Target Costing

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TARGET COSTING
1
Determine the selling

price of a product using
the total cost, product
cost, variable cost, and
target cost concepts.
2
Setting Normal Product Selling Prices
The basic approaches to setting prices are:

Market Methods
1. Demand-based methods
2. Competition-based methods
Cost-Plus Methods
1. Total cost concept
2. Product cost concept
3. Variable cost concept 3
Market Methods
 Demand-based methods set

the price according to the
demand for the product.
 Competition-based methods
set the price according to the
price offered by competitors.
4
Markup
Using the cost-plus methods,

managers add to the cost an
amount called a markup, so that
all costs plus a profit are included
in the selling price.
5
Total Cost Concept
Using the total cost

concept, all costs of
manufacturing a
product...
Manufacturing
Cost
66
…plus the selling and

administrative expenses...
Administrative
Expenses
Selling Expenses
Manufacturing
Cost
77
…are included in the

cost to which the
Administrative markup is added.
Expenses
Selling Expenses
Total cost
Manufacturing
Cost
88
9-2
Click
s D e
to edit Master title style
ell s
ing ired
pr
ice
The markup is
Desired Profit determined by applying
Administrative the following formula:
Expenses
Markup Desired profit
Selling Expenses percentage = Total costs
Manufacturing
Cost
99
Digital Solutions Inc.—100,000
calculators
Per Unit Total
Variable Costs: Cost Cost
Direct materials P 3.00 P 300,000
Direct labor 10.00 1,000,000
Factory overhead 1.50 150,000
Selling and admin. exp. 1.50 150,000
Total variable costs P16.00 P1,600,000
Fixed Costs:
Factory overhead .50 50,000
Selling and admin. exp. .20 20,000
Total fixed costs . 70 70,000
Total costs P16.70 P1,670,000 10
10
Markup Percentage
Desired profit P160,000

= = 9.6%
Total costs P1,670,000
Total cost per calculator P16.70
Markup (P16.70 x 9.6%) 1.60
Selling price P18.30
Only the desired profit is

covered in the markup.
11
11
Proof That Selling the
Calculators at P18.30 Will
Generate the Desired Profit
Digital Solutions Inc.

Income Statement
For the Year Ended December 31, 2008
Sales (100,000 units x P18.30) P1,830,000
Expenses:
Variable (100,000 units x P16.00) P1,600,000
Fixed (P50,000 + P20,000) 70,000 1,670,000
Income from operations P 160,000
12
12
9-2

Example Exercise 9-7
Apex Corporation produces and sells Product Z at

a total cost of P30 per unit. Of this amount, P10
per unit is selling and administrative costs. The
total variable cost is P18 per unit. The desired
profit is P3 per unit. Determine the markup
percentage on total cost.
13
13
9-2
Product Cost Concept
Using the product cost

concept, only the costs
of manufacturing the
product, termed the
product cost, are
included in the cost
amount to which the
markup is added.
14
9-2
Digital Solutions Inc.—100,000
calculators
Per Unit Total
Variable Costs: Cost Cost
Direct materials P 3.00 P 300,000
Direct labor 10.00 1,000,000 Product
Factory overhead 1.50 150,000 cost
Selling and administrative 1.50 150,000 P1.5
Total variable costs P16.00 P1,600,000 million
Fixed Costs:
Factory overhead .50 50,000
Selling and administrative .20 20,000
Total fixed costs .70 70,000
Total costs P16.70 P1,670,000 15
15
9-2
Desired Selling Price
De Administrative
Se sir
l l ed Expense
Pr ing
i ce + Markup
Selling Expense
+
Desired Profit
Manufacturing Product Cost
Cost
16
16
9-2
Markup Percentage Formula
The markup percentage for the product cost

concept is determined by applying the following
formula:
Total Selling and
Markup Desired Profit + Administrative Expenses
=
Percentage Total Manufacturing Costs
17
17
9-2
Markup Percentage
Total Selling and

=
Markup P160,000 + P170,000

=
Percentage P1,500,000
DM
DM(P3(P3xx100,000)
100,000) PP 300,000
300,000
DL
DL(P10
(P10xx100,000)
100,000) 1,000,000
1,000,000
Factory
Factoryoverhead:
overhead:
Variable
Variable(P1.50
(P1.50xx100,000)
100,000) 150,000
150,000 18
18
Fixed
Fixed 50,000
50,000
Total
Totalmanufacturing
manufacturingcosts
costs P1,500,000
P1,500,000
9-2
Markup Percentage
Total Selling and

=
Markup P160,000 + P170,000

=
Markup
= P330,000 = 22%
19
19
9-2
Digital Solutions Inc. would price each
calculator at P18.30 per unit, as shown
below:
Manufacturing cost per calculator P15.00
Markup (P15.00 x 22%) 3.30
Selling price P18.30
20
20
Apex Corporation produces and sells Product Z at a total cost

of P30 per unit. Of this amount, P10 per unit is selling and
administrative costs. The total variable cost is P18 per unit.
The desired profit is P3 per unit. Determine the markup
percentage on product cost.
21
21
Variable Cost Concept
The variable cost concept

emphasizes the distinction
between variable and fixed
costs in product pricing.
Only variable costs are
included in the cost amount
to which the markup is
added.
22
De Total Fixed Markup
Se sir Costs +
l l ed
Pr ing Desired
i ce
Profit
Variable
Manufacturing
Cost Product Cost
+
Variable
Administrative
and Selling 23
23
Expenses
Markup Percentage
Markup Desired Profit + Total Fixed Costs

=
Percentage Total Variable Costs
Markup P160,000 + P50,000 + P20,000

=
Direct materials (P3 x 100,000) P 300,000

Direct labor (P10 x 100,000) 1,000,000
Variable factory overhead
(P1.50 x 100,000) 150,000
Variable selling and
administrative expenses
(P1.50 x 100,000) 150,000
24
24
Total variable costs P1,600,000
9-2
Markup Percentage
Markup Desired Profit + Total Fixed Costs

=
Percentage Total Variable Costs
Markup P160,000 + P50,000 + P20,000

=
Markup P230,000
= = 14.4%
25
25
Apex Corporation produces and sells Product Z at a total

cost of P30 per unit. Of this amount, P10 per unit is
selling and administrative costs. The total variable cost is
P18 per unit. The desired profit is P3 per unit.
Determine the markup percentage on variable cost,
rounded to one decimal place.
26
26
Target Costing
Under target costing, a future

selling price is anticipated, using
the demand-based methods or the
competition-based methods. The
targeted cost is determined by
subtracting a desired profit from
the expected selling price.
27
Target Costing
Target Costing is a technique in which the

firm determines the desired cost for the
product or service, given a competitive
market price so the firm can earn a desired
profit.
Target Cost = Competitive Price – Desired
Profit
28
Target Costing
Target Costing is a very useful way to

manage the needed trade-off between
increased functionality and higher cost.
29
Target Cost Concept
30
30
Present Future
Target Costing
How to Reduce Costs to a Target Cost Level

1. Integrate new manufacturing technology
using advanced cost management techniques
such as activity-based costing and seeking
higher productivity through improved
organization and labor relations.
31
Target Costing
How to Reduce Costs to a Target Cost Level

2. Redesign the product or service. This
approach is more common than the first one
because it recognizes that design decisions
account for much of the product life cycle
costs.
32
Target Costing
Steps in Implementing a Target Cost Approach

1.Determine the market price
2.Determine the desired profit
3.Calculate the target cost at market price less
desired profit
4.Use value engineering to identify ways to
reduce product costs
5.Use Kaizen costing and operating control to
further reduce costs.
33
Target Costing
Role of Value Engineering

Value engineering is used in target costing to
reduce product cost by analyzing the trade-offs
between
(1)Different types and levels of products
functionality
(2)Total product cost
34
Target Costing
Types of Value Engineering

Consumer analysis identifies critical consumer
preferences that define the desired
functionality for the new product.
Functional analysis is when the performance
and cost of each major functions or feature of
the product is examined.
35
Target Costing

Design analysis is a common form of value
engineering for industrial and specialized products.
The design team prepare several possible designs of
the product, each having similar features that have
different levels of performance and different costs.
The design team works with cost management
personnel to select the one design that best meets
customer preference while not exceeding the target
cost. 36
Target Costing

Cost tables are computer-based databases that include
comprehensive information about the firm’s drivers.
Cost drivers include the size of the product, the
materials used in its manufacture and the number of
features. Firms that manufacture different sized parts
from the same design use cost tables to show the
difference in cost for parts of different sizes and types
of materials.
37
Target Costing

Group technology is a method of identifying
similarities in the parts of products a firm
manufactures, so the same parts can be used in two or
more products, thereby reducing costs.
38
Target Costing
Target Costing and Kaizen Costing

Target costing use kaizen costing and operational
control to further reduce costs.
Kaizen means “continual improvement”, that

is ongoing research for new ways to reduce
costs in the manufacturing process of a product
with a given design and functionality.
39
Target Costing
Illustration:
MotoDrive manufactures a wide variety of parts for
recreational boating, including Part A and Part B component
for high-powered outboard engines. The component is
purchased by original equipment manufacturers such as
Mercury and Honda, for use in large, more powerful
outboards. The units sell for P510 and sales volume averages
25,000 units per year.
MotoDrive’s major competitor reduced the price of its
equivalent part to P450. The market is very competitive and
MotoDrive realizes it must meet the new price or lose40
significant market share.
Target Costing
The controller has assembled these cost and usage data for the
most recent year for MotoDrive’s production of 25,000 units:
Standard Cost Actual Quantity Actual Cost
Materials P5,125,000 P5,500,000
Direct labor 1,750,000 1,670,000
Indirect labor 2,500,000 2,359,000
Inspection (hours and cost) 2,000 350,000
Materials handling (no. of
purchases and cost 56,000 245,000
Machine setups (no. and cost) 3,500 980,000
Returns and rework (no. of
times and cost) 500 65,000
Total P11,169,000
41
Target Costing
Required: Calculate the target cost for maintaining current
market share and profitability
Solution:
11,169,000
Current unit Cost = = P446.76
25,000 units
Current profit per item:

Current selling price P510.00
Current unit cost 446.76
Profit per team P63.24
Target Cost to meet the Competitive Price

Competitor's price P450.00
Less: Desired profit 63.24
Target Cost P386.76 42

Target Costing

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Target Costing

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Click to edit Master title style

Determine the selling

The basic approaches to setting prices are:

 Demand-based methods set

Using the cost-plus methods,

Using the total cost

…plus the selling and

…are included in the

Desired profit P160,000

Only the desired profit is

Digital Solutions Inc.

Click to edit Master title style

Apex Corporation produces and sells Product Z at

Using the product cost

The markup percentage for the product cost

Total Selling and

Markup P160,000 + P170,000

Total Selling and

Markup P160,000 + P170,000

Apex Corporation produces and sells Product Z at a total cost

The variable cost concept

Markup Desired Profit + Total Fixed Costs

Markup P160,000 + P50,000 + P20,000

Direct materials (P3 x 100,000) P 300,000

Markup Desired Profit + Total Fixed Costs

Markup P160,000 + P50,000 + P20,000

Apex Corporation produces and sells Product Z at a total

Under target costing, a future

Target Costing is a technique in which the

Target Costing is a very useful way to

How to Reduce Costs to a Target Cost Level

How to Reduce Costs to a Target Cost Level

Steps in Implementing a Target Cost Approach

Role of Value Engineering

Types of Value Engineering

Types of Value Engineering

Types of Value Engineering

Types of Value Engineering

Target Costing and Kaizen Costing

Kaizen means “continual improvement”, that

Current profit per item:

Target Cost to meet the Competitive Price

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