life cycle costing

Life Cycle Costing:

Meaning:Life-cycle cost refers to the total cost of ownership over the life of an asset. It is also

commonly known as “cradle to Grave” costs. Life Cycle Costing has been developed to assist managers in decision making based on performing a systematic assessment of the life cycle costs of selected assets. A life cycle cost analysis involves the analysis of the costs of a system or a component over its entire life span. Typical costs for a system may include:

Acquisition costs (or design and development costs). Operating costs:

Cost of failures Cost of repairs Cost for spares Downtime costs Loss of production

Maintenance costs: Cost of corrective maintenance Cost of preventive maintenance Cost for predictive maintenance

Disposal costs.

A complete life cycle cost projection (LCCP) analysis may also include other costs, as well as other accounting/financial elements (such as, interest rates, depreciation, present value of money/discount rates, etc.).

For the purpose of this Tool, it is sufficient to say that if one has all the required cost values (inputs), then a complete LCCP analysis can be performed readily in a spreadsheet, since it really involves summations of costs for several options and computations involving discount rates. With respect to the cost inputs for such an analysis, the costs involved are either deterministic (such as acquisition costs, disposal costs, etc.) or probabilistic (such as cost of failures, repairs, spares, downtime, etc.). Most of the probabilistic costs are directly related to the reliability and maintainability characteristics of the system.

How it works? The life cycle of an asset is defined as the time interval between the initial planning for the creation of an asset and its final disposal. This life cycle is characterized by a number of key stages: Initial concept definition. Development of the detailed design requirements,

specifications and documentation. Construction, manufacture or purchase. Warranty period and early stages of usage or occupation. Prime period of usage and functional support, including

operational and maintenance costs, with the associated

COST ACCOUNTING CIA-3

series of upgrades and renewal. The disposal and cleanup at the end of the asset’s useful life.

Article Related to Life Cycle Costing:

The Life Cycle Costing is called the Total Cost of Ownership in Automobile Industry.

Article: Total Cost of Ownership: A Gas versus Diesel ComparisonAuthors: Bruce M. Belzowski and Paul Green. Both of them are Assistant research scientists in Michigan University.

Abstract:

The U.S. automotive market is evolving to a more fuel efficient fleet, and alternative power trains are part of the mix of options manufacturers and consumers view as part of this evolution. This report reviews the role clean diesel vehicles play in the current vehicle fleet by analyzing the Total Cost of Ownership (TCO) for clean diesel vehicles and comparing their TCO to their gas vehicle counterparts. We build our TCO model by developing three and five year cost estimates of depreciation by modeling used vehicle auction data and fuel costs by modeling government data. We combine these estimates with three and five year estimates for repairs, fees and taxes, insurance, and maintenance from an outside data source. Our results show that clean diesel vehicles generally provide a return on investment in both the three and five year timeframes, though there are differences in the amounts of return among mass market vehicles, medium duty trucks, and luxury vehicles.

Review:

The article is a study about the power trains in the U.S. automotive that uses both gas and diesel as fuel using various techniques and comparing the results with total ownership costing (life Cycle costing). The study is conducted by the Michigan University Professors to know the total ownership costs of various power trains that are owned by the U.S. government to improve the sustainability of eco system by reducing costs now. They have compared the compared gas and diesel versions of the same or nearly identical vehicle. This research is sponsored by Bosch Corporation (Robert Bosch LLC)

In order to calculate the Total Cost of Ownership value of each kind of the power train they included the costs of:

a) Depreciation based on resale model and original MSRPb) Fuel cost based on vehicle model, vehicles miles per gallon, the average number of miles

driven and vehicle survivability, annual average cost of fuel per gallon.c) Repairsd) Insurancee) Maintenancef) Fees and taxes.

The various models used by them include Resale value model, Fuel cost model etc.


These are the major results that they came up using LCC that are really important in making the decision about the discharge of power trains:

a) All the diesel vehicles have better miles per gallon than their gas counterparts. This will affect the fuel costs that are a part of the TCO formula.

b) The average difference in MSRP among groups of vehicles differs significantly. While comparing the total ownership value, they’ve also depreciated the value according to the time. The analysis displays a point that will occur in the TCO analysis as well: the gap in depreciation between the gas and diesel versions of the same vehicle tends to narrow as a vehicle ages.

c) Depreciation plays a large role in a vehicle’s Total cost of ownership (TCO) analysis, and things that affect it such as a poor reputation in the marketplace can decrease its price when it comes to market for resale.

d) Manufacturers also sometimes charge higher prices for very new vehicles in order to recoup their R&D expenses. This higher price may not hold up in the resale market, thus making the TCO higher for a vehicle with new technology.

e) Manufacturers can also support particular technologies by making them less expensive than their competitors. Luxury manufacturers may have more room to influence prices because they generally have a larger profit margin on their vehicles than do mass market manufacturers.

f) Finally, fuel costs are the second largest contributor to TCO and higher diesel prices can also have a negative effect on TCO if the gap between the price gasoline and diesel fuel is wide.

Benefits of using TCO:

a) The life cycle concept results in earlier actions to generate revenue or to lower costs than otherwise might be considered.

b) Better decisions should follow from a more accurate and realistic assessment of revenues and costs, at least within a particular life cycle stage.

c) Life cycle thinking promotes long-term rewarding in contrast to short-term profitability rewarding.

d) The life cycle concept helped to understand acquisition costs vs. operating and support costs. It encouraged them to find a correct balance between investment costs and operating expenses.

e) With life cycle costing, non-production costs are traced to individual products over complete life cycles. The total of these costs for each individual product can therefore be reported and compared with revenues generated in the future.

f) Individual product profitability can be better understood by attributing all costs to products.

Conclusion:

The assistant scientists concluded from the results that they got that, the diesel vehicles provide owners with a total cost ownership that is less than that of gas vehicles of the same vehicles. Though the cost of ownership of diesel power trains is less than that of gasoline power trains, they ended up using more gasoline power trains as the prices of diesel sore up due to a crisis in OPEC. They are planning to improve the mileage of the diesel power trains


as they can spend less compared to past and various funds are transferred to innovations in diesel power trains.

Disadvantages

a) The expenses of an asset are spread over years, it takes longer to turn a profit.b) Expensive implementation due to observance of the product till the end.c) Misinterpretation of data due to reports produced by this system contain information,

such as product margins, that vary from the information reported for a traditional cost method.

d) Drop in Productivity as the life-cycle costing concept assumes an asset will be as productive in later years as it is when it's new. This may not be the case. If a piece of equipment, for example, gradually slows down, you'll be earning less income from it while receiving the same write-off you got when the product was first put into production.

e) The value of money that is written off from an asset may not be of the same value of today.

f) The costs incorporated are the current costs only. They are the marginal costs plus a share of the fixed costs for the current accounting period.

Chances of Improvement:

Target costing and Life cycle costing are regarded as relatively modern advance in the cost accounting techniques. The life cycle costing can be improved by using target costing along with it. As Target costing involves setting a target cost by subtracting a desired profit margin from a competitive market price. This improves the efficiency all the process of the life cycle of the product as the target cost is already fixed, so the efficient personnel tries to make the product less than or equal to the target cost.

Target costing tries to answer these questions: Are customers homogeneous or can we identify different segments within the market? What features does each market segment want in the product? What price are customers willing to pay? , To what competitor products or services are customers comparing ours? How will we advertise and distribute our products? It helps life-cycle costing to concentrate more on these costs which can generate the organizations a certain amount of profits. The product’s price is based on its cost, but no-one might want to buy at that price. The product might incorporate features which customers do not value and therefore do not want to pay for and competitors’ products might be cheaper, or at least offer better value for money. This flaw is addressed by target costing.

ABC technique can also be used along with life-cycle costing to be more productive. With the help of ABC technique, the key activities in the life cycle of the product are identified and more resources can be allocated to those activities to minimize the costs. Life cycle costing


is effective but, in order to be more effective it should involve either of target or ABC costing or both to its process.

Conclusion:

Life cycle costing is the best tool to determine the most cost-effective option among different competing alternatives to purchase, own, operate, maintain and, finally, dispose of an object or process, when each is equally appropriate to be implemented on technical grounds. It helps the organization to help in decision making of whether to dispose-off the asset or to hold on to it. Though it is an important tool, it involves a lot of investment to do as it includes finding of various other costs. It is also time consuming but the results it give is incomparable to the costs.

BY Harsha Vardhan

1310911


life cycle costing

Education