Target Costing

Presented By:

Woodrow Arrington (Future CPSM)

Kohl’s – Merchandise Analyst

Contact me at woodyarr@gmail.com for more information

Training Overview

• Target Costing Definition• Brainstorming Exercise• Goal of Target Costing• Target Costing Nuts & Bolts• Target Costing Overview

• Part 1- Analysis• Part 2 – Design• Part 3 – Implement

• Real World Application • Now It’s Your Turn• Review & Summary• Reading List & Further Research

An approach used to identify the anticipated selling price for product as well as the allowable price for each component

What is Target Costing?

• Why would a company consider target costing?

• What advantages can target costing provide?

• Where can target costing be used?

Brainstorming Exercise

The goal of Target costing is:

o Design a product following a set cost structure in

o Cut unnecessary costs

o Improve product design

Goal of Target Costing

Target Costing: The Nuts & Bolts

Determine anticipated selling price

Identify desired profit

margin

Calculate allowable price for each unit

component

Component #1

Component #2

Component #3

Target costing is based off this simple equation:

Determine Target Price & Desired Profit Margin

Perform Market Research & Identify Customer Needs

Production

Continuous Cost Reduction

Explore Different Product Design Alternatives

Develop Cost Projections for Each Component

Perform Value Engineering / Value Analysis

How it Works – Overview

Approved final

product design

How it Works - Part 1 - Analysis

Determine Target Price & Desired Profit Margin

Perform Market Research & Identify Customer Needs

Part 1 - Analysiso Begin by researching the target market and consumero Determine a target price that consumers expecto Determine how much profit margin you expect

Exampleo Arrington Enterprises sells widgetso Market prices for widgets are $15; Arrington wants to sell widgets at $13o Arrington wants to earn a 10% margin on all widgets soldo With an target sell price of $13, a 10% margin, Arrington can spend $11.70 to create

a widget

How it Works - Part 2- Design

Explore Different Product Design Alternatives

Develop Cost Projections for Each Component

Perform Value Engineering / Value Analysis

Part 2 - Designo Once an overall cost allowance is calculated, determine cost projections for each

component within the producto Design the component within the allocated cost budgeto Value Engineering / Value Analysis (VE/VA) for each component asks whether the

part can be substituted, simplified, or eliminatedo Repeat the cycle as necessary

Exampleo Arrington can spend $11.70 to create a widgeto Allocated cost budgets for each part is as follows: Part A= $5, Part B= $4.75, Part C=

$1.95o Each part is designed according to its allocated cost budget

How it Works - Part 3 - Implement

Production

Continuous Cost Reduction

Perform Value Engineering / Value Analysis Approved final

product design

Part 3 - Implemento Once a final product is design that meets the allocated cost budget production

beginso Continue to re-evaluate the product design using VA/VE to continue cost reductions

Exampleo Arrington succeeds in designing a widget that costs $11.70 and sells it at $13, =

10% margino Arrington continues to re-evaluate the widget design for more cost reductionso Through more Target Costing and VA/VE, Arrington further reduces costs to $11.35

Real World Example

In Business | Target Costing Approach--An Iterative Process:

Target costing Technique is widely used in Japan. In the automobile industry, the target cost for a new model is decomposed into target costs for each of the elements of the car--down to a target cost for each of the individual parts. The designers draft a trial blueprint, and a check is made to see if the estimated cost of the car is within reasonable distance of the target cost. If not, design changes are made, and a new trial blueprint is drawn up. This process continues until there is sufficient confidence in the design to make a prototype car according to the trial blueprint. If there is still a gap between the target cost and estimated cost, the design of the car will be further modified.

After repeating this process a number of times, the final blueprint is drawn up and turned over to the production department. In the first several months of production, the target costs will ordinarily not be achieved due to problems in getting a new model into production. However after that initial period, target costs are compared to actual costs and discrepancies between the two are investigated with the aim of eliminating the discrepancies and achieving target costs.

Source: Yasuhiro Monden and Kazuki Hamada, "Target Costing-Kaizen Costing in Japanese Automobile Companies," Journal of Management Accounting Research 3, pp. 16-34.

Now It’s Your Turn

Toyota wants to compete with GM’s Chevy Cobalt by reducing the price of its Corolla by 7%. In order to do so costs need to be reduced while still protecting Toyota’s mandatory profit margin of 5%. Three components of Toyota’s Corolla have been identified as opportunities for reducing significant costs, the chassis, the electronics, and the engine, other parts are also expected to reduce similar costs. What should the new cost structure of these parts look like to give the new Toyota Corolla a price advantage over the Chevy Cobalt?

Info (Assume Cobalt is comparable to Corolla):

GM’s Chevy Cobalt currently retails at $15,000

Toyota Corolla retails at $15,500

Toyota Corolla parts:

Chassis = $3,600

Electronics = $1700

Engine = $4000

Other = $5425

Now It’s Your Turn - Solution

GM’s Chevy Cobalt currently retails at $15,000

Toyota Corolla retails at $15,500

Target market price of new Toyota Corolla = $14,415 ($15,500 * .93) 7% Price reduction

Allowable cost budget for entire car = $13,694 ($14,415 * .95) 5% Profit Margin

New cost budgets for Toyota Corolla parts:

Chassis = $3348 ($3,600 * .93) 7% Price reduction

Electronics = $1581 ($1700 * .93) 7% Price reduction

Engine = $3720 ($4000 * .93) 7% Price reduction

Other = $5045 ($5425 * .93) 7% Price reduction

By reducing the costs of each component by about 7% Toyota can still maintain its 5% profit margin and reduce the price of its Corolla from $15,500 to $14,415.

Review & Summary

Determine anticipated

selling price

Identify desired profit

margin

Calculate allowable price for each unit

component

Component #1

Component #2

Component #3

Target costing is based off this simple equation:

Reading List & Further Research

Best Practices in Target Costing : http://www.imanet.org/pdf/1236.pdf

Target Costing Approach to Pricing: http://www.accountingformanagement.com/target_costing_pricing_products_and_services.htm

Managerial Implications of Target Costing: http://www.allbusiness.com/accounting-reporting/methods-standards-cost-accounting/846519-1.html

Accounting for Management, “Target Costing Approach to Pricing”, Apr 8, 2010, http://www.accountingformanagement.com/target_costing_pricing_products_and_services.htm

All Business A D&B Company, “Managerial implications of target costing” Apr 6, 2010, http://www.allbusiness.com/accounting-reporting/methods-standards-cost-accounting/846519-1.html

Management Accounting Quarterly, “Best Practices in Target Costing”, Apr 7, 2010, http://www.imanet.org/pdf/1236.pdf

ISM, “Target Costing Model”, Apr 8, 2010, http://images.google.com/imgres?imgurl=http://www.npd-solutions.com/image33.gif&imgrefurl=http://www.npd-solutions.com/target.html&usg=__iiMpHaeUC8MEhTdCrdQLiSX-0A8=&h=275&w=361&sz=5&hl=en&start=1&itbs=1&tbnid=8DLY8XciaXc3lM:&tbnh=92&tbnw=121&prev=/images%3Fq%3Dtarget%2Bcosting%26hl%3Den%26safe%3Dactive%26sa%3DN%26gbv%3D2%26ndsp%3D20%26tbs%3Disch:1

Yasuhiro Monden and Kazuki Hamada, "Target Costing-Kaizen Costing in Japanese Automobile Companies," Journal of Management Accounting Research 3, pp. 16-34.

Sources