- 10 Marks
Question
Oria Software Ltd, a computer software company, is developing a new accounting package, “Future Accounting”. The following are the budgeted amounts for the product over a four-year product life-cycle:
| Year | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 |
|---|---|---|---|---|---|
| Estimated quantity in units | 3,500 | 5,000 | 2,000 | 500 | |
| GH¢ | GH¢ | GH¢ | GH¢ | GH¢ | |
| Research & Development costs | 360,000 | ||||
| Design costs | 240,000 | 250,000 | |||
| Production costs: | |||||
| Variable cost per unit | 42 | 35 | 35 | 40 | |
| Fixed costs | 150,000 | 150,000 | 120,000 | 100,000 | |
| Marketing costs: | |||||
| Variable cost per unit | 40 | 35 | 10 | 22 | |
| Fixed costs | 30,000 | 20,000 | 12,000 | 15,000 | |
| Distribution costs: | |||||
| Variable cost per unit | 20 | 22 | 18 | 10 | |
| Fixed costs | 50,000 | 60,000 | 40,000 | 30,000 | |
| Customer service costs: | |||||
| Variable cost per unit | 8 | 12 | 14 | 10 | |
| Fixed costs | 80,000 | 85,000 | 45,000 | – |
To be profitable, Oria Software Ltd must generate revenues to cover costs for all six business functions taken together and, in particular, its high non-production costs. The company has therefore proposed a selling price of GH¢250 per software over the entire product life cycle.
Required:
i) Explain lifecycle costing and identify TWO (2) benefits Oria Software Ltd will derive from using lifecycle costing. (3 marks)
ii) Calculate the cost per software taking into account the entire lifecycle and comment on the proposed selling price. (7 marks)
Answer
i) Lifecycle Costing:
Lifecycle costing is a concept that traces all costs to a product over its complete lifecycle, from design through to cessation. It recognizes that for many products there are significant costs incurred in the early stages of their lifecycle. This is particularly relevant for Oria Software Ltd, as the design and development of software is a long and complex process with significant associated costs.
Benefits of Lifecycle Costing:
- The profitability of a product can be assessed by taking all costs into consideration, not just those incurred during production.
- It enhances decision-making regarding product introduction, product mix, and discontinuation by providing a comprehensive view of costs.
- It helps in pricing decisions, thereby preventing underpricing at the launch point and ensuring that all costs are covered over the product’s lifecycle.
(3 marks)
Conclusion:
Clearly, proposed selling price per software of GH¢250 is not advisable as it is
lower than cost of production. Oria Software Inc. may either increase the selling
price or undertake cost reduction techniques like value engineering, quality cycle
or alternative source of cheaper material to be able to reduce the cost to be lower
than GH¢ 250 per unit.
- Tags: Cost Analysis, Lifecycle costing, pricing decision, software development
- Level: Level 2
- Topic: Relevant Cost and Revenue
- Series: MAY 2019
- Uploader: Joseph