Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 16

Life-Cycle Costing Tim Waters, the COO of BioDerm, has asked his cost management team for a product-line profitability analysis for his firm’s two products, Xderm and Yderm. The two skin care products require a large amount of research and development and advertising. After receiving the following statement from BioDerm’s auditor, Tim concludes that Xderm is the more profitable product and that perhaps cost-cutting measures should be applied to Yderm.

	Xderm	Yderm	Total
Sales	$3,000,000	$2,000,000	$5,000,000
Cost of goods sold	(1,900,000)	(1,600,000)	(3,500,000)
Gross profit	$1,100,000	$ 400,000	$1,500,000
Research and development			(900,000)
Selling expenses			(100,000)
Profit before taxes			$ 500,000

Required

1. Explain why Tim may be wrong in his assessment of the relative performances of the two products.

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2. Suppose that 80 percent of the R&D and selling expenses are traceable to Xderm. Prepare life-cycle income statements for each product. What does this tell you about the importance of accurate life-cycle costing?

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3. Consider again your answers in requirements 1 and 2 with the following additional information. R&D and selling expenses are substantially higher for Xderm because it is a new product. Tim has strongly supported development of the new product, including the high selling and R&D expenses. He has assured senior managers that the Xderm investment will pay off in improved profits for the firm. What are the ethical issues, if any, facing Tim as he reports to top management on the profitability of the firm’s two products?

Step 1 of 3

1.?Waters’ analysis based on the prepared report fails to consider the very significant amount of research and development and selling costs. It is unlikely that the two products consumed equal shares of these costs. As the calculations in part 2 below illustrate, the determination of profitability can be significantly affected by the tracing of these non-manufacturing costs each product. The idea is that life-cycle costing, including upstream and downstream costs (research and development, and selling costs, respectively) as well as the manufacturing costs, is necessary to get an accurate picture of each product’s overall profitability.