Product Life-Cycle Costing - Essay Example

Strategic Accounting Introduction The present day business environment is so complex and competitive that increased use of automated production processes and advanced technological equipments are the order of the day. The management of the firms has to take into account the rapid technological changes the market undergoes to remain competitive. This necessitates the managers to have a thorough understanding and appreciation of the costs involved in different phases of the life cycle of a product in order to maximise the earnings of the firm. Stiff competition in the international markets, adoption of innovative technological changes and improved production systems have necessitated radical changes in the management accounting systems being followed by different manufacturing companies to remain globally competitive. One of the major developments in the area of managerial accounting is the product life cycle costing which has gained serious recognition during recent periods to meet the challenges of changes in the production systems and procedures. Product Life-Cycle Costing Product life-cycle costing being the new development in the management accounting system has been defined as "a new area of reporting in cost management systems which is the accumulation of costs for activities that occur over the entire life cycle of product"(Hilton, 1994, p.230). Product life cycle examines the life of the product from its development stage to the stage till the removal of the product from the usage. According to Horngren & Foster (1991), product life-cycle covers the life of the product from the time of initial research and development to the time when sales and support of the product to the customers is withdrawn. Product Life Cycle Burstein (1988) observes that the life cycle costing becomes more and more crucial and important in the light of rapid changes in technology and the shortening of the product life cycle. There is a sharp distinction between the product's life cycle costs and the whole life cycle costs. Life cycle costs cover all the costs that the manufacturer will have to incur and whole life cycle cost includes the costs at the hands of the consumer like installation, operation, maintenance, revitalization and disposal (Shields & Young 1991.) Adamany & Gonsalves (1994) have identified the following seven stages in the life cycle of a product: 1. Analysis Stage - involving a critical assessment of the concept and the effects of investing on the concept 2. Start Up Stage - comprising of prototyping, dedication of the manufacturing facilities and practical assessment of the effects of the investment 3. Entry Stage - where the entry into the market with a new product or service is planned 4. Growth Stage - during which the firm receives back the returns on investment as potential sales revenues 5. Maturity Stage - at which the firm harvests the profit from the product or service 6. Decline Stage - signifying the tampering down of the sales which necessitates moving to the withdrawal stage or revitalizing the product 7. Withdrawal Stage - the product is withdrawn from the market It is also vitally important that the managers gather all the required information at the different stages of the life cycle and the life cycle concept introduces an integrated approach to planning and budgeting. Mapping of Key Information Requirements Life Cycle Phase Time Customer Requirement Satisfaction Target Pricing Resource Requirement Continuous Improvements Cash Flow Analysis Critical Critical Critical Critical Critical Start up Critical Critical Critical Critical Critical Entry Critical Critical Critical Critical Critical Growth Critical Critical Critical Critical Critical Critical Maturity Critical Critical Critical Critical Decline Critical Critical Withdrawal Critical Source: (Adamany & Gonsalves 1994) Actions under Life Cycle Costing for Generating Revenue and Reducing Costs Revenue Generation Cost Reduction Product Improvement: New Processes Features Cumulative Volume Performance Experience Curve Durability Average Volume Maintainability Capacity Utilization Serviceability Focused Factories Customer Service: Coordination Costs Fast Delivery Advanced Manufacturing Tech. Hotlines Less WIP, rework, Less inventory, floor space Product Customization Design for Manufacturing Expanded Product Line Less Assembly time New Use, New Users Warranty Costs Price Increases Training Costs Advertising Spare Parts Design for Logistics Support Design for Maintainability Design for Reliability Source: Susman (1989) Benefits accruing from Product Life Cycle Costing Despite several criticisms levelled against the product life cycle costing the following benefits accrue to the firm adopting the concept. (1) The life cycle concept enables the firm to take actions to ensure the generation of greater revenue or the reduction in the costs than otherwise thought to be resulting from the introduction of the product or service (2) The concept ensures that the management takes fit and proper decisions based on a full and accurate assessment of revenues and costs at least during the period of a particular life cycle stage (3) Product life cycle concept promotes a long term generation of profitability and growth in contrast to a short-term view point about the earnings of the firm (4) By analysing the life cycle costs the managers are able to figure out the differences between the costs of acquisition and operating and support costs in order to arrive at a proper balance between investment costs and operating expenses (Susman 1989) (5) Product life cycle helps in understanding the consequences of the costs involved in development and introduction of new products and also to identify the areas where the firms can fruitfully employ the cost reduction efforts (Drury, 2004). (6) The profitability resulting from a new product can be easily ascertained and thereby the success or failure in developing the new products can be inferred by the management (Drury, 2004). Criticisms against Product Life Cycle Costing One of the major criticisms is the assumption by the product life cycle costing about the age of the product. This assumption will make the firms spend huge costs for designing and improving their products after the life cycle time is completed. This necessitates the company to have large financial resources to meet the changing needs of the market over the period and sustain their competitive strength. Hence this system does not become suitable for low cap companies. The next limitation of the life cycle costing concept is that it is based on more and more estimations and assumptions which may prove wrong in the long run due to changes in the customer preferences and needs. In that case the entire time and cost spent on the development stage of the product may go waste. According to Ahmed (2005) implementation of the life cycle costing techniques by the companies following calendar based reporting systems may be difficult. This is due to the fact that the life cycle costing system uses a product by product basis of reporting. The implementation of the life cycle costing techniques requires the tracking costs and revenues for the different products over several calendar years. Consider Insight Llc - A Case Study Consider Insight LLc a computer software company developing a new accounting package 'General Ledger' has adopted the product life-cycle costing technique and several features of the technique made the life cycle budgeting important for the company. Non-production costs are very large. Production costs are often visible by product in most of the accounting systems. But non-production costs associated with activities like R&D, Design, marketing, distribution, and customer service are less visible on a product by product basis. When the non production costs are significant as in the case of a product like 'General Ledger' identifying these costs by product is essential for target pricing, target costing, value engineering and cost management. The development period for R&D and design is long and costly. In the 'General Ledger' product the R&D and design span over a period of two years and constituted over 30 percent of the total costs for the different combinations of selling price and predicted sales quantity. When a high percentage of total life cycle costs are incurred before any production begins and before revenues are received it is crucial for the company to have as accurate a set of revenue and cost predictions for the product as possible. This is important information for deciding whether the company should commence costly R&D and design activities. Many of the costs predicted to be incurred over several years in production, marketing, distribution, and customer service are locked at the R&D and design stages. In the case of the product 'General Ledger' a poorly designed package that is difficult to install and use would result in higher marketing, distribution and consumer service costs. If the product fails to meet promised quality performance levels the costs of marketing, distribution and customer service would be even higher. A life cycle revenue and cost budget prevents these casual relationships among business function costs from being overlooked in decision making. Thus life cycle budgeting facilitates value engineering at the design stage before costs are locked in. Conclusion: From the foregoing it is observed that the product life cycle costing concept when properly prepared and implemented would enable the firm to track the costs and revenues from the time of the initial research and development till the time the firm withdraws the product from the market. The concept also enables the management of the firms to take into account the costing and other information about the products and services for the whole life cycle so that they are in a position to take vital decisions to the advantage of the firm and enhance the profitability. When the product life cycle costing is successfully implemented in an organization, it can bridge the information gap between the functional departments responsible for purchasing budgets and maintaining operating costs. Thereby the firm would be able to achieve greater revenues over the long run in respect of every product or service being manufactured and marketed by it. Bibliography: Adamany H & Gonsalves F (1994) Life cycle management: An integrated approach to managing investments Cost management, Vol 8, nr 2, p 35-48. Ahmed M.N. (2005), Cost Management for Hospitality Industry, Anmol Publication Pvt. Ltd, New Delhi. Article Directory 'Management Accounting' Burstein M (1988) Life-cycle costing NAA conference proceedings, cost accounting for the 90's: Responding to technological change, p 257-271 Drury C. (2004), Management and Cost Accounting, Cost Management: Life Cycle Costing, Sixth edition, Thomson Learning Hilton Ronald W. (1994), Managerial Accounting, Budgeting: Profit Planning and Control Systems, Second Edition, McGraw Hill Inc Horngren Charles T. & Foster George (1991), Cost Accounting: A Managerial Emphasis, Life-Cycle Product Budgeting and Costing, 7th Edition, Prentice-Hall International Editions Shields M & Young M (1991) Managing product life cycle costs: An organizational model Journal of cost management, Vol 5, Autumn, p 39-52. Susman G (1989) Product life cycle management Journal of cost management, Vol 3, Summer, p 8-22 Read More