Presented By: Woodrow Arrington (Future CPSM) Kohls Merchandise Analyst Contact me at woodyarr@gmail.

com for more information

Target Costing Definition Brainstorming Exercise Goal of Target Costing Target Costing Nuts & Bolts Target Costing Overview
Part 1- Analysis Part 2 Design Part 3 Implement

Real World Application Now Its Your Turn Review & Summary Reading List & Further Research

An approach used to identify the anticipated selling price for product as well as the allowable price for each component

 Why would a company consider target costing? What advantages can target costing provide? Where can target costing be used?

The goal of Target costing is: o Design a product following a set cost structure in o Cut unnecessary costs o Improve product design

Target costing is based off this simple equation:

Determine anticipated selling price

Identify desired profit margin

Calculate allowable price for each unit component

Component #1 Component #2 Component #3

Perform Market Research & Identify Customer Needs

Determine Target Price & Desired Profit Margin

Develop Cost Projections for Each Component

Explore Different Product Design Alternatives Perform Value Engineering / Value Analysis

Production

Approved final product design

Continuous Cost Reduction

Perform Market Research & Identify Customer Needs

Determine Target Price & Desired Profit Margin

Part 1 - Analysis o Begin by researching the target market and consumer o Determine a target price that consumers expect o Determine how much profit margin you expect Example o Arrington Enterprises sells widgets o Market prices for widgets are $15; Arrington wants to sell widgets at $13 o Arrington wants to earn a 10% margin on all widgets sold o With an target sell price of $13, a 10% margin, Arrington can spend $11.70 to create a widget

Develop Cost Projections for Each Component

Explore Different Product Design Alternatives Perform Value Engineering / Value Analysis
Part 2 - Design o Once an overall cost allowance is calculated, determine cost projections for each component within the product o Design the component within the allocated cost budget o Value Engineering / Value Analysis (VE/VA) for each component asks whether the part can be substituted, simplified, or eliminated o Repeat the cycle as necessary Example o Arrington can spend $11.70 to create a widget o Allocated cost budgets for each part is as follows: Part A= $5, Part B= $4.75, Part C= $1.95 o Each part is designed according to its allocated cost budget

Perform Value Engineering / Value Analysis

Production

Approved final product design

Continuous Cost Reduction

Part 3 - Implement o Once a final product is design that meets the allocated cost budget production begins o Continue to re-evaluate the product design using VA/VE to continue cost reductions Example o Arrington succeeds in designing a widget that costs $11.70 and sells it at $13, = 10% margin o Arrington continues to re-evaluate the widget design for more cost reductions o Through more Target Costing and VA/VE, Arrington further reduces costs to $11.35

In Business | Target Costing Approach--An Iterative Process: Target costing Technique is widely used in Japan. In the automobile industry, the target cost for a new model is decomposed into target costs for each of the elements of the car--down to a target cost for each of the individual parts. The designers draft a trial blueprint, and a check is made to see if the estimated cost of the car is within reasonable distance of the target cost. If not, design changes are made, and a new trial blueprint is drawn up. This process continues until there is sufficient confidence in the design to make a prototype car according to the trial blueprint. If there is still a gap between the target cost and estimated cost, the design of the car will be further modified. After repeating this process a number of times, the final blueprint is drawn up and turned over to the production department. In the first several months of production, the target costs will ordinarily not be achieved due to problems in getting a new model into production. However after that initial period, target costs are compared to actual costs and discrepancies between the two are investigated with the aim of eliminating the discrepancies and achieving target costs.
Source: Yasuhiro Monden and Kazuki Hamada, "Target Costing-Kaizen Costing in Japanese Automobile Companies," Journal of Management Accounting Research 3, pp. 16-34.

Toyota wants to compete with GMs Chevy Cobalt by reducing the price of its Corolla by 7%. In order to do so costs need to be reduced while still protecting Toyotas mandatory profit margin of 5%. Three components of Toyotas Corolla have been identified as opportunities for reducing significant costs, the chassis, the electronics, and the engine, other parts are also expected to reduce similar costs. What should the new cost structure of these parts look like to give the new Toyota Corolla a price advantage over the Chevy Cobalt? Info (Assume Cobalt is comparable to Corolla): GMs Chevy Cobalt currently retails at $15,000 Toyota Corolla retails at $15,500 Toyota Corolla parts: Chassis = $3,600 Electronics = $1700 Engine = $4000 Other = $5425

GMs Chevy Cobalt currently retails at $15,000 Toyota Corolla retails at $15,500 Target market price of new Toyota Corolla = $14,415 ($15,500 * .93) 7% Price reduction Allowable cost budget for entire car = $13,694 ($14,415 * .95) 5% Profit Margin New cost budgets for Toyota Corolla parts: Chassis = $3348 ($3,600 * .93) 7% Price reduction Electronics = $1581 ($1700 * .93) 7% Price reduction Engine = $3720 ($4000 * .93) 7% Price reduction Other = $5045 ($5425 * .93) 7% Price reduction By reducing the costs of each component by about 7% Toyota can still maintain its 5% profit margin and reduce the price of its Corolla from $15,500 to $14,415.

Target costing is based off this simple equation:

Determine anticipated selling price

Identify desired profit margin

Calculate allowable price for each unit component

Component #1 Component #2 Component #3

Best Practices in Target Costing : http://www.imanet.org/pdf/1236.pdf Target Costing Approach to Pricing: http://www.accountingformanagement.com/target_costing_pricing_pro ducts_and_services.htm Managerial Implications of Target Costing: http://www.allbusiness.com/accounting-reporting/methods-standardscost-accounting/846519-1.html

Accounting for Management, Target Costing Approach to Pricing, Apr 8, 2010, http://www.accountingformanagement.com/target_costing_pricing_products_and_services.htm All Business A D&B Company, Managerial implications of target costing Apr 6, 2010, http://www.allbusiness.com/accounting-reporting/methods-standards-cost-accounting/8465191.html Management Accounting Quarterly, Best Practices in Target Costing, Apr 7, 2010, http://www.imanet.org/pdf/1236.pdf ISM, Target Costing Model, Apr 8, 2010, http://images.google.com/imgres?imgurl=http://www.npdsolutions.com/image33.gif&imgrefurl=http://www.npdsolutions.com/target.html&usg=__iiMpHaeUC8MEhTdCrdQLiSX0A8=&h=275&w=361&sz=5&hl=en&start=1&itbs=1&tbnid=8DLY8XciaXc3lM:&tbnh=92&tbnw=121&p rev=/images%3Fq%3Dtarget%2Bcosting%26hl%3Den%26safe%3Dactive%26sa%3DN%26gbv%3D2%26nd sp%3D20%26tbs%3Disch:1

Yasuhiro Monden and Kazuki Hamada, "Target Costing-Kaizen Costing in Japanese Automobile Companies," Journal of Management Accounting Research 3, pp. 16-34.