CIMA P2 Syllabus A. Managing The Costs Of Creating Value - Identifying the Costs at different stages of the Life Cycle - Notes 6 / 7
Life-cycle costing
Life-cycle costing tracks and accumulates the actual costs and revenues attributable to each product from inception to abandonment.
It enables a product’s true profitability to be determined at the end of the economic life.
Traditional cost accounting systems do not accumulate costs over a product’s entire life but focus instead on (normally) twelve month accounting periods. As a result the total profitability of a product over its entire life becomes difficult to determine.
As mentioned in the previous chapter, target costing places great emphasis on controlling any of the costs that relate to any part of the product’s life.
Every product goes through a life cycle.
Development.
The product has a research and development stage where costs are incurred but no revenue is generated.
The majority of a product’s life cycle costs (around 80-90%) are determined at the design and development stage because, during this stage, a high level of setup costs will be incurred, including research and development, product design and building of production facilities.
Introduction.
The product is introduced to the market. Potential customers will be unaware of the product or service, and the organisation may have to spend further on advertising to bring the product or service to the attention of the market.
Therefore, this stage will involve extensive marketing and promotion costs. High prices may be changed to recoup these high development costs.
Growth.
The product gains a bigger market as demand builds up. Sales revenues increase and the product begins to make a profit. Marketing and promotion will continue through this stage.
Unit costs tend to fall as fixed costs are recovered over greater volumes. Competition also increases and the company may need to reduce prices to remain competitive.
Maturity.
Eventually, the growth in demand for the product will slow down and it will enter a period of relative maturity.
It will continue to be profitable. However, price competition and product differentiation will start to erode profitability.
The product may be modified or improved, as a means of sustaining its demand.
Decline.
At some stage, the market will have bought enough of the product and it will therefore reach 'saturation point'.
Demand will start to fall and prices will also fall. Eventually it will become a loss maker and this is the time when the organisation should decide to stop selling the product or service.
During this stage, the costs involved would be environmental clean-up, disposal and decommissioning.
Meanwhile, a replacement product will need to have been developed, incurring new levels of research and development and other setup costs.
The level of sales and profits earned over a life cycle can be illustrated diagrammatically as follows.
