HANDOUT 6.

COST MANAGEMENT FOR PRODUCT LIFE CYCLE: LIFE-CYCLE COSTING AND THEORY OF CONSTRAINTS
By: REMAR ALLEN M. BAUTISTA, CPA, CTT

Know the true value of time; snatch, seize, and enjoy every moment of it. No idleness,
no laziness, no procrastination: never put off till tomorrow what you can do today. -
Philip Stanhope, 4th Earl of Chesterfield
I. Definition of Terms
a. Cost Life Cycle – sequence of activities within the firm that begins with research and development, followed by design,
manufacturing, marketing/distribution and customer service.
b. Sales Life Cycle – the sequence of phases in the product’s or service’s life in the market – from introduction to growth
then maturity to decline and lastly withdrawal from the market.
c. Life Cycle Costing – used throughout the cost life cycle to minimize overall cost. It is a management technique used to
identify and monitor the costs of product or service throughout its life cycle. It provides long term perspective of
product costs and product or service profitability.
d. Upstream Costs – incurred as the company prepares to start its production process. It can range from raw materials to
research and development to product design. Upstream costs can have a significant impact on the efficiency and
profitability of the production process.
e. Manufacturing Costs - Manufacturing costs are the costs of materials plus the costs to convert the materials into
products.
f. Downstream Cost – incurred after the company has completed its production process. These downstream costs can
range from distribution expenses to marketing plans to sales channels. Downstream costs also act as a determining
factor in the company's profitability. If distribution costs are too high or sales efforts are ineffective, the downstream
costs will eat away at expected revenues.
g. Target Costing – used for managing costs primarily in the design activity
h. Theory of Constraints – method for managing manufacturing costs
II. Upstream Costs
a. IAS 38 par 8 defines research as: “original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding,”
b. IAS 38 par 8 defines development as: “the application of research findings or other knowledge to a plan or design for
the production of new or substantially improved materials, devices, products, processes, systems or services before the
start of commercial production or use.”
• In Financial accounting, all research cost is charged to expense. While development costs are capitalized only after
technical and commercial feasibility of the asset for sale or use have been established. This means that the entity must
intend and be able to complete the intangible asset and either use it or sell it and be able to demonstrate how the
asset will generate future economic benefits. If an entity cannot distinguish the research phase of an internal project to
create an intangible asset from the development phase, the entity treats the expenditure for that project as if it were
incurred in the research phase only.
• IFRS for SME’s has just a short sentence in S18.14 (Intangible Assets other than Goodwill) where the treatment of R&D
is prescribed: “An entity shall recognize expenditure incurred internally on an intangible item, including all expenditure
for both research and development activities, as an expense when it is incurred unless it forms part of the cost of
another asset that meets the recognition criteria in this Standard.”
c. Design. Decision making in design stage is critical although cost incurred on this stage may be very small compared to
the total cost over the entire life cycle. Design stage lock in most of the remaining life-cycle cost. Critical Success
Factors in design stage include:
• Reduced time-to-market
• Reduced expected service costs
• Improve ease-of-manufacture
• Production planning and design
Common Design Models
• Basic Engineering – a method in which product designers work independently from marketing and manufacturing to
develop design from specific plans and specifications.
• Prototyping – a method in which functional models of the product are developed and tested by engineers and trial
customers
• Templating – a design method in which an existing product is scaled up or down to fir the specifications of the
desired new product
• Concurrent Engineering – also called simultaneous engineering, is an important new approach in which product
design is integrated with manufacturing and marketing throughout the product’s life cycle.
III. Sales Life Cycle
a. Introduction
1. little competition
2. sales rise slowly as customers become aware of the new product
3. costs are high due to R&D and capital costs of setting up
4. process is relatively high because of product differentiation and the high costs at this phase
5. product variety is limited
6. management focuses on design, differentiation and marketing
b. Growth
1. Sales begin to grow rapidly and variety increases
2. Product enjoys the benefit of differentiation
 3. Increasing competition and prices begin to soften
4. Management focuses on new product development and pricing
c. Maturity
1. Sales continue to increase but at a decreasing rate
2. Reduction in number of competitors and variety
3. Prices soften further and differentiation is no longer important
4. Competition is based on cost
5. Management focuses on cost control, quality and service
d. Decline
1. Sales and number of competitors begin to decline
2. Prices stabilize
e. Withdrawal
IV. Target Costing - a technique in which the firm determines the desired cost for the product or service, given a competitive
market price so the firm can earn a desired profit. Target Cost = Competitive Price – Desired Profit
V. Steps in Implementing Target Costing
a. Determine market price.
b. Determine desired profit.
c. Calculate the target cost at market price less desired profit.
d. Use value engineering to identify ways to reduce cost.
e. Use kaizen costing and operational control to further reduce cost.
VI. Value engineering – used in target costing to reduce product cost by analyzing trade-offs between (1) different types and
levels of products functionality and (2) total product cost.
a. Consumer Analysis – identifying critical consumer preferences that define the desired functionality for the new product
b. Functional Analysis – examination of performance and cost of each major function or feature of the product.
c. Design Analysis – involves selection of a design among several possible designs that best meet customer preferences
while not exceeding target cost.
d. Cost Tables – computer-based databases that include comprehensive information about the firm’s drivers/
e. Group Technology – method of identifying similarities in the parts of products a firm manufactures, so the same parts
can be used in two or more products, thereby reducing costs.
VII. Target Costing and Kaizen Costing – Kaizen Costing occurs at the manufacturing stage. The role for cost reduction is to
develop new manufacturing methods such as flexible manufacturing systems and new management techniques such as
operational control, TQM and TOC.
VIII. Theory of Constraints – process of identifying and managing constraint in the making of the products or in the providing of
service. “BOTTLENECK’
Theory of constraints is used to improve speed in manufacturing process. Unlike target costing which focuses on early
phases of CLC, TOC focuses on manufacturing. It focuses on constraints or bottlenecks that slow production process.
IX. Measurements of Theory of Constraints
a. Throughput Contribution (Selling Price – Direct Materials)
b. Investments
c. Operating Costs
X. Steps in Theory of Constraints Analysis
a. Identify binding constraints by developing network diagrams. Network diagram is a flowchart of the work done that
shows the sequence of process and the amount of the time required for each.
b. Determining the most efficient utilization of each binding constraint.
c. Managing the flows through the binding constraint.
d. Adding capacity to the constraint.
e. Redesigning the manufacturing process for flexibility and fast cycle time.
XI. Network Diagram - is a flowchart of the work done that shows the sequence of process and the amount of the time
required for each. It is a graphical representation of all the tasks, responsibilities and work-flow for a project. It often looks
like a chart with a series of boxes and arrows. It is used to map out the schedule and work sequence for the project, as well
as track its progress through each stage, up to and including completion. Since it encompasses every single action and
outcome associated with the project, a network diagram also illustrates the scope of the project.
XII. CRITICAL PATH METHOD (CPM) - a convenient analytical and visual technique that is extremely valuable in assisting the
managers in managing the projects.
XIII. PERT/CPM NETWORK COMPONENTS
a. Activities. An activity represents an action and consumption of resources (time, money, energy) required to complete a
portion of a project. Activity is represented by an arrow;

1. Preceding Activity - activity performed before given event.

2. Succeeding Activity – activity performed after a given event.
3. Dummy Activity - an imaginary activity which does not consume any resource and time. Dummy activities are simply
used to represent a connection between events in order to maintain a logic in the network. It is represented by a
dotted line in a network
 b. Events. An event (or node) will always occur at the beginning and end of an activity. The event has no resources and is
represented by a circle. The ith event and jth event are the tail event and head event respectively.

1. Merge Event – An event where two or more activities ends simultaneously.

2. Burst Event – An event where two or more activities starts simultaneously.

XIV. ERRORS TO BE AVOIDED IN CONSTRUCTING A NETWORK

a. Two activities starting from a tail event must not have a same end event. To ensure this, it is absolutely necessary to
introduce a dummy activity. There should be only one start event and one ending event as shown below

b. Looping error should not be formed in a network, as it represents performance of activities repeatedly in a cyclic
manner. The direction of arrows should flow from left to right avoiding mixing of direction.

XV. RULES IN CONSTRUCTING A NETWORK

a. No single activity can be represented more than once in a network. The length of an arrow has no significance.
b. The event numbered 1 is the start event and an event with highest number is the end event. Before an activity can be
undertaken, all activities preceding it must be completed. That is, the activities must follow a logical sequence (or –
interrelationship) between activities.
XVI. CRITICAL PATH ANALYSIS
• The critical path for any network is the longest path through the entire network.
• Since all activities must be completed to complete the entire project, the length of the critical path is also the shortest
time allowable for completion of the project.
• The activity, which does not lie on the critical path, is called non-critical activity.
• These non-critical activities may have some slack time. The slack is the amount of time by which the start of an activity
may be delayed without affecting the overall completion time of the project.
• Before the critical path in a network is determined, it is necessary to find the earliest and latest time of each event to
know the earliest expected time (TE) at which the activities originating from the event can be started and to know the
latest allowable time (TL) at which activities terminating at the event can be completed.
XVII. Forward Pass Computations (to calculate Earliest, Time TE)
• Step 1: Begin from the start event and move towards the end event.
• Step 2: Put TE = 0 for the start event.
• Step 3: Go to the next event (i.e node 2) if there is an incoming activity for event 2, add calculate TE of previous
event (i.e event 1) and activity time. Note: If there are more than one incoming activities, calculate TE for all incoming
activities and take the maximum value. This value is the TE for event 2.
• Step 4: Repeat the same procedure from step 3 till the end event
XVIII. Backward Pass Computations (to calculate Latest Time T L) Procedure
a. Step 1: Begin from end event and move towards the start event. Assume that the direction of arrows is reversed.
b. Step 2: Latest Time TL for the last event is the earliest time. TE of the last event.
 c. Step 3: Go to the next event, if there is an incoming activity, subtract the value of TL of previous event from the
activity duration time. The arrived value is TL for that event. If there are more than one incoming activities, take the
minimum TE value.
d. Step 4: Repeat the same procedure from step 2 till the end event
XIX. DETERMINATION OF FLOAT AND SLACK TIMES
a. the non – critical activities have some slack or float. The float of an activity is the amount of time available by which it is
possible to delay its completion time without extending the overall project completion time.
b. For an activity i = j, let
tij = duration of activity
TE = earliest expected time
TL = latest allowable time
ESij = earliest start time of the activity
EFij = earliest finish time of the activity
LSij = latest start time of the activity
LFij = latest finish time of the activity
c. Total Float TFij: is the difference between the latest start time and the earliest start time of that activity.
Formula: TFij = LSij – Esij
d. Free Float FFij: The time by which the completion of an activity can be delayed from its earliest finish time without
affecting the earliest start time of the succeeding activity is called free float.
Formula: FFij = (Ej – Ei) – tij ....................(3)
FFij = Total float – Head event slack
XX. Critical Path: After determining the earliest and the latest scheduled times for various activities, the minimum time required
to complete the project is calculated. In a network, among various paths, the longest path which determines the total time
duration of the project is called the critical path. The following conditions must be satisfied in locating the critical path of a
network.
XXI. An activity is said to be critical only if both the conditions are satisfied.
a. 1. TL – TE = 0
b. 2. TLj – tij – TEj = 0