PM - Specialist cost and management
accounting techniques
Contents
Target Costing ............................................................................................................................. 2
DEFINITION: ............................................................................................................................. 2
TARGET COSTING PROCESS: .................................................................................................... 2
AREAS OF COST REDUCTION: .................................................................................................. 4
TARGET COSTING IN SERVICE INDUSTRIES: ............................................................................. 5
Activity Based Costing ................................................................................................................. 6
ACTIVITY BASED COSTING VS ABSORPTION COSTING: ........................................................... 6
CALCULATING ABC: .................................................................................................................. 8
PROBLEMS WITH ABC: ........................................................................................................... 13
Lifecycle Costing ........................................................................................................................ 14
Environmental Cost Accounting ................................................................................................ 17
ENVIRONMENTAL MANAGEMENT ACCOUNTING: ................................................................ 17
ENVIRONMENTAL COSTS: ...................................................................................................... 17
MANAGEMENT ACCOUNTING TECHNIQUES: ........................................................................ 18
Throughput Accounting ............................................................................................................ 20
DEFINITION: ........................................................................................................................... 20
THEORY OF CONSTRAINTS: .................................................................................................... 20
LIMITING FACTOR ANALYSIS:................................................................................................. 21
THROUGHPUT ACCOUNTING RATIO: .................................................................................... 21
1
,Target Costing
DEFINITION:
Target costing is a market driven approach to price that calculates the acceptable level of costs
based on the external selling price.
TARGET COSTING PROCESS:
Steps involved in the target costing process for manufacturing company are:
1) Specify the product that the company wishes to sell. This involves analysis of the market
and determination of product features;
2) Consider selling price. This is a market driven price based on what the customer is
willing to pay or the perceived value of the product, which is referred to as target price;
3) Calculate required profit. This profit is determined based on acceptable return on
investment, which is referred to as target profit;
4) Determine target cost. Target cost = target price - target profit. The target cost
represents the highest acceptable cost of the product;
5) Close the cost gap. If estimated costs are greater than target costs, there is a cost gap. It
is important that quality of the product is not impaired as a result of any cost
reductions;
6) Negotiate with customers if a cost gap still exists. This is necessary in order to
determine whether to manufacture the product or not.
Example 1:
Company A has calculated a selling price for a new product, Product P, of $100. A profit margin
of 30% is required to satisfy the company investors. We are required to calculate target cost.
Solution:
Sales price - Target profit = Target cost
We can assume that significant market research has been undertaken to ensure that Product P
is of interest to customers. We can also assume that the price of $100 is competitive and has
been set based on what a customer may be willing to pay for this product as well as the desired
2
, share of the market sought by Company A. In other words, we can say that the $100 sales price
is a target price.
A profit margin is calculated based on what is an acceptable return to Company A’s investors. A
30% required profit margin equates to a $30 profit based on the product P’s sales price of $100.
Based on these numbers we can derive the target cost of the new product:
Target cost = $100 - $30 = $70
The target cost of $70 represents the highest acceptable cost to Company A of making Product
P.
Example 2 (сontinued):
Company A calculates that material, labour and overhead costs associated with producing
Product P are $40, $25 and $13 respectively. We are required to calculate any cost gap that
may exist regarding Product P.
Solution:
The total estimated cost of making Product P amounts to:
Estimated cost = $40 + $25 + $13 = $78
This estimated cost of $78 exceeds the maximum allowable cost (or target cost) of $70 by $8.
This $8 is referred to as a cost gap or a target gap. Company A must focus on reducing or
eliminating this cost gap, i.e., the anticipated material, labour and overhead costs incurred
during the design and production of product P must be re-visited to see if any cost reductions
can be made.
Value engineering is a term often associated with target costing at this stage of the process.
Value engineering helps businesses achieve cost efficiencies and meet their cost and
profitability targets. Attention, therefore, should be focused more on reducing the costs of
product features perceived by the customer as non-value adding.
3
accounting techniques
Contents
Target Costing ............................................................................................................................. 2
DEFINITION: ............................................................................................................................. 2
TARGET COSTING PROCESS: .................................................................................................... 2
AREAS OF COST REDUCTION: .................................................................................................. 4
TARGET COSTING IN SERVICE INDUSTRIES: ............................................................................. 5
Activity Based Costing ................................................................................................................. 6
ACTIVITY BASED COSTING VS ABSORPTION COSTING: ........................................................... 6
CALCULATING ABC: .................................................................................................................. 8
PROBLEMS WITH ABC: ........................................................................................................... 13
Lifecycle Costing ........................................................................................................................ 14
Environmental Cost Accounting ................................................................................................ 17
ENVIRONMENTAL MANAGEMENT ACCOUNTING: ................................................................ 17
ENVIRONMENTAL COSTS: ...................................................................................................... 17
MANAGEMENT ACCOUNTING TECHNIQUES: ........................................................................ 18
Throughput Accounting ............................................................................................................ 20
DEFINITION: ........................................................................................................................... 20
THEORY OF CONSTRAINTS: .................................................................................................... 20
LIMITING FACTOR ANALYSIS:................................................................................................. 21
THROUGHPUT ACCOUNTING RATIO: .................................................................................... 21
1
,Target Costing
DEFINITION:
Target costing is a market driven approach to price that calculates the acceptable level of costs
based on the external selling price.
TARGET COSTING PROCESS:
Steps involved in the target costing process for manufacturing company are:
1) Specify the product that the company wishes to sell. This involves analysis of the market
and determination of product features;
2) Consider selling price. This is a market driven price based on what the customer is
willing to pay or the perceived value of the product, which is referred to as target price;
3) Calculate required profit. This profit is determined based on acceptable return on
investment, which is referred to as target profit;
4) Determine target cost. Target cost = target price - target profit. The target cost
represents the highest acceptable cost of the product;
5) Close the cost gap. If estimated costs are greater than target costs, there is a cost gap. It
is important that quality of the product is not impaired as a result of any cost
reductions;
6) Negotiate with customers if a cost gap still exists. This is necessary in order to
determine whether to manufacture the product or not.
Example 1:
Company A has calculated a selling price for a new product, Product P, of $100. A profit margin
of 30% is required to satisfy the company investors. We are required to calculate target cost.
Solution:
Sales price - Target profit = Target cost
We can assume that significant market research has been undertaken to ensure that Product P
is of interest to customers. We can also assume that the price of $100 is competitive and has
been set based on what a customer may be willing to pay for this product as well as the desired
2
, share of the market sought by Company A. In other words, we can say that the $100 sales price
is a target price.
A profit margin is calculated based on what is an acceptable return to Company A’s investors. A
30% required profit margin equates to a $30 profit based on the product P’s sales price of $100.
Based on these numbers we can derive the target cost of the new product:
Target cost = $100 - $30 = $70
The target cost of $70 represents the highest acceptable cost to Company A of making Product
P.
Example 2 (сontinued):
Company A calculates that material, labour and overhead costs associated with producing
Product P are $40, $25 and $13 respectively. We are required to calculate any cost gap that
may exist regarding Product P.
Solution:
The total estimated cost of making Product P amounts to:
Estimated cost = $40 + $25 + $13 = $78
This estimated cost of $78 exceeds the maximum allowable cost (or target cost) of $70 by $8.
This $8 is referred to as a cost gap or a target gap. Company A must focus on reducing or
eliminating this cost gap, i.e., the anticipated material, labour and overhead costs incurred
during the design and production of product P must be re-visited to see if any cost reductions
can be made.
Value engineering is a term often associated with target costing at this stage of the process.
Value engineering helps businesses achieve cost efficiencies and meet their cost and
profitability targets. Attention, therefore, should be focused more on reducing the costs of
product features perceived by the customer as non-value adding.
3
