Life cycle costing

JEFFRY NDHLOVU BSC (HONS) ACCOUNTANCY, MPHIL,

ACCA
Definition
Life cycle costing tracks and accumulates costs and revenues attributable to each product over
the entire product life cycle.
Introduction
The product is introduced to the market. Potential customers will be unaware of the
product or service, and the organisation may have to spend further on advertising to bring the
product or service to the attention of the market.
Growth
The product gains a bigger market as demand builds up. Sales revenues increase and
the product begins to make a profit.
Maturity
Eventually, the growth in demand for the product will slow down and it will enter a
period of relative maturity. It will continue to be profitable. The product may be modified or
improved as a means of sustaining its demand.
Decline
At some stage, the market will have bought enough of the product and it will therefore
reach 'saturation point'. Demand will start to fall. Eventually it will become a loss-maker and this
is the time when the organisation should decide to stop selling the product or service.
Product life cycle
$

Sales

+
Time
– Introduction Growth Maturity Decline Senility
Profit
What are lifecycle costs?
(a) Research and development costs
(b) The cost of purchasing any technical data required
(c) Retirement and disposal costs
(d) Training costs (including initial operator training and skills updating)
(e) Production costs
(f) Distribution costs
(g) Marketing costs
(h) Inventory costs (holding spare parts, warehousing and so on)
Life cycle costs can apply to services, customers and projects as well as to physical products.
Problems with traditional accounting
systems
Traditional cost accumulation systems are based on the financial accounting year and tend to
dissect a product's life cycle into a series of 12-month periods. This means that traditional
management accounting systems do not accumulate costs over a product's entire life cycle and
therefore do not assess a product's profitability over its entire life. Instead they do it on a
periodic basis.
Life cycle costing, on the other hand, tracks and accumulates actual costs and revenues
attributable to each product over the entire product life cycle. Hence the total profitability of
any given product can be determined.
Life cycle cost Stages
1) Acquisition costs
This represents the first stage of costs and covers set up costs or market entry costs. Costs are
incurred initially to bring the product into production and start selling it or the costs incurred to
complete the construction of a building or other construction assets. Acquisition /setup costs
are mainly’ one-off’, or are once –off capital expenditure and once off only costs such as cost of
training staff ,establishing systems of documentation and performance report. It should also be
noted that end –of –life costs are also once –off costs that is they occur just once.
2) Operational costs or running costs
These are costs incurred throughout the life of the asset or product. Examples of such costs are
repairs and maintenance, advertising e.t.c. Running costs and operational costs are regular and
recurring annual costs throughout the life of the product or asset. However, these costs may
vary overtime for example maintenance and repair cost of equipment such as elevators in a
building industry which are likely to increase as equipment ages.
3) End of life costs
Costs incurred to withdraw a product from the market or to demolish the asset after its use full
life.
N.B Although costs are incurred throughout the life span of an asset, a large proportion of these
costs are incurred or committed at a very early stage of the product’s life cycle when the
decision to develop the new product or construct a new building is made.
End