Target Costing

ACCA F5 - Performance Management 

'Cost-Volume-Profit-Part2' last paragraph we see how firms establish their selling price to achieve target profit. This way where firms adjust their selling price to stay in desired profit margin/markup is known as target pricing. Traditional, push based mechanism focused in target pricing. However, there is alternative way to stay competitive in price and not reducing the profit level. This technique is known as target costing.

Target costing is driven by modern market led mechanism. Under target costing first revenue is determined and the expected profit margin is deducted from the selling price to arrive at the cost of producing goods/services. (i.e. Target costing is a product cost estimated derived by subtracting a desired profit margin.) There are different ways to reduce cost gap (i.e. the difference between the current cost and the target cost). Example of cost reduction: Multinational textile industries are renowned in moving their production center to low labor cost countries like Bangladesh and Philippines.

Different approaches to reduce cost gap are:

Ø  Changing material composition without hampering quality

Ø  Operating in Just in Time environment where possible

Ø  Reducing waste and increasing efficiency through Kaizen management

The key features of target costing are:

Ø  Market let approach - focus on customer - costing starts before production of goods and services

Ø  Consider life cycle of the product - evenly distributes research/development/environmental costs

Ø  Kaizen costing - continuous improvement of production system and iteration of cost for best estimation

Ø  Provides cost target - reducing waste and increasing efficiency

Synopsis from the article

Value analysis CIMA Official Terminology: Value Analysis is "systematic inter-disciplinary examination of factors affecting the cost of a product or service, in order to devise means of achieving the specified purpose most economically at the required standard of quality and reliability".

Value engineering CIMA Official Terminology: Value engineering is "Redesign of an activity, product or service so that value to the customer is enhanced while costs are reduced (or at least increased by less than the resulting price increase)".

Value engineering relates closely to target costing as it is cost avoidance or cost reduction before production. Value analysis is cost avoidance or cost reduction of a product already in production; both adopt the same approach (details below) i.e. a complete audit of the product.

Value Analysis, Functional Analysis, Value Engineering andTarget Costing

CPA Ireland Article:Target costing