CU-BCOM-SEM-III-Cost Accounting-Second Draft-converted

Cost Driver: In an ABC system, the allocation basis that are used for applying costs to services or procedures are called cost drivers. It is a factor that causes a change in the cost of an activity. Cost Pool: Costs are grouped into pools according to the activities, which drive them. In this costs associated with procurement i.e. ordering, inspection, storing etc., would be included in this cost pool and cost driver is identified. Unit level cost: Historically, cost drivers were only considered at the unit stage. The development or acquisition of a single unit of product, or the distribution of a single unit or service, causes these drivers to produce unit-level costs. Batch level cost: Costs are caused by a group of things being made, handled or processed at a single time are referred to as batch level costs. Product-level cost: A product level or process level cost is a cost incurred as a result of the development, distribution, or acquisition of various products. Engineering change orders, equipment repairs, product production, and scrap, if relevant to product design, are all examples of these. Facility-level cost: Some costs cannot be related to a particular product line. These are instead related to providing a facility. For e.g. Cost of maintaining a building or plant security or advertisement promoting the organization. Organizational-level cost: Certain expenses are borne at the corporate level primarily to sustain the ongoing operation of the facility. These organizational-level costs, which are common to a broad range of activities, goods, and services, can only be prorated ad hoc among services and products. These expenditures have little to do with the commodity. As a result, instead of an arbitrary and illogical apportionment, they should be subtracted from total product revenues. 10.4 STAGES IN DEVELOPING ABC SYSTEM: • Identify resources - The expenditure of a company is represented by its resources. These are the same costs as in conventional accounting; however, ABC correlates these costs with goods, clients, or services. • Identify activities - The work that is done in an organization is represented by activities. ABC pays for expenses depending on the events that resulted in them. It is then possible to more reliably link these costs to consumers, goods, and facilities by assessing the actual activities that occur in different departments. • Identify cost objects - Profitability is provided by one or more cost objects in ABC. To justify different departments or business units, cost object profitability is used to classify 151 CU IDOL SELF LEARNING MATERIAL (SLM)

money-losing customers. A significant step in an effective ABC implementation is specifying the outputs to be tested. • Identify cost drivers - Cost drivers provide the link between the expenditure of an Organization and activities performed within the Organization. • Determine cost driver rate - Determination of cost drivers completes the last stage of the model. Cost drivers trace or links the cost of performing certain activities to cost objects. Cost driver rate = Total activity cost (Cost pool) Cost driver • Assign cost to the cost objects – Following formula to be used for assigning cost to the cost objects. ABC system-based cost = Resources consumed * Cost driver rate 10.5 ACTIVITIES FOR ABC Activities comprise of units of work or tasks. For example, purchase of materials is an activity consisting a series of tasks like purchase requisition, advertisement inviting quotations, identification of suppliers, placement of purchase order, follow-up etc. Types of Activities: Activities basically fall into four different categories, known as the manufacturing cost hierarchy. The categories are: Type of Activity Examples Unit level activities: These are activities for which the consumption of resources can be identified with the number of units Use of indirect materials/consumables. produced. It is performed each time a unit is produced. Batch level activities: The costs of some activities are driven by the number of batches of units produced. These are activities Material ordering, Inspection of related to setting up of a batch or a production run. It is performed Products. each time a batch is processed. Designing the product, Product level activities: The cost of some activities are driven by Producing parts specifications the creation of a new product line and its maintenance. and keeping technical drawings of products. Facility Level activities: It must be carried out regardless of Plant Security, Production which products are produced. These are activities necessary for Manager’s Salary and sustaining the manufacturing process and cannot be directly Maintenance of buildings. attributed to individual products 152 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustration Activity in ABC An automobile company, uses activity-based costing and accumulates overhead costs in the cost pools. You are to find out for each cost pool whether the cost pool would be unit-level, batch-level, product-level or facility level. Cost pool Human Resources Parts management Purchasing Quality Control Equipment set-up Training employees Assembly department Receiving department Solution: Activity Cost pool Facility-level Human Resources Product-level Parts management Batch-level Purchasing Unit-level Quality Control Unit-level Equipment set-up Facility-level Training employees Unit-level Assembly department Batch-level Receiving department 153 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustration: ABC in manufacturing industry - The cost accountant of ABC Manufacturing attended a workshop on activity-based costing and was impressed by the results. After consulting with the production personnel, he prepared the following information on cost drivers and the estimated volume for each driver. Products Total 45000 ABC Units produced 25000 15000 5000 55 Material cost p.u (in Rs.) 40 30 15 Labour (in Rs.) 15 15 Cost driver Cost driver volume Total ABC Number of set ups 250 Machine Hours 125 75 50 6000 Labour Hrs 2500 1500 2000 45000 Number of inspection 25000 15000 5000 100 50 25 25 The cost accountant also determined how much overhead (OH) costs were incurred in each of the four activities as follows: Setup - Rs. 1,50,000 Machining - Rs. 7,50,000 Assembly - Rs. 3,60,000 Inspection - Rs. 90,000 Total OH - Rs.13,50,000 Required: 1. Determine the cost driver rate for each activity cost pool. 2. Use the activity-based costing method to determine the unit cost for each product Solution: ABC driver rate: 154 CU IDOL SELF LEARNING MATERIAL (SLM)

Activitie s Cost pool Cost driver Cost driver rate = Cost pool / cost Set up 1,50,000 volume Machining 7,50,000 driver volume Assembly 3,60,000 Inspection 250 600 90,000 6000 125 45000 8 100 900 Allocation of Activity based cost: Activitie s Products Total 1,50,000 AB C Set up 75,000 45,000 30,000 600 per set up * number of set ups 125*600 75*600 50*600 Machining 3,12,500 1,87,500 2,50,000 7,50,000 125 per machine hrs * machine hrs 2500*125 1500*125 2000*125 Assembly 2,00,000 1,20,000 40,000 3,60,000 8 per labour hrs * labour hrs 25000*8 15000*8 5000*8 Inspection 45,000 22,500 22,500 90,000 900 per insp., * number of insp., 50*900 25*900 25*900 Cost per unit under ABC: Particulars A Products C 10,00,000 B 2,75,000 Material A 3,75,000 4,50,000 Labour B 2,25,000 75,000 Set up 75,000 45,000 30,000 Machining 3,12,500 1,87,500 2,50,000 Assembly 2,00,000 1,20,000 40,000 Inspection 22,500 22,500 Total cost (Rs.) 45,000 10,50,000 6,92,500 Number of units (Qty) 20,07,500 15,000 5,000 Cost per unit (Rs.) = (A/B) 70.00 138.50 25,000 80.30 10.6 SUMMARY 155 CU IDOL SELF LEARNING MATERIAL (SLM)

• Activity-Based Costing (ABC) is a costing method that focuses on the activities that occur during the development of a commodity. • ABC costing is a method of costing in which costs are traced first to operations, then to goods. • ABC was created in response to a number of flaws in traditional costing systems. • In a conventional product costing system, costs are first traced to an organizational entity, such as a department or factory, before being traced to goods. • A cost driver is a cost-generating activity. Costs are categorized according to what motivates or causes them to occur. • A Cost Object is an entity that needs cost calculation, such as a product, a task, or a consumer. • For each operation, a cost pool is generated, and these activities are connected to and category of product to calculate the cost of that product. • The stages of the evolved ABC system are as follows: • Locate tools • Make a list of events. • Recognize cost items • Identify resource drivers. • Find out the cost (activity) drivers. • Costs should be assigned to cost items. 10.7 KEY WORDS • Activity based Costing (ABC): Activity based Costing is a system that focuses on activities as the fundamental cost objects and uses the cost of these activities for compiling the costs of products and other cost objects. The product cost is built up from the cost of the specific activities undertaken to manufacture it. • Cost Driver: Cost Driver is the factor influencing the level of cost, often used in the context of ABC to denote the factor which links activity resource consumption to produce outputs, for example, the number of purchase orders would be a cost driver for procurement cost. • Cost Object: Cost Object is anything for which a separate measurement of cost is required. Cost object may be a product, a service, a project, a customer, a brand category, an activity, a department or a program etc. • Cost Unit: Cost Unit is a unit of product or service in relation to which costs are ascertained. 10.8 LEARNING ACTIVITY 1. List out cost drivers in case of the following activities 156 CU IDOL SELF LEARNING MATERIAL (SLM)

1. Accounting administration 2. Laser printing 3. Diagnostic center 4. Research and development 5. Consulting ___________________________________________________________________________ ___________________________________________________________________________ 10.9 UNIT END QUESTIONS QUESTIONS A. Descriptive Questions Short Questions 1. What is Activity Based Costing? 2. What is a ‘Cost Driver’? 3. Discuss the stages in developing Activity Based Costing system? 4. What are the objectives of activity-based costing? 5. List different stages in ABC system. Long Questions 1. Differentiate Traditional vs ABC system 2. Explain important terms involved in ABC system 3. Explain resource driver 4. How ABC can help as a decision-making Tool? 5. What are the cost drivers involved in relation to Inventory? B. Multiple choice questions: 1.________ is an activity which generate cost a. Cost pool b. Cost object c. Cost driver d. None 2. In ABC system cost is allocated to ________ a. Cost of Material b. Cost of Labour c. Overhead cost d. None 157 CU IDOL SELF LEARNING MATERIAL (SLM)

3. Cost pool and Cost drivers are synonyms a. True b. False c. Depends on the case d. None of these 4. ABC system focuses on activities which generate revenue a. True b. False c. Depends on the case d. None of these 5. Cost driver for customer care unit is a. No. of calls b. No. of systems c. No. of personnel d. None of these Answer 1-c 2-d3-b 4-b 5-a 10.10 REFERENCES Textbooks: • T1 Introduction to Cost Accounting, Charles T. Horngren, PHI. • T2 Cost Accounting, Jawahar Lall & Seema Srivastava, TMH, 4th edition. Reference Books: • R1 Cost and Management Accounting, Arora M N, Vikas Publishing, 8thedition. • R2 Cost Accounting, S.N Maheshwari, S.Chand Publications 158 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 11 : TARGET COSTING Structure 11.0 Learning Objectives 11.1 Introduction 11.2 Steps in Target costing 11.3 Components 11.4 Implementation 11.5 Advantages 11.6 Disadvantages 11.7 kaizen 11.8 Summary 11.9 Keywords 11.10 Learning Activity 11.11 Unit End Questions 11.12 References 11.0 LEARNING OBJECTIVES After studying this unit students will be able to: • Explain the target costing • State the Implementation of target costing • Advantages and disadvantages of target costing 11.1 INTRODUCTION It should be considered an integral part of product design and introduction rather than merely a cost-cutting or cost-management tool. Target costing is almost the polar opposite of the Cost plus Margin model, in which a company manufactures a commodity with no regard for cost structure. To arrive at the final selling price, they apply a profit margin to the product after it is built. In Target Costing, an organization can first assess the price at which the consumer is willing to pay. The company would then set a margin and deduct it from the sale price. The number will be used as a budgeted expense for the product to be made. This can be demonstrated as follows: Target cost = Target selling price (-) Target profit margin 159 CU IDOL SELF LEARNING MATERIAL (SLM)

11.2 STEPS INVOLVED IN TARGET COSTING APPROACH TO PRICING: The main practices followed in the Target costing are as follows: • Create a target selling price based on consumer preferences in terms of design, usage, need, or enhancement of an established product • Create a production and sales volume target. • Determine a target profit margin based on a company's long-term profit goals. • For and commodity, set a target cost per unit (i.e., target selling price (minus) target profit margin). • Measure the current expense • Set a cost-cutting goal to get from where you are now to where you want to be. • Break down the cost-cutting goals into different elements, such as Value Engineering and Value Analysis. • Adopt cost-cutting decisions to achieve cost-cutting and benefit targets. • Continue to look for further cost-cutting opportunities through a performance improvement programme. 11.3 COMPONENTS OF TARGET COSTING The Target cost is broken down into various components and such components are studied and opportunities for cost reductions are identified. Such activity is often referred to as Value Engineering (VE) and Value Analysis (VA). Value Engineering: This entails looking for ways to minimize costs by altering the design of each component or part of a product, while maintaining the product's functionality and quality. Value Analysis: This entails examining the tasks involved in making the product in order to identify non-value added activities that can be omitted or reduced in order to save money without compromising the product's functionality or quality. Value Engineering and Value Analysis assist in the classification of costs into value-added and non-value-added. The aim is to keep (or reduce) value-added costs while avoiding or removing non-value-added costs entirely. 160 CU IDOL SELF LEARNING MATERIAL (SLM)

Customers get less benefit or utility from using a product or service if value-added costs are reduced. Non-value-added costs, or those that, even if removed, will not decrease the value or utility that consumers get from using the product or service. 11.4 STEPS INVOLVED IN IMPLEMENTING TARGET COSTING • Create a project charter: It is a document that outlines priorities and action plans and has been accepted by top management. This is focused on mission and target statements. This offers a solid foundation of support and guidance for the goal costing initiative in all subsequent efforts. • Obtain a management sponsor: It's a part of the company's upper management. His job would be to help the project in any way possible, including obtaining funding, coordinating, and quickly resolving issues. • Obtain budget: The funding should be based on formal allocation of money through the budget. This should be given freely to the target costing efforts. • Assign a strong team manager: The active participation of a large number of people with a variety of backgrounds is critical to the effective implementation of target costing. A good team manager is needed to bring the group together to ensure smooth operation in order to achieve the goals. He should be capable of dealing with senior management and full-time staff so that he can devote his full attention to the project. • Enroll full-time participants: Members of the team should be devoted to it full-time and have a single focus on ensuring the success of the target costing program. • Use project management tools: Target costing is a highly complex effort for high- cost products with many features and components. The team should use all available tools/software containing various types of costing information. 11.5 ADVANTAGES OF TARGET COSTING Advantages of target costing are as follows: • It ensures adequate preparation prior to production and marketing. • Goal costing increases employee recognition and empowerment because it requires active involvement from team members. • Reduces costs by eliminating non-value-added operations. • It allows a company to gain a competitive advantage over its competitors. • Strengthen supplier partnerships • Encourages the use of the cheapest value-added activities. 161 CU IDOL SELF LEARNING MATERIAL (SLM)

11.6 DISADVANTAGES OF TARGET COSTING Disadvantages of target costing are as follows: • Goal costing is a difficult concept to put into practice. It may take many design iterations for the design team to come up with a reasonably low-cost product that meets the target cost and margin. • The project manager must possess outstanding interpersonal and negotiating skills. • Team members should be able to communicate with one another at all times. 11.7 OTHER AREA Kaizen costing: It refers to the ongoing continuous improvement program that focuses on the reduction of waste in the production process, thereby further lowering cost below the initial targets specified during the design phase. It is a Japanese term for a number of cost reduction steps that can be used, subsequent to issuing a new design to the factory floor. Activities in kaizen costing include elimination of wastages in production, assembly and distribution process, as well as the elimination of unnecessary work steps in any of these areas. Thus, it is intended to repeat many of the value engineering steps, thereby eliminating extra costs at each stage. Illustrations State whether the following are Value-Added (VA) or Non-Value Added (NVA) activities: Item VA / NVA Polishing of furniture used by a system engineer in a NVA software firm VA Maintenance of a banking software for a banking company Painting of pencils by a pencil manufacturing industry NVA VA Cleaning of customer’s computer keyboard by a service VA centre Providing brake adjustments in cars by a car service station True / False 162 CU IDOL SELF LEARNING MATERIAL (SLM)

Statement True / False Target costing is not applicable to a monopoly True. Target costing is applied where the market price is market determined. In a monopolistic market, price is determined by the entity itself. Target costing ignores Non value added True. Target costing aims to confine the activities total cost to the set target. To achieve this, non-value added activities are eliminated. 11.8 KAIZEN COSTING An entity is planning to introduce kaizen costing approach in its plant. State whether and why the following are valid or not in respect of kaizen costing: Statement Valid / Invalid Management is of the view that huge investment Invalid. Kaizen costing is the system of to bring huge modification in the production cost reduction procedures which involves process small and continuous improvements rather than innovations or large scale investments. Management is of the opinion that the Valid. Since the method involves introduction of kaizen costing does not eliminate continuous improvements in the process, the training requirement of employees training becomes part of the same. Management is also of the view that only shop Invalid. This method requires floor employees’ involvement is prerequisite in involvement from the top level management to the shop floor employees. this method Target costing vs. Traditional method XYZ Ltd is engaged in the production of 3 types of ice-cream products: A, B and C. The present activity of the Company is as follows: Particulars AB C 163 CU IDOL SELF LEARNING MATERIAL (SLM)

Current production (Qty) 20,000 10,000 30,000 Selling price p.u (Rs.) 30 25 20 The demand for the product increases by 10% for every reduction of Rs.1 in the selling price. The company has the production capacity of 24,200, 12,100 and 36,300 of A, B and C respectively. The company marks up 25% on cost. Other relevant information are as follows: Particulars AB C Direct material (Rs. p.u) 10 8 12 Direct Labour (Rs. p.h) 4 3 5 Other cost 30% of prime cost Required: Calculate target cost for each product after reduction of selling price required (i) to achieve the sales equal to the production capacity. (ii) Also, calculate the cost of each product at the maximum level using traditional approach. Solution: Statement showing demand and selling price A BC S.P Demand S.P Demand S.P Demand 30 20000 25 10000 20 30000 29 22000 24 11000 19 33000 28 24200 23 12100 18 36300 Cost per unit as per target costing: Particulars ABC Selling price per unit (S.P) 28 23 18 5.6 4.6 3.6 Margin - 25% on cost => 164 CU IDOL SELF LEARNING MATERIAL (SLM)

20% on S.P 22.4 18.4 14.4 Target cost per unit Cost as per traditional approach A B C Particulars 24200 12100 36300 Production 10 8 12 Material 4 3 5 Labour 14 11 17 Prime cost 4.2 3.3 5.1 Overheads 18.2 14.3 22.1 Total cost Target costing vs. Traditional costing Particulars ABC Cost as per target cost 22.4 18.4 14.4 Cost as per traditional method 18.2 14.3 22.1 Labour hours Rs. Following is the budget for the Year 1: 60 Quantity – 20000 units Particulars 14 Selling price per unit 12 Variable cost per unit Direct materials Direct labour (2hrs*Rs.6) 165 CU IDOL SELF LEARNING MATERIAL (SLM)

Variable OH (2hrs*Rs.2) 4 Contribution 30 Total contribution Total budgeted Fixed OH 6,00,000 Budgeted profit 3,80,000 2,20,000 The management is not satisfied with the budget and proposes the following changes: 1) Budgeted profit is Rs. 3,20,000 2) Advertisement to the tune of Rs. 48,000 shall be spent and Selling price to be increased to Rs.65 per unit 3) Sales volume shall rise to 24,000 units despite the spike in selling price In order to meet the above, the workforce must be able to reduce the time taken to make each product. It is proposed to increase the wage rate per hour to Rs.8. Others remain unchanged. Calculate the target labour time to achieve the targeted profit. Solution: Target cost for Labour and Variable OH Particulars Rs. Sales (24,000 * 65) 15,60,000 Less: Material (24000 * 14) 3,36,000 Advertisement expenses 48,000 Fixed OH 3,80,000 Target profit 3,20,000 Target cost for labour and variable OH 4,76,000 Target labour time to achieve target profit 166 CU IDOL SELF LEARNING MATERIAL (SLM)

= Target cost of Direct labour & variable OH Wage rate + Variable OH rate = 4,76,000 8+ 2 = 47,600 hours 11.8 SUMMARY • Target cost = Target selling price (-) Target profit margin • Value Engineering: This means looking for ways to minimize costs by altering the design of each component or part of a product while preserving the product's functionality and quality. • Value Analysis: This entails examining the tasks that go into making a product in order to identify non-value added activities that can be omitted or reduced to save money without compromising the product's functionality or quality. 11.9 KEY WORDS • Target costing has been described as a process that occurs in a competitive environment, in which cost minimization is an important component of profitability. This newer approach of product costing may take into account initial design and engineering costs, as well as manufacturing costs, plus the costs of distribution, sales and services. • Kaizen costing, focuses on the reduction of waste in the production process, thereby further lowering costs below the initial targets specified during the design phase CIMA defines “Kaizen as Japanese term for continuous improvement in all aspects of an entity’s performance at every level. See continuous improvement • Porter describes the value chain as “internal processes or activities a company performs to design, produce, market, deliver and support its product.” He further stated that “a firm’s value chain and the way it performs individual activities are a reflection of its history, its strategy, its approach of implementing its strategy, and the underlying economics of the activities themselves.” 11.10 LEARNING ACTIVITY 1. Develop a flow chart on how target costing can be used for continuous reduction of cost 167 CU IDOL SELF LEARNING MATERIAL (SLM)

___________________________________________________________________________ ____________________________________________________________________ 11.11 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain Kaizen costing. 2. What is value Engineering? 3. Define Value analysis. 4. What are the advantages of Target Costing? 5. Explain how Target costing is opposite to cost plus modelling Long Questions 1. Explain components of Target costing system 2. Differentiate Target costing and Traditional costing 3. What are value added and Nonvalue added activities 4. Discuss impact of Target costing on the profits of an organization 5. Define the Term Target Cost. B. Multiple Choice Questions: 1. A company has the capacity of producing 80000 units and presently sells 20000 units at ₹ 100 each. The demand is sensitive to selling price and it has been observed that with every reduction of ₹ 10 in selling price the demand is doubled. What should be the target cost in selling price if the demand is doubled at full capacity and profit margin on sale is taken at 25%? a. ₹75 b. ₹90 c. ₹25 d. ₹60 2. Desktop Co. manufactures and sells 7,500 units of a product. The full Cost per unit is ₹100. The Company has fixed Its price so as to earn a 20% return on an Investment of ₹ 9,00,000 In response to competitive pressures, the Company must reduce the price to ₹105 next year, in order to achieve sales of 7,500 units. The company also plans to reduce its 168 CU IDOL SELF LEARNING MATERIAL (SLM)

investment to ₹ 8,25,000. If a 20% return on Investment should be maintained, what is the Target Cost per unit for the next year? a. ₹83 b. ₹90 c. ₹89 d. ₹60 3.Target cost= a. Cost + profit margin b. Cost of material , Labour and direct cost c. Targeted Selling price – Profit Margin d. ₹60 4.Cost reduction from Kaizen are smaller than those from Value Engineering a. True b. False c. cannot be determined d. None of these 5.Standard costing and kaizen costing Together is used for cost reduction a. True b. False c. cannot be determined d. None of these Answers 1-d 2-a 3-c 4-a 5-b 11.12 REFERENCES Text Books: • T1 Introduction to Cost Accounting, Charles T. Horngren, PHI. • T2 Cost Accounting, Jawahar Lall & Seema Srivastava, TMH, 4th edition. 169 CU IDOL SELF LEARNING MATERIAL (SLM)

Reference Books: • R1 Cost and Management Accounting, Arora M N, Vikas Publishing, 8thedition. • R2 Cost Accounting, S.N Maheshwari, S.Chand Publications 170 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 12: LIFE CYCLE COSTING Structure 12.0 Learning Objectives 12.1 Introduction 12.2 Features 12.3 Phases 12.4 Stages in Life cycle costing 12.5 Importance of Life cycle costing 12.6 Summary 12.7 Keywords 12.8 Learning Activity 12.9 Unit End Questions 12.10 References 12.0 LEARNING OBJECTIVES After studying this unit students will be able to: • Understand features of life cycle costing • Phases of cycle costing • Importance • Features • Stages in life cycle costing 12.1INTRODUCTION A product life cycle is a pattern of spending, sales volume, income, and profits that occurs from the conception of a new idea to the removal of a product from the range of goods. The aim of life cycle costing is to determine the cost of a product, project, or other item over its expected lifespan. It's a mechanism that keeps track of and accumulates the real costs and profits attributable to a cost item (i.e., a product) from the beginning to the end. Cradle-to-grave and womb-to-tomb costing are words that refer to entirely collecting all costs associated with a commodity from its inception to its final stages. Life cycle costing forecasts, monitors, and accumulates costs over a product's entire life cycle, from conception to abandonment, or from initial R&D to final consumer service and support, which can vary depending on the product's existence and use. 171 CU IDOL SELF LEARNING MATERIAL (SLM)

12.2ESSENTIAL FEATURES OF LIFE CYCLE COSTING Product life cycle costing involves: • Cost and sales tracking of products over several calendar years – over their entire life cycle • It focuses on expense and income accumulation over the product's entire life cycle, as well as research and design costs. • It also considers the costs of product production over the duration of the product's entire life cycle. • The costs of research and development are tallied and compared to the sales earned in subsequent periods. 12.3 PHASES IN LIFE CYCLE OF A PRODUCT Phases in Life cycle of a product shall be understood by way of the following diagram. Introduction Decline Product Growth life cycle Maturity Fig 12.1 Product life cycle A comparative analysis of these phases is given below: Particulars Introduction Growth Maturity Decline Sales Initial stage and Rise in sale at Rise in sale at Saturation stage decreasing price and hence sales hence low. increasing price start decreasing Prices Either high / low Generally retained Prices fall closer Products may 172 CU IDOL SELF LEARNING MATERIAL (SLM)

– Skimming at high price. to cost have to be sold pricing / However, due to at throw away Penetration any change in prices. pricing market conditions, prices may have to be reduced Ratio of Highest at this Amount of Sales Normal at this Since, the promotion stage OH increases. But point. The same demand is low expenses to the ratio of Sales shall also be at this stage, no sales OH to sales industry need to spend on decreases due to standard. any promotional huge spike in the activities Sales. Competition Negligible Entry of large Fierce Withdrawal of number of competition products and competitors hence competition disappears Major cost R&D, Design, Manufacturing, distribution and Plants re-used, Promotion costs support costs sold or scrapped etc 12.4 VARIOUS STAGES IN PRODUCT LIFE CYCLE Stages Activity description 1) Market research To understand and identify the customer requirements and how much he is ready to pay for it and how many units he will buy i.e., Product, Price and Quantity 2) Design specification To identify details such as life of a product, maintenance cost, maximum manufacturing costs, quantity required, delivery period, performance etc., 3) Design Drawings and process schedules, which define the product 4) Prototype To produce small quantity called prototype and make adjustments / improvement till the product meets the 173 CU IDOL SELF LEARNING MATERIAL (SLM)

specification 5) Developments To analyses, modify and tests the product manufactured as prototypes 6) Tooling To build / arrange a production line consisting necessary machinery, tools etc., 7) Manufacture This involves, Purchase of raw material and use of labour for making or assembling of a product 8) Selling To create demand for the product and awareness through campaigns 9) Distribution To move the product from factories to various locations to meet the demands 10) Support To ensure that necessary spares and expert servicing professionals are made available at the respective places to satisfy the customers grievance which may arise over the life of a product 11) Decommissioning / When manufacturing comes to an end, the plant erected for Replacement the manufacturing activities should be sold, scrapped or re- used. 12.5 IMPORTANCE OF LIFE CYCLE COSTING The importance of life cycle costing is summarized as follows: • When non-production costs viz., R&D, Design, Marketing and Distribution costs are significant, it is essential to identify them for target pricing and other cost management activities. For instance, a poorly designed product may involve higher promotional expenses, after sales service cost over a period. • There may be instances where the pre manufacturing expenses like R&D and design are expected to constitute a sizeable portion of the life cycle costs. Therefore, an enterprise needs to identify the costs to be incurred before the commencement. • Life cycle budgeting highlights costs throughout the product life cycle and facilitates value engineering at the design stage itself before costs are locked in. 174 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustrations Phase of Product life cycle Identify the phase of product life cycle with reason in each of the following cases: Case Phase Reason There is a lot of competition and Maturity Rise in sale at decreasing rate quantity sold is increasing at 10%, 8% and 6% in the last 3 years Until last year, there was no Growth 1) Entry of new competition and suddenly competitors during the year there are many new players entered the market 2) Increase in sales and sales for the company has been rising Huge inventory are piled up at Decline 1) Huge inventory the godown and a substitute 2) Availability product is also available in the of market at a lesser price substitutes Life cycle income statement & Pricing decision XYZ Ltd., provides data on its new product as follows: Total cost of R&D and Design incurred during year 1 are Rs.5,00,000 and Rs.3,20,000 respectively. Other costs to be incurred are as follows: Function Costs per unit (Rs.) Production 30 Marketing 18 Distribution 11 After sale service 15 175 CU IDOL SELF LEARNING MATERIAL (SLM)

Sales related information are as follows: Particulars Option I Option II Option III 400 500 Selling price / 300 unit (Rs.) 3500 2500 Sales Quantity 4000 (units) Required: Compute the net income generated over life cycle of the product in all three options and suggest which option should be chosen by the Company? Solution Income statement Particulars Cost per Option I Option II Option III unit Sales Qty 4000 3500 2500 S.P per unit 30 300 400 500 Sales revenue 18 12,00,000 14,00,000 12,50,000 Life cycle costs 11 15 5,00,000 5,00,000 5,00,000 R&D 3,20,000 3,20,000 3,20,000 Design 1,20,000 1,05,000 Production 75,000 Marketing 72,000 63,000 45,000 Distribution 44,000 38,500 27,500 After sales service 60,000 52,500 37,500 Total life cycle costs 11,16,000 10,79,000 10,05,000 Life cycle net income 84,000 3,21,000 2,45,000 The Company may go for Option II, since the net income in the case is better when compared with the other options. 12.6 SUMMARY • Life cycle costing is a pattern of expenditures, sales levels, income, and earnings over time, from the inception of a new concept to the removal of a product from a product line. 176 CU IDOL SELF LEARNING MATERIAL (SLM)

• Introduction, Development, Maturity, and Decline are the four phases of life cycle costing. • Pricing Techniques for new products entering the market include skimming pricing and penetration pricing. • A product's life cycle is divided into four stages: launch, development, maturation, saturation, and decline • Product Life Cycle Applications • As a planning tool, it identifies marketing issues at each point and suggests major alternative solutions, such as kaizen. • As a management mechanism, the PLC model helps the company to equate product output to that of previous products. • It is less effective as a forecasting method because sales histories show a variety of trends and the phases differ in duration. 12.7 KEY WORDS • Product Life Cycle is a pattern of expenditure, sale level, revenue and profit over the period from new idea generation to the deletion of product from product range. • CIMA defines life cycle costing as “the practice of obtaining over their life time, the best use of physical asset at the lowest cost of entity”. • Product life cycle costing involves tracing of costs and revenues of each product over several calendar periods throughout their entire life cycle. Costs and revenues can be analyzed by time periods, but the emphasis is on cost and revenue accumulation over the entire life cycle for each product. • Under the 80:20 rule, 20 per cent of the value-creating processes often account for 80 per cent of total costs 12.8 LEARNING ACTIVITY https://www.pomsmeetings.org/confpapers/059/059-0068.pdf Learn about mathematical derivation of a Life cycle cost ___________________________________________________________________________ ____________________________________________________________________ 12.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 177 CU IDOL SELF LEARNING MATERIAL (SLM)

1. Explain about Product Life Cycle 2. What is Life cycle costing process 3. Explain different phases of product Life cycle 4. Explain the benefits of product Life cycle costing 5. Give a comparative analysis of stages of product life cycle Long Questions 1. What are pricing strategies for new products entering the market 2. What are the characteristics of product Life Cycle 3. What are the elements of Life cycle cost 4. What is Life cycle cost tree? B. Multiple choice Questions 1. In which phase of product Life cycle there will be fierce competition a. Growth b. Maturity c. Introduction d. Decline 2. Company X is forced to choose between two machines A and B. The two machines are designed differently but have identical capacity and do exactly the same job. Machine A costs ₹ 1,50,000 and will last for 3 years. It costs ₹40,000 per year to run. Machine B is an ‘economy’ model costing only ₹ 1,00,000, but will last only for 2 years, and costs ₹ 60,000 per year to run. These are real cash flows. The costs are forecasted in rupees of constant purchasing power. Ignore tax. Opportunity cost of capital is 10%. Which machine Company X should buy? a. Indifferent b. Machine B c. Machine A d. None of these 3. In which phase of product Life cycle the difference between cost and price is almost nil a. Growth b. Maturity 178 CU IDOL SELF LEARNING MATERIAL (SLM)

c. Introduction d. Decline 4. Product Life cycle costing Involves: a. Computation of cost from Womb to Tomb of the product b. Computation of Net revenue during the life of the product c. Involves tracing of costs and revenues of each product over several calendar periods throughout their entire life cycle. d. None of these 5. Life cycle costing begins a. From production and ends with after sales service b. From purchase of Raw material till production is complete c. From production till breakeven is achieved d. None of these Answer 1-b 2-b 3-d 4-c 5-d 12.10 REFERENCES Text Books: • T1 Introduction to Cost Accounting, Charles T. Horngren, PHI. • T2 Cost Accounting, Jawahar Lall& Seema Srivastava, TMH, 4th edition. Reference Books: • R1 Cost and Management Accounting, Arora M N, Vikas Publishing, 8thedition. • R2 Cost Accounting, S. N Maheshwari, S. Chand Publications. 179 CU IDOL SELF LEARNING MATERIAL (SLM)