Performance management. Target costing. (Topic 1) презентация

Exam guide
Target costing may be examined in Section A multiple choice questions or it may form a part of a Section B mini case study question where a calculation of a target cost may be required, followed by a multiple choice question on the theory of target costing.
ACCA exam references

1. What is target costing?
Target costing involves setting a target cost for a product, having identified a target selling price and a required profit margin. The target cost equals the target selling price minus the required profit.
Target cost = Selling price – Required profit
or
Target cost = Selling price × (1 – required profit margin)
Selling price – determined mainly by outside factors and cannot be manipulated in competitive environment.
Required profit margin – is that minimal level of return required by the owners of a business.
Target costing focuses on getting the expected cost of a product down to a target cost amount.
Estimated cost of a product
Target cost for a product
Should be reduced to

1. What is target costing?
Target costing is most effective at the DESIGN stage and less effective for established products that are produced in established processes.
At the design stage it is easier and cheaper to make changes that reduce costs.
Examples of decisions made at the design stage which impact the cost of a product:
The number of different components in a product that have to be assembled in the production process
May we use standard or specific components: use of standard components is usually cheaper
We should exclude design features of the product that don’t add value to the end user
Use of cheaper inputs such as materials or labor – where possible in order not to negatively impact the set quality of the product
Simplifying the production process – like automation, modern management techniques, etc.
Etc.
When a product is first planned, its estimated cost will often be higher than the target cost. The aim of the target costing is to find ways of closing the target cost gap, which would enable production and sales of a product at target cost and price.

2. Implementing target costing
Usually target cost is based on target selling price per unit, however it may also be based on the expected volume of sales

2. Implementing target costing – Case study
Swedish retailer IKEA dominates the home furniture market in many countries. The “IKEA concept” as defined on the company’s website www.ikea.com is “based on offering a wide range of well designed functional home furnishing products at prices so low that as many people as possible will be able to afford them.”
IKEA is widely known for pricing products at 30-50% below the price charged by competitors. Extracts from the website outline how the company has successfully employed a strategy of target pricing.
While most retailers use design to justify a higher price, IKEA designers work in exactly opposite way. Instead they use design to secure the lowest possible price. IKEA designers design every IKEA product starting with a functional need and a price. Then they use their vast knowledge of innovative, low-cost manufacturing processes to create functional products, often coordinated in style. Then large volumes are purchased to push prices down even further.
Most IKEA products are also designed to be transported in flat packs and assembled at the customer’s home. This lowers the price by minimizing transportation and storage costs. In this way, the IKEA concept uses design to ensure that IKEA products can be purchased and enjoyed by as many people as possible.

3. Deriving a target cost
Example 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 target cost?
Solution:
Profit required = 8% × $17’950 = $1’436
Target cost = $(17’950 – 1’436) = $16’514 or = $17’950 × (1-0.08) = 16’514

3. Deriving a target cost
Example 2: Target costing and the target cost gap
Great Games, a manufacturer of computer games, is in the process of introducing a new game to the market and has undertaken a market research to find out about customers’ views on the value of the product and also to obtain comparison with competitors’ products. The result of this research have been used to establish a target selling price of $60. This is the price that the company thinks it will have to sell the product at to achieve the required sales volume.
Cost estimates have been prepared based on the proposed product specification.
Solution:
Target selling price -> $60
Target profit margin (30% of selling price) = $18
Target cost = $(60 – 18) = $42
Projected cost =
3.21+24.03+1.12+0.23+4.60+8.15+3.25+1.30 = $45.89
Target cost gap = $(45.89 – 42) = $3.89
Required:
Calculate the target cost of the new game and the target cost gap.
Great Games has to investigate ways to reduce the cost from the current estimated amount down to the target cost.

4. Closing a target cost gap
Increasing the price will not close the cost gap.
What to do?
Split the target cost into broad cost categories
such as development, marketing, manufacturing
Manufacturing target cost per unit is split up across the different functional areas of the product.
Product is designed so that each functional product area can be made within the target cost.
If the target cost gap cannot be fully eliminated in a particular product area:
Target for other areas are reduced
Product is redesigned
Product is rejected
Product should be developed in an atmosphere of continuous improvement using value engineering techniques and close collaboration with suppliers to
enhance the product (in terms of service, quality, durability, etc.) and
reduce costs.

4. Closing a target cost gap
After you split the costs -> set benchmarks for improvement of target cost by improving production technologies and processes. Various techniques can be employed, like:
Reducing the number of components, maybe some of them are not needed for the end customer?
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)
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.
Exam focus point
When answering a question on closing a target cost gap, you may be expected to refer to the specific circumstances of the business in question.

5. Target costing in service industries
Examples of service businesses:
Mass service eg banking, transportation (rail, air), mass entertainment
Either/or eg fast food, teaching, hotels and holidays, psychoterapy
Personal service eg financial advisory, car maintenance, audit
Five major characteristics of services that distinguish services from products:
Intangibility (of what is provided to and valued by individual customers)
Inseparability/Simultaneity (production and consumption of the service coincide)
Perishability (the inability to store the service)
Heterogeneity (variability in the standard of performance of the provision of the service)
No transfer of ownership

5. Target costing in service industries
Remind that: a target cost for a product is a cost for an item whose design and make-up is specified in exact detail in a product specification. A target cost is a cost for this detailed specification.
Services are much more difficult to specify exactly due to the following characteristics:
Intangibility.
and target price
what exactly does a customer receive – and thus ->
what exactly every particular customer is paying for? ->
What should be the benchmark target price for this service?
and cost of materials
the major cost in the service industry is salaries. Bought-in materials are usually low when compared to salaries. It is very difficult to reduce the cost of salaries.
Variability/homogeneity
A service can differ every time it is provided, and standard service may not exist.
Ex: repairing a motor car, providing an audit, pulling out a tooth are 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.