Target Costing

Target Costing
 Is not just a method of costing, but rather a management technique wherein prices
are determined by its market conditions, several factors that could be taken into
account, an example would be products, level of competition and the shifting of
costs.
 This is a very useful way to manage its needed trade-off between the increased
functionality and higher value of products.

Target Costing in the Cost Life Cycle
Advantages of Target Costing:
 With the passage of time, this improves the company’s operations and create economies
of scale.
 This proves management’s commitment to process its improvements and innovation of
products to gain competitive advantages.
How to reduce costs to a target cost level
1. Combine new manufactured technology using an advanced cost management techniques

in particular a costing which is an activity-based and seek for a higher productivity
through improved organizations as well as its labor relations.
2. Modify the product and service.
Steps in Implementing a Target Cost Approach
1. Determine the market price

2. Determine the desired profit
3. Calculate the target cost at market price less desired profit
4. Use value engineering to identify ways to reduce its product cost
5. Use kaizen costing and operational control to further reduce costs
The following sections will explain the fourth and fifth steps:
a. Role of Value Engineering
Value engineering is used in target costing to reduce the cost of product by analyzing the
trade-offs between the types and level of the products’ functionality and its total cost of
product. The type of value engineering that would be use depends on the product’s
functionality. A common type of value engineering which is known to be active in these
firms is functional analysis in which the performance and the cost of each major function
or the product’s features will be examined.
Cost Reduction Approaches:
 Design Analysis- is the common form of value engineering for the products which
is assigned in group two, industrialized and specialized products. The design team
works with one of the cost management personnel to properly select the one
design that meets the preferences of the customers without exceeding its prepared
target cost.
 Cost tables- These are a computer-based databases which includes comprehensive
information about the driver of the firm.
 Group technology- is a method of identifying the similarities in the parts of
product that a firm will manufacture. So, the same parts can be used in different
products that will cause to reducing of costs.
b. Kaizen costing and operational control
The fifth step in the target costing is to use the kaizen costing and operational control to
reduce costs. This occurs in the manufacturing stage the effects of value engineering and
the designs are much improved. The role for cost reduction in this phase is to develop
manufacturing methods and to use new management techniques. Kaizen means
“continuity of its improvement”, that clearly means that there will always be an
improvement of every cost in the manufacturing process that will lead to reduce the costs.
Required:
1. Calculate the target cost for maintaining current market share and profitability
2. Can the target cost be achieved? How?
Solution to Illustrative Case IV: Target Costing
Requirement 1:
Current unit cost: P11,169,000/25,000 units= P446.76
Current profit per item:
Current selling price P510
Less: Current unit cost 446.76
Profit per item P 63.24

Target cost to meet the competitive price:
Competitor’s price P450
Less: Desired Profit 63.24
Target cost P386.76
Requirement 2:
The target cost can probably be achieved by efforts in two areas:
a. The standard cost analysis shows an unfavorable materials variance of P375,000

(P5,500,000 – P5,125,000) or P15 per unit, a very significant variance. Efforts to reduce
or eliminate this variance will make this firm much more competitive. Notice that the
labor usage variances, both for direct and indirect labor, are favorable, so it appears no
additional work is needed here, assuming the standards are properly set.
b. The manufacturing costs except for direct materials and direct labor can be considered
non-value adding costs, since they do not add to the functionality or quality of its
product. Efforts can be made to reduce the total cost of these manufacturing costs, which
now total a significant P3,999,000 or P159.96 per unit.
References:
Target Costing - Key Features, Advantages and Examples (corporatefinanceinstitute.com)
Strategic Cost Management (Cabrera) 2021 Edition

Target Costing

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Target Costing

Target Costing in the Cost Life Cycle

Advantages of Target Costing:

How to reduce costs to a target cost level

1. Combine new manufactured technology using an advanced cost management techniques

Steps in Implementing a Target Cost Approach

1. Determine the market price

a. Role of Value Engineering

Cost Reduction Approaches:

b. Kaizen costing and operational control

Solution to Illustrative Case IV: Target Costing

Current unit cost: P11,169,000/25,000 units= P446.76

Current profit per item:

Current selling price P510

Less: Current unit cost 446.76

Profit per item P 63.24

Competitor’s price P450

Less: Desired Profit 63.24

Target cost P386.76

The target cost can probably be achieved by efforts in two areas:

a. The standard cost analysis shows an unfavorable materials variance of P375,000

Target Costing - Key Features, Advantages and Examples (corporatefinanceinstitute.com)

Strategic Cost Management (Cabrera) 2021 Edition

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