Question

In: Accounting

Question 1: Target Costing Anglia Designs have developed a new type of chair. Their market research...

Question 1: Target Costing

Anglia Designs have developed a new type of chair. Their market research indicates

that it would sell at £125 and the company has set a target profit margin of 30% on the

selling price.

The manufacturing costs are expected to be as follows;

Direct materials – Wood is bought in and costs £20 per item when purchased in

batches of 1000. Delivery costs are £750 per batch. Fabric costs £200 for a roll and

10 items can be cut from a roll. Other materials cost £15 per unit.

Direct Labour – It takes 3 hours to assemble one chair and labour costs £12 per hour.

Production overheads are £ 140,000 per year.

The company are planning for a sales volume of 50,000. Overheads are allocated on

the basis of number of units produced.

Required:

a) Explain the concept of target costing to Anglia Designs and describe how the use of this approach could help them

b) Calculate the expected cost per unit and identify any difference between the Target cost and the expected cost.

c) Assuming a difference in costs identified in part (b), describe possible steps that the company could use to reduce to reduce the cost gap.

Solutions

Expert Solution

The selling price of the chair is £ 125.

Target profit margin is 30% of the selling price.

30% of £ 125 = £ 37.5

Thus target cost = Selling Price - Target Profit

Target cost = £ 125 - £ 37.5 = £ 87.5

Target costing ensures that the product is produced within the desired cost limit to ensure that the company earns the desired profit margin.

Target costing is necessary to earn the profit and it is important for the company to make sure it uses all available means to produce the product within specific cost.

Target costing will not only help in saving the cost to the company but will also help in ensuring higher profit margin.

Target cost = £ 87.5

Expected cost calculation -

Direct material cost = £ 20 for 1000 units

Assuming in batches of 1000, the cost will be

Transportation cost = £ 750 / 1000 = £ 0.75/unit

Fabric cost = £ 200 / 10 = £ 20 per unit

Otherwise material cost = £ 15 per unit

Direct labour = 3 hour @ £ 12 per hour

= 3 * 12 = £ 36

Production overheads = £ 140,000 / 50,000

= £ 2.8 per unit

Total Expected cost = 20 + 0.75 + 20 + 15 + 36 +2.8 = £ 94.55

Expected cost is more than Target cost. Hence, it is important to reduce the Expected cost to achieve the target cost.

Target cost can be achieved by reducing the direct material cost.

Direct material per chair if possible should bt reduced. The waste should be reduced to be able to make more chairs. Fabric cost should also be reduced.

Direct labour cost per chair should be reduced.

Production overheads should be reduced.

The company should try to have negotiations with material supplier to reduce the cost. With labourers to reduce the cost or to be more productive and reduce the time per chair.

This all will help in reducing the cost and achieving the target cost.


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