Target Costing

---

Target Costing – Involves setting a target cost by identifying target selling price and then deducting the required profit margin to reach a target cost.

There are the following seven steps to implement target costing

1. 1. Product specification : determine a product specification of which an adequate sales volume is estimated.
   2. Target selling price: we will decide a target selling price that company can sell the products and achieve market share.
   3. Target Profit : we need to estimate required target profit how much we want
   4. Target Cost : target cost = target selling price – target profit
   5. Estimated Cost : we will estimate cost for product based on the initial design specification and current cost levels.
   6. Cost gap : target cost gap = estimated cost – target cost
   7. Closing cost gap – if we want to achieve target profit, so we will try to close cost gap.

How to Close Cost Gap

Avoiding loss of value to the customer: Closing the cost gap should use smart ways; it should not lose value to the customers when we try to reduce cost of product.

Various techniques can be employed to close the cost gap.

1. 1. • Removal of non-value-adding features
      • Reducing the number of components
      • Using standard components wherever possible
      • Acquiring new and more efficient technology
      • Product redesign
      • Using cheaper employee
      • Training staff in more efficient techniques
      • Using alternative materials etc.

Example

ABC Company manufactured and sold product Y. Company decided to estimate a target selling price of $70. This is the price that will have to sell the product to achieve the required sales volume. Estimated costs have been prepared based on the proposed product specification.

Production cost :

Direct material …………30

Direct labor……………….20

Production overhead……5

Non-Production Cost :

Marketing expense…….3

Distribution cost………..2

The target margin for Product Y is 20% of the target selling price.

Required
1. Calculate the target cost and target cost gap.

2.Calculate the target cost gap.

3.Recommend way to close cost gap.

Answer

1.Target cost

Target cost = target selling price – target profit

Target selling price = $70

Target profit = $70 x 20%=14

Target cost = 70-14=$56

Target cost is $56.

2.Target cost gap

Cost gap = estimated cost – target cost

Estimated cost = 30 + 20 + 5 + 3 +2=$60

Target cost = $56

Cost gap=60-56=$4

Cost gap is $4.

3.Way to close cost gap.

ABC Company wants to get profit of $14, but estimated cost is $60, so profit will be $10 ( $70-$60). To reach required profit of $14, we must close cost gap of $4 (from $4 to reach $0).

Various techniques can be employed to close the cost gap.

1. 1. • Removal of non-value-adding features
      • Reducing the number of components
      • Using standard components wherever possible
      • Acquiring new and more efficient technology
      • Product redesign
      • Using cheaper employee
      • Training staff in more efficient techniques
      • Using alternative materials etc.

Please note: closing the cost gap should not lose value to the customers if so you will lose your customers.