Chapter 4: Life cycle costing

Product life cycle

Importance of life cycle costing

Maximizing the returns over the products life cycle

Differences between life cycle costing and traditional cost

accumulation systems
 Life-cycle costing
Life cycle costing

Is the profiling of cost over a product’s life,

including the pre-production stage.

Tracks and accumulates the actual costs and

revenues attributable to each product from
inception to abandonment.

Enables a product’s true profitability to be

determined at the end of its economic life.
Product life cycle
 Product life cycle
The product has a R&D stage where costs are incurred
but no revenue generated.

The product is introduced to the market.

The product gains a bigger market as demands builds up.

The demand for the product will slow down but remain
to be profitable.

The demand of the product will eventually fall and

becomes a loss-maker
 Maximizing the returns over
the products life cycle
1. Design cost of the products
2. Minimizing the time to market the product
3. Minimizing breakeven time
4. Maximizing the length of the life span
5. Maximizing product proliferation
6. Manage the product’s cash flow over its life cycle
 Differences between life cycle costing and
traditional cost accumulation systems
LIFE CYCLE COSTING TRADITIONAL COSTING

Life cycle costing tracks costs and Traditional cost are based on financial
revenue over the entire product life accounting periods
cycle

Non production cost such as R&D Research and development costs are
are traced to individual products over written off annually against revenue as
complete life cycle period expense

Total profitability of the product can True profitability of the product

be assessed cannot be assessed
 Implications of lifecycle
costing
• Pricing decisions can be based on total lifecycle costs
rather than simply the costs for the current period.
• Decision making - a timetable of life cycle costs helps
show what costs need to be recovered.
• Control - Lifecycle costing reinforces the importance of
tight control over locked-in costs, such as R&D.
• Performance reporting - Life cycle costing costs to
products over their entire life cycles, to aid comparison
with product revenues generated in later periods.
 Practise question 1
Solaris specializes in the manufacture of solar panels. It is planning to
introduce a new slim line solar panel specially designed for small houses.
Development of the new panel is to begin shortly and Solaris is in the
process of determining the price of the panel. It expects the new product
to have the following costs
Year 1 Year 2 Year 3 Year 4
Units manufactured and sold 2,000 15,000 20,000 5,000
R & D costs $1,900,000 $100,000
Marketing costs $100,000 $75,000 $50,000 $10,000
Production cost per unit $500 $450 $400 $450
Customer service costs per unit $50 $40 $40 $40
Disposal of specialist equipment $300,000

The Marketing Director believes that customers will be prepared to pay

$500 for a solar panel but the Financial Director believes this will not
cover all of the costs throughout the lifecycle.
Required: Calculate the cost per unit looking at the whole life cycle and
comment on the suggested price
 Other question
Question 2 Dec/2011 (Question bank pg.9)
Required (a)