricing Using the Product Life Cycle

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 RELEVANT COST&COST PLANNING FOR PRODUCT LIFE CYCLE

Management accountants are involved in three pricing situations: special order decisions, target
costing, and pricing decisions that do not involve special orders or market-determined prices.

1. Pricing Using the Cost Life Cycle

2. Full Production Cost Plus Price Increase.Life Cycle Cost Plus Price Increase (Total life cycle
cost x cost increase = price)
3. Full Cost and Desired Gross Margin Percentage
Price= Total Production Cost/(1-Percentage of Desired Life Cycle Limit)

Alternatively, a variation of this method can be used to achieve the desired profit at a
percentage of life cycle costs.

Price=Full lifecycle cost/(1-Presentation of desired lifecycle limit)

4. Full Cost Plus Desired Asset Return
Price increase cycle=Desired pretax profit/Estimated life cycle cost of sales

Strategic Pricing for Stages in the Sales Life Cycle

In contrast to the cost life cycle as described above, the sales life cycle refers to the years a product
or service is sold in the market from the introduction of the product or service to the decline and
withdrawal of the product from the market. Stage 1: Introduction, Stage 2: Growth, Stage 3:
Maturity, Stage 4:Sales Drop

Strategic Pricing: Analysis-Based Pricing Method

Recently, retail companies and some manufacturers are using a strategic approach to pricing where
they determine prices at a price level that can be borne by customers, they often use analytical
methods based on extensive data analysis of customer buying behavior.

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