Target costing is a technique used to design products and processes to achieve a target cost that allows the product to be sold at a predetermined price and achieve the desired profit margin. It focuses on reducing costs during the design stage when changes are easier to make. Implementing target costing involves determining specifications, price, profit, and calculating the target cost. The gap between estimated and target costs is then closed through redesigning the product or process. Value analysis examines which features customers value and which costs can be reduced without affecting customer perceived quality.

1. TARGET COSTING
Prepared by: Jessy Chong
URL: chongsk818.blogspot.com

2. TARGET COSTING
 Target costing is concerned with designing a product and its
production process so that it can be made and sold at a cost
that delivers the required profit at the chosen price. It focuses
on getting the expected cost of a product down to a target cost
amount. Achieving a target cost will usually require some re-
designing of the product and the removal of unnecessary costs.
 In many markets, new product innovation and the re-designing
of existing products is a continual process. Target costing is
most effective at the product design stage; rand is less effective
for established products that are made in established
processes. At the design stage, it is easier and cheaper to make
changes that reduce costs.

3. EXAMPLE:
 The number of different components in a product, that have to be
assembled in the production process
 Whether the components are standard or not: using standard
components can reduce costs
 Deciding to exclude design features on the product that do not add any
value for the customer
 Using cheaper materials to make the product, where this does not
affect product quality
 Simplifying the production process, for example to make it easier and
quicker to change over tools.

4. IMPLEMENTING TARGET COSTING
 Step 1: Determine a product specification of which an adequate sales volume
is estimated.
 Step 2: Decide a target selling price at which the organization will be able to
sell the product successfully and achieve a desired market share.
 Step 3: Estimate the required profit, based on required profit margin or return
on investment.
 Step 4: Calculate: Target cost = Target selling price – Target profit.
 Step 5: Prepare an estimated cost for the product, based on the initial design
specification and current cost levels.
 Step 6: Calculate: Target cost gap = Estimated cost – Target cost.
 Step 7: Make efforts to close the gap. This is more likely to be successful if
efforts are made to ‘design out’ costs prior to production, rather than to
’control out’ costs after ‘live’ production has started.

5. ILLUSTRATION
Illustration 1
 A car manufacturer wants to calculate a target cost for a new car, the price of
which will be set at $17,950. The company requires an 8% profit margin on
sales.
 Required:
 What is the target cost?
 Illustration 2
 Funtoosh Ltd decided to launch a new sewing machine in the market. The
management of the company expected to maintain an ROI of 25%. The initial
investment required to launch the new machine was $6,250,000.
 Annual sales level was estimated at 5,500 machines at $1,500 per machine.
 Required:
 What is the target cost per machine?

6. CLOSING S TARGET COST GAP
 The target cost gap is the estimated cost less the target cost. When a product is first
manufactured, its currently-attainable cost may be higher than the target cost.
Management can then set benchmarks for improvement towards the target cost, by
improving production technologies and processes. Various techniques can be
employed.
 Reducing the number of components
 Using cheaper staff
 Using standard components wherever possible
 Acquiring new, more efficient technology
 Training staff in more efficient techniques
 Cutting out non-value-added activities
 Using different materials (identified using activity analysis etc)
 However, the most effective time to eliminate unnecessary cost and reduce the
expected cost to the target cost level is during the product design and development
phase, not after ‘live’ production has begun.

7. VALUE ANALYSIS
 A key aspect of this is to understand which features of the
product are essential to customer perceived quality and which
are not. This process is known as ‘value analysis’. Attention
should be focused more on reducing the costs of features
perceived by the customer not to add value.
 Value analysis, otherwise known as ‘cost engineering’ and
‘value engineering’, is a technique in which a firm’s products,
and maybe those of its competitors, are subjected to a critical
and systematic examination by a small group of specialists.
They can be representing various functions such as design,
production, sales and finance.

8. VALUE ANALYSIS (CONT’D)
Value analysis asks of a product the following questions:
 Does the use of the product contribute value?
 Is its cost proportionate to its usefulness?
 Does it need all of its features?
 Is there anything better for the intended use?
 Can a usable part be made better at lower cost?
 Can a standard product be found which will be equally usable?
 Is it made on appropriate tooling, considering the quantities
used?
 Do material, labour, overheads and profit constitute total cost?
 Will another dependable supplier provide it for less cost?
 Is anyone buying it for less than its stated price?

9. VALUE ANALYSIS (CONT’D)
 The strategic implications can be measured in terms of a component’s relative
cost versus its relative performance. There are four different situations:
 If a component is both more expensive than an inferior to that of a competitor,
a strategic problem requiring change might be necessary. It could be, however,
that the component is such a small item in terms of both cost and impact on
the customer that it should be ignored.
 If the component is competitively superior, a value analysis, where a
component’s value to the customer is quantified, may suggest a price increase
or promotion campaign.
 If a component is less expensive than but inferior to that of a competitor, a
value analysis might suggest either deemphasising that part or upgrading the
relative rating.
 If a component is less expensive than and superior to that of a competitor, a
value analysis might suggest that component is emphasised, perhaps playing a
key role in promotion and positioning strategies.

10. PROBLEMS WITH TARGET COSTING FOR
SERVICES
 Services are much more difficult to specify exactly. This is due to some of the
characteristics of a service.
 Intangibility. Some of the features of a service cannot be properly specified because
they are intangible. What exactly does a customer receive, for example, when he or she
goes to a cinema? When services are provided by a human, the quality of the personal
service can be critically important for the customer, but this is difficult or impossible to
specify.
 When services do not have any material content, it is not possible to reduce costs to a
target level by reducing material costs. In comparison, reducing material costs can be
an effective approach to target costing for products.
 Variability/homogeneity. A service can differ every time it is provided, and a standard
service may not exist. For example, repairing a motor car, providing an accountancy
service or driving a delivery truck from London to Paris is never exactly the same each
time. When services are variable, it is possible to calculate an estimated average cost,
but this is not specific and so not ideal for target costing.