AC2105 Lesson 4

AC2105 - Accounting for
Decision Making and

Control
a
Lesson 4
Life-Cycle Costing
Lesson 4.1
3
Learning Objectives
1. Apply life-cycle costing to facilitate strategic

management.
Life-Cycle Costing
Provides a more complete perspective of product costs
and profitability than pricing based on manufacturing costs
alone
• Upstream and downstream costs can account for a

significant portion of total life-cycle costs.
• Decisions at the design stage commit a firm to a given

production, marketing, and service plan, and lock in most
of the product’s total life-cycle costs.
4
The Cost Life Cycle
It is the life cycle of a product or service from the viewpoint of
costs incurred.
It is the sequence of activities within the firm to design,

manufacture and deliver the product and service to the
customers:
• Research and development
• Design
• Manufacturing
• Marketing and distribution
• Customer service
5
The Cost Life Cycle of a
Product or Service
Marketing
R&D Customer
Design Manufacturing and
Service
Distribution
Upstream Activities Downstream Activities
Design decisions account for much of total life-cycle costs
6
The Sales Life Cycle
It is the life cycle of a product or service from the
viewpoint of sales volume achieved.
It is the sequence of phases in a product or service’s life

in the market:
• Introduction of product or service to the market
• Growth in sales
• Maturity
• Decline and withdrawal from the market
7
The Sales Life Cycle of a
Product or Service
Sales Growth Maturity
Decline
Introduction
Time
8
Target Costing
Lesson 4.2
10
Learning Objectives
1. Apply target costing to facilitate strategic management.

What is Target Costing?
It is a costing method in which the firm determines the
allowable (i.e., “target”) cost for a product or service, given
a competitive market price and a targeted profit.
11
Implementing Target Costing
1. Determine the market price.
2. Determine the desired profit.
• Profit per unit
• Profit as a % of revenue or cost
3. Calculate the target cost as market price less desired
profit.
4. Use “value engineering”, kaizen costing and operational
control to reduce costs.
12
Target Costing Example
ABC Limited manufactures a mobility aid that has 30% of
the market share. It has a cost of $650 and sells for $750. A
competitor has just introduced a new model of mobility aid
that sells for $700. A consumer analysis indicates that cost-
conscious consumers will remain loyal to ABC Limited as
long as the price does not exceed $700. What is the target
cost if ABC Limited wants to maintain the current rate of
profit, $100 per unit?
Target cost = $700 − $100 = $600
13
Management and Control
of Quality
Lesson 4.3
15
Learning Objectives
1. Explain the strategic importance of quality initiatives and

framework for managing quality.
2. Prepare and analyse the cost of quality reporting.
Strategic Importance of Quality
Total Quality Management—efforts made by organisations
to improve quality
Awards/Standards:
• Baldrige Quality Award
• ISO 9000 and ISO 14000
Conceptual linkage between Quality and Financial

Performance
16
Conceptual Relationship between
Improved Quality and Financial
Performance
17
Definition of Quality
Quality is the level of satisfaction a customer has with the
organisation’s product or service.
A measure of quality is the difference between customer

expectations and actual performance of the product or
service.
There are two quality dimensions:

• Performance quality
• Design quality
18
Dimensions of Quality
19
Role of Accountants in the
Management and Control of Quality
• Accountants provide relevant financial and non-financial
information related to quality to decision makers.
• Decision makers use the information to make investment

decisions and to plan and control the quality-related
costs, with an aim to improve financial performance.
20
Comprehensive Framework
For Managing and Controlling
Quality
21
Cost of Quality Reporting:
Four Cost Categories
1. Prevention costs—expenditures incurred to keep quality
defects from occurring
2. Appraisal costs—costs incurred in the measurement and
analysis of data to find out if products and services conform
to specification/customer expectations
3. Internal failure costs—costs incurred as a result of poor
quality found through appraisal prior to delivery to customers
4. External failure costs—costs incurred to rectify quality defects
after unacceptable products or services reach the customer
22
Sample Costs of Quality
Prevention Costs Appraisal Costs
• Quality training costs • Test and inspection costs
• Equipment maintenance  Raw materials
costs  Work-in-process
 Finished goods
• Information system costs
• Test equipment and
• Product redesign and instruments
process improvement
• Supplier-assurance/vendor
certification
23
Sample Costs of Quality
Internal Failure Costs External Failure Costs
• Costs of corrective action • Sales returns and allowances
• Rework and (net) scrap costs • Repair or replacement costs/
warranty costs
• Process costs
• Cost to handle customer
• Reinspection and retest costs complaints and returns
of reworked units • Product recalls
• Lost contribution due to • Product liability costs
rework/work interruptions • Lost sales
• Cost to restore reputation
24
Cost of Quality Report
25
Conformance and
Non-Conformance Quality Costs
Conformance Costs Non-Conformance Costs
• Prevention costs • Internal failure costs
• Appraisal costs • External failure costs
26
Non-Financial Quality Indicators
Internal Non-Financial External Non-Financial
Quality Metrics Quality Metrics
• Process yield • Customer response time
• Productivity • No. of defective units shipped
• Machine up-time • No. of customer complaints
• Safety record • Delivery delays
• Throughput • On-time delivery rate
• Manufacturing cycle efficiency • Percentage of products that
experience early or excessive
failure
27
28
Summary
1. Apply life-cycle costing to facilitate strategic

management.
2. Apply target costing to facilitate strategic management.
3. Explain the strategic importance of quality initiatives and
framework for managing quality.
4. Prepare and analyse the cost of quality reporting.

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AC2105 - Accounting for

Decision Making and

1. Apply life-cycle costing to facilitate strategic

• Upstream and downstream costs can account for a

• Decisions at the design stage commit a firm to a given

It is the sequence of activities within the firm to design,

Upstream Activities Downstream Activities

Design decisions account for much of total life-cycle costs

It is the sequence of phases in a product or service’s life

Sales Growth Maturity

1. Apply target costing to facilitate strategic management.

1. Explain the strategic importance of quality initiatives and

Conceptual linkage between Quality and Financial

A measure of quality is the difference between customer

There are two quality dimensions:

• Decision makers use the information to make investment

1. Apply life-cycle costing to facilitate strategic

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