Target Costing
Learning Objectives
What
Product life-cycle
Objectives
Characteristics
Stages/ Process
Types
Numerical
Advantages/ Disadvantages
What
It was introduced in Japan
It is a cost management tool for reducing the overall cost of a product
over its entire life-cycle with the help of production, engineering ,
research and design.
It is maximum amount of cost that can be incurred on a product and
with the firm can still earn the required profit margin from the product
at a particular selling price.
Target Cost thus refers to product cost estimate after deducting
certain percentage of profit from the selling price
Formula: Target Costing= Selling Price- Profit Margin
Product chain
It is applied at the initial stages of product development and applies throughout product
life-cycle by actively involving entire value chain ( Research- Raw material-Manufacturing-
packing-selling product)
Purchase of Manufacturin Selling
Research Packaging
Raw material g Products
Objectives
To lower cost of new products so that the required profit margin
ensured
The new products meet the levels of quality, delivery time and price
required by the market
To motivate all company employees to achieve the target profit
during new product development by making target costing as a profit
management activity
Characteristics of Target costing
Company is Price taker rather than a Price maker
It is viewed as an integral part of the design and introduction of new
products
A target selling price is determined using various sales forecasting
techniques
Target selling price is the establishment of target production volumes,
given the relationship between price and volume
The minimum required profit margin is already included in target SP.
Target costing process is to determine, cost reduction targets
A team is formed to carry out activities like; designing the product,
purchasing the raw material, manufacturing and research to reduce
overall costing
Stages in Target costing
Stage 1- What the company is selling and to whom? What the customer want it to do? What features they want?
Quality of product.
Stage 2 -What will the customer pay for it and what should it cost to produce? Competitors prices, Level of
production, volume
Stage e 3- Long term strategy of the company. Achieve the Target- How we get there. Are we getting there
Stage 4- Target Cost= SP – Profit
Stage 5 -Costs- Fixed and variable
Stage 6 and 7- Maintain competitive cost. How can we stay ahead?- Target cost is to be dependent variable
Market- Target
Customer Profitability -
Selling Price Setting Target
Product Design Target profit
and Production Cost
Specification Margin
Volume
Identifying cost Setting cost
Computing
reduction Reduction
Current Cost
opportunities targets
Types of Target Cost Gap- Cost reduction
opportunities
Types of
Target Cost
Gap
Value Value Functional
Analysis Engineering Analysis
Reducing of components
Reduce labour cost-Training, learning curve, motivation
Using standardization- Less wastages
Acquiring efficient technology- less inputs, saves time
Non-valueadded activities to be eliminated
Using substitute material
Numerical 1
A company sells its products at Rs. 1000 per unit. One of the competitor’s reduces price by 15%. Now the
company wants to reduce price by 20% and expects that the present volume of 1,50,000 units p.a. will
increase to 2,00,000. A Company wants to earn a 10% target profit on sales. The data given is as follows:
(Note :Manufacturing overheads are allocated using relevant cost drivers.). Find the Total Target Cost.
Particulars Existing Target
Direct Material cost per unit 400 385
Direct labour cost per unit 55 50
Direct Machinery cost per unit 70 60
Total Direct Manufacturing 525 495
Cost per unit
Overheads: No. of orders (Rs. 22500 21250
80 per unit)
Testing hours (Rs. 2 per hour) 4500000 3000000
Units reworked (rs. 100 per 12000 13000
unit)
Other operating costs per unit for the expected volume are estimated as follows:
Particulars
R&D 50
Marketing promotion 130
Solution 1
SP= Rs. 1000 Alternative Target Costing
Direct Cost = Rs. 495
- 20%= -200
Rs. Overheads
No. of orders= (21250*80)/200000=Rs.
New SP = rs.
8.5 per order
800
Testing hours= 30,00,000*2/2,00,000=
- 10%= 80 Rs. Rs.30 per hr
Unit reworked= 13000*100/2,00,000=
Target Cost =
6.5 per unit
Rs. 720
Total Mfg Cost = Rs. 540
R&D Cost= rs. 50
Marketing promotion –Rs. 130
Total Target Cost – Rs. 720
Advantages
Process Improvements :Quality and innovation into the product
Customer expectation: Balance between quality and cost so to make
it affordable
Economies of scale: Increase in volume to reduce cost and increase
financial performance
Market Opportunities: Lower cost to competitors
Disadvantages
Rely on final selling price: Error in estimating SP may fail the whole
marketing strategy
Low estimation of SP: It will burden the total cost and production
department
Inferior technology: compromise on technology and raw material
Ascertaining Quantity: not able to sell the units which will have major
losses.
