Target costing is a pro-active cost control system. Techniques such as value analysis are used to change production methods and/or reduce expected costs so that the target cost is met.
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Target cost management:
• It is effective in managing costs in new product design and development stages.
• It also enables the production cost of a proposed product to be identified so that when sold it generates the desired profit level.
• It also plays a useful role in enabling enterprise to set and support the attainment of cost levels.
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Target costing requires managers to change the way they think about the relationship between cost, price and profit.
(a) Traditional approach is to develop a product, determine the expected standard production cost of that product and then set a selling price (probably based on cost) with a resulting profit or loss. Costs are controlled through variance analysis at monthly intervals.
(b) The target costing approach is to develop a product concept and the primary specifications for performance and design and then to determine the price the customers would be willing to pay for that concept. The desired profit margin is deducted from the price leaving a figure that represents total cost.
This is the target cost and the product must be capable of being produced for this amount otherwise the product will not be manufactured.
During the product’s life target cost will constantly be reduced so that the price can fall. Continuous cost reduction techniques must therefore be employed.
(source : BPP Learning Media)
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