TOPIC 8 Materials and TLA Answers

1. Definition of Target Costing:

Target costing is a cost management technique used in product development and
design. It involves setting a target cost for a product based on market conditions, customer
expectations, and desired profit margins. The goal of target costing is to design and produce a
product that meets these cost constraints while maintaining the required quality and
functionality.

2. Key Features of Target Costing:

● The price of the product is determined by market conditions. The company is a price
taker rather than a price maker.
● The minimum required profit margin is already included in the target selling price.
● It is part of management’s strategy to focus on cost reduction and effective cost
management.
● Product design, specifications, and customer expectations are already built-in while
formulating the total selling price.
● The difference between the current cost and the target cost is the “cost reduction,” which
management wants to achieve.
● A team is formed to integrate activities such as designing, purchasing, manufacturing,
marketing, etc., to find and achieve the target cost.

3. Characteristics of Target Costing:

● Cost-Driven: Target costing is primarily cost-driven, with a focus on cost reduction and
cost control during product development.
● Market-Oriented: It considers customer price expectations and market competition to
determine the target cost.
● Early Stage Application: Typically applied in the early stages of product planning and
design.
● Cross-Functional Collaboration: Involves collaboration between various departments,
including design, engineering, manufacturing, and finance, to meet the cost target.
● Continuous Improvement: It encourages ongoing efforts to reduce costs and improve
efficiency.

4. Advantages and Disadvantages of Target Costing:

Advantages:
● Helps align product cost with market demands and price expectations.
● Encourages cross-functional teamwork and communication.
● Supports cost control and cost reduction efforts throughout the product lifecycle.
● Enhances competitiveness and profitability.
Disadvantages:
● Can be challenging to set accurate target costs, especially for new or innovative
products.
● Overemphasis on cost reduction may lead to compromises in quality or features.
● Implementation can be time-consuming and resource-intensive.
● Effectiveness relies on accurate market analysis and cost estimation.
5. Steps in Implementing Target Costing:
Implementing target costing involves several steps:
● Determine the product's target selling price based on market analysis.
● Deduct the desired profit margin to calculate the target cost.
● Collaborate with cross-functional teams to design the product within the cost constraints.
● Continuously monitor and adjust the design and production processes to meet the target
cost.
● Maintain a balance between cost reduction and product quality.

6. Define Value Engineering:

Value engineering (VE) is a systematic and organized approach to improving the value of a
product or process. It aims to enhance performance, quality, and functionality while reducing
costs. VE involves analyzing the design and production processes to identify opportunities for
cost savings without compromising the product's essential functions.

7. Steps in Value Engineering:

Value engineering typically follows a structured process:
1. Information Gathering: Collect all relevant data about the product or process under
consideration.
2. Functional Analysis: Identify the essential functions and performance requirements of the
product or process.
3. Idea Generation: Generate a wide range of cost-saving and value-enhancing ideas through
brainstorming and analysis.
4. Evaluation: Assess the feasibility and impact of each idea in terms of cost reduction and
value improvement.
5. Implementation: Put the selected ideas into action, making changes to the product or
process.
6. Follow-Up: Continuously monitor the results to ensure the desired cost savings and value
improvements are achieved.

8. Value Engineering in Target Costing:

Value engineering plays a crucial role in target costing by helping achieve cost reduction and
product improvement objectives. In the context of target costing, value engineering may involve
reevaluating the product's design, materials, and processes to identify areas where cost savings
can be realized while maintaining or enhancing customer value. It is a tool used within the target
costing framework to optimize the product's value within the cost constraints.
TLA 5

1. What is a “target cost per unit”?

Answer:
Target price minus the targeted profit margin. It is the long-run cost of a product or service
which when sold enables the organization to earn the targeted income. Continuous
improvement of the product or process is done to achieve the target cost and the desired
profit margin.

2. Describe value engineering and its role in target costing.

Answer:
Value engineering is a systematic evaluation of all aspects of research and development,
design of products and processes, production, marketing, distribution, and customer service
with the objective of reducing costs but at the same time satisfying customer needs. Value
engineering leads to improvements in product design, changes in materials specifications, or
modification in process methods. To do value engineering, managers must distinguish when
costs are incurred from when costs are locked in.
Cost incurrence describes when a resource is consumed (or benefit forgone) to meet job
objective.
Locked-in or designed-in costs are costs that have not yet been incurred but, based on
decisions that have already been made, will be incurred in the future.

3. How do companies price products using target costing?

Answer:
Companies price products using target costing by first determining the target selling price
based on market analysis and desired profit margins. They then subtract the desired profit
margin from the target selling price to calculate the target cost. Cross-functional teams work
collaboratively to design the product within this target cost, continuously analyzing and
optimizing costs during the development process. The final selling price is set based on the
target cost, ensuring competitiveness and profitability.

4. Explain the implementation process of target prices and target costs.

Answer:
● Develop a product that satisfies the needs of potential customers.
● Choose a target price based on the customer’s perceived value of the product and the
prices competitors charge.
● Derive a target cost by subtracting the desired profit margin from target price.
● Perform value engineering to achieve target costs.

5. Medical Instruments uses a manufacturing costing system with one direct-cost category
(direct materials) and three indirect cost categories:
a. Setup, production order, and materials-handling costs that vary with the number of batches
b. Manufacturing-operations costs that vary with machine-hours.
c. Costs of engineering changes that vary with the number of engineering changes made.

In response to competitive pressures at the end of 2022, Medical Instruments used value-
engineering techniques to reduce manufacturing costs. Actual information for 2022 and 2023
is:
2022 2023
Setup, production order, and materials-handling costs per 80,000 75,000
batch
Total manufacturing-operations costs per machine hour 550 500
 Costs of engineering change 120,000 100,000

The management of Medical Instruments wants to evaluate whether value engineering has
succeeded in reducing the target manufacturing cost per unit of one of its products, HJ6 by
10%.
Actual Results for Actual Results for
2022 2023
Units Of HJ6 produced 35,000 40,000
Direct material cost per unit of HJ6 12,000 11,000
Total number of batches required to 700 800
produce HJ6
Total machine hours required to produce 210,000 220,000
HJ6
Number of engineering changes made 140 100
Required:
1. Calculate the manufacturing cost per unit of HJ6 in 2022.
2. Calculate the manufacturing cost per unit of HJ6 in 2023.
3. Did Medical Instruments achieve the target manufacturing cost per unit for HJ6 in 2013?
Explain.
4. Explain how Medical Instruments reduced the manufacturing cost per unit of HJ6 in 2023.