Life cycle costing is also termed as whole life costing. It is a technique to determine the total cost of ownership. The approach is structured one which addresses all elements of cost. It can be used to produce a spend profile of the product or service over its anticipated life-span.
Life cycle costing is achieved through a combination of financial, engineering, management and other disciplines. Life cycle costing emphasise to the total life cycle costs to arrive at the optimum decision.
As a part of price strategy, most of the firms prefer to recover almost total cost during the growth stage, so that during maturity and decline stage, they may be able to face competition by lowering the price of their products.
- Meaning of Life Cycle Costing
- Features of Life Cycle Costing
- Phases of Life Cycle Costing
- Fundamental Concepts Common to Applications of Life Cycle Costing
- Applications of Life Cycle Costing
- Types of Costs to be Considered at the Planning Stage
- Factors Responsible for Increased use of the Technique
- Steps Involved for Conducting Life Cycle Costing
- Operational Procedure
- Customer Life Cycle Costing
- Difference between Traditional Costing System and Life Cycle Costing
- Important Points to be Borne in Mind
- Benefits of Life Cycle Costing
- Advantages of Life Cycle Costing
- Drawbacks of Life Cycle Costing
What is Life Cycle Costing: Meaning, Cost Analysis, Product Life Cycle, Process,Features, Phases, Factors, Steps, Operational Procedure, Important Points, Difference, Benefits, Drawbacks and Examples…
What is Life Cycle Costing – Meaning
The technique used to estimate the total life cycle cost of a procurement is called life cycle costing. In other words, life cycle costing is a procurement process which considers overall total cost, i.e., sum of acquisition and life cycle ownership cost of an item.
Life cycle costing is also termed as whole life costing. It is a technique to determine the total cost of ownership. The approach is structured one which addresses all elements of cost. It can be used to produce a spend profile of the product or service over its anticipated life-span.
Life cycle cost analysis comprises of:
(i) Life Cycle assessment, the investigation and valuation of the environmental impacts of a given product or service caused or necessitated by its existence.
(ii) Whole Life Cost, ‘the total cost of ownership over the life of an asset’, also commonly referred to as ”cradle to grave” or “womb to tomb”.
The results of such an analysis are used to help management in decision-making process where there are different alternatives out of which one has to make a choice. The accuracy may wane with the time, therefore, this tool is valuable when long-term assumptions apply to all the alternatives and consequently have the same impact.
Examples of usefulness of the technique are – aircraft, computers, military systems, heavy industrial equipment, automobiles, hospital facilities, buildings, tractors, heat pumps, copying machines, air- conditioners, refrigerators, audio-visual equipments, medical equipments, diesel engines, electric items etc.
Life cycle costing is achieved through a combination of financial, engineering, management and other disciplines. Life cycle costing emphasise to the total life cycle costs to arrive at the optimum decision. As a part of price strategy, most of the firms prefer to recover almost total cost during the growth stage, so that during maturity and decline stage, they may be able to face competition by lowering the price of their products.
LCC is the total cost of ownership of machinery and equipment, including its cost of acquisition, operation, maintenance and conversion. It is a summation of cost estimates from inception to disposal for both equipment and projects as determined by an analytical study and estimate of total costs experienced in annual time increments during the project life with consideration for the time value of money.
LCC is an economic model over the project life span. It is said that the best balance among cost elements is achieved when the total LCC is minimised. LCC provides best results when engineering art and science are merged with good judgment to build a sound business case for action.
Under LCC the businesses should summarise LCC results in NPV (net present value) format considering depreciation, taxes and the time value of money. But for government organisations there is no need to consider depreciation and taxes but time value of money should be considered for LCC decisions.
2 Main Features of Life Cycle Costing
The main features of life cycle costing are as under:
(1) Tracing of Costs –
Life cycle costing involves tracing of costs and revenue of each product of over several years throughout its entire life cycle. The emphasis is given on the entire costs and entire revenue accumulation over the entire life cycle of the product.
(2) Traces Research and Design –
Life cycle costing traces research and design costs etc., incurred to individual products over its life cycle so that proper comparison be made available and beneficial situation be recorded.
Top 4 Phases of Life Cycle Costing
Life cycle is the cycle of competitive degeneration. It starts with the invention of a new product and ends at which the customer support and withdraws it. The time taken from the invention of the product till to its degeneration is known as product life cycle.
Life cycle consists of four phases as –
(3) Maturity, and
It can be shown as under:
Thus life cycle is a system that traces the actual costs attributable to each product from its initial stage to its final resource and support in the market. It attempts accumulation of costs that occur over the entire life cycle of a product.
It focuses attention on total cost including design and development, operation, acquisition, servicing, maintenance etc. In service cost, marketing, distribution, administration and after sales service costs etc. are included.
Fundamental Concepts Common to all Applications of Life Cycle Costing
To arrive at a meaningful purchasing decision, a full account must be taken of each available option. Explicit consideration must be given to all relevant costs for each of the options from initial consideration till disposal.
Fundamental concepts common to all applications of life cycle costing are:
1. Cost break-down structure
2. Cost estimating
Detailed explanation of the above follows:
1. Cost Breakdown Structure:
Complexity of structure varies according to purchasing decisions. The objective is to identify all the relevant cost elements. Cost boundaries are also well defined to avoid omission or duplication.
Characteristics of the cost breakdown structure have been outlined hereunder:
(i) All relevant cost elements must be included.
(ii) Each cost element must be well defined so that all involved have no doubts as to what is to be included.
(iii) Each cost element must be identifiable with a significant level of activity or major item of equipment.
(iv) Structuring of cost breakdown should be capable of analysing specific areas.
(v) The structure should be compatible with management accounting procedures used in cost collection, so that information may be fed directly for life cycle costing.
(vi) The structure should be designed to allow different levels of data within various cost categories. Sufficient flexibility must be ensured for cost allocation.
2. Cost Estimating:
As a next step, it is essential to compute the costs of each category.
The methods of estimation are as under:
(i) Known factors or rates are inputs to life cycle cost analysis, e.g., given the unit cost of production and quantity, the procurement cost can be easily calculated.
(ii) Cost estimating relationships – are derived from historical or empirical data, e.g., on the basis of experience, a rate for charging cost can be determined. However, rapidly changing circumstances force adjustments to be made lest the data may become out of date.
(iii) Expert opinion – It is, at times, the only method available when real data is not obtainable. Such estimations must include supporting assumptions and rationale.
Discounting technique is used to compare costs and benefits occurring in different time periods, since people generally prefer to receive goods and services at present rather than in future. It is also called ‘time preference’.
When comparing two or more options, a common base is a must to ensure correct evaluation that is why, generally discounting is done of all future values to the present base. An appropriate rate of discounting is required to be determined so that correct purchasing decision can be taken.
Inflation effects should also be adjusted while discounting. The rate of discounting, if takes into account only the factor of inflation, correct decisions can’t be arrived at. Discounting rate is ‘investment’ ‘premium’ which is over and above the rate of inflation.
Life Cycle Costing – Top 10 Applications
The applications of life cycle costing are:
(i) Selection of the most beneficial procurement strategy;
(ii) Determination of cost drivers;
(iii) Selection among various options;
(iv) Selection of sources of procurement;
(v) Strategic decision-making and design trade-off;
(vi) Assessment of application of new technology;
(vii) Optimisation of training needs;
(ix) Improvement of comprehension of basic design associated parameters in product design and development.
(x) Policy formulation regarding incentives etc.
3 Main Types of Costs to be Considered at the Planning Stage
The cost of ownership of an asset or service is incurred throughout its whole life and does not at all occur at the point of acquisition.
Following three main types of costs are incurred which must be considered at the planning stage itself:
(i) Acquisition costs –
These are incurred between the decision to proceed with the procurement and the entry of goods or services for operational use.
(ii) Operational costs –
These are incurred during the operational life of the asset or service.
(iii) End life costs –
These are associated with disposal, termination or replacement of the asset or service. Asset may have a resale value on disposal rather than additional cost.
Normally, cost of the asset once owned doesn’t change. The principle of life cycle costing can be made applicable to both complex and simple projects, though a more developed approach is required to be adopted in case of large projects.
Factors Responsible for Increased Use of Life Cycle Technique
(i) Rising inflation, though in recessionary phase too, the technique is equally effective.
(ii) Budget constraints; by and large, most of the firms have constraints of finance, hence usefulness of this technique.
(iii) Escalating cost effectiveness awareness among users.
(iv) Growing competition; in today’s economic scenario, in particular, there is a cut-throat competition, hence demand of the times is use of sophisticated techniques like it.
(v) Heavy maintenance cost; cost of maintenance has been increasing. Life cycle costing is important in establishing, reducing and controlling costs.
Steps Involved for Conducting Life Cycle Costing
The steps involved for conducting life cycle costing are as follows:
(i) Operating profile of item or equipment is to be developed. It portrays periodic cycle associated with item or equipment.
(ii) Utilisation factors need to be developed. These indicate how or in what way item or equipment will be operating in each operating project.
(iii) All cost components involved are required to be identified.
(iv) Crucial cost related parameters are to be determined.
(v) All costs involved are to be computed at present prices.
(vi) Presents costs associated with material and labour may require escalation.
(vii) All costs involved are, thereafter, discounted to base time.
(viii) All costs involved, i.e., discounted as well as undiscounted are totalled.
Life Cycle Costing – Operational Procedure
(i) Useful operational life of item or product is determined.
(ii) Estimates for costs involved including costs of operation and maintenance are obtained.
(iii) Terminal value of the item or product is determined.
(iv) Terminal value is deducted from the cost of ownership of the item or the product.
(v) Amount arrived at under point (iv) is discounted to present value.
(vi) Procurement cost is added to the amount estimated under point (v).
(vii) Above steps are repeated for every item or product under consideration for procurement.
(viii) Comparisons of life cycle costs of items 01 products being considered for purchase are made.
(ix) Item or equipment with least life cycle cost is purchased.
Customer Life Cycle Costing
It is imperative that a firm should recover total cost from ‘cradle to grave’ over the estimated number of the units that the company expects to sell over the life cycle of the product. The life cycle cost includes cost of R&D, product development costs, cost of plant and equipment, manufacturing cost, and product promotion costs.
Often firms plan to recover the life cycle cost over the leadership period. It helps the firm to compete on price when competitors introduce similar products.
A different notion of life cycle cost is ‘customer life cycle costs’. Customer life cycle costs are the total of the purchase price and ownership costs. Ownership costs are the aggregate of costs of operating the system/equipment, its maintenance and costs estimated to be incurred on disposal.
While applying value analysis, the manufacturer should add the ‘customer life cycle costs’ to the manufacturing life cycle cost. E.g., customer may pay a premium for a system that is maintenance free. The manufacturer may incur some additional cost to provide this higher quality, but the premium is expected to be much higher than that of the additional cost. Therefore, it is worth to search for the functionalities and qualities that will reduce ownership costs.
Customer life cycle cost should be considered while pricing the product. A buyer compares the total cost, which is the total of the purchase price and ownership costs of different variants of the product while deciding on the variant that it will purchase.
Difference between Traditional Costing System and Life Cycle Costing
Traditional costing and life cycle costing both are useful for the organisation.
But life cycle costing is quite different from the traditional cost accounting system and the main difference between the two may be mentioned as under-
(1) Traditional system of cost accounting declares costs and profit for a particular basis such as monthly, quarterly and annually. But under life cycle costing system cost and revenue of a product is shown for several calendar periods.
(2) In traditional system, costs and revenues are analysed on the basis of time, but in life cycle costing system cost and revenue is accumulated over the entire life cycle of each product.
(3) In traditional costing system, profitability of a cost product is determined periodically, but in life cycle costing, profitability can be ascertained only after the abandonment of cost object.
Life Cycle Costing – Important Points to be Borne in Mind
1. Management plays a key role in making life cycle costing effort worthwhile.
2. Both the manufacturer and the user are required to organise effectively to control life cycle cost.
3. The objective of life cycle costing is to obtain maximum benefits from limited resources.
4. Accurate and reliable data are indispensable for fair estimates of life cycle costs.
5. Cost analyst must possess expert knowledge and wide experience-in such a case, even data base difficulties may be encountered.
6. Strategic decision-making is possible by using life cycle costing. Design optimisation is feasible.
7. Life cycle cost model must comprise of all concerned costs associated with the programme.
8. Throughout the life of the programme the trade-offs between life cycle cost, performance and design to cost must be performed.
9. Risk factor must also be accounted for. Assessment of risk is required to be made for the purpose.
10. Sensitivity of cost estimates to factors such as changes in volumes, usage etc., require consideration.
11. The organisation must not be over-optimistic about results. In spite of best of efforts, estimates may go awry and decisions may deceive.
12. One of the sound ways to apply the technique is to consider the best and worst case scenarios, where there is a balancing of optimism and pessimism. Probabilities can be assigned and expected expenditure may be adjusted accordingly. It requires application of quantitative techniques.
Life Cycle Costing – Benefits
The benefits may be grouped under four heads, which have been explained in brief:
(i) Evaluation of purchase options –
Competing proposals can be evaluated on the basis of whole life cost. Analysis is relevant particularly for service contracts and equipment purchasing decisions.
(ii) Better cost awareness –
Management gets an insight into the factors driving cost and resources required for the purchase. Identification of cost drivers is possible so that management effort is directed towards most cost effective areas of purchase. In addition, improved awareness of cost drivers highlights areas in existing items which would benefit from involvement of management.
(iii) More accurate cost forecasting –
Full cost associated with a procurement can be better estimated, leading to improved decision-making at all levels. Additionally, the analysis leads to more accurate forecasting of future expenditure and capital investments.
(iv) Performance trade-off against cost –
Cost is not the sole factor to be considered in purchasing decisions. Other factors such as overall fitness against requirement and quality of the products and levels of service to be provided are also relevant. This analysis gives a cost trade-off against the varying attributes of purchasing options.
In other words, the primary uses of the life cycle costing technique are –
(i) comparing competing projects
(ii) long-range planning and budgeting,
(iii) selecting among competing bidders,
(iv) controlling an ongoing project, and
(v) deciding replacement of an ageing equipment.
Other benefits can be outlined as under:
(i) Useful for controlling programmes;
(ii) An excellent tool for making selections of contractors as well as projects and
(iii) Useful in reducing total cost.
Advantages of Product Life Cycle Costing
The main advantages of product life cycle costing are as under:
(1) Better Decision –
Within a particular life cycle stage, better decisions can be taken with the help of accurate and realistic assessment of revenues and costs.
(2) Important Information –
It provides important informations for taking better pricing decisions. In this method, all costs during the life span of the product become the base for fixing the price of the product.
(3) Capital Budgeting Decisions –
Life cycle costing is very much important in taking capital budgeting decisions because it considers both capital costs as well as revenue costs which is related to the product over its life time.
(4) Earlier Action –
Product life cycle costing provides the facilities of taking earlier actions for generating revenue and to lower down the cost of the product. It provides chances to the manager to help and to prepare the plans for generating revenue from the product.
(5) Covering Costs –
This costing covers costs relating to all activities of research and development, design, marketing, manufacturing, distribution and service after sales etc.
(6) Long Term Reward –
Product life cycle costing can promote long term rewarding in place of short-term profitability.
(7) Total Incremental Costs –
This costing system provides an overall framework for considering total incremental costs over the entire life span of a product.
Drawbacks of Life Cycle Costing
The technique of life cycle costing is, at times, criticised because:
(i) It is deemed to be costly;
(ii) It is labelled as time consuming;
(iii) Accuracy of data is doubted; and
(iv) Collecting data for analysis is a tedious job.
These drawbacks may apply for a small firm. Moreover, a cost-benefit analysis is always desirable before implementing any technique whatsoever. In nutshell, the benefits far exceed the limitations and an all-out effort must be made to apply this technique systematically.
Life Cycle Costing: Meaning, Benefits and Effects
Life-Cycle Costs are all the costs associated with the product for its entire life cycle. Product life cycle costing traces costs and revenues of each product over several calendar periods throughout their entire life cycle.
The costs are included in different stages of the product life cycle.
Development phase -R&D cost/Design cost.
Introduction phase – Promotional cost/Capacity costs.
Growth phase/Maturity – Manufacturing cost/Distribution costs/Product support cost.
Decline/Replacement phase – Plants reused/sold/scrapped/related costs.
Manufacturers would base life cycle costing expense allocations on an expected number of units to be sold over the product’s life. Each period’s internal income statement using life cycle costing would show revenues on a life-to-date basis along-with total cost of goods sold, total R and D project costs and total distribution and other marketing costs.
The following are the benefits of product life cycle costing:
(i) It results in earlier actions to generate revenue or to lower costs than otherwise might be considered.
(ii) It ensures better decision from a more accurate and realistic assessment of revenues and costs, at-least within a particular life cycle stage.
(iii) It promotes long-term rewarding.
(iv) It provides an overall framework for considering total incremental costs over the life span of the product.
Effects of Life-Cycle Costing:
Life cycle costing helps companies to be aware of where their products are in their life cycles, because in addition to the sales effects, the life-cycle stage may have a tremendous impact on costs and profits. The life-cycle impact on each of these items is shown in Exhibit 17.3.
- Variable Costing, Direct Costing, Marginal Costing!
- Difference between Job Costing and Process Costing
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Lifecycle costing is the maintenance of physical asset cost records over entire asset lives. This means decisions around the acquisition, use or disposal of assets can be made in a way that achieves the optimum asset usage at the lowest possible cost to the entity.What are the advantages of life cycle costing? ›
Primary benefits of life cycle cost analysis
It provides a mechanism for identifying and addressing issues with the original design. An LCC's lifetime perspective results in better durability, less maintenance, fewer risks, and lower operational spending and can even lead to an increased building lifespan.
What are the types of life cycle costing? There are three different types of LCC: conventional, environmental and societal.What are the features of life cycle costing? ›
The life-cycle cost includes the following costs: a) design cost b) development costs; c) introduction costs; d) manufacturing costs; e) selling and logistical costs; f) service and warranty costs; and g) abandonment costs. 11.6.Who uses lifecycle costing? ›
It is used by businesses that are involved in long-term planning. Life cycle costing enables businesses to make better decisions with regard to their investments. If there are two assets you are considering, calculating the life cycle costing of the two assets can unveil which asset is more profitable in the long run.What is costing a product? ›
What is product costing? The product costing definition is the cost incurred to create a product that is to be sold in the market. The cost includes materials, labour, and overheads of manufacturing.What are the advantages of standard costing? ›
- Helps with accurate budgeting. ...
- Simplifies inventory costing. ...
- Makes it easy to price products accurately. ...
- Provides efficient financial records management. ...
- Facilitates production benchmarking. ...
- Rate variance. ...
- Volume variance.
The purpose of an LCCA is to estimate the overall costs of project alternatives and to select the design that ensures the facility will provide the lowest overall cost of ownership consistent with its quality and function.What are the advantages of Activity Based Costing? ›
Activity-based costing provides a more accurate method of product/service costing, leading to more accurate pricing decisions. It increases understanding of overheads and cost drivers; and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them.What is LCC method? ›
Life cycle cost (LCC) is an approach that assesses the total cost of an asset over its life cycle including initial capital costs, maintenance costs, operating costs and the asset's residual value at the end of its life.
LCC = C+PV Recurring – PV Residual Value
LCC is the life cycle cost. C is the 0-year construction cost. PV recurring is the present value of all recurring cost.
Life cycle cost (LCC) is an important technique for evaluating the total cost of ownership between mutually exclusive alternatives. Executive Order 13123 requires government agencies to use life cycle cost analysis (LCCA) to minimize the government's cost of ownership.What are stages of product life cycle? ›
A product life cycle consists of four stages: introduction, growth, maturity, and decline.What is life cycle cost of equipment? ›
Equipment life-cycle cost analysis (LCCA) is typically used as one component of the equipment fleet management process and allows the fleet manager to make equipment repair, replacement, and retention decisions on the basis of a given piece of equipment's economic life.What is life cycle assessment? ›
Life-cycle assessment (LCA) is a process of evaluating the effects that a product has on the environment over the entire period of its life thereby increasing resource-use efficiency and decreasing liabilities.What does value analysis mean? ›
Value Analysis (VA), also known as Value Engineering (VE) and Value Management(VM), is a systematic and function-based approach to improving the value of products, projects, or processes. Value Analysis uses a combination of creative and analytical techniques to identify alternative ways to achieve objectives.What is an initial cost? ›
Initial cost is the average cost of purchasing or manufacturing your stock on hand. Here are some reasons why it's important to determine and set up the initial cost of your stock. It helps keep track of the moving average cost.What is the target costing process? ›
Target costing is an approach to determine a product's life-cycle cost which should be sufficient to develop specified functionality and quality, while ensuring its desired profit. It involves setting a target cost by subtracting a desired profit margin from a competitive market price.What are the 3 types of cost? ›
- Variable costs: This type of expense is one that varies depending on the company's needs and usage during the production process. ...
- Fixed costs: Fixed costs are expenses that don't change despite the level of production. ...
- Direct costs: These costs are directly related to manufacturing a product.
- Direct material. Direct material costs are the costs of raw materials or parts that go directly into producing products. ...
- Direct labor. ...
- Manufacturing overhead.
Production costs refer to all of the direct and indirect costs businesses face from manufacturing a product or providing a service. Production costs can include a variety of expenses, such as labor, raw materials, consumable manufacturing supplies, and general overhead.What are advantages of variance? ›
The advantage of variance is that it treats all deviations from the mean as the same regardless of their direction. The squared deviations cannot sum to zero and give the appearance of no variability at all in the data. One drawback to variance, though, is that it gives added weight to outliers.What are the advantages of variance analysis? ›
Comparing Budget with Actual: Variance analysis helps in managing the annual budgets by monitoring the budgeted figures and comparing it with the actual revenue/cost. In case of companies which are project or program driven, the financial data are evaluated at key intervals such as month close, quarter end, etc.How life cycle cost analysis is prepared? ›
- Establish objectives.
- Identify constraints and specify assumptions.
- Define base case and identify alternatives.
- Set analysis period.
- Define level of effort for screening alternatives.
- Analyze traffic effects.
- Estimate benefits and costs relative to base case.
- Evaluate risk.
Broadly, life cycle costs are those associated directly with constructing and operating the building; while whole life costs include other costs such as land, income from the building and support costs associated with the activity within the building.What is ABC Mcq? ›
Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services.What are the advantages of ABC analysis? ›
Why Use ABC Analysis? Using ABC analysis for inventory helps better control working capital costs. The information gained from the analysis reduces obsolete inventory and can boost the inventory turnover rate, or how often a business has to replace items after selling through them.What is cost accounting with example? ›
Cost accounting involves determining fixed and variable costs. Fixed costs are expenses that recur each month regardless of the level of production. Examples include rent, depreciation, interest on loans and lease expenses.What are the disadvantages of life cycle costing? ›
Generally, life cycle costing calculation includes adding six sorts of costs;
- Purchase costs.
- Operational costs.
- Maintenance costs.
- Depreciation costs.
- Financing costs.
- End-of-life costs.
Life cycle costing, which is often referred to as whole-life costing, is a process of estimation that helps facilities managers understand how expensive a building and/or its assets will be across its useful life, from purchase to disposal.