TARGET

COSTING
 It originated in Japan in the 1970s, it
came to being as a result of recognition
that customers were demanding more
diversity in products that they bought
and that the life cycle of the products
were getting shorter and as such, it
meant that new products had to be
designed more frequently.
 Companies realised that the larger
proportion of costs were committed in
the design stage of the product and
hence the design stage become critical
for the company to make profit.
Companies have two options for
reducing costs to acceptable level:
1 Through adoption of integrating new
manufacturing technology, using
advanced cost management techniques
such as activity-based costing, and
seeking higher productivity.
2 By redesigning the product or service.
This approach recognizes that design
decisions account for much of total
product life cycle costs. By paying
attention to the design stage, massive
reductions in total cost are attainable.
PURPOSE

 Target costing is a method that is

employed to manage costs and profits.
It involves setting a target cost of a
product /service and working out to
achieve this target.
 . It is used for business strategy and
marketing strategy in particular by
companies who operate in a competitive
environment and where new products
are continuously being introduced.
STAGES IN TARGET COSTING

1 Determine the market price.

 Normally, a target costing technique is
employed at the product development
stage. The focus remains on the needs of
potential customers. The challenge is to
satisfy those needs. A manufacturer or
service provider tries to assess the value
of the product or service as would be
perceived by potential customers. In order
to assess the value perceived by potential
customers, the manufacturer or service
provider uses extensive market research.
2 DETERMINE THE DESIRED PROFIT.

 Top management, on the basis of the

firm’s strategy and financial goals,
determines the target profit. Instead of
expressing the profit target as ‘Return
on Investment’ (as it is done
traditionally), the target profit is set as
‘Return on Sales’ (i.e., Operating profit /
Revenue).
3 CALCULATE THE TARGET COST AT MARKET PRICE .

 Target cost per unit is the estimated

long-run cost per unit of product or
service, which enables the manufacturer
or service provider to achieve the
desired profit per unit when selling at
the target price. In calculating target
cost, we include all future costs, both
variable and fixed. The rationale is that
a firm’s revenues must recover all its
costs in the long run.
Target selling price xxxx

Less target profit xxx

Target cost xxxxx

EXAMPLE 1

 Futuristic Plc produces televisions

amongst other electronic equipment.
The company has decided on a fixed
price of $300 per unit on its new range
of televisions. The target price should
be fixed considering the additional
features of the new model and keeping
an eye on the competitors’ price for
similar kinds of models. The company’s
top management wishes to maintain a
‘Return on Sales’ of 25%
SOLUTION

Target cost =selling price –profit

=$300-(25%x$300)
=$225
 the target cost per unit of the new
television model would be $225
EXAMPLE 2

 A company intends to design a new

product, Wedding cake; it currently
estimates that in the current market,
the product could be sold for $900.00 a
unit. A gross profit margin of 30% on the
selling price would be required to cover
administration, marketing overheads
and also make an acceptable level of
profit. A cost estimation study has
produced the following estimate of
production cost for chicken lick.
 Direct material m1 $90/unit
 Direct material m2 each unit would
require 3kgs of material m2 . Material
m2 cost $111.80 per kg. Direct labour –
each unit of Wedding cake will require
0,5hours of direct labour time. total
labour time paid at $190 per hour.
 Production overheads –it is expected
that production overheads will be
absorbed to production cost at a rate of
$600 per direct labour hour for each
labour hour worked
 Required
 To calculate:
 i) Expected cost per wedding cake.
 ii) Target cost for wedding cake.
 Iii) The size of the cost gap
SOLUTION
 Production cost of chicken lick

 a) Expected cost of the product

 Direct material m1 90.00

 M2 (3kg*$111.80) 335.40

 Direct labour- (0.5hrs*$190) 95.00

 Prime cost 520.40
 Production overheads ($600*0.5) 300.00
 Expected production cost 820.40
 b) Calculation of target cost

Selling price 900

Minimum expected return (30%*900.00)
270
Target cost
630
 c) Cost gap
= expected cost –target cost

=820.40 - 630.00= 190.40

 The company needs to identify ways of
closing the gap.
STEPS TO CLOSE THE GAP
Value Engineering
 is a systematic inter-disciplinary
assessment of factors affecting the cost
of a product or service. Its objective is to
reduce cost while satisfying customer
needs.
 It can result in improvements in product
design, changes in material
specifications, or modifications in
process methods.
 The aim of value engineering is to
achieve the assigned target cost by:
1. Identifying improved product designs
that reduce the product’s cost without
sacrificing functionality (design analysis)
2. Eliminating unnecessary functions that
increase the product’s costs and for
which customers are not prepared to
pay extra (functional analysis)
 Changing material specifications without
affecting the quality of the material.
 Kaizen means continuous improvement,
that is, the ongoing search for new ways
to reduce costs in the manufacturing
process of a product with a given design
and functionality.
 Bulk buying to enjoy economies of scale
ADVANTAGES OF TARGET COSTING

 i) It helps to improve the understanding

within a company of product cost and.
recognizes that the most effective way
of reducing costs is to plan and control
cost from the design stage onwards.
 ii) Increases customer satisfaction, as
design is focused on customer values
and hence reduces costs, through more
effective and efficient designs
 iii) Helps the firm achieve desired
profitability on new or redesigned
products and as such can decrease the
total time required for product
development, through improved
coordination of design, manufacturing,
and marketing managers.
 iv) it can help provide a competitive
edge in times of economic recession, as
well as improve overall product quality,
as the design is carefully developed and
manufacturing issues are considered
explicitly in the design phase.
LIMITATIONS

1 It is sometimes unrealistic hence

unachievable targets are set.
2 May demotivate workers if they fail to
meet their targets.
IMPLICATIONS OF TARGET
COSTING
 Pricing- competitive pricing can be set
and still making required profit
 A policy of penetration pricing can be
pursued
 It centers on reducing cost in order to
meet the target cost
 It fosters new ideas and new ways of
thinking through value engineering
 Thank you