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Using relevant examples, distinguish between target costing and activity based costing.

Target costing is a method that aims to manage the costs before they are realized and to realize
target profit realizable cost without making any concessions on quality.

It emerged as a result of being focused on the market related to product development and pricing
and emerged as a strategic cost reduction and management method that is mostly used to advance
product life cycle and used in product designing processes.

It calculates a predetermined cost of manufacturing a product to serve as a reference and to


determine if the project will be profitable.

It aims to improve competitiveness of the businesses by means of ensuring their management


of activities regarding the products they manufactured to be market oriented and cost-
oriented.

It has become a modern approach that focuses on the planning and designing phases of the
costing process, and aims to ensure the product is manufactured in accordance with the target
cost acquired by subtracting the target profit from the determined target sale price.

Target costing is a product development strategy that is concentrated on customer


expectations and new opportunities in the market, and it is identified as management process
of strategical profit and cost

Sakurai and Monden described target costing as an effective cost management


tool for reducing the product cost comprehensively with the help of other departments in the
business.
Target costing is defined as “a product cost estimate derived from a competitive market price”.

Target costing involves the technique wherein prices are determined by market conditions, taking
into account several factors such as homogenous products.

The alternative formula for estimating Target cost.

If the product base on the selling price;

Target cost=selling price- (selling price*profit%)

If the profit margin base on cost;

Target cost =selling price/ (1+profit%)

The company has no control over the the price setting; instead, the market determines it.

The selling price includes the minimum profit margin that the company desires.

Below are the principles of target costing and the processes involved;

THE PRINCIPLES INCLUDE;


Price led costing

Focus on the customer

Focus of process and design

Cross-functional teams

Value chain involvement

PROCESS;

step1: conduct research

Step2: set the selling price

Step3set the target profit margin

Step4: calculate the target cost

Step5: calculate cost gap and lastly close cost gap.

While,

The first of these approaches was Activity-based Costing method (ABC) that is developed to

ensure the desired accuracy of the informations used in managerial decisions of the
businesses, and to ensure the monitoring thus controlling of the costs as required.
ABC method that uses activities as base while indirect costs are being allocated,
eliminated the miscalculations caused by conventional costing method which undercharges
the cost to small-scale products and overcharges the cost to large-scale products. The method
also emerged as a system that provides cost data to the management about the decisions they
make regarding the products and as a method that charges costs to products in accordance
with the amount of activities they required
The method
also emerged as a system that provides cost data to the management about the decisions they
make regarding the products and as a method that charges costs to products in accordance
with the amount of activities they required. Following this, ABC has also been realized into
budgets, thus activity-based budgets have been developed. In this way, ABC’s connection to
operational control has been established.
ABC enables more accurate and precise calculations in situations such as indirect
costs that are not directly charged to the product cost. Because, allocating indirect costs in
volume-based methods is not easy.
b) examine the applications of target costing in the transport sector

The use of target costing in the development of new products such as MERCEDEZ BENZ M-class,
target costing prices treat selling prices and margins as uncontrollable variables, because the
markets determine selling prices and companies.

Mercedes should continue to use target costing as it is a systematic process of enterpriser-wide cost
management and profit planning.

Firms use financial data from their cost management systems to plan, and control operations in their
supply chain.

In addition to that; target costing helps in the establishment of a product cost and other additional
services moving through the supply chain.

Target costing is most applied to companies that compete by continually issuing a stream of new or
upgraded products into the market place for example consumer goods. For them target costing is a
key survival tool.

Conversely target costing is less necessary for those companies that have a small number of legacy
products that require minimal updates.

For which long term profitability is more closely associated with market penetration and
geographical coverage such as soft drinks.

Since its introduction in 1960`sby Toyota, the use of target costing has significantly grown, as
evidenced by its presence in almost all sectors.

However, its particularly popular amongst Japanese firms such as Toyota, Nissan, Toshiba and
Daihatsu Motor in various industries such as automobile, electronics, machine tooling, and precision
machine manufacturing

During the times of early 1990s, over an 80% of Japanese assembly manufacturing firms were using
target costing (lockamy and smith,2000).

Target costing can be used in determining transport service prices; public transport services in
Kampala city are largely made up of minibus, motorbike taxis

Several cities have attempted to target the informal and semi-formal transport sector to improve
city-wide connectivity, ranging from outright bans to upgrading of the informal system
Target costing helps to compare four broad policy directions cities have adopted when interacting
with informal transport providers and highlights key lessons to inform informal transport reform in
Kampala.

Despite it’s mentioned that the main idea of target costing and the first applications
are emerged at Ford Motor in USA in early 1900s and it’s implemented at Volkswagen in
Germany in early 1930s, the first systematical operation and development is realized in
Japanese Toyota Company in the mid-1960s. After that, it’s partially used in other European
countries, particularly in Germany and USA. (Koçsoy and Gürdal, 2008:77) It has found a
wide operation area in Japan with 100% in transportation equipments industry, 88% in
electrical and electronics industry, 83% in machine manufacturing industry and 67% in
metalware industry. (Yılmaz and Baral, 2009: 3) Cost reducing in planning and designing
stages is an important matter in Japan since the production is substantially assembly-based.
Japanese cost accountants have to calculate 100% of product costs in marketing and
designing stages. And this indicates how the target costing concept is developed. (
c) discuss the advantages and disadvantages of target costing in the transport sector.

ADVANTAGES;

The following are the main advantages of target costing;

It establishes early on the profitability of a product and serves as a valuable guide through out the
products life cycle to reduce the cost and labor of manufacturing it.

It’s a proactive method of costing therefore you have clear financial goals regarding production and
sale of goods.

It helps to understand if there is need to improve processes and bring innovation to achieve cost
targets.

It enables the exploration of new market opportunities.

New market opportunities can be converted into real savings to achieve the best value for money
rather than to simply realize the lowest cost.

The company’s approach to designing and manufacturing products becomes market-driven

With the passage of time, the company’s operations improve drastically, creating economies of scale

The product is created from the exception of customers and, hence, the cost is also based on similar
lines. Thus, the customer feels more value is delivered
It shows management’s commitment to process improvements and product innovation to gain
competitive advantages.

DISADVANTAGES;

The following are the main disadvantages of target costing;

It might result in an excessive burden to control the cost for example an existing supplier may be
enjoying economies of scale due to strong roots hence they may be able to supply the cheap product
so they need to make some manual adjustments to the product’s market price.

An attempt to control cost may compromise as the manager might use cheap material and
technology to keep the cost under control.

Sometimes the team may decide to go forward with an inferior product to meet the target costing.

The project has to work tirelessly to meet the target cost.

Since the approach involves the contribution of several people, it often gets difficult to reach
consensus.

Reducing cost may sometime hurt employee’s morale.

Often the development process is very lengthy because the product has to go through several
alterations to meet the target cost.

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