Life Cycle Costing Versus Budget Setting - Essay Example

Life cycle costing versus Budget Setting s Submitted by s: Introduction Business in the modern times involves several transactions and the efficiency and success of the business depends on how the management of the business handles these transactions. These business transactions are normally measured and expressed according to their money value and since these transactions greatly affect the business, they have to be recorded, analyzed and reported to the management of the business. This assists in the procedure of assessment of the performance attributed to the business and as a result three forms of accounting developed and they included; financial accounting, cost accounting as well as management accounting all of which have distinct functions. Management accounting deals with presentation of accounting information which assists the management of a business to come up with policies and also to facilitate the management in it normal activities (Bhattacharyya, 2011, p. 1). It is a process that involves identification, measurement, accumulation analysis, interpretation and communication of financial information that helps to facilitate planning, evaluating and controlling the activities and accountability of resources (Thukaram Rao, 2003, p. 1). For a long time, strategic management accounting was considered as a possible area of development that would boost the future contribution of management accounting. In the 1980, the United Kingdom Chartered Institute of Management Accountants ordered an inquiry that was to review the current state of the development of management accounting. The findings were consequently published in a report entitled Management Accounting: Evolution and Revolution which drew attention to strategic management accounting as an area for future development (Drury, 2008, p. 570). There are a number of new techniques that have been introduced that are aimed at making management accounting more relevant to the production methods that are used in the modern world. This management accounting methods include; strategy management accounting, life cycle costing, target costing and Kaizen among others (Collier and Agyei-Ampomah, 2008, p. 50). The traditional focus of management accounting was on the period after the product had passed the design and development stage and has gone into production so that it can be taken to the market for the consumers to buy (Collier and Agyei-Ampomah, 2008, p. 51). Life-cycle costing In traditional management accounting, the control procedures focused mainly on the manufacturing stage of the whole life associated with a product. Cost that were realized before manufacturing started which included research and development and design and the cost that were associated with post-manufacturing abandonment and disposal costs were considered as period costs. This meant that they would not be included in the product cost calculations and they are also not a part of the conventional management accounting control processes. Value for money is a concept that is frequently considered when an individual or an or an organization wants to make a purchase or an investment it is therefore considered that the larger the cost of a product, the more important it is to consider the long term costs associated with it. For instance, buildings are high cost purchases, yet the consideration on the long term costs do not get the attention that they should be accorded. Life cycle costing is new to many of the industries and the techniques that are related to it are mainly used in the areas of procurement (Boussabaine and Kirkham, 2004, p. 3). Life cycle costing is improving in both significance and capacity and generally points towards to a costing technique that takes into account the summation of all costs linked with the project as it goes on. It is an approach that is structured and mainly takes into account all the attributes of a project costs that include the costs that are associated with planning, designing and execution. Therefore, this approach to costing strives to determine the sum of all the costs that are connected to the ownership of a system when it is in its active life. Product life cycle costing assists the organization not only in the making of decision but also in coming up with products that are of a high quality to marketing by employing its efficiency and speed. There are many instances that life cycle costing is used for life cycle management and this is utterly incorrect since life cycle costing encompasses all the costs that are associated with acquiring, using, maintaining and disposal of the system (Banerjee, 2006, p. 14). In contrast, life cycle management is an approach that is broader that attempts to incorporate all the sectors that are concerned and involved with the development of the product. This means that the two terms are related but they are not uniform and life cycle costing can be considered to be integral part of life cycle management. The basic aim of life cycle costing is to assist the management in product costing whereas life cycle management aims to support sustainable development (Sahaf, 2010, p. 603). Life cycle costing approximates and accumulates the costs over the whole life cycle of a product in order to find out whether the profits that are earned in the manufacturing phase are able to cover the costs that are incurred during both pre-manufacturing and the post-manufacturing phases. Identifying the costs that are incurred during the stages of the life cycle of the product helps to appreciate the total cost incurred throughout the lifecycle and managing them. These costs help the management to understand the cost consequences of developing and making a product and point out the areas where cost reduction efforts are likely to have the most effect (Drury, 2008, p. 538). The process of life cycle costing consists of four major steps that include identifying the items that are supposed to be monitored, identifying the cost structure, definition of the links to estimate costs and establishing a method to be used in formulating life cycle costs. The application of the life cycle costing is based on basic steps that entail cost breakdown structure, cost estimating, discounting and inflation (Sahaf, 2010, p. 603). Cost breakdown structure which essentially encompasses identification of appropriate cost elements of a project during it operational life is considered to be an important analysis of the life cycle costing. Cost breakdown structure is then followed by cost estimation which generally deals with the calculation of the costs for each of the categories and after it is made, the next step involves comparing it with the benefits that are expected from the project during that period. To make this analysis fair, a cost mutual scale for both costs and benefits is essential and thus life cycle cost analysis implies the use of discounting for this particular purpose. It also advocates that the impact of inflation must be established in the analysis. Most of the accountings systems report on a period by period basis and the profits that are realized from the product are not monitored over their life cycles but in contrast, product life cycle reporting entails tracing the costs and revenues on a product by product basis over a number of calendar periods as their life cycle progresses. Failing to do this might hinder the management from understanding how profitable the product can be since the profit that comes from the life cycle of the product is unknown and this will also means that the feedback information that will be available on the success or failure in the development of the new product will not be adequate. Committed or lock in costs are those which haven’t been incurred as yet but are bound to come up later as a result of the resolutions that have been arrived at already. Generally, costs are incurred when a resource is sacrificed and costing systems post record costs only when they have been incurred. It is not easy to make major changes to costs after they have been committed. For instance, product design specifications establish the material and labour inputs that go into the production process of the product. At this part of development, the costs become committed and widely establish the future cost that will be incurred when the product reaches the manufacturing stage (Drury, 2008, p. 538). An estimate eighty percent of the product’s costs are committed during the planning and design stage where the designers are supposed to come u with the design of the product and the procedures for production that they will use. On the contrary, most costs come up when the product is at the manufacturing phase preceding the locking-in during planning and design and are not easily altered. It is evident that cost management can have the most impact when initiated during the planning and design stage as opposed to the manufacturing stage when the design and the production process of the product have already been settled on and their costs already committed. At this stage, the efforts should be directed towards the cost containment rather than management. Cost reduction’s centre of attention is on life cycle cost management and ought not to be confused with cost control (Hansen and Mowen, 2011, p. 548). The strategies that are aimed at cost reduction explicitly recognize that the actions that are taken in the early stages of the production life cycle can greatly decrease the cost that are associated with later production and also the consumption stages. Since a great percentage of the product life cycle is determined during the development stage, it then makes a lot of sense to emphasize management activities during this particular phase of the existence of the product. Many of the opportunities that enable cost reduction occur even before the actual production begins. More investment should be made in the preproduction assets and more resources dedicated to the activities that occur in the early phases of the production life cycle that will ultimately help in the reduction of costs that are associated with production, marketing and post purchase costs (Hansen, Guan and Mowen, 2009, p. 392). Budget setting Budgeting plays a vital role in planning and control where plans are meant to identify objectives and goals as well as the actions that are required to achieve them (Mowen, Hansen, and Heitger, 2012, p. 358). Budgets can be considered to be the quantitative expression of these plans that are stated in terms that are either physical or financial or in some instances both. When applied in planning, a budget is a technique that is used to translate the objectives and strategies that an organization has into terms that are operational. As far as control is concerned, the use of budgets can also be employed, where control is the process that involves setting standards, receiving feedback on the actual performance as well as taking action that is corrective in the case that actual performance deviates extensively from the planned performance. Budgets can therefore be used in making comparisons between actual outcomes with the planned outcomes and they steer operations back on course in the event that they might have derailed. Budgets are dependent on the long run objectives of the firm and generally form the basis for the operations that it conducts (Fabozzi, Peterson and Peterson, 2003, p. 938). The actual results are compared against the budgeted amount through control and these controls provide feedback for the operations that are ongoing and budgets that will be created in the future. The process can range from being informal that is undertaken by a small firm to one that is intricately detailed and which involves a procedure that might last several months in the case of firms that are larger. Normally, the controller of an organization is tasked with the responsibility of directing and coordinating the overall budgeting process. The need for coordination in the budgeting process is very important and the interrelation that exists between functional budgets means that one budget cannot be completed without making reference to several others. For instance, the purchasing budget cannot be completed without consulting to the production budget and it may also be impossible to come up with the sales budget without consultations with the production budget. The best way to arrive at this coordination is coming up with a budget committee which should involve all the representatives from all the functions of the organization including, sales, marketing, personnel, production among others. The committee should make sure that there are regular meetings that will review the progress of the budgetary planning process and solve the problems that might have come up as a result. These meetings will in an effective unite the whole organization and make sure that there is a coordinated technique involved in the preparation of the budget (Walker, 2006, p. 306). On the other hand the benefits that are involved in participating in a budget are, first, that the lower level managers are have more knowledge of their particular area and therefore are in a position to avail more accurate budgetary approximations. Second, when the lower level managers are allowed to take part in the budgeting process, they are more likely to adopt the resulting budget as one that is fair. The main aim is arriving at a budget that will be considered by the managers to be achievable and fair but which also meets the goals that have been set by the company’s management. The meeting of these goals will be a source of motivation for the managers but if they think the budget is unfair and unrealistic, they may feel discouraged and uncommitted to the goals that the budget aims to achieve (Weygandt, Kieso and Kimmel, 2010, p. 391). When a budget is prepared and organized in a manner that is non-participative and rigid it is bound to produce the overall efficiency of the firm (Hoque, 2005, p. 44). In conclusion, managers estimate the costs and revenues for each product from its initial research and development to its final customers support and the life-cycle costs track these cost elements to each of the products from the beginning to the end. These costs provide important information that is needed when it comes to pricing and many of the costs are usually incurred before the manufacturing phase. A product life cycle budget is responsible for highlighting to the managers the importance of coming up with prices that are be able to cover the costs that in all the value chain categories. For companies to be profitable and successful, they should be in a position to cover the costs in all the stages of production (Scarlett, 2005, p. 225). Bibliography Banerjee, B. 2006. Cost accounting. PHI Learning Private Limited. New Delhi. Bhattacharyya, D. 2011. Management accounting. Pearson. Noida, India. Boussabaine, H. A. and Kirkham, R. J. 2004. Whole life-cycle costing. Blackwell Pub. 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Oxford, U.K. Thukaram Rao, M. V. 2003. Management Accounting. New Age. New Delhi. Walker, J. 2006. Fundamentals of management accounting. CIMA. Oxford. Weygandt, J. J., Kieso, D. E. and Kimmel, P. D. 2010. Managerial accounting. Wiley. Hoboken, NJ. Read More