Question

ActFast Ltd is a company that manufactures and sells a wide range of laptops to both domestic and international market. It has two divisions, i.e. Assembly Division and Battery Division. Battery Division sells batteries to both Assembly Division and to other laptop manufacturers. Assembly Division could also purchase batteries from other suppliers.

The following data is available for both divisions:

Assembly Division
Selling price for each laptop, including battery	$1,800
Costs per laptop:
Battery from battery Division	$130
Other materials	$450
Variable overheads	$350
Annual production and sales of laptops	150,000 units
Maximum annual external sales for laptops	180,000 units
Battery Division
Transfer price per battery sold to Assembly Division	$130
Selling price per battery to external customers	$140
Variable costs per battery (see Note*)	$70
Current maximum production capacity	350,000 units
Maximum potential external sales	220,000 units

(Note*) Battery Division saves a variable overhead of $5 per battery if sold internally.

Additional Information:

1. Currently, ActFast’s purchasing policy requires Assembly Division to purchase all the batteries needed from Battery Division at a price determined by the Head Office, which is $130. However, Battery Division has refused to sell to Assembly Division any quantity more than the current level of batteries it supplies to Assembly Division, i.e. 150,000 units. This purchasing policy is not favourable to both managers as they cannot maximize their profit. The manager of Assembly Division has an external battery supplier who can supply batteries at $128.
2. The marketing director is planning to launch a new model of laptop, LS100, in six-month’s time. It is near completion in its design stage. The purpose of LS100 is to compete with a close competitor. The selling price of the competing laptop is $2,500 and the marketing director believes the launching price of LS100 could be in the range of $2,200 to $2,400. During the recent progress report, the laptop design engineers stated that the new laptop needs to incorporate some new features as this is necessary in order to stay ahead of competition. However, this would mean additional costs to be incurred.

Required:

1. Explain how target costing could be used by Act Fast Ltd on its LS100 model. You need to draw specific examples from the case given. (Max 250 words)

Answer 1

Target Costing has been described as a process that occurs in a competitive environment, in which cost minimization is an important component of profitability. This newer approach of product costing may take into account initial design and engineering costs, as well as manufacturing costs, costs of distribution, sales and services.

Target costing can be defined as " a structured approach to determining the cost at which a proposed product wiht specified functionality and quality must be produced, to generate a desired level of profitability at its anticipated selling price.

It is viewed as an integral part of the design and introduction of new products. In Target costing, we first determine what price we think the consumer willl pay for our product. We then determine how much of a profit margin we expect and subtract that from the final price. The remaining amount left is what is available as a budget to be used for creatinig the product.

Given that the marketing director is planning to launch a new model of laptop, LS100, in six-month’s time. It is near completion in its design stage.The marketing director believes the launching price of LS100 could be in the range of $2,200 to $2,400.

Selling price ranges between $2200-$2400, after reducing desired profit margin we will arrive at target cost.  Also engineers stated that the new laptop needs to incorporate some new features as this is necessary in order to stay ahead of competition.Value engineering in the target cost helps in cost avoidance or cost reduction before Production. The following are the issues to be dealt in Value engineering review.

• Can we eliminate functions from the production process?
• Can we eliminate some durability or reliability?
• Can we minimize the design?
• Can we design the product better for the manufacturing process?
• Can we substitute parts?
• Can we combine steps?
• Can we take suppliers assistance?
• Is there a better way?

Addressing the above concerns helps Act Fast Ltd in reduction of initial or additonal cost of the product.