Life Cycle Cost Analysis

What is Life Cycle Cost (LCC) Analysis? A method of calculating the cost of a system over its entire life span.

Objectives of LCC Analysis

Evaluate the economic effectiveness of different mutually exclusive investment alternatives over a certain period  Identify the most cost-effective alternative

maintenance.Life Cycle Cost (LCC)  Life cycle costing. . conversion. and/or decommission. including its cost of installation. LCC. is the process of economic analysis to asses the total cost of ownership of a product. operation.

. total cost of the product can be calculated over the total span of product life cycle.Life Cycle Cost (LCC)  By using LCC.

development and use.Life Cycle Cost (LCC)  LCC is a economic tool which combines both engineering art and science to make logical business decision. .  This analysis provides important inputs in the decision making process in the product design.

product suppliers can evaluate various operating and maintenance cost strategies (to assist product users).LCC for product supplier  By using LCC. product suppliers can optimize their design by evaluation of alternatives and by performing tradeoff studies. .  By using LCC.

LCC for customer  By using LCC. customers can evaluate and compare alternative products. . customers can assess economic viability of projects or products.  By using LCC.

 Maintenance Engineering wants to minimize repair hours as the only criteria.  Accounting wants to maximize project net present value as the only criteria.  Reliability Engineering wants to nullify failures as the only criteria. .  Production wants to maximize operation hours as the only criteria.Why use LCC? Typical conflict in most of the company:  Project Engineering wants to minimize capital costs as the only criteria.  Shareholders want to increase stockholder wealth as the only criteria.

. money.Why use LCC?  LCC can be used as a management decision tool for synchronizing the divisional conflicts by focusing on facts. and time.

Why use LCC?  Why should engineers be concerned about cost elements? It is important for engineers to think like managers and act like engineers for a profit maximizing organization. Money Does Matter!!! .

Cost element  For an equipment. and 2) Operation & Maintenance Cost  The identification of cost elements and their sub-division are based on the purpose and scope of the LCC study. there are TWO cost elements: 1) Initial Cost. .

Cost element  Initial Cost: – Design & development cost. – Installation cost or erection & commission cost. or cost of equipment. . – Investment on asset.

Cost element  Operation & Maintenance Cost: – Labour cost. – Raw material cost. . – Energy cost. – Spare & maintenance cost.

Computation of Life Cycle Cost Analysis (Steps for LCCA) .

Steps for computation of LCC Step 1: Determine time for each cost element.  Step 4: Calculate LCC by adding all cost element.  Step 5: Analyze the results. for every year (over its time period). at every year.  .  Step 3: Calculate Net Present Value of each element.  Step 2: Estimate value of each cost element.

Conventional concept of Product Life Cycle implies to the time span based on demand of the product in the market. in this case). equipment. starting from launch of the product up to the time when company withdraw the product from the market. That is purely a marketing concept. This Life cycle is not similar to conventional concept of Product Life Cycle.Step 1: Determination of time – Determination of life cycle of the product (i. To be continued…… .e.

To be continued…… . customer decides the Life Cycle. – The product supplier provides the life cycle depending on design calculation and experience. productive life time of the product. Customer considers the effect of available maintenance facility. life cycle means the life of the product that is installed in the plant. how long he/ she wants to use the machine. i. i. also.Step 1: Determination of time – In LCC analysis of an equipment. – Based on supplier’s data.e. technological obsolescence and economic uncertainty factor.e.

say. – Example.Step 1: Determination of time – After that. a company decides that total life cycle of the product will be 10 years from the allocation the fund. . company decides the time span for each component. among which first one year will be initial cost zone and remaining 9 years will be under operation and maintenance cost zone.

This value is basically future income at each year. calculation based on facts and experience. e. MIS report for similar existing machines. etc. which is estimated. various source can be used. – This estimated value will be incurred in every year.g.Step 2: Estimation of value – Estimate monetary value for each cost element. – To estimate the value. .

To be continued…… . – The present value of future income or future cost can be calculated by using discounting factor and inflation factor.Step 3: Net Present Value – Money has a time value.

e. 1. 1.10]).000 in a year's time would be equivalent of Rs. Ram expects Rs. let's say Mr. the Rs. Assuming a discount rate of 10%.000 in one year's time. 909. To determine the present value of this Rs. – For example. a central bank charges depository institutions that borrow reserves from it.09 to Ram today (i. 1000/[1+0.Step 3: Net Present Value  Discount factor – The discount rate is an interest rate.000 Ram would need to discount it by a particular rate of interest (often the risk-free rate but not always). To be continued…… . 1.

To be continued…… .Step 3: Net Present Value  Inflation factor – The inflation rate is the percentage by which prices of goods and services rise beyond their average levels. It is the rate by which the purchasing power of the people in a particular geography has declined in a specified period.

Step 3: Net Present Value  Formula for Net Present Value (NPV) C (1+i/100) (n-1) PV= ----------------------(1+d/100) n where. C = any cost element at nth year I = inflation rate d = discount rate/ interest rate .

 The process is done for every year over the life cycle.  PVs of each cost element in a year are added. i.Step 4: Summation of PVs PVs of each cost elements is calculated for an equipment (at every year).  . LCC is calculated for every year.e.

and the lowest LCC option become preferred.  If one product has to be selected among multiple equipments.  . political and environmental concerns are taken into account.  Datas for every product are analyzed. then LCC is calculated for every product.Step 5: Analysis The datas collected from LCC are analyzed. available budgets.  But lowest LCC option may not necessarily be implemented when other considerations such as risk.

An important reminder…. but not the final answer. LCC provides critical information to the overall decision-making process.. .

Backflush Costing .

.Backflush Costing Backflush costing describes a costing system that omits recording some or all of the journal entries relating to the cycle from purchase of direct materials to the sale of finished goods.

.Backflush Costing Where journal entries for one or more stages in the cycle are omitted. the journal entries for a subsequent stage use normal or standard costs to work backward to flush out the costs in the cycle for which journal entries were not made.

This eliminates the detailed tracking of costs throughout the production process. . A product costing system generally used in a just-in-time inventory environment. Costs are then “flushed” back at the end of the production run and assigned to the goods. Backflush costing delays the costing process until the production of goods is completed. which is a feature of traditional costing systems.

. Another drawback of this system is the lack of a sequential audit trail.Contd. . However. this simplification and other deviations from traditional costing systems mean that backflush costing may not always conform to generally accepted accounting principles (GAAP).  By eliminating work-in-process accounts. backflush costing simplifies the accounting process.