Question

What is the concept of target costing? Why do companies pursue target costing? How does successful target costing work?

Answer 1

Target costing is a system of costing as per which an entity plans well in advance on the price, costs to be incurred, and margins that the entity it wants to achieve for a new product. If the entity is unable to manufacture a product at determined levels, then the design of the project is cancelled in entirety.

With target costing, management has a tool for continuous monitoring of products from the moment they initiate design phase and onwards, throughout the entire product life cycle. It is considered to be an important tools to achieve consistent profitability in a manufacturing company.

Benefits of Target Costing:

Broad advantages of target costing are:

1. It reinforces top to bottom commitment to process development and product innovation to enable achieving competitive advantages over other companies’
2. Enables to create an environment in company which is market-driven and bent towards designing and manufacturing products which meet the price required for the market success.
3. It utilizes management control system to support and reinforce innovative manufacturing strategies
4. It enables identification of market opportunities which can be converted into saving to achieve best value for money rather than simply reducing cost
5. It assures that products are better matched to customers’ requirements
6. It aligns the costs features with willingness of customers to pay for them
7. Reduces product development cycle.
8. Enhances the teamwork and co-ordination among internal organizations associated with marketing, planning, developing, manufacturing, distributing and installation

Process for Target Costing;

Target cost is the amount that should be incurred on a product with the organisation can still earn the requisite profit margin from the product at a particular selling price. It decomposes the target cost from product level to each component. It spreads the competitive pressure faced by the company to product’s designers and suppliers.

Entire process of Target costing can be enumerated as under;

The process can be categorised into three sections:

1. Market-driven target costing, it focuses on analysing market condition and identification of allowable cost in order to meet entity’s profit margin at requisite selling price;
2. Product level target costing; it involves in performing cost reduction strategies with the design effort and creativity identifying the product-level target cost;
3. Component-level target cost; it decomposes the production cost to component levels and to transmits cost to suppliers, being their responsibility