Target costing is a system that is utilized to plan prices, product costs, and margins for a new product. It is a process that begins during the design phase and continues throughout a product’s life cycle. This method of costing is beneficial for companies to ensure consistent profitability in manufacturing. It allows for close monitoring of a product’s costs and profitability and also helps companies to make sound decisions regarding product pricing.

Key aspects of target costing include assessing and forecasting costs for the design of the product, setting a target price and cost for the product, and evaluating the design to ensure it meets the planned price and cost. If the design does not meet the planned price and cost, the project is canceled.

Target costing is a valuable tool for companies as it enables them to plan for price points, product costs, and margins prior to the production of a product. This system helps to ensure that companies remain profitable and are able to produce products that are cost-effective.

Formula

Target cost = Market price – Target profit

Example

XYZ Ltd. is a company that produces and sells consumer electronics. In order to stay competitive in the market, the company has decided to set a selling price of $200 per unit for its latest product. If the company’s intended profit margin is 15% on the selling price, calculate the target cost per unit.

Solution

Target Profit Margin = 15% of $200 = $30 per unit

Target Cost = Selling Price – Profit Margin ($200 – $30)

Target Cost = $170 per unit

This means that the company must produce the product at a cost of $170 or less in order to achieve a profit margin of 15% on the selling price of $200. By using the target costing method, XYZ Ltd. can ensure that it is producing its products in a cost-effective manner while still achieving its desired level of profitability.

Process of Target Costing

The process of target costing involves several steps:

• Determine the target selling price: This involves identifying the desired profit margin and determining the target selling price based on that margin and the estimated costs of production.
• Establish target cost: The target cost is determined by subtracting the desired profit margin from the target selling price.
• Evaluate product design and production processes: The product design and production processes are evaluated to determine ways to reduce costs while still meeting customer requirements and maintaining the desired level of quality and functionality.
• Implement cost reduction measures: The cost reduction measures identified in step 3 are implemented to bring the actual cost of production in line with the target cost.
• Monitor and adjust: The target costing process is ongoing and requires regular monitoring and adjustment to ensure that the target cost is being met and that the desired level of profitability is being achieved.

Key Features of Target Costing

Market-Driven Approach One of the key features of target costing is that it is a market-driven approach. Companies using this method are the price takers, which means they follow the market and adjust their prices to meet the market demand. This approach ensures that the company remains competitive and is able to sell its products or services at a price that is in line with what customers are willing to pay.

Required Profit Margin Another important feature of target costing is that it focuses on the required profit margin. Companies using this method set a target cost for their products or services, based on the required profit margin, and then work to reduce costs to meet that target. This approach helps companies ensure that they are making a profit and can continue to grow and develop over time.

Cost Reduction and Effective Cost Management A key objective of target costing is to reduce costs and effectively manage them. Companies using this method focus on finding ways to streamline their operations, reduce waste, and improve their processes. This approach helps companies become more efficient and reduces the cost of production, making it easier to meet their target costs.

Redesigning Products and Production The target costing also involves redesigning products and production to meet target costs. Companies using this method may need to make changes to their products or processes in order to reduce costs and meet their target costs. This approach helps companies stay competitive and continue to meet the needs of their customers, while also ensuring that they remain profitable.

Advantage of Target Costing

Advantages of proactive costing include:

• The ability to identify the need for process improvement and innovation
• The incorporation of market factors into business operations
• The exploration of new market opportunities
• The ability to decide on cost or quality-oriented approaches based on a target price

Target costing is a proactive method of costing that allows for clear financial goals to be set. This helps businesses to achieve their desired price points while still providing quality goods and services.

In addition, target costing enables businesses to incorporate market factors into their operations. This can help them identify new market opportunities and explore them accordingly.

Furthermore, target costing allows businesses to decide on a cost or quality-oriented approach based on their desired target price. This helps them achieve their desired price points while still providing quality goods and services.

Overall, target costing is an effective tool for businesses to use in order to stay competitive and achieve their financial goals.

Disadvantage of Target Costing

Disadvantages of proactive costing include the difficulty of accurately predicting market trends and the potential for unexpected costs that may not be accounted for in the target price. Target costing requires extensive research into the market to forecast future trends and the associated costs, which can be time-consuming and costly.

Additionally, the target price may not accurately reflect the true costs of production, leading to a loss of profit margins or the need for additional financing. It is also possible for unexpected costs to arise, due to fluctuations in market prices or the unavailability of certain materials, which may not be accounted for in the target price.

Overall, target costing requires businesses to invest a significant amount of time and resources in order to ensure its accuracy. If done correctly, it can be a beneficial tool for businesses, allowing them to accurately set a target price and make decisions regarding cost or quality.

However, if not done properly, it can lead to unexpected costs and losses in profit margins. Therefore, it is important for businesses to carefully consider the advantages and disadvantages of target costing before making a decision.

Conclusion

Target costing is a strategy used by businesses to set a predetermined cost target for a product. By setting this target cost, businesses can develop cost-effective strategies that will help them meet their cost objectives.

This cost-effective approach is beneficial for businesses as it helps them to maximize the value of their products and services. However, it can also lead to reduced product quality and increased cost of production if the cost target is not achieved.

Overall, target costing is an effective tool for businesses to create cost-effective strategies and maximize the value of their products and services.

The post Target Costing | Formula | Advantage | Disadvantage appeared first on Accounting Official.