Targeting costs
1 Definition of target costing
Target cost
A target cost is a cost estimate derived by subtracting desired profit margin from a competitive market price.
In effect it the opposite of conventional ‘cost plus pricing’ and is sometimes referred to as ‘price minus costing’。
It may be used in both manufacturing and service industries.
The main theme behind target costing is thus not finding what a new product does cost but what it should or needs to cost. The firm can then focus on which costs can be reduced and which can not to see whether such a target cost is achievable. Obviously cost reductions must be seen in the context of quality concerns as well. This will involve product comparisons with the competitors used to set the competitive market price in the first place.
Illustrative 4 targeting costs
§ Sony
§ Toyota
§ Swiss watchmakers – Swatch.
Test your understanding 6
Briefly identify the implications for a profit-orientated organisation if it chooses to use cost plus pricing.
2 Deriving a target cost
Steps
1 Estimate a selling price for a new product that will enable a firm to capture a required share of the market.
2 Reduce this figure by the firm’s required level of profit. This could take into account the return required on any new investment and on working capital requirements or could involve a target margin on sales.
3 Produce a target cost figure for product designers to meet.
4 Reduce costs to provide a product that meets that target cost.www.ExamW.CoM
Illustration 5 – Targeting costs
Katy Inc, a toy manufacturer, is about to launch a new type of bicycle on which it requires a Return on Investment of 30%.
Buildings and equipment needed for production are to cost $5,000,000.
Expected sales levels are $40,000 toys pa at a selling price of $67.50 per item costs are currently estimated to be $32 per unit.
Required:
What is the target cost for annual production?
Solution
Working$
Revenue（67.50×40,000）2,700,00
Target costs（balancing figure）（1,200,000）
Target return（30%×5,000,000）1,500,000