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Life cycle costing, the costs incurred during manufacturing Essay

Life-cycle costag estimations and accumulates costs over a merchandise ‘s full life rhythm in order to find whether the net incomes earned during the fabrication stage will cover

the costs incurred duing the pre- and post-manufacturing phases. Identifying the costs

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incurred during the diferent phases of a merchandise ‘s life rhythm provides an penetration into

apprehension and pull offing the sum costs incurred throughout its life rhythm. In peculiar,

life-cycle costing helps direction to understand the cost effects of developing

and doing a merchandise and to place countries in which cost decrease eforts are likely to be

most efective.

Figure illustrates a typical form of cost committedness and cost incurrence during

the three phases of a merchandise ‘s life rhythm – the planning and design phase, the fabrication

phase and the service and abandonment phase. Committed or locked-m costs are those

costs that have non been incurred but that will be incurred in the hereafter on the footing of

determinations that have already been made. It is hard to signiicantly change costs ater they

have been committed. For illustration, the merchandise design speciications determine a merchandise ‘s

stuff and labor inputs and the production procedure. At this phase costs become

committed and loosely find the hereafter costs that will be incurred during the

fabrication phase.

An apprehension of life-cycle costs and how they are committed and incurred at diferent

phases throughout a merchandise ‘s life rhythm led to the outgrowth of mark costSeg, a technique

that focuses on pull offing costs during a merchandise ‘s planning and design stage.

Target costing:

Phase 1: Determine the mark pice which clients will be prepared to pay for

the merchandise.

Phase 2: Deduct a mark proit border rom the mark pice to find the mark cost

Phase 3: Estimate the existent cost of the merchandise.

Phase 4: If estimated existent cost exceeds the mark cost investigate ways of plunging

down the existent cost to the mark cost.

Activity-based direction

The early adoptive parents of acivity-based costing ( ABC ) used it to bring forth moe accurate merchandise ( or service ) costs but it shortly became appaent to the users that it could be extended beyond puely merchandise bing to a scope of cost direction applications. The footings actiiviitty-ased mmannageinnieimt ( ABM ) or aictnvBty-Ibaised cost nmaimageiimeiiit ( ABCM ) ae used to descibe the cost direction applicaions of ABC.

separating characteristic of ABM coverage is that it oten studies information on aciviies

that cross departmental boundaies. For illustration, diferent producion sections and the

distribuion section might set about client processing acivities. They may decide

client jobs by hastening late bringings. The inance section may measure

client recognition worthiness and the staying client processing acivities might be

undertaken by the client service section. Therefore the entire cost of the client

processing activity could be well in surplus of the costs that are assigned to the

client service section. However, to simplify the pesentaion it is assumed in

Exhibit 15.1 that the departmental and acivity costs are idenical but if the cost of the

client order processing acivity was found to be, state, three times the sum assigned to

the client service section, this would be of import informaion because it may

alter the manner in which the directors view the acivity. For illustration, the directors may

give more attenion to evoking the costs of the client processing acivity.

It is evident rom an scrutiny of Exhibit 15.1 that the ABM attack provides more meaningful information. It gives more visibleness to the cost of set abouting the acivities that make up the organizaion and may raise issues for direction acion that are non highlighted by the traditional analysis. For illustration, why is & A ; lb ; 90000 spent on deciding client jobs? Attention-diecting informaion such as this is of import for pull offing the cost of the aciviies.

Johnson ( 1990 ) suggests that cognizing costs by activiies is a accelerator that finally tiggers the acion necessary to go compeiive. See a state of affairs where sales¬ individuals, as a consequence of bing activiies, are informed that it costs & A ; lb ; 50 to treat a client ‘s order. They theefore become awae that it is quesionable to prosecute orders with a low gross revenues value. By extinguishing many little orders, and concentrating on larger value orders, the demand for customer-processing activiies should die, and future spend¬ ing on this acivity should be reduced.


Pior to the introducion of ABM most organizaions have been incognizant of the cost of

set abouting the activiies that make up the organizaion. Knowing the cost of acivities

enables those aciviies with the highest cost to be highlighted so that they can be

pioitized for elaborate surveies to determine whether they can be eliminated or performed

more expeditiously. To place and pioitize the potency for cost decrease many organiza¬

ions have fouia* it utile to sort aciviies as either value added or non-value added.

Deiniions of what constitutes value added and non-value added acivities vary. A

common deinition is that a valune added activity is an activity that clients perceive

as adding utility to the merchandise or service they purchase. For illustration, painting a auto

would be a value added acivity in an organizaion that manufactures autos. Other

deinitions are an activity that is being performed every bit eficiently as possible or an activity

that supports the primary aim of bring forthing end products.

In contrast, a aoM-vakiie added activity is an acivity where there is an chance for

cost reducion without cut downing the merchandise ‘s service potency to the client. Examples

of non-value added aciviies include inspecting, hive awaying and traveling natural mateials. The

cost of these aciviies can be reduced without cut downing the value of the merchandises to the

clients. Non-value added aciviies are basically those activiies that clients should

non be expected to pay for. Reporting the cost of non-value added aciviies draws

direction ‘s attending to the huge sum of waste that has been tolerated by the

organisation. This should pioitize those aciviies with the greatest potency for cost

decrease by extinguishing or transporting them out more efectively, such as cut downing mateial

motions, bettering production depressions and taking acions to cut down stock degrees. Taking

acion to cut down or extinguish non-value added aciviies is given top pioity because by

making so the organizaion for good reduces the cost it incurs without cut downing the value

of the merchandise to the client.

Kaplan and Cooper ( 1998 ) citicize the classiication of aciviies by simplisic value

added and non-value added categoies. They point out, that apart rom the extreme

illustrations similar to the 1s illustrated above, people can non systematically deine what

constitutes a value added or non-value added acivity. To reenforce this point they discuss

whether the activity of puting up a machine is value added or non-value added. One position

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is that clients do non comprehend executing set-ups as adding usefulness to merchandises and

the acivity is non-value added. However, without set-ups a works can merely bring forth individual

merchandises. If clients value customized or diverse merchandises, altering machine scenes

rom the ability to bring forth diferent merchandise vaieies creates value for clients. Kaplan

and Cooper besides point out the demoivating impact when employees are informed that they

are executing non-value added acivities.

To get the better of the above jobs Kaplan and Cooper advocate that alternatively of utilizing a

value added/non-value added classiication the undermentioned simple ive point graduated table should be

used to summaize an ABC undertaking squad ‘s initial opinion about the current eiciency of

an acivity:

1. extremely eicient, with small ( less than 5 % ) apparent chance for betterment ;

2. modestly eicient, some ( 5-15 % ) chance for betterment ;

3. mean eiciency, good opportuniies ( 15-25 % ) for betterment ;

4. ineicient, major chances ( 25-50 % ) for betterment ;

5. extremely ineicient, possibly should non be done at all ; 50-100 % chance for


By placing the cost of acivities that make up their organizaion and sorting them

into the above ive classs, opportuniies for cost decrease can be pioitized. Cost

reducion can be achieved by either extinguishing the activiies, executing them more


eiciently with fewer organizaional resources or redesigning them so that they are performed in an enirely diferent and more cost eicient manner. We shall see how acivities can be redesigned subsequently in the chapter.

Our treatment so far has related to the application of ABM during the fabrication

or service stage of a merchandise ‘s life rhythm. However, some organizaions have used their

acivity-based bing systems to act upon future costs at the design phase within the mark

bing procedure. For illustration, the Tektronix Portable Instruments Division assigned

mateial support disbursals utilizing a individual cost diver-number of portion Numberss. The

company wanted to promote design applied scientists to concentrate their attending on cut downing the

figure of portion Numberss, parts and sellers in future generaions of merchandises. Merchandise

seasonableness was seen as a citical success factor and this was facilitated by designs which

simpliied parts procurance and production procedures. The cost system moivated

applied scientists to plan simpler merchandises necessitating less development clip because they had

fewer parts and portion Numberss. The cost system designers knew that most of the mateial

support disbursals were non incurred in direct proporion to the individual cost frogman chosen,

but the simpliied and imprecise cost system focused attending on factors deemed to be

most citical to the division ‘s future success.

A study of acivity-based costing applications by Innes and Mitchell ( 1995a ) indicated

that many organisations use cost frogman rates as a step of cost eiciency and

public presentation for the activity concerned. The cost driver rate is computed by spliting

the activity costs by the cost frogman volume. For illustration, if the cost of treating 10000

purchase orders is & A ; lb ; 100000, the cost per buying order is & A ; lb ; 10. Assume now that

betterments in processs in the buying activity enable costs to be reduced to

& A ; lb ; 80000. If the same figure of orders can be processed with fewer resources the cost of

treating an order will be reduced to & A ; lb ; 8. Coverage and concentrating on cost frogman rates can

therefore be used to moivate directors to cut down the cost of executing acivities.

There is a danger, nevertheless, that cost frogman rates can promote dysfunctional

behavior. An betterment in the cost frogman rate can be achieved by dividing some

purchase orders and increasing the orders processed to, state, 12 000. Assuming that the cost

of the acivity remains unchanged at & A ; lb ; 100000 the cost per buying order will be

reduced read-only memory & A ; lb ; 10 to & A ; lb ; 8.33 if all costs are ixed in the short term. The overall efect is that

the work load will be increased and, in the long term, this could ensue in an addition in

costs. Care should hence be taken to avoid these dysfunctional effects by utilizing

cost frogman rates as feedback informaion to steer employees in bettering the eiciency of

executing activiies. If the steps are interpreted in a recriminatory or threatening

mode, there is a danger that they will take to dysfunctional behavior.

Business procedure re-engineering

BtmsDimess procedure jre-engimeernmg involves analyzing concern procedures and doing substanial alterations to how the organizaion presently operates. It involves the redesign of how work is done through aciviies. A concern procedure consists of a collecion of activiies that are linked together in a coordinated mode to accomplish a speciic aim. For illustration, mateial handling might be classed as a concern procedure dwelling of separate aciviies associating to scheduling production, hive awaying mateials, treating purchase orders, inspecting mateials and paying providers.

The purpose of concern procedure re-engineering is to better the key concern procedures in

an organisation by concentrating on simpliicaion, cost decrease, improved quality and

enhanced client satisfaction. See the mateials managing procedure outlined in the

above paragraph. The procedure might be re-engineered by directing the production agenda


direct to nominative providers and come ining into contractual understandings to present the mateials in conformity with the production agenda and besides vouching their quality by inspecting them pior to bringing. The terminal consequence might be the riddance, or a lasting decrease, of the storing, buying and review aciviies. These aciviies are non-value added activiies since they represent an chance for cost decrease without cut downing the merchandises ‘ service potencies to clients.

A distinguishing characteristic of concern procedure re-engineering is that it involves extremist

and dramaic alterations in procedures by abandoning current patterns and reinventing

wholly new methods of executing concern procedures. The focal point is on major alterations

instead than fringy betterments. A farther illustration of concern procedure e-engineering

is traveling rom a traditional functional works layout to a just-in-time cellular merchandise layout

and following a just-in-time doctrine. Adopting a just-in-time ( JIT ) system and

doctrine has of import implicaions for cost direction and public presentation coverage.

It is hence of import that you understand the nature of such systems and how they difer

rom tradiional systems, but instead than diverting at this point rom our treatment of cost

direction the descipion of a JIT system will be deferred unil the terminal of the chapter.

Cost of quality

To vie successfully in today ‘s planetary competiive environment companies are

going ‘customer-diven ‘ and doing client saisfacion an overiding pioity.

Customers are demanding ever-improving degrees of service sing cost, quality,

dependability, bringing and the pick of innovaive new merchandises. Quality has become one

of the cardinal compeitive variables and this has created the demand for direction comptrollers

to go more involved in the proviso of informaion associating to the quality of merchandises

and services and activiies that produce them. In the UK quality related costs have been

reported to run rom 5 to 15 % of entire company gross revenues gross ( Plunkett et ai, 1985 ) .

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Extinguishing infeior quality can therefore consequence in substanial nest eggs and higher grosss.

Entire qanaMiry maaiinmgeinmeioit ( TQM ) , a term used to descibe a situaion where all

concern maps are involved in a procedure of uninterrupted quality betterment, has been

adopted by many companies. TQM has broadened, rom its early concentration on the

staisical monitoring of fabrication procedures, to a customer-oiented procedure of

uninterrupted betterment that focuses on presenting merchandises or services of consistent

high quality in a timely manner. In the 1980s most European and Ameican companies

considered quality to be an addiional cost of fabrication, but by the terminal of the decennary

they began to recognize that quality saved money. The doctrine of stressing producion

volume over quality resulted in high degrees of stocks at each production phase in order to

protect against deficits caused by infeior quality at old phases and inordinate

outgo on inspecion, rework, bit and guarantee fixs. Companies discovered that

it was cheaper to bring forth the points right the irst clip instead than blowing resources by

doing deficient points that have to be detected, eworked, scrapped or returned by


Management accounting systems can assist organizaions accomplish their quality ends by

supplying a vaiety of studies and steps that moivate and evaluate manageial eforts

to better quality. These will include inancial and non-inancial steps. Many

companies are presently non cognizant of how much they are passing on quality. Directors

demand to cognize the costs of quality and how they are altering over clip. A cost of quality

study should be prepared to bespeak the entire cost to the organizaion of bring forthing

merchandises or services that do non conform with quality demands. Four categoies of

costs should be reported.


1. FreveimtEOE costs are the costs incured in forestalling the producion of merchandises that

make non conform to speciicaion. They include the costs of prevenive care,

quality planning and preparation and the excess costs of geting higher quality raw


2. Appraisal! costs are the costs incurred to guarantee that mateials and merchandises run into

quality conformity criterions. They include the costs of inspecting purchased parts,

work in procedure and inished goods, quality audits and ield trials.

3. Innemmall failure costs are the costs associated with mateials and merchandises that fail to

meet quality criterions. They include costs incurred before the merchandise is despatched to

the client, such as the costs of bit, fix, downtime and work arrests caused

by defects.

4. Extenal faioire costs are the costs incurred when merchandises and services fail to

conform to demands or saisfy client demands ater they have been delivered.

They include the costs of managing client ailments, warranty replacing, fixs

of returned merchandises and the costs aising rom a damaged company repute. Costss

within this class can hold a dramaic impact on future gross revenues.

Exhibit 15.2 nowadayss a typical cost of choice study. Note that some of the points in the

study will hold to be estimated. For illustration, included in the external failure costs

class is the forgone contibuion read-only memory lost gross revenues aising read-only memory hapless quality. This cost is

highly dificult to gauge. Nevertheless, the lost contibution can be significant and it

is preferred to include an estimation instead than exclude it rom the study. By showing each

class of costs as a per centum of gross revenues grosss compaisons can be made with old

peiods, other organizaions and divisions within the same group. Such compaisons can

high spot job countries. For illustration, compaisons of external failure costs with other

companies can supply an indicaion of the current degree of client saisfaction.

The cost of choice study can be used as an attention-directing device to do the top direction of a company aware of how much is being spent on quality-related costs. The study can besides pull direction ‘s attenion to the possibility of cut downing entire quality costs by a wiser allocaion of costs among the four quality categoies. For illustration, by passing more on the bar costs, the sum of disbursement in the internal and external failure categoies can be substanially reduced, and hence entire disbursement can be lowered. Besides, by planing quality into the merchandises and procedures, assessment costs can be reduced, since far less inspecion is required.

Prevenion and assessment costs are sometimes referred to as the costs of qanaMty

coeformamice or compMamice and internal and external failure costs are besides known as the

costs of Eoe-coefonmainice or nnoim-coinnipMaece. Costss of conformity are incurred with the

intenion of extinguishing the costs of failure. They are discreionary in the sense that they do

non hold to be incurred whereas costs of non-compliance are the consequence of production

imperfectnesss and can merely be reduced by increasing conformity outgo. The optimum

investing in conformity costs is when entire costs of quality reach a lower limit. This can

occur when 100 per cent quality conformity has non been achieved. It is virtually

impossible to mensurate accurately all quality costs ( peculiarly the lost contibuion

read-only memory forgone gross revenues ) and find the optimum investing in conformity costs. However, some people argue that a failure to accomplish 100 per cent quality conformity is non-optimal and that a zero-defects policy is optimum. With a zero-defects policy the focal point is on uninterrupted betterment with the ultimate purpose of accomplishing zero-defects and extinguishing all internal and external failure costs.

A zero-defects policy does non utilize per centums as the unit of measuring because a

little per centum defect rate can ensue in a big figure of defects. For illustration, a 1 %

defect rate rom an end product of 1 million units consequences in 10000 faulty units. To get the better of


Exhibit 15.2

Cost of quality


% of gross revenues

Prevention costs

Quality preparation

Supplier reappraisals

Quality engineeing

Preventive care

Appraisal costs

Inspection of mateials received

Inspection of WIP and completed units Testing equipment

Quality audits

Internal failure costs



Downtime due to quality jobs Retesting

External failure costs

Tax returns


Warranty fixs

Managing client ailments

Foregone contibuion read-only memory lost gross revenues

( & A ; lb ; 000s ) ( & A ; lb ; 50 million )





2200 4.4





2600 5.2




400 2800 5.6






3 000

7300 14.6

14900 29.8

this job the attainment of a zero-defects end is measured in parts per million ( PPM )

so that apparently little Numberss can be transferred into big Numberss. Therefore, alternatively of

describing a 1 % defect rate, a step of 10 000 PPM is more likely to make force per unit area for

action and highlight the tendency in defect rates. Cost of quality studies provide a utile

sum-up of quality attempts and advancement to exceed direction, but at lower direction

degrees non-inancial quality steps provide more timely and appropriate mark steps

for quality betterment. These steps will be discussed in the following chapter.

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Life cycle costing, the costs incurred during manufacturing Essay
Life-cycle costag estimations and accumulates costs over a merchandise 's full life rhythm in order to find whether the net incomes earned during the fabrication stage will coverthe costs incurred duing the pre- and post-manufacturing phases. Identifying the costsincurred during the diferent phases of a merchandise 's life rhythm provides an penetration intoapprehension and pull offing the sum costs incurred throughout its life rhythm. In peculiar,life-cycle c
2018-10-21 23:13:40
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