Target Costing

Dr. Bhakti V Dandekar

Meaning

Target costing is a system under which a company plans in advance for the
price points, product costs, and margins that it wants to achieve for a new
product.

With target costing, a management team has a powerful tool for continually
monitoring products from the moment they enter the design phase and onward
throughout their product life cycles.

It is considered one of the most important tools for achieving consistent

profitability in a manufacturing environment.
It is a management technique

prices are determined by market conditions, taking into account several factors,
such as homogeneous products, level of competition, no/low switching costs
for the end customer, etc.
Features of Target Costing

● The price of the product is determined by market conditions. The company is a price
taker rather than a price maker.
● The minimum required profit margin is already included in the target selling price.
● It is part of management’s strategy to focus on cost reduction and effective cost
management.
● Product design, specifications, and customer expectations are already built-in while
formulating the total selling price.
● The difference between the current cost and the target cost is the “cost reduction,”
which management wants to achieve.
● A team is formed to integrate activities such as designing, purchasing,
manufacturing, marketing, etc., to find and achieve the target cost.
Advantages of Target Costing
● It shows management’s commitment to process improvements and
product innovation to gain competitive advantages.
● The product is created from the expectation of the customer and, hence,
the cost is also based on similar lines. Thus, the customer feels more value
is delivered.
● With the passage of time, the company’s operations improve drastically,
creating economies of scale.
● The company’s approach to designing and manufacturing products
becomes market-driven.
● New market opportunities can be converted into real savings to achieve the
best value for money rather than to simply realize the lowest cost.
Disadvantages of Target Costing
● Any miscalculation in target costing, which depends on the estimation of
the product's final selling price, could lead to the failure of the entire
marketing strategy.
● The business can use less expensive technology or materials to meet the
target cost, which is ultimately unfavourable and even turns out to be the
worst disadvantage.
● Target costing can place an unreasonably heavy strain on the production
line when the predicted cost is too low.
● A loss may result when the company doesn't sell all of the quantity it
produces due to improper quantity assessment.
Steps in the process
1. Conduct Market Research- review the marketplace and product features that
customers are most likely to buy, and the amount they will pay for those features.

In marketing, customers rule, and marketing departments attempt to find answers

to the following questions:
● Are customers homogeneous or can we identify different segments within
the market?
● What features does each market segment want in the product?
● What price are customers willing to pay?
● To what competitor products or services are customers comparing ours?
● How will we advertise and distribute our products? (There are costs
associated with those activities too)
2. Identifying the market:

The information collected via market research proves a blessing for the business entity. It informs about the
types of products prevalent in the market, level of competition it can face, number of rival companies that it will
have to handle and the prices at which the products are already available in the market.

It is also vital to get an estimate of the amount which a customer considers affordable pricing so that it can
make its adjustments.
3. Product features

Gaining information about the preference of a customer is a tedious process as their wants and needs may
vary from one to another. The organization takes into account the average requirement and converts them
into a tangible entity called a product.

Now it needs target costing to follow the needed path for its growth and prosperity
4. Product design

The organization designs a product that it considers suitable for the prevalent market conditions by analyzing
needs of the customer, prevalent marker forces, models adopted by rival companies, relevant technology,
process capabilities, design alternatives, and service requirements.

5. Determine cost, margin, and price

It is the market survey that determines the target selling price of a product. The business entities also add
standard margin in the target selling price.
6. Value engineering process

Carry out a value engineering process if you are interested in reaching the target cost.

7. Improve designs

The organization can conduct a trial production in small scale to ensure target profit margin, target cost, and product
performances. It ends when you find the match between target cost and product design.

8. Formal approval

The top management receives a detailed report about the design of a particular product, costs to be incurred, and
elements of cost and production process for a formal approval so that the company can say yes to commercial
production.
9. Maintaining accounts

It is vital to maintain separate accounts for each product design so that you can verify whether total expenses
exceed the target cost for any product.

10. Implementing target costing

The organization acquires the necessary information in relation to the expenses that have incurred for every
design and that too separately. It keeps a close watch so that it can nudge the total cost within the target cost.
Throughput Costing

Throughput costing is a system

whereby only direct material cost is
considered as variable and all other
costs are treated as “period cost”.
Throughput costing, also known as super-variable costing, is a relatively
recent concept

Throughput costing only makes sense for manufacturing organisations when

the majority of labour and administrative expenses are fixed. Highly
automated assembly-line and continuous operations are more likely to fit this
requirement.
Businesses uses throughput accounting as an intelligent mechanism to plan production.

The purpose of using this accounting approach is profit maximization.

The basic science of throughput accounting is that scarce resources should be utilized for products
that produce the highest return while using the lowest scarce resource. So, production decision is
taken on the basis of scarce resource utilization.
Advantages

1. Helps to formulate the best possible production plan. This plan leads to maximum utilization
of scarce resources and maximum profit.
2. It helps closely understand contribution, production procedures, fixed cost behavior, and
variable costs.
3. Throughput concepts can be applied quickly; it’s flexible in terms of application and greatly
help in decision making.
4. It’s rational and considers product demand while making a production plan.
Disadvantages

1. It can be difficult to understand the concept of throughput accounting.

2. It’s not easy to compile small details like variable and fixed production elements.
3. The concept is only applicable when you have bottleneck resources and multiple products.
4. It’s a short-term approach to profitability that does not consider long-term objectives that
might be achieved by selling some other product mix rather than suggested by throughput.
5. The application can be more complicated if there are multiple bottlenecks.