Value Analysis:

Value Analysis can be defined as a process of systematic review that is applied to existing product designs in order to compare
the function of the product required by a customer to meet their requirements at the lowest cost consistent with the specified
performance and reliability needed.

key points and elements:

1. Value Analysis (and Value Engineering) is a systematic, formal and organized process of analysis and evaluation. It is
not random or informal and it is a management activity that requires planning, control and co-ordination.

2. The analysis concerns the function of a product to meet the demands or application needed by a customer. To meet this
functional requirement the review process must include an understanding of the purpose to which the product is used.

3. Understanding the use of a product implies that specifications can be established to assess the level of fit between the
product and the value derived by the customer or consumer.

4. To succeed, the formal management process must meet these functional specification and performance criteria
consistently in order to give value to the customer.

5. In order to yield a benefit to the company, the formal review process must result in a process of design improvements that
serve to lower the production costs of that product whilst maintaining this level of value through function.
Defining Cost and Value
Any attempt to improve the value of a product must consider two elements, the first concerns
the use of the product (known as Use value) and the second source of value comes from
ownership (Esteem value).

Basically, there are three key costs of a product:

Cost of the parts purchased: These are costs associated with the supply of parts and
materials.

Cost of direct labor used to convert products

Cost of factory overheads that recover the expenses of production

Although there are three elements of total cost accumulation it is traditionally the case that
cost reduction activities have focused on the labor element of a product.

Activities such as work-study, incentive payments and automation have compressed labor costs
and as a result there is little to be gained, for most companies, in attempting to reduce this.

This approach to the ‘total costs’ of a product involves taking a much broader look at the way
costs in the factory accumulate and the relationship between costs and value generation.

Cost of manufacture
Cost of assembly
Cost of poor quality
Cost of warranty
The rules governing the application of the VA approach are therefore simple:

No cost can be removed if it compromises the quality of the product or its reliability,
as this would lower customer value, create complaints and inevitably lead to the
withdrawal of the product or lost sales.

Salability is another issue that cannot be compromised, as this is an aspect of the

product that makes it attractive to the market and gives it appeal value.

Any activity that reduces the maintainability of the product increases the cost of
ownership to the customer and can lower the value attached to the product.
Why Use Value Analysis
Design related issues
The designer may not be aware of ‘best practice’ with which to develop an optimal design.

The designer may have produced a drawing that was intended for technology that has been replaced by the company
since the product went into full production.

Traditional thinking and customary practice may have led the designer to believe that a particular solution was the best
without questioning the line of logic.

The designer, under time pressure to create designs for immediate production and sale, may be forced to cut corners
and pay insufficient attention to the design itself due to the pressure to release a design for production.

Market induced Reasons

Pricing Practice. The traditional approach to setting the price of a product has been to determine the costs of the product
and then to add a ‘margin’ to provide the profit (known as ‘cost plus’ pricing).
The Advent of E-Commerce. The new information technology available to customers means that product purchasing is
now a global exercise
Reducing Complexity. The general trend in European industry is to rationalize the number of suppliers to a business and to
reduce the vast number of parts that were traditionally bought and stocked.
HOW TO USE VALUE ANALYSIS
Gain approval of senior management to conduct a Value Analysis exercise. Senior management support, endorsement and
mandate for the VA project provides legitimacy and importance to the project within the business

Establish the reporting procedure for the team and the timing of the project. This project plan needs to be formal and
displayed as a means of controlling and evaluating achievements against time.

Present the VA concept and objectives of the team to all the middle and senior managers in the business
Maintain a list of those business functions that should receive a regular communication of progress even though they may
not be directly involved with the project.

Train the team in both the process of VA and also in basic team building activities.

Write down the objectives of the project and the key project review points.

Provide an office space and co-locate the team members where practical and possible to do so.
Orientation Phase
Forming the Value Analysis Team
If it is accepted that costs accumulate from the design office all the way to the customer and that this is not the fault of any
individual, then the VA process can be used to build a proper and effective system of control.

An Extended Team Approach

A purely internal VA process is limited in that improvements can only be aimed at the processes within the factory. As
companies engage in greater levels of purchasing from suppliers, then the relative percentage of supplied costs to the overall
cost of the product rises. This implies the need to enlist the support and participation of suppliers but also to complete the
process and involve customers, too.

Selecting the Product

Essentially, VA can be applied to any product however certain commercial attributes will make the VA process more
commercially important and potentially profitable to the business

Preparation
To understand properly the function of a product the team must experience the product and this stage is important for both
team building and creating a common understanding (including a common language) regarding the different components of
the product under study.
Creative Brainstorming

This step requires a certain amount of creative thinking by the team.

A technique that is useful for this type of analysis is brainstorming which allows all the members of the team to participate
and for some strange yet ultimately commercial ideas to be promoted amongst the team.

This stage is concerned with developing alternative, more cost-effective ways of achieving the basic function.

All rules of brainstorming are allowed, and criticism needs to be avoided as it could cease the flow of ideas.

Simply list down all ideas, not regardi ng whether they sound apparently ridiculous.
Analysis and Evaluation
The third stage is to evaluate the ‘cost’ and ‘worth’ of each function.

This is not an exact process but allows the existing cost of the product to be apportioned between the functions based on
the assumptions that have been made by the team.

The worth is determined by estimating the lowest cost of producing each basic function if cut down to its minimum.

The value potential is therefore the difference between the cost and the worth figures.

In some cases, it might be necessary to for the team to take a break while specialist team members, or seconded resources,
evaluate the costs and feasibility of some of their suggestions that have been generated.
Implementation

The final stage of the VA team is to report the findings to the senior management team and to gain permission to implement
the findings of the report.

This is the most rewarding stage as the many hours of brainstorming; classification and calculation begin to become ‘the new
product’ and ‘the new way of manufacturing’.

At this point, each product or service that is conducted is done so with the knowledge that it generates profit for the business
and generates value for the customer in the most effective and efficient way.

It should be noted that changes need to be scheduled in order to prevent ‘change overload’ within the factory whereby many
elements of a product are replaced or modified and to allow specialist departments such as the Purchasing Department to
make the necessary changes to material and part specifications.

These activities need to be phased to avoid the chaos of multiple changes happening at once and to allow the anticipated cost
savings to be tracked and monitored.

Indeed, it may be necessary to track the improvement in the quality performance of the product (in the factory) over many
months before the improvements can be proven to work.

This is especially true where the company has to run down the existing stocks of the problem part before introducing the
modified part.
Any equipment which is purchased today will not work for ever.

This may be due to wear and tear of the equipment or obsolescence of technology.

Hence, it is to be replaced at the proper time for continuance of any business.

The replacement of the equipment at the end of its life involves money.

This must be internally generated from the earnings of the equipment.

The recovery of money from the earnings of an equipment for its replacement purpose is called depreciation fund since we
assume that the value of the equipment decreases with the passage of time.

Thus, the word “depreciation” means decrease in value of any physical asset with the passage of time.
METHODS OF DEPRECIATION

There are several methods of accounting depreciation fund. These are as

follows:

1. Straight line method of depreciation

2. Declining balance method of depreciation

3. Sum of the years—digits method of depreciation

4. Sinking-fund method of depreciation

5. Service output method of depreciation

Straight Line Method of Depreciation

In this method of depreciation, a fixed sum is charged as the depreciation amount throughout the lifetime of an asset such
that the accumulated sum at the end of the life of the asset is exactly equal to the purchase value of the asset.

Here, we make an important assumption that inflation is absent.

Let
P = first cost of the asset,
F = salvage value of the asset,
n = life of the asset,
Bt = book value of the asset at the end of the period t,
Dt = depreciation amount for the period t.

The formulae for depreciation and book value are as follows:

Dt = (P – F)/n

Bt = Bt–1 – Dt = P – t [(P – F)/n]

A company has purchased an equipment whose first cost is Rs. 1,00,000 with an estimated life of eight years. The estimated
salvage value of the equipment at the end of its lifetime is Rs. 20,000. Determine the depreciation charge and book value at
the end of various years using the straight-line method of depreciation.

Solution
P = Rs. 1,00,000
F = Rs. 20,000
n = 8 years
Dt = (P – F)/n
= (1,00,000 – 20,000)/8
= Rs. 10,000

In this method of depreciation, the value of Dt is the same for all the years. The calculations pertaining to Bt for different
values of t are summarized in table.
Dt and Bt Values under Straight line Method of Depreciation
P = Rs. 1,00,000

F = Rs. 20,000

n = 8 years

D5 = (P – F)/n
= (1,00,000 – 20,000)/8
= Rs. 10,000 (This is independent of the time period.)
Bt = P – t (P – F)/n
B5 = 1,00,000 – 5 (1,00,000 – 20,000)/8
= Rs. 50,000
Declining Balance Method of Depreciation

In this method of depreciation, a constant percentage of the book value of the previous period of the asset will be
charged as the depreciation amount for the current period.

This approach is a more realistic approach, since the depreciation charge decreases with the life of the asset which
matches with the earning potential of the asset.

The book value at the end of the life of the asset may not be exactly equal to the salvage value of the asset.

This is a major limitation of this approach.

 Let
P = first cost of the asset,
F = salvage value of the asset,
n = life of the asset,
Bt = book value of the asset at the end of the period t,
K = a fixed percentage
Dt = depreciation amount at the end of the period t.

The formulae for depreciation and book value are as follows:

Dt = K x Bt-1
Bt = Bt–1 – Dt = Bt–1 – K x Bt–1
= (1 – K) x Bt–1

The formulae for depreciation and book value in terms of P are as follows:

Dt = K(1 – K)t–1 x P
Bt = (1 – K)t x P
While availing income-tax exception for the depreciation amount paid in each year, the rate K is limited to at the most 2/n.
If this rate is used, then the corresponding approach is called the double declining balance method of depreciation.
Consider Example and demonstrate the calculations of the declining balance method of
depreciation by assuming 0.2 for K

Solution
P = Rs. 1,00,000
F = Rs. 20,000
n = 8 years
K = 0.2

The calculations pertaining to Dt and Bt for different values of t are summarized in Table using
the following formulae:
Dt = K x Bt–1
Bt = Bt–1 – Dt
Consider Example 9.1 and calculate the depreciation and the book value for period 5 using
the declining balance method of depreciation by assuming 0.2 for K.

Solution
P = Rs. 1,00,000
F = Rs. 20,000
n = 8 years
K = 0.2

Dt = K(1 – K)t –1 x P
D5 = 0.2(1 – 0.2)4 x 1,00,000
D5 = Rs. 8,192

Bt = (1 – K)t x P
B5 = (1 – 0.2)5 x 1,00,000
= Rs. 32,768
Sum-of-the-Years-Digits Method of Depreciation

In this method of depreciation also, it is assumed that the book value of the asset decreases at a
decreasing rate.
If the asset has a life of eight years, first the sum of the years is computed as

Sum of the years = 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 = 36 = n(n + 1)/2

The rate of depreciation charge for the first year is assumed as the highest and then it
decreases.
The rates of depreciation for the years 1–8, respectively are as follows: 8/36, 7/36, 6/36, 5/36,
4/36, 3/36, 2/36, and 1/36.
For any year, the depreciation is calculated by multiplying the corresponding rate of
depreciation with (P – F).
Dt = Rate x (P – F)
Bt = Bt–1 – Dt
The formulae for Dt and Bt for a specific year t are as follows:

Consider Example 9.1 and demonstrate the calculations of the sum-of-the-years-digits method of depreciation.
Solution
P = Rs. 1,00,000
F = Rs. 20,000
n = 8 years
Sum = n(n + 1)/2 = 8 9/2 = 36
The rates for years 1–8, are respectively 8/36, 7/36, 6/36, 5/36, 4/36, 3/36,
2/36 and 1/36.
The calculations of Dt and Bt for different values of t are summarized in Table using the following formulae:
Dt = Rate x (P – F)
Bt = Bt–1 – Dt
Sinking Fund Method of Depreciation

In this method of depreciation, the book value decreases at increasing rates with
respect to the life of the asset. Let
P = first cost of the asset,
F = salvage value of the asset,

n = life of the asset,

i = rate of return compounded annually,
A = the annual equivalent amount,
Bt = the book value of the asset at the end of the period t, and
Dt = the depreciation amount at the end of the period t.

The loss in value of the asset (P – F) is made available the form of cumulative depreciation amount at the end of the life of
the asset by setting up an equal depreciation amount (A) at the end of each period during the lifetime
of the asset.

A = (P – F) x [A/F, i, n]
The fixed sum depreciated at the end of every time period earns an interest at the rate of i
% compounded annually, and hence the actual depreciation amount will be in the
increasing manner with respect to the time period.

A generalized formula for Dt is Dt = (P – F) (A/F, i, n) (F/P, i, t – 1).

The formula to calculate the book value at the end of period t is

Bt = P – (P – F) (A/F, i, n) (F/A, i, t).

The above two formulae are very useful if we must calculate Dt and Bt for any specific
period.

If we calculate Dt and Bt for all the periods, then the tabular approach would be better.
Service Output Method of Depreciation

In some situations, it may not be realistic to compute depreciation based on time period. In such cases, the depreciation is
computed based on service rendered by an asset.

Let
P = first cost of the asset
F = salvage value of the asset
X = maximum capacity of service of the asset during its lifetime
x = quantity of service rendered in a period.

Then, the depreciation is defined per unit of service rendered:

Depreciation/unit of service = (P – F)/X
Depreciation for x units of service in a period = P – F/X(x)