Life cycle costing involves evaluating the costs related to ownership, operation, maintenance and disposal of project facilities. BusinessDictionary. com (2010) defines life cycle costing as the Sum of all recurring and one-time (non-recurring) costs over the full life span or a specified period of a good, service, structure, or system. It includes purchase price, installation cost, operating costs, maintenance and upgrade costs, and remaining (residual or salvage) value at the end of ownership or its useful life.
Non-recurring costs include procurement, implementation and acceptance, initial training, documentation, facilities, transition from the suppliers, changes to business processes and the withdrawal from service and disposal. The recurring costs include retraining, operating costs, service charges, contract and supplier management costs, changing volumes, cost of changes, downtime, maintenance and repair, transport and handling (Sieglinde, 2009). The life cycle tools are used to assess the processes of production, manufacturing, distribution and the disposal of the end and by-products.
It also includes the transportation of the products from the manufacturer to the consumers. The results of life cycle costing are used to make decisions about the best options to adopt when producing different products. The tool is more accurate as the project begins and the accuracy reduces as the project proceeds in the future. Life cycle costing is important because it evaluates the total costs of ownership. It also provides a guideline as to the most efficient processes of acquisition and support funding to a project (Sieglinde, 2009).
The various approaches to life cycle accounting Life cycle accounting looks at the entire value chain of a product on cost basis. The technique does not evaluate the production process but also looks into the costs associated with the research and developmental phases of the product from the beginning to the end. Life cycle accounting evaluates the cost of a product before it enters the production process until it is finally transported to the customers. However, life cycle costing is not applicable to financial reporting since it is not consistent with the generally accepted accounting principles (GAAP).
From a planning point of view, life cycle accounting is the best tool for managers. Product managers use the tools of life cycle costing throughout the product life cycle. Costs are calculated from the point of entry of the products up to the point where no more products are made. The total costs of production are then divided by the number of units produced to obtain the unit costs. The managers are able to get the actual costs of a product produced, thus, they can adjust and design the products according to the prevailing conditions. Life cycle costing is applicable when the product is being designed or in the pre-design stages.
The management cannot obtain the actual life-cycle costs when the products are already in the market (Bradford, 2008). The methodology of life cycle costing is based on the idea that the purchasing decisions are made through evaluation of all available options. All expenditures related to a decision are addressed. The complexity of the life cycle costing is determined by how complex the goods and services produced by the organization are. The fundamental concepts applicable in life cycle costing are cost breakdown structure, cost estimating, discounting and inflation (Mearig, Coffee & Morgan, 1999).
Cost breakdown structures vary depending on the complexity of the purchasing decisions. All cost elements which are relevant to the purchasing decisions are considered. Boundaries are determined to avoid omission or duplication of some elements. All cost elements relevant to the purchasing options are considered. All cost elements are well defined so that all people involved can understand the components used. The costs should be broken down to analyze the specific areas (Ehlen1, 1997). Cost estimating involves calculating the costs of each category.
This can be determined through the known factors or rates, cost estimating relationships and expert opinion. The known rates are the inputs with known accuracy. For example, if the cost and quantity of production per unit are known, the cost of procurement can be estimated. Cost estimating relationships are generated from historical data. Expert opinion is used to support the data when real data cannot be obtained. Assumptions are included in the expert opinion as well as rationale to support the opinions provided in the data (Sieglinde, 2009). The process of discounting compares the costs and benefits occurring in different periods of time.
The concept of discounting is based on time value of money, that is, people prefer receiving goods purchased now than later. Time preference for money causes people to request for supplies immediately after purchasing rather than delaying. All the future costs must be adjusted to their present costs when evaluating the time of receiving purchases ordered. The discount rates differ with the organization. Common discount rates should be applied throughout the industry to avoid bias. Inflation causes the prices of products to fluctuate and should be considered when evaluating the actual life cycle cost of a product (Sieglinde, 2009).
Life cycle costing is important because it helps evaluate the competing options when purchasing products. Decisions to enter into contracts by the management are made by the use of the tools of life cycle costing. The management evaluates the various proposals about the best options to adopt. Another importance of the life cycle costing is that it improves awareness about the total costs of production. The management is able to understand the factors that cause costs as well as the resources to be used when purchasing products. The cost drivers enable the management identify the most effective strategies of purchasing products.
The knowledge about the cost drivers helps the management identify the most beneficial areas of production to guarantee investing the resources of the organization (Ehlen1, 1997). The third benefit of life cycle costing is the improved accuracy in forecasting the cost profiles. The managers can estimate the full costs associated with procurement of certain products. Decision making about the major investments is easily made through the life cycle costing. The forecasting of future expenditures is accurately done with the use of the tools.
Lastly, the management can be able to trade-off performance against cost by the use of life cycle tools. When purchasing, cost is not the only factor to consider. The management must consider the performance of the items being purchased. The decision makers must consider both the costs and performance of the items being purchased by the organization (Mearig, Coffee & Morgan, 1999). Life cycle costing helps to assess better the effectiveness of planning by comparing actual with budgeted life cycle costs as well as the distribution of those costs. The management is able to determine the deviations in performance of different departments.
It also enhances the management to make better pricing decisions since all the costs attached to a particular product are evaluated. The tools of life cycle costing help improve the assessment of product profitability. The costs are compared with the actual amounts obtained from the production process. The costing strategies provide information about the revenues and costs associated with a particular unit of a product. It also helps in the design of more environmentally desirable products (Sieglinde, 2009).
Identify how environmental issues may be integrated into life cycle costing methods The process of life cycle costing evaluates and investigates the environmental impacts of products that are caused by their existence. The life cycle assessment compares the environmental and social impacts that can be assigned to products and services. The products with the least burden are chosen for production. The life cycle methods are used to evaluate the effects of technology on the production of goods and services. The methods of life cycle costing also provide with tools for evaluating the measuring the effects of technologies on the delivery of products. The process of manufacturing the products has some impacts on the environment.
The life cycle costing evaluates the amount of wastes released to the environment at a given period of time. The ISO 14000 provides standards for environmental management. Life cycle assessment is contained in the ISO 14040:2006 and 14044:2006. There are four main phases of life cycle assessment. The first step involves specification and formulation of the goals and scope of the study (Ehlen1, 1997). The life cycle costing procedures help the management integrate the environmental factors to the activities of the organization. The development of products requires the exploitation of raw materials.
The process of converting the raw materials to more useful products creates some impacts to the environment. The management must be aware of the various environmental impacts of the products being produced by the organization. There are various lobby groups which influence the strategies to be adopted by the organizations. Contravening to the rules of the environmental groups may bring conflicts which may lead to the closure of the business (Mearig, Coffee & Morgan, 1999). There are laws established by various governments concerning the manufacture, distribution and disposal of products.
The government controls the distribution of products to ensure all people obtain goods and services. To discourage concentration of businesses in one region the government has established polices to attract investment in the remote regions. The life cycle costing determines the distribution channels to be used by the organization. The cheapest mode of distribution should be chosen even though various factors will have to be considered. The suppliers to be involved in the distribution should be reliable to ensure timely delivery of products and to provide with quality products.
The business environment is composed of various participants and the organization should integrate all factors to ensure the interests of all the people affected by the activities of the organization are adhered to (Sieglinde, 2009). The process of manufacturing process involves the conversion of the raw materials to the final products for the resale to the consumers. The management should ensure the process does not pollute the environment. Emission of poisonous end-products should be controlled to ensure the organization does not contravene to environmental standards.
Various standards have been created to ensure that proper components are used in the manufacturing process (Mearig, Coffee & Morgan, 1999). The consumers are the end users of the products and their interests should be considered. The life cycle of the product should consider the health standards of the products being produced. The manufacturing process should be done in a clean environment to avoid contamination of the products with substances which may affect the consumers. The government has established standards to control and protect the consumers against unscrupulous business people (Ehlen1, 1997).
The employees manufacturing the products should be protected from harmful substance. A conducive environment should be created for employees to work in. To ensure the safety of the employees the organization should ensure the employees are protected from all hazards. The image of the company is affected by the environment in which the employees work in. Fifth, life cycle cost analysis is argued to facilitate an understanding of the environmental impact of products from development through manufacture, distribution, customer use, disposal and potential recycling (Mearig, Coffee & Morgan, 1999).
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