Life Cycle, Target and Kaizen Costing
Costing
Life Cycle, Target and Kaizen Costing
Syllabus tag: KASNEB CPA | Advanced Level | CA34S3 Advanced Management Accounting | Topic 3 Life Cycle, Target and Kaizen Costing
Lesson objectives
By the end of this topic, you will be able to:
- Compute a life cycle cost and explain why period costing understates it
- Compute a target cost and the resulting cost gap
- Explain how a cost gap is closed
- Apply Kaizen costing and distinguish it from standard costing
- Apply a learning curve
Why this matters
Traditional costing reports one period at a time and starts from what the product costs. These three techniques take the opposite view: they look across the whole life of a product and start from what the market will pay.
Life cycle costing
Life cycle cost = all costs from concept to decommissioning, spread over the units produced across the life.
| Stage | KES |
|---|---|
| Research and development | 18,000,000 |
| Design | 9,500,000 |
| Manufacturing | 64,000,000 |
| Marketing | 22,000,000 |
| Distribution | 11,500,000 |
| Decommissioning | 5,000,000 |
| Total | 130,000,000 |
Over 40,000 units:
Life cycle cost per unit = 130,000,000 / 40,000 = KES 3,250
Manufacturing cost alone gives 64,000,000 / 40,000 = KES 1,600.
Traditional costing understates the true cost by KES 1,650 a unit — more than the manufacturing cost itself. A product priced on manufacturing cost plus a margin can lose money across its life while appearing profitable in every monthly report.
The design stage commits most of the cost. Around 80% of a product's life cycle cost — here 104,000,000 — is locked in by design decisions, before significant spending occurs. Once the product is in production, most of the cost is already determined and cost control has little left to influence.
That is the practical lesson: cost is designed in, not managed down.
:::checkpoint A company reports strong monthly margins on a product but finds the programme made a loss when it was withdrawn. Using the figures above, explain how both can be true. :::
Target costing
Target costing reverses the usual sequence.
Conventional: Cost + Margin = Price Target: Price − Required margin = Allowable cost
The steps:
- Determine the price the market will accept for a product with the required features
- Deduct the required profit margin
- The result is the target cost
- Compare with the current estimated cost; the difference is the cost gap
- Close the gap before production begins
Worked example. Market price KES 4,800, required margin 25%:
Target cost = 4,800 × 0.75 = KES 3,600
Current estimated cost is KES 4,150.
Cost gap = 4,150 − 3,600 = KES 550, or 13.25% of current cost.
Closing the gap
- Value engineering — redesign to remove cost without removing what the customer values
- Design simplification — fewer parts, fewer processes, standard components
- Supplier negotiation and involvement, early enough to influence design
- Process redesign and automation
- Removing features customers do not value, identified by customer research
Note what is not on the list: reducing the margin, or accepting a lower specification the customer does want. Those abandon the discipline rather than apply it.
If the gap cannot be closed, the correct decision is not to launch. That is the point of doing the analysis before committing.
Kaizen costing
Where target costing applies at the design stage, Kaizen costing applies during production, seeking small continuous reductions.
Its distinctive feature is a declining standard. Rather than a fixed target to be met, the cost target falls each period.
A unit cost of KES 3,250 with a 3% annual reduction target:
| Year | Target cost |
|---|---|
| 1 | 3,250.00 |
| 2 | 3,152.50 |
| 3 | 3,057.93 |
| Standard costing | Kaizen costing | |
|---|---|---|
| Target | Fixed for the period | Falls continuously |
| Meeting the standard is | Success | The starting point |
| Improvement driven by | Management, via variances | Workers, closest to the process |
| Assumes | Current process is correct | Process can always improve |
The philosophical difference matters. Standard costing treats the current process as the right one and asks whether it was followed. Kaizen assumes it can always be bettered and asks by how much.
Learning curves
Where a task is labour-intensive and repetitive, the time per unit falls as cumulative output doubles.
Cumulative average time per unit = a × x^b, where b = log r / log 2
For an 80% learning curve, b = log 0.8 / log 2 = −0.3219.
First unit takes 120 hours:
| Cumulative units | Average time | Total time |
|---|---|---|
| 4 | 76.80 | 307.20 |
| 8 | 61.44 | 491.52 |
Incremental time for units 5 to 8 = 491.52 − 307.20 = 184.32 hours, or 46.08 hours each — well below the 120 hours the first unit took.
The practical consequences: a quotation based on the first unit's cost will be far too high; the learning effect ends once the process stabilises, and pricing that assumes indefinite learning will be too low; and the effect applies to labour, so it matters less in an automated plant.
:::checkpoint A company quotes for a contract of 8 units using the time taken for its first prototype. Using the figures above, compute how much labour time it would overstate, and explain the commercial consequence. :::