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break even and not to make a profit, but to transfer knowledge. It was also established that the cost of a project is influenced by what the customer is willing to pay. The entities receive income as the project progresses. In a metallurgical research project, the accurate estimate of costs and their management during the introduction phase are crucial. After acceptance of a project, the costs can only be altered if the customer agrees. During the growth phase, the costs committed during the introduction phase will be incurred.
Most of the income will be received during the maturity phase. During the decline phase, disposal and discontinuation costs may be considerable.
During the empirical study it was determined that the entities do estimate the majority of their costs during the introduction phase, but only manage these costs during the growth phase after they have already been committed (see sec 5.6.11). The other major concern is that they do not include all costs over the entire life cycle in the initial cost estimates (see sec 5.6.12). The cost of metallurgical research projects is therefore not estimated accurately and not properly managed in terms of the life cycle costing technique.
Now that the phases of the life cycle have been discussed, the need for life cycle costing will be determined.
36 Figure 2.7 Basic uses of life cycle cost
Source:
Adapted from Dhillon (1989:31)
While Brown and Yanuck (1980:1) only consider procurement, Dhillon (1989:31) argues that life cycle costing can be used for more than procurement, namely comparing projects, planning and control and selection.
Life cycle costing became more pertinent during the 1980s, in a broader context than only procurement. According to Emblemsvag (2003:4), nowdays life cycle costing serves mainly three purposes, namely
(1) to be an effective engineering tool for use in design and procurement (2) to be applied proactively in cost accounting and management
(3) to be a design and engineering tool for environmental purposes These purposes will now be discussed.
(1) Life cycle costing as an engineering tool. Since its inception early in 1965, the concept of life cycle costing has spread from defence-related matters to a variety of industries. For both manufacturer and purchaser, it is vital to assess, eliminate by design and manage downstream costs as well as their risks and uncertainties. Downstream costs consist of marketing, distribution
Comparing competing projects
Long-range planning and budgeting
Selecting from competing bidders
Uses of life cycle cost
Controlling an ongoing
project Comparing logistics concepts
Deciding on the replace- ment of ageing equipment
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and customer services costs (Langfield-Smith et al 2006:49). Downstream costs after purchasing should play a major role in purchasing decisions because they tend to be extremely significant after purchasing. Knowledge about downstream costs and their associated risks and uncertainties can be used during costs/pricing and risk management. Products can be designed in such a way that they eliminate the costs before they actually occur (Emblemsvag 2003:25).
According to Sakurai (1996:187) it is preferable for an engineer to be in charge of life cycle costing. Accountants are likely to overemphasise the financial elements. In the USA, life cycle costing is sometimes conducted as a financial process, such as capital budgeting. During the financial emphasis, management may become motivated by short-term considerations. Life cycle costing may be more effective as an engineering tool, with accountants helping to meet the information needs of the engineers.
(2) Life cycle costing as decision support for management. Engineers have always been involved in cost management. According to Fleischman (cited in Emblemsvag 2003:24), standard costing was developed by the American Society of Mechanical Engineers in the 1870s, but only used from the 1920s onwards. Factories were technologically simple and labour intensive and product variety was limited. It made perfect sense to allocate costs according to direct labour hours. The situation changed after World War II when major business environmental changes occurred. The invention of the digital computer effected the most significant change.
(3) Life cycle costing as an environmental tool. Life cycle costing not only makes cost management more relevant and pro-active, but can also help companies toward “doing (economically) well by doing (environmentally) good”
(Emblemsvag 2003:26; Emblemsvag 2001:17).
In South Africa, manufacturers will soon have to assume responsibility for the life cycle of the goods they produce, with more stringent regulations relating to plastics, glass, rubber tyres and asbestos products being anticipated. A
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compulsory charge for the sale of plastic bags has already been implemented (Paton 2003:39).
The common denominator of the three purposes, as stated in Emblemsvag (2003:4) is the role of life cycle costing to provide insight into future matters relating to all costs. The future, however, is always filled with uncertainty and risk. Business risks are the new focal point of corporate governance.
2.5.1 Corporate governance
Emblemsvag (2003:4) reports that because of numerous corporate scandals in the 1980s and 1990s, many large institutional investors demanded better financial transparency, integrity and accountability. This resulted in the Turnbull Report, published in the UK in 1999, on request of the London Stock Exchange.
According to Ward (2001:5), the Turnbull Report focuses attention on risk management and internal control, but at board level. The areas that directors should be looking at include not only financial, operational or technological risks, but also reputational or environmental risks.
In South Africa, the King Report on Corporate Governance (King I) was published in 1994 by the King Committee on Corporate Governance, headed by former High Court judge, Mervyn King SC. Evolving global economic environment and legislative developments necessitated the updating of King I.
The King Report on Corporate Governance for South Africa (King II) was developed and published in 2002 (Dekker 2002). According to a report by the Institute of International Finance (IIF), South Africa rates among the best performers in corporate governance in emerging markets (South Africa Info Reporter 2003).
Ward (2001:8) states that corporate governance ensures that directors understand the business risks and opportunities and know what to communicate and how to talk to the markets and the world at large.
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Noncompliance with corporate governance may result in embarrassing disclosure in annual reports, which could attract the attention of the press, shareholder activists and institutional investors.
It is therefore necessary that cost management ideally be expanded to risk- based cost management and also focus on total costs. Emblemsvag (2003:4) argues that in the same way the Turnbull Report is about the adoption of a risk- based approach towards a system of internal control and reviewing its effectiveness, life cycle costing should take risks and uncertainties into account if it is to assist decision makers. Life cycle costing should help companies to eliminate costs before they are incurred and manage any crucial business risks relating to costs, cash flow and profitability.
Emblemsvag (2003:5) identifies a shortcoming in life cycle costing. He argues that most life cycle methods cannot credibly handle both of the above issues, except cash flows - hence his development of a new approach, referred to as activity-based life cycle costing.