LCC - Life Cycle Costing

L C C - LIFE CYCLE COSTING

(Important 5 marks/10 marks question in  Management Accounting Section of LDCE.)

Ø  Also called as "Cradle to Grave Costing"  or " Womb to Tomb Costing" or "Whole Life Cost"

Ø  If considers definition and concept of LCC, the substitute names as referred above are perfect ones.

Ø  Definition:  Sum of all Recurring ( Revenue) and Non-recurring (Capital) costs over the Full Life period of a goods, services/system etc. That means a method of calculating the Total cost of a physical asset throughout its life i.e., costs incurred from its purchase to its disposal, incl: design, installation, operating and maintenance costs (through out life period of asset).  But Depreciation will not be taken into the account of such Total cost.

Ø  LCC includes: A) Purchase/Acquisition price  B) Installation and other associated costs  C) Maintenance/operating costs  D) Salvage value (deduct one).   All these costs usually discounted and totaled to a PRESENT DAY VALUE known as NPV - NET PRESENT VALUE.

Ø  Beginning phase of LCC:  In USA for procurement of Defense equipment in the year 1960

Ø  Simple illustration:  The organisation wants to buy an Machinery.  It called for tenders and the offers were as follows.

Machine A -  Initial Cost -Rs.1,00,000,  Maintenance costs -Rs.10,000 per year. Life -10 Years

Machine B - Initial Cost - Rs.75,000,  Maintenance costs - Rs.15,000 per year. Life  - 10 years

Note: Both Machine A & B are as per organisation's specifications and requirements.

Decision under Conventional system:  Machine B will be finalised because, the initial cost is 75,000 is less than Machine A's initial cost Rs.1,00,000.

Decision under LCC:    Machine A will be finalised.  Because the LCC of Machine A is less than Machine B as shown  below.

A.   The Life Cycle Costs of Machine A :  Rs.1,00,000 + Rs.1,00,000 ( Maintenance costs -10 years @ Rs.10,000 ) = 2,00,000

B.     The Life Cycle Costs of Machine B:    Rs. 75,000  + Rs.1,50,000 ( Maintenance costs - 10 years @ Rs.15,000)  = Rs. 2,25,000

Note:  Here Time value of money or NPV is not considered for the sake of brevity. Otherwise these too will be taken into the account before arriving the decission.

Ø  Advantages:

1. Costs incurred after an asset has been constructed or acquired, such as maintenance, operation, disposal become an important consideration in decision making.

2. Previously, the focus has been on the up-front capital costs of creation or acquisition and failed to take account of the maintenance and operating costs.

LCC & Indian Railways

ü   Indian Railways employs LCC while procuring the Box N Wagons (life 35 years) and Energy intensive products.

ü  Ministry of Railways have constituted a Committee of Executive Directors to identify TWO ITEMS each of Engineering, Electrical, Mechanical and S & T Depts for undertaking their procurement on LCC basis and to examine various issues involved in adopting LCC.

ü  The Committee identified EIGHT ITEMS subject to

1.    The functional specifications & minimum technical parameters for any item procured through LCC basis should be specified by RDSO.

2.    INTER-DEPENDANT ITEMS (Example ERC & Rail pad) should preferable have similar life cycle.

3.    Railways may like to include more safety related items for procurement on LCC  basis, which have maximum anticipated life of 8 years to start with.

4.    20 % of the total requirement may be procured on trial basis by each Zonal Railway on the basis of LCC.

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