Chapter 2b Target Costing

Question 1 Target Costing

Edward Co assembles and sells many types of radio. It is considering extending its
product range to include digital radios. These radios produce a better sound quality
than traditional radios and have a large number of potential additional features not
possible with the previous technologies (station scanning, more choice, one touch
tuning, station identification text and song identification text etc.
! radio is produced by assembly wor"ers assembling a variety of components.
#roduction overheads are currently absorbed into product costs on an assembly labour
hour basis.
Edward Co is considering a target costing approach for its new digital radio product.
Required:
(a $riefly describe the target costing process that Edward Co should underta"e.
(% mar"s
(b Explain the benefits to Edward Co of adopting a target costing approach at such
an early stage in the product development process. (& mar"s
(c !ssuming a cost gap was identified in the process, outline possible steps Edward
Co could ta"e to reduce this gap. (' mar"s
! selling price of (&& has been set in order to compete with a similar radio on the
mar"et that has comparable features to Edward Co)s intended product. The board have
agreed that the acceptable margin (after allowing for all production costs should be
*+,.
Cost information for the new radio is as follows-
Component 1 (Circuit board . these are bought in and cost (&/0+ each. They are
bought in batches of &,+++ and additional delivery costs are (*,&++ per batch.
Component 2 (1iring . in an ideal situation *' cm of wiring is needed for each
completed radio. 2owever, there is some waste involved in the process as wire is
occasionally cut to the wrong length or is damaged in the assembly process. Edward
Co estimates that *, of the purchased wire is lost in the assembly process. 1ire costs
#. 0
(+/'+ per metre to buy.
Other material . other materials cost (3/0+ per radio.
Assembly labour . these are s"illed people who are difficult to recruit and retain.
Edward Co has more staff of this type than needed but is prepared to carry this extra
cost in return for the security it gives the business. It ta"es %+ minutes to assemble a
radio and the assembly wor"ers are paid (0*/4+ per hour. It is estimated that 0+, of
hours paid to the assembly wor"ers is for idle time.
Production Oerheads . recent historic cost analysis has revealed the following
production overhead data-
Total production oerhead Total assembly labour hours
(
5onth 0 4*+,+++ 06,+++
5onth * 7++,+++ *%,+++
8ixed production overheads are absorbed on an assembly hour basis based on normal
annual activity levels. In a typical year *&+,+++ assembly hours will be wor"ed by
Edward Co.
9equired-
(d Calculate the expected cost per unit for the radio and identify any cost gap that
might exist. (0% mar"s
(Total *' mar"s
(!CC! 8' #erformance 5anagement :ecember *++7 ;0
Question 2 Target Costing and !earning Cure
$ig Cheese Chairs ($CC manufactures and sells executive leather chairs. They are
considering a new design of massaging chair to launch into the competitive mar"et in
which they operate.
They have carried out an investigation in the mar"et and using a target costing system
have targeted a competitive selling price of (0*+ for the chair. $CC wants a margin
on selling price of *+, (ignoring any overheads.
#. *
The frame and massage mechanism will be bought in for ('0 per chair and $CC will
upholster it in leather and assemble it ready for despatch.
<eather costs (0+ per metre and two metres are needed for a complete chair although
*+, of all leather is wasted in the upholstery process.
The upholstery and assembly process will be sub=ect to a learning effect as the
wor"ers get used to the new design. $CC estimates that the first chair will ta"e two
hours to prepare but this will be sub=ect to a learning rate (<9 of 6',. The learning
improvement will stop once 0*3 chairs have been made and the time for the 0*3th
chair will be the time for all subsequent chairs. The cost of labour is (0' per hour.
The learning formula is shown on the formula sheet and at the 6', learning rate the
value of b is .+/+7&+++'30.
Required:
(a Calculate the average cost for the first 0*3 chairs made and identify any cost
gap that may be present at that stage. (3 mar"s
(b !ssuming that a cost gap for the chair exists suggest four ways in which it could
be closed. (4 mar"s
The production manager denies any claims that a cost gap exists and has stated that
the cost of the 0*3th chair will be low enough to yield the required margin.
(c Calculate the cost of the 0*3th chair made and state whether the target cost is
being achieved on the 0*3
th
chair. (4 mar"s
(Total *+ mar"s
(!CC! 8' #erformance 5anagement :ecember *++6 ;*
#. %
Question " Target Costing and !i#e Cycle Costing
>EE12I??, a manufacturer of computer games, has developed a new game called
the !ction !ccountant (!!. This is an interactive %: game and is the first of its "ind
to be introduced to the mar"et. >EE12I?? is due to launch the !! in time for the
pea" selling season.
>EE1I?? has been using a traditional absorption costing system to calculate costs
and price its products. The new management accountant believes that this is
inappropriate for this company and is arguing for a new approach to be adopted.
Required:
(a :iscuss how the following techniques could have been applied to the !!.
(i <ife cycle costing
(ii Target costing
(0+ mar"s
! few months later, >EE12I?? is in the process of introducing another new game,
the <aughing <awyer (<< and has underta"en mar"et research to find out about
customers@ views on the value of the product and also to obtain a comparison with
competitors@ products. The results of this research have been used to establish a target
selling price of A'' and a pro=ected lifetime volume of *++,+++ games.
Cost estimates have also been prepared based on the proposed product specification.
$anu#acturing cost A
:irect material %.*0
:irect labour &.*%
:irect machinery costs 0.0*
Brdering and receiving +.*%
;uality assurance &.4+
:esign 06.3+
%on&manu#acturing costs
5ar"eting 3.0'
:istribution %.*'
!fterCsales service and warranty costs 0.%+
The target profit margin for the << is %+, of the proposed selling price.
#. &
Required:
(b Calculate the target cost of the << and discuss the implications of the result.
Explain the limitations of target costing for >EE1I??. (7 mar"s
(c $riefly explain how and why mar"et research is used by companies such as
>EE12I??. (% mar"s
(Total *+ mar"s
#. '