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Introduction to costing

Discuss about the Concept Of Annual Worth (Aw).

The concept of annual worth (AW) is used in capital budgeting decision for comparing alternatives with dissimilar lives under LCM assumptions. The AW value has to be calculated for only one life cycle.

In case of comparison of several option, the highest AW will be chosen for most feasible alternative. This is calculated as the difference between capital recovery and annual cost for a given rate of return.

Degree

A

B

C

D

First Cost

 $10,000.00

$14,000.00

 $20,000.00

 $30,000.00

Annual Labour Cost

 $9,000.00

 $7,500.00

 $ 5,000.00

 $3,000.00

Annual Power and Maintenance Cost

 $500.00

 $800.00

 $1,000.00

 $1,500.00

Salvage Value

 $500.00

 $700.00

 $1,000.00

 $1,500.00

(A/P,i%,n)

0.22960738

0.22960738

0.22960738

0.22960738

(A/F,i%,n)

0.12960738

0.12960738

0.12960738

0.12960738

Annual Worth

 -$11,731.27

 -$11,423.78

 -$10,462.54

 -$11,193.81

From the above table it has seen that AW for Degree C is highest compare to other methods. Hence, as per Annual Worth method, Degree C should be considered here.

Again, the concept of Present Worth (PW) is utilised further to evaluate the viability of any project considering the life span as well as discount factor. It converts all the earnings to present value. According to PW technique, the project will be selected if it has maximum PW.

Degree

A

B

C

D

First Cost

 $   10,000.00

 $                 14,000.00

 $    20,000.00

 $       30,000.00

Annual Labour Cost

 $     9,000.00

 $                    7,500.00

 $       5,000.00

 $         3,000.00

Annual Power and Maintenance Cost

 $         500.00

 $                       800.00

 $       1,000.00

 $         1,500.00

Salvage Value

 $         500.00

 $                       700.00

 $       1,000.00

 $         1,500.00

(P/A,i%,n)

4.355260699

4.355260699

4.355260699

4.355260699

(P/F,i%,n)

0.56447393

0.56447393

0.56447393

0.56447393

Present Worth

 $ -51,092.74

 $                -49,753.53

 $   -45,567.09

 $     -48,751.96

The above table has shown that Degree C has the highest PW and thus it will be selected.

Finally, the initial rate of return (IRR) is the most useful technique in capital budgeting decision, as it considered all time value of money constraints. This is a specific rate, where the NPV of any proposed project/investment will be zero. According to IRR, if the rate is higher than rate of return, then the project will be financially feasible. In case of multiple alternatives, project/option with highest will be chosen. According to the IRR calculations, Degree A will be chosen as it has the highest IRR compare to rest three alternatives.

IRR

Degree A

37%

Degree B

31%

Degree C

28%

Degree D

19%

The benefit and cost ratio (BCR) explains the association between costs as well as benefits of any project. This method is used to assess the project cost and benefits considering both qualitative and quantitative aspects. However, in case of qualitative factors, these are converted to financial terms to perform this calculation. It is the proportion of discounted benefits and discounted costs for given discounting factor. In case of modified benefit cost ratio, the operating and maintenance cost is subtracted from the benefits and then the proportion is calculated.


For the given two options, the Benefit cost ratios are as follows:

BCR

Machine A

106.28%

Machine B

102.93%

Since, Machine A has the highest BCR, it should be selected to produce greater revenue.

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Year 9

Year 10

Annual Cash flow of Leasing

80000

60000

50000

50000

50000

50000

50000

50000

50000

50000

Tax shield

70.0%

70.0%

70.0%

70.0%

70.0%

70.0%

70.0%

70.0%

70.0%

70.0%

Periodic after-tax cash flows of lease

56000

42000

35000

35000

35000

35000

35000

35000

35000

35000

Cost of capital

10%

10%

10%

10%

10%

10%

10%

10%

10%

10%

After tax cost of capital

0.07

0.07

0.07

0.07

0.07

0.07

0.07

0.07

0.07

0.07

Discounting factor

0.934579

0.873439

0.816298

0.762895

0.712986

0.666342

0.62275

0.582009

0.543934

0.508349

Present value of leasing

52336.45

36684.43

28570.43

26701.33

24954.52

23321.98

21796.24

20370.32

19037.68

17792.23

Total Present Value

271565.5933

Hence, the equivalent annual cost of leasing is $271565.59

According to the given information, there are three options available, keep X, replace X with Y and replace X with Z.

Gaps Identified in life cycle costing

Considering all three option, in order to choose which one would be viable option, present worth analysis has been taken place as mentioned below:

Degree

Keep X

Replace X with Y

Replace X with Z

Book Value

 $       20,000.00

 $       1,20,000.00

 $       1,60,000.00

Annual operating and maintenance costs

 $       90,000.00

 $           70,000.00

 $           60,000.00

Salvage Value

 $                      -   

 $           30,000.00

 $           50,000.00

(P/A,i%,n)

6.144567106

6.144567106

6.144567106

(P/F,i%,n)

0.56447393

0.56447393

0.56447393

Present Worth

 $ -5,73,011.04

 $      -5,33,185.48

 $      -5,00,450.33


Cost bookkeeping is the way toward deciding and aggregating the cost of item or movement. It is a procedure of representing the incurrence and the control of cost. It likewise covers characterization, investigation, and translation of cost. At the end of the day, it is an arrangement of bookkeeping, which gives the data about the ascertainment, and control of expenses of items, or administrations. It quantifies the working effectiveness of the venture. There is a relationship among data needs of administration, cost bookkeeping targets, and procedures and devices utilized for investigation in cost bookkeeping.

Life cycle costing (LCC) is characterized in the International Organization for Standardization standard, Structures and Constructed Assets, Service-life Planning, Part 5: Life-cycle Costing (ISO 15686-5) as a "monetary appraisal considering all concurred anticipated critical and pertinent cost streams over a period of examination communicated in money related esteem. The anticipated expenses are those expected to accomplish characterized levels of execution, including unwavering quality, wellbeing and accessibility."

The utilization of LCC is basic to show that acquisition procedures and choices need to move past considering the price tag of a decent or on the other hand benefit, at the buy cost does not mirror the budgetary and non-monetary profits that are advertised by earth and socially best resources as they gather amid the activities and utilize stages of the benefit life cycle (Lanen, 2016).

However, there are several research works that identified that LCC has several issue or gap while applying to current scenario. The first and foremost gap in LCC is that any decision taken considering this LCC will lead paying more upfront (Ellul et al. 2015). In a few nations, the generation of maintainable and LCC-proficient products and ventures is still embryonic, which implies that the best way to source maintainable options will be through costly imports or paying a high cost premium to fortify baby neighbourhood businesses. In bring down pay economies, this distinction can be higher, as much as 10 to 50 for each penny. In time, in any case, the substantial volumes requested by open obtainment contracts can make economies of scale more attainable, and the costs of these items can be relied upon to diminish as more makers enter the market. Moreover, open procurers can start to utilize their solid market situating to arrange mass rebates as the advertise starts to develop (Taleb et al. 2015).

Another important gap in LCC is that the capital as well as revenue budgets are conflicting in terms of organisation’s nature as well as time frame. There is additionally the issue of spending proprietorship, in other words, split duties regarding capital and working costs. While obtainment contracting may be the obligation of one organization, spending plans are controlled by another and the utilization and upkeep of the item/benefit/advancement has a place with yet another (Christ and Burritt, 2015). As the advantages of SPP collect amid the undertaking life and at its end transfer, those bearing the capital expenses may not be the first to understand the advantages of reasonable options. Further, there are issue related application of LCC due to insufficient amount of research.

The crucial legitimization for the use of money saving advantage examination (all the more effectively social cost advantage investigation, however we overlook that capability for effortlessness) is that it permits arrangement producers to evaluate whether an undertaking conveys picks up in monetary productivity (Bierer et al. 2015). The thought of effectiveness being evoked here is that depicted by the Hicks-Kaldor paradigm: in particular that a venture is an change over the present state of affairs on the off chance that it is feasible for those that advantage from the venture to repay those that lose, and still be in an ideal situation themselves. The Hicks-Kaldor measure is on the other hand known as the potential Pareto change model or basically the pay guideline (Just et al., 2005).

A fruitful advantage cost investigation produces believable outcomes at a level of detail that is proper for its expected utilize and the task's level of examination (Rieckhof et al. 2015). The underlying arranging exercises ought to characterize a typical structure for contrasting the impacts of an Alternative against the Base Case. Vital components to characterize right on time in the examination procedure incorporate the interstate situations to be dissected, the begin and end a very long time for the investigation, the geological zone considered, and the approach that will be utilized to break down movement conduct. It is fundamental that all choices be produced and investigated to a similar level of detail; this ought to be represented in the arranging stage (Ladabaum et al. 2017). A typical system can be set up by finishing the accompanying below process:

An initial phase in setting up a structure for the examination is to characterize the motivation behind the advantage cost investigation. Recognizing the motivation behind the investigation characterizes the level of detail suitable for the examination. Two different factors additionally help characterize the fitting level of detail: accessible information and investigation spending plan. Accessible information fluctuates by task and impacts the level of detail proper for the advantage cost investigation. Information sources go from customary building techniques to modern provincial travel request models. The accessibility of this information differs with each undertaking. Advantage cost examination arranging ought to set up what information is accessible, and after that check that the accessible information suits the investigation reason and gives the proper level of detail for the advantage cost investigation. The investigation spending impacts the suitable level of detail too. The level of detail ought to be reliable all through the investigation (the same for the Base Case and Alternatives) and comparable with the accessible spending plan.

Reference List

Bierer, A., Götze, U., Meynerts, L. and Sygulla, R., 2015. Integrating life cycle costing and life cycle assessment using extended material flow cost accounting. Journal of Cleaner Production, 108, pp.1289-1301.

Christ, K.L. and Burritt, R.L., 2015. Material flow cost accounting: a review and agenda for future research. Journal of Cleaner Production, 108, pp.1378-1389.

Ellul, A., Jotikasthira, C., Lundblad, C.T. and Wang, Y., 2015. Is historical cost accounting a panacea? Market stress, incentive distortions, and gains trading. The Journal of Finance, 70(6), pp.2489-2538.

Ladabaum, U., Mannalithara, A., Rachocki, C., Laleau, V., Garcia, D., Chen, E., Grimes, B., Vittinghoff, E. and Somsouk, M., 2017. Prospective Cost-Accounting of an Outreach Program to Increase Fecal Immunochemical Test (FIT)-Based Colorectal Cancer (CRC) Screening Among Underinsured Persons in a Randomized Trial. Gastroenterology, 152(5), p.S75.

Lanen, W., 2016. Fundamentals of cost accounting. McGraw-Hill Higher Education.

Rieckhof, R., Bergmann, A. and Guenther, E., 2015. Interrelating material flow cost accounting with management control systems to introduce resource efficiency into strategy. Journal of Cleaner Production, 108, pp.1262-1278.

Taleb, M.A., Gibson, B. and Hovey, M., 2015. Fifty years of Sustainability Accounting: does accounting for income in business sustainability really exist?. International Journal of Accounting and Financial Reporting, 5(1), pp.36-47.

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