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What is life cycle costing?


UntitledYou may have seen the typical product life cycle graph in your previous studies (see left). The basic idea is that sales in money and volume increase over time, but gradually tail off as the product comes to the end of its cycle.

When we think of management accounting  and product costing, we are generally looking at short-term costs, and not all costs a product may incur over it’s life cycle. For example, there may be advertising costs to boost sales of mature products, costs of product development or even remediation/disposal costs. Life cycle costing include all costs of a product or service from design to end-of-life. All recurring and once-off costs are included over the entire life cycle. These costs can then be compared with expected revenues to determine if a product is profitable or not.

To give you an example, consider the drug development life cycle.  It may take many years and cost €billions to bring a drug to market (see here for example, which depicts the process at Bayer), before a single euro in revenue is earned. Then, there are the on-going manufacturing costs. Perhaps the drug has side effects, and needs some improvement during its life. And perhaps as the drug ends its life, there may be costs in dismantling purpose-built manufacturing facilities. Taking all these items (and more no doubt) a drug company can consider if a particular drug is profitable.

 

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About martinjquinn

I am an accounting academic, accountant and author based near Dublin, Ireland.

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