46923162 life cycle costing theory

7/29/2019 46923162 Life Cycle Costing Theory

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Life cycle costing ( LCC )

Meaning :-

Sum of all recurring and non-recurring cost over the full life span or a specified period of a

good , service, structure, orsystem. In includes purchase price , installation cost, operating

costs , maintenance and upgrade costs, and remaining (residual orsalvage) value at the end

of ownership or its useful life.

Life-cycle costing is a method of costing that looks at a products entire value chain from a costperspective. Other types of costing generally look only at the production process, whereas life-cycle costing tracks and evaluates costing from the research and development phase of a

products life, through to the decline and eventual conclusion of a products life.

This approach to costing makes sense for several reasons. First of all, most of a products costs

are committed before the product is in the production phase. This means that the majority of

control management can exert over production and other costs is during the design phase of theproducts life-cycle

The LCC can be easily understand with the help of product life cycle , product life cycle has 4

stages

1) Introduction

2) Growth

3) Maturity

4) Decline

1) Introduction in this stage the product is new and introduced in the market though it is

new the expenses such as R&D, manufacturing, promotion expenses are incurred so first

this cost is calculated .

2) Growth- in this stage the product is on the stage of growth is slowly capturing the market

and expenses incurred on product growth are calculated

3) Maturity this is the stage where the product is reach at its top position and all the

expenses slowly coming in the profit .4) Decline thought technology is changing and with this change the taste and preference

also changes the comp. need to R&D and make alteration according to the need and

demand of the customer all the cost calculated here and the process keep on going ant

never end .


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Form the above explanation we can easily understand that how the Life cycle cost is identified of

the product and also say that this is the process never end it the going concern process.

Life-Cycle Costing Procedures

In its standard form, life-cycle costing cannot be used for financial reporting and in and of itself

is not consistent with generally accepted accounting principles (GAAP). However, life-cycle

costing is perhaps the best form of costing from a planning standpoint, and is a great tool that canbe used by product managers throughout the life-cycle of a product.

n order to use life-cycle costing to its fullest, costs must be calculated from the point of the initialidea for the product, until the product is no longer made. These costs are then divided by the total

number of expected units to be sold throughout the lifetime of the product to come to a total costper unit. This process can help product managers to get a realistic view of the total cost of a

product, so they can design and adjust accordingly.

When Is Life-Cycle Costing Appropriate?

Life-cycle costing is most appropriate when a product is in the design, or pre-design stages. This

will allow management to gain the most benefit from the process, as opposed to attempting touse life-cycle costing after a product is already in the marketplace. n order to use life-cycle

costing to its fullest, costs must be calculated from the point of the initial idea for the product,until the product is no longer made. These costs are then divided by the total number of expected

units to be sold throughout the lifetime of the product to come to a total cost per unit. Thisprocess can help product managers to get a realistic view of the total cost of a product, so they

can design and adjust accordingly.

Identification ofLCC:-

1)

Construction2) Maintenance

3) Operation

4) Occupancy

5) End of Life


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1) Construction - Construction works costs ,Other construction related costs ( design fee ,

planning cost , contribution etc.)

2) Maintenance - Major replacement, Subsequent adaptation, Minor replacement, repairs

and maintenance ,Unscheduled replacement, repairs and maintenance ,Groundsmaintenance

3) Operation Cleaning, Utilities , Administrative costs, Overheads costs, Taxes4) Occupancy - Internal moves, Reception and customer hosting, Security, Helpdesk

5) End ofLife -Disposal ,Demolition, Reinstatement to meet contractual requirements

WHY USELCC?

LCC helps change provincial perspectives for business issues with emphasis on enhancingeconomic competitiveness

by working for the lowest long term cost of ownership which is not an easy answer to obtain.

Consider these typical

problems and conflicts observed in most companies:

1. Project Engineering wants to minimize capital costs as the only criteria,

2. Maintenance Engineering wants to minimize repair hours as the only criteria,

3. Production wants to maximize uptime hours as the only criteria,

4. Reliability Engineering wants to avoid failures as the only criteria,

5. Accounting wants to maximize project net present value as the only criteria, and

6. Shareholders want to increase stockholder wealth as the only criteria.

Management is responsible for harmonizing these potential conflicts under the banner of

operating for the lowest long term cost of ownership. LCC can be used as a managementdecision tool for harmonizing the never ending conflicts by focusing on facts, money, and time.

Why should engineers be concerned about cost details for LCC? It is important to help engineersthink like MBAs and act like engineers for profit making enterprises--Its all about the money!

Economic calculations are well defined but the discount rate is important (US Government2002). Accounting and finance organizations set internal discount rates (which often change) to

make economic decisions easy for engineers. Discount factors reflect a host of relationships andconsiderations which include very low risk investment returns such as Government T-bills,


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factors for projects such as estimated uncertainty errors, internal rates of returns, and so forth.Ingeneral, consider a typical discount value of 12% which is neither very low nor very high for

calculations which will follow (the discount rate can also be used for inflation/deflation factors):

Engineering always want a simple, single value, criteria for a projectthe answer for LCC is

called net present value (NPV). NPV is the present value of proceeds minus present value ofoutlays. Projects and processes with the greatest NPV is usually the winner. Often forincremental changes on a project or within a plant, you lack enough details to arrive at a positive

NPV. Thus many improvement projects must be selected on the least negative NPV valuesfrom many alternatives. So once again, we can have the single number engineers always want

its NPV but in this case, its the least negative NPV.

Most fixed assets and other projects have a limited useful life. All equipment has a finite lifebased on both deterioration and obsolescence. The most common depreciation methods is

straight line depreciation based on acquisition cost less salvage. Straight line depreciation isbased on consumption of a fixed percentage of the equipment cost. Often straight line

depreciation is used for internal accounting reports of profit/loss and for calculating NPV.Incometax rates vary and may require inclusion of state as well as federal taxes. For calculation

purposes, consider the tax rate is 38% based on the profit before tax numbers. Profit before taxesmay be positive or negative. When profit before tax is negative, the company receives a tax

credit either a carry-back or carry-forward. When profit before tax is positive, the company paystaxes. For a project or process, tax numbers are used to calculate cash flows. After the tax is

included, the cash flow is discounted to get present value, and the sum of all present values givesthe NPV.

Engineers must be concerned with life cycle costs for making important economic decisionsthrough engineering actions. Management deplores engineers who are engineering bright but

economics dim. Engineers must get the equation balanced to create wealth for stockholders.Often this means: stop doing some things the old way, and start doing new things in smarter

ways such as using NPV decisions via LCC.

4. WHAT GOES INTO LCC?

LCC includes every cost that is appropriate and appropriateness changes with each specific casewhich is tailored to fit the situation. LCC follows a process (Fabryck 1991Appendix A) as

shown in Figure 1. The steps are:

Step 1-Identify what has to be analyzed and the time period for the project life study along with

the appropriate financial criteria.

Step 2-Focus on the technical features by way of the economic consequences to look foralternative solutions.

Step 3-Develop the cost details by year considering memory joggers for cost structures.


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Step 4-Select the appropriate cost model, simple discrete, simple with some variability forrepairs and replacements, complex with random variations, etc.required by project complexity.

Step 5-Acquire the cost details.

Step 6-Assemble the yearly cost profiles.

Step 7-For key issues prepare breakeven charts to simplify the details into time and money.

Step 8-Sort the big cost items into a Pareto distribution to reconsider further study.

Step 9-Test alternatives for high cost items such as what happens if maintenance cost is 10%than planned, etc.

Step 10-Study uncertainty/risk of errors or /alternatives for high cost items as a sanity check andprovide feedback to

the LCC studies in iterative fashion

Step 11-Select the preferred course of action and plan to defend the decisions with graphics


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From the above diagram we can easily understand the life cycle of product and at each stage theexpenses the comp. bears and at last the product is disposed of make some alteration and again

the cycle is going on up to endless life. All the cost bear by the comp. from manufacturing to the

disposal or reuse if we add all the cost then we find the life cycle cost.

46923162 life cycle costing theory

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