Question

QUESTION THREE

Treble Plc is planning to commence production of a new product – the Dom. It is expected that demand for the Dom will last for 6 years and that they will sell 1,000 units in the first year; 3,000 units in the second year and 6,000 units per year thereafter. The selling price will be ZMW15 per unit and the company wishes to achieve a mark-up of 50% on cost.

The following costs have been estimated:

Design and development               ZMW 40,000

Variable production Cost:              ZMW 7 per unit

Additional fixed production cost ZMW 4000 per year

End of life cost                                  ZMW 10,000

Required

1. Calculate the target cost per unit for the production of Doms.     
2. Calculate the actual full production cost per unit for the first year and comment as to whether or not there is a cost gap.                                              
3. Calculate the lifecycle cost per unit and comment as to whether or not there is a cost gap.                                                                                                   
4. State and explain three measures a company could take to close a cost gap.

                                                                                                                

5. Explain how target costing can be beneficial to modern day business managers.                                                                                                          

                                                                                                                  

                                                                                                                                  

Answer 1

1
	Target cost per unit
	Particulars	ZMW
A	Selling price per unit	15
B	Markup 50% on cost = 33.33% on selling price)	5
	Cost per unit (A-B)	10
	Therefore, Target cost is ZMW 10 per unit
2
	Actual production cost for the first year
	Particulars	ZMW/ unit	Units	ZMW
	Variable production cost	7	1000	7,000
	Fixed production cost			4000
	Total production cost			11,000
	Production cost per unit (11,000/ 1000 units)			11
	Actual production cost per unit for the first year is ZMW 11. It has exceeded the target cost by ZMW 1 per unit. Hence, the cost gap is ZMW 1 per unit.
3
	Life cycle cost per unit
	Particulars	ZMW (A)	Units over the life of the product (B)	ZMW/ unit (A)/(B)
	Research and Development costs	40,000	28,000	1.43
	Variable production cost			7
	Fixed production cost(ZMW 4000 per * 6 years)	24,000	28,000	0.86
	End of life cost	10,000	28,000	0.36
	Life cycle cost per unit			9.64
	Note
	Units over the life of the product
	Year 1	1,000
	Year 2	3,000
	Year 3-6	24,000
	Units over the life of the product	28,000
	From the workings it can be seen that the Life cycle cost per unit is less than the target cost by ZMW 0.36 per unit. Hence, no cost gap exists in this situation.

4. Measures to close a cost gap:
1) Value Engineering Analysis - This involves analyzing activities into valued and non-value added, thereby helping in eliminating non-value added activities and contributing to cost reduction.
2) Kaizen costing - This approach focuses on waste reduction in the production phase and thereby would help in achieving the target cost or even lower than the target.
3) Identify opportunities for cost reductions such as supplier negotiations, target costing at research and development phase, focusing on reducing costs of designing without compromizing the utility of the product etc.

5. Benefits of target costing to modern day managers:

a. It is a dynamic approach that helps in cost reduction. Though target costing helps maintain cost control, its focus is cost reduction through methods such as VE and Kaizen costing.
b. By implementing systems such as VE and Kaizen costing, helps in gaining a competitive advantage and the production process becomes very efficient.
c. Helps in eliminating non value added activities, thereby resulting in cost savings thereby helping the manager achieve the goals and targets set
d. Helps in planning and making the managers aware of the production requirements and the budget to be adhered to threby assisting in better price negotiation with the suppliers.