LIFE CYCLE COSTING

ADVANCED MANAGERIAL ACCOUNTING TERM REPORT

SIR MAQBOOL UR REHMAN

SHAHNOOR SHAFI- 13361

29TH APRIL 2013

 LETTER OF TRANSMITTAL

Sir Maqbool ur Rehman

Instructor for Advanced Managerial Accounting

Institute of Business Management

Karachi.

Dear Sir,

I request you to accept this report on LIFE CYLE COSTING that you assigned during semester
spring 2013.

It has been a privilege to work on this project and I have put in my utmost effort to prepare a
comprehensive report on this topic. If you will be having any queries regarding this report I will
be happy to discuss it with you.

Sincerely,

SHAHNOOR SHAFI

13361
 ACKNOWLEDGEMENT

Firstly and foremost I would like to thank Almighty Allah who gave me the strength to carry out
this research activity. Secondly, I would also like to thank Sir Maqbool ur Rehman for the
valuable guidance and advice. He inspired me greatly to work on this report. His willingness to
motivate me contributed tremendously to my report. Finally, an honorable mention goes to my
families and friends for their understandings and supports on me in completing this project.
Without the support of the above mentioned it wouldn’t have been possible.
 EXECUTIVE SUMMARY

The following report gives an overview of life cycle costing. Moreover, the report will briefly
outline the definition of life cycle costing, use of life cycle costing, swot analysis on life cycle
costing and literature review of five different articles.

The report will further focus on the implementation of life cycle costing in Pakistan.
 TABLE OF CONTENTS

Table of Contents

LETTER OF TRANSMITTAL
ACKNOWLEDGEMENT
EXECUTIVE SUMMARY
TABLE OF CONTENTS
INTRODUCTION ............................................................................................................................................. 1
WHY USE LCC?............................................................................................................................................... 2
STEPS FOR COMPUTATION OF LCC ............................................................................................................... 3
SWOT ANALYSIS ............................................................................................................................................ 5
LITERATURE REVIEW ..................................................................................................................................... 6
IMPLEMENTATION IN PAKISTAN................................................................................................................. 11
CALCULATING LCC: AN EXAMPLE................................................................................................................ 12
REFERENCES ................................................................................................................................................ 13
 INTRODUCTION

Life-cycle costing is a method for assessing the total cost of facility ownership. It takes into
account all costs of acquiring, owning, and disposing of a building or building system. LCC is
especially useful when project alternatives that fulfill the same performance requirements, but
differ with respect to initial costs and operating costs, have to be compared in order to select
the one that maximizes net savings.

LCC is a tool to calculate the economic costs caused by a product or a service during its entire
life cycle, from purchase of raw material and components, cost of production and investments
to usage, maintenance and waste management. There are no international standards for LCC.

The scope of LCC studies is mostly more limited than the scope of LCA studies. An LCC study
may for example start at the gate of suppliers, where raw material extraction and refining
processes are not accounted for. In most cases, LCC studies end at the part of the life cycle
where costs for waste management occur. Thus, LCC studies consider purchase, maintenance,
use and end-of-life handling costs of the product.

LCC is particularly suitable for evaluation of design alternatives that satisfy a specified
performance level. An LCC may show that different alternatives have different investment,
operating, maintenance or repair costs, and possibly different life spans. LCC can be applied to
any capital investment decision. It is most relevant when high initial costs are traded for
reduced future cost.

The life-cycle cost of an asset can be expressed by the simple formula:

LCC = capital cost + life-time operating costs

+ life-time maintenance costs

+ disposal cost

- residual value.

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 WHY USE LCC?

LCC helps change provincial perspectives for business issues with emphasis on enhancing
economic competitiveness by working for the lowest long term cost of ownership which is not
an easy answer to obtain. Consider these typical problems and conflicts observed in most
companies:

1. Project Engineering wants to minimize capital costs as the only criteria,

2. Maintenance Engineering wants to minimize repair hours as the only criteria,

3. Production wants to maximize uptime hours as the only criteria,

4. Reliability Engineering wants to avoid failures as the only criteria,

5. Accounting wants to maximize project net present value as the only criteria, and

6. Shareholders want to increase stockholder wealth as the only criteria.

Management is responsible for harmonizing these potential conflicts under the banner of
operating for the lowest long term cost of ownership. LCC can be used as a management
decision tool for harmonizing the never ending conflicts by focusing on facts, money, and time.
Why should engineers be concerned about cost details for LCC? It is important to help
engineers think like MBAs and act like engineers for profit making enterprises--It’s all about the
money!

Other than that by using LCC, product suppliers can optimize their design by evaluation of alternatives
and by performing trade-off studies. And customers can evaluate and compare alternative products.
They can also assess economic viability of projects or products.

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 STEPS FOR COMPUTATION OF LCC

STEP 1: DETERMINE TIME FOR EACH COST ELEMENT

Determination of life cycle of the product (i.e. equipment, in this case). This Life cycle is not
similar to conventional concept of Product Life Cycle. Conventional concept of Product Life
Cycle implies to the time span based on demand of the product in the market, starting from
launch of the product up to the time when company withdraw the product from the market.
That is purely a marketing concept.

Determination of time In LCC analysis of equipment, life cycle means the life of the product that
is installed in the plant, i.e. productive life time of the product. The product supplier provides
the life cycle depending on design calculation and experience. Based on supplier’s data,
customer decides the Life Cycle, i.e. how long he/ she wants to use the machine. Customer
considers the effect of available maintenance facility, technological obsolescence and economic
uncertainty factor, also.

After that, company decides the time span for each component. Example, say, a company
decides that total life cycle of the product will be 10 years from the allocation the fund, among
which first one year will be initial cost zone and remaining 9 years will be under operation and
maintenance cost zone.

STEP 2: ESTIMATE VALUE OF EACH COST ELEMENT

Estimation of value Estimate monetary value for each cost element. This estimated value will be
incurred in every year. This value is basically future income at each year, which is estimated. To
estimate the value, various sources can be used; e.g. calculation based on facts and experience,
MIS report for similar existing machines, etc.

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STEP 3: CALCULATE NET PRESENT VALUE OF EACH ELEMENT, FOR EVERY YEAR
(OVER ITS TIME PERIOD)
Net Present Value Money has a time value. The present value of future income or future cost
can be calculated by using discounting factor and inflation factor.

Net Present Value Discount factor the discount rate is an interest rate, a central bank charges
depository institution that borrow reserves from it.
For example, let's say Mr. Ram expects Rs. 1,000 in one year's time. To determine the present
value of this Rs. 1,000 Ram would need to discount it by a particular rate of interest (often the
risk-free rate but not always). Assuming a discount rate of 10%, the Rs. 1,000 in a year's time
would be equivalent of Rs. 909.09 to Ram today (i.e. 1000/[1+0.10]).

Net Present Value Inflation factor: The inflation rate is the percentage by which prices of goods
and services rise beyond their average levels. It is the rate by which the purchasing power of
the people in a particular geography has declined in a specified period.

STEP 4: CALCULATE LCC BY ADDING ALL COST ELEMENT, AT EVERY YEAR

Summation of PVs of each cost elements is calculated for equipment (at every year). PVs of
each cost element in a year are added. The process is done for every year over the life cycle, i.e.
LCC is calculated for every year.

STEP 5: ANALYZE THE RESULTS.

Analysis the data collected from LCC are analyzed. If one product has to be selected among
multiple equipment, then LCC is calculated for every product. Data for every product are
analyzed, and the lowest LCC option becomes preferred. But lowest LCC option may not
necessarily be implemented when other considerations such as risk, available budgets, political
and environmental concerns are taken into account.

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 SWOT ANALYSIS

STRENGTHS
It contributes to the evaluation of the
economic dimension of sustainability.
By evaluating the costs in relation to the
environmental effects, it is possible to
appreciate the impact that a cost saving can
have on environmental effects.
Makes it possible to take into consideration
future costs at an early stage and relate
them to the initial costs.
Gives the investment analysis an expanded
time perspective and enable an
investigation of the environmental costs
which can make visible future revenues.
the process of realizing an LCC stimulates
learning.
WEAKNESSES
lack of uniform practices, common
approaches and measures,
difficulties in defining some of the cost
factors,
difficulties in evaluation of the effects
of the changes in a product’s
operational conditions,
too many factors of uncertainty, and
poor quality of data from suppliers and
lack of comprehensive data for
products’ performance in the
operational phase.

THREATS
There are few scientific journals that focus
on environmental LCC
OPPORTUNITIES There is no generic data format for
Within the EU policies there Environmental LCC,
exists a growing interest of There are no adequate databases; cost
information is much more variable over
life cycle thinking and time than life cycle inventory data;
especially to enhance the use therefore static databases are not very
of the LCC useful for LCC,
There is insufficient knowledge and lack of
quality training, and
There is often limited cooperation between
clients and suppliers,

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 LITERATURE REVIEW

ARTICLE NO.1
JOURNAL ELSEVIER

ARTICLE Life cycle cost based procurement decisions: A case study of Norwegian Defense Procurement projects.
( 4 September 2007)

AUTHOR Bernt E. Tysseland

IMPACT FACTOR No impact

RESEARCH What can explain that some procurement projects are still carried out and reviewed based on initial
OBJECTIVE procurement costs alone when the official policy is to apply the life cycle cost approach?

RESEARCH Dependent variable:

MODEL
-Use of LCC.
Independent variables:

- Project uncertainty

- Attitude towards LCC

- Information symmetry

- Knowledge of LCC

RESEARCH The measuring instrument of choice is a questionnaire with a sample size of 150 respondents.
DESIGN
Hypothesis testing using SPSS

Regression Analysis on cost elements

DATA ANALYSIS
Anova

CONCLUSION - If the project uncertainty is high the project board would be more informed about the use of LCC.
- The positive attitude of the project leader will positively affect the use of LCC.
- It is very likely that information symmetry between the principal and the agent really makes a unique
contribution to the use of LCC.
- Lack of knowledge is reason why LCC is not used.

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 ARTICLE NO.2
JOURNAL ELSEVIER

ARTICLE The life cycle costing (LCC) approach: a conceptual discussion of its usefulness for environmental
decision-making. 16 October 2003

AUTHOR Pernilla Glucha, Henrikke Baumann

IMPACT FACTOR No impact

ABSTRACT The purpose of this article is to discuss theoretical assumptions and the practical usefulness of the
LCC approach in making environmentally responsible investment decisions. LCC’s monetary unit and
extended scope may speak in favour of using LCC but LCC fails to handle irreversible decisions,
neglects items that have no owner and does not consider costs to future generations.

To handle these inconsistencies in future development of environmental decision support tools three
research solutions are proposed.

CONCLUSION - In order to raise the decision makers’ trust in the results from LCC, the availability and reliability of
data must be secured.

- Extend the system boundaries by complementing LCC-oriented tools with tools that focus on
physical measures.

- Improve the understanding of environmentally related decision-making and use of tools.

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 ARTICLE NO.3
ARTICLE EduBuilding: Material Selection from Life Cycle Costing Sensitivity. 2010

AUTHOR Mat Noor N. A.

Chris Eves

IMPACT NO IMPACT
FACTOR

ABSTRACT The purpose of this research is to examine the Life Cycle Cost Analysis on building floor
materials. By implementing the life cycle cost analysis, the true cost of each material will be
computed projecting 60 years as the building service life and 5.4% as the inflation rate
percentage to classify and appreciate the different among the materials. The analysis results
showed the high impact in selecting the floor materials according to the potential of service
life cycle cost next.

HYPOTHESIS The hypothesis of this research is that a low initial capital cost of a material will result in a life
cycle cost higher than the cost benefit of the initial purchase.

Initial Capital Cost = LCCA ≥ Cost Benefit

CONCLUSION A low life cycle cost material may not be suitable for the requirements associated with an
educational asset. Materials characteristics and properties must be considered before
selecting any flooring material. Life cycle cost quantitative results should only be used as
partial indicators and not a final decisive tool for the selection of interior flooring surfaces.

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 ARTICLE NO. 4
ARTICLE LIFE CYCLE COST CALCULATION: MODELS FOR BUILDINGS. 2005

AUTHOR Erika Levander, Jutta Schade and Lars Stehn

IMPACT FACTOR No impact

ABSTRACT Most commonly, production cost is the main cost factor in construction and is often set to the minimum,
which does not necessarily improve the lifetime performance of buildings. However, a higher production
cost might decrease total life cycle cost (LCC). This paper presents a state of the art analysis in the area of
LCC for construction. The paper also reveals the primary data which are required to carry out a LCC analysis
and discusses limitations in the application of life cycle costing from the client’s perspective.

CONCLUSION The choice of the right calculation method for LCC is easy and obvious if the advantages and disadvantages
are appreciated. If LCC is adopted as a decision making tool. The lifetime quality and the cost effectiveness
of buildings would improve by using LCC in the early stage design.

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 ARTICLE NO. 5
ARTICLE A method-based survey of life cycle costing literature pertinent to infrastructure design
and renewal. 2005

AUTHOR Paul N. Christensen, Gordon A. Sparks, and Kent J. Kostuk

IMPACT FACTOR No Impact

ABSTRACT Motivated by Canada’s infrastructure crisis, the Intelligent Sensing for Innovative
Structures (ISIS) Canada Research Network has developed and demonstrated the efficacy
of innovative materials and monitoring technologies to support infrastructure design and
renewal efforts. The purpose of this paper is to review and broadly classify LCC methods
evident in relevant literature.

RESEARCH Structured interview & observation

DESIGN

CONCLUSION By following through the iterative method of LCC, both engineers and, most importantly,
their customers can be reasonably assured that the design ultimately selected and
pursued will deliver the required performance at minimum life cycle cost. The iterative
method of LCC addresses uncertainty through explicit inclusion of sensitivity and risk
analyses. Also, it acknowledges and addresses the complexity of the design process.

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 IMPLEMENTATION IN PAKISTAN

There are no direct or indirect traces as to where LCC is implemented in Pakistan.

This may be due to:

 insufficient knowledge

 perception of managers that LCC analysis is too complicated.

 lack of quality training in Pakistan

 There is often limited cooperation between clients and suppliers

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 CALCULATING LCC: AN EXAMPLE

The formula for calculating life cycle cost is

LIFE CYCLE COST =

INITIAL COST + (ANNUAL COSTS x PROJECT LIFE x DISCOUNT FACTOR)

PROJECT A PROJECT B

Initial Cost $3,000 $2,000

Annual Costs
Electricity $150 $250
Maintenance $50 $150

Project Life
15 15
(Years)

Discount Factor
(Based on an interest rate of 0.64 0.64
3%)

Calculations $3,000 + ($200 x 15 x 0.64) $2,000 + ($400 x 15 x 0.64)

LIFE CYCLE COST $4,920 $5,840

As the above comparison demonstrates, the lowest initial cost does not lead to the lowest cost
overall. Project A is the more cost effective option to pursue.

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 REFERENCES

http://en.wikipedia.org/wiki/Life_cycle_cost_analysis

http://www.slideshare.net/nirjhar_jgec/life-cycle-cost-analysis

http://www.bchydro.com/powersmart/business/technology_tips/managing_energy_costs/life_cycle_co
sting.html

http://www.businessdictionary.com/definition/life-cycle-cost.html

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