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Traditional standard costing method adopt general administrative, estimate of product, distribution costs into consideration. In contrary, target costing is showing a more positive approach to pricing which is the pricing are consider prior to the production. For instance, traditional costing establish a price through identifies the cost based on the design of costs and adds a markup but in contrast, setting price is the first step of the target costing. After setting a price, minus the target income and will reaching a cost.
Target costing reduce the costs during the planning and design stage of the product life cycle since mostly of the product costs is identifies in the target costing. Target costing reduces costing in the production stage and allocates more of the total costs to the development at the development stage. Material requirement planning, total quality control, just-in-time are used in the cost reducing process. Target costing method is suitable for assembly oriented industries used which is medium to small volume production.
The following of the case study is show the process of determined target costing using production and cost figures
PCBM, a Silicon Valley PCB manufacturer, is offered $50 per unit for 100,000 units of a multi-layer panel product by an electronic manufacturer. Return on sales of the PCBM's return on sales (ROS) rate is 25 percent, on this offer the desired return is $ 1,250,000.
Amount of the offer: $50 x 100,000 units = $ 5,000,000.
Desired return: 0.25 x $50 = $12.50 per unit.
Offer: $12.50 x 100,000 = 1,250,000.
Sales price - desired return = allowable cost for production
$50,00 - $12,50 = $37.50
The allowable cost for this production of 100,000 units is $37.50 per unit, or $3,750,000 for the offer.
The estimated cost id calculated by the cost management team as $42.00 per unit, or $4,200,000 for the offer.
The cost was estimated based on two solder mask sides requested, four layers requests, board length, five images per panel, board-width, one component legend side, estimated yield rate of 85%, panel size, material cost per panel of $20.00.
The impact of accepting the offer on the production plan and the cost of total production for the period was also considered.
The different between allowable cost ($3,750,000) and the estimated cost ($4,200,000) for the offer, which is adopted as the target cost reduction:
$4,200,000 - $3,750,000= $450,000
Strive to eliminate the different of $450,000 started with the VE activities. VE activities should focuses on the flaw rate and material handling and purchasing after careful appraisal for long hour by production supervisors, cost management employee, process and product engineers
Propose improvement in performance by 35%, which is estimated to cut down unit cost by $2 after a series of studies and analyses of material scraps and other types of flaw were performed.
But, since the new target costing induced management plan has been accepted by all supervisors and managers of the plant suggestion were aggressively implemented by the process and areas involved.
Improvements in material handling were centered on reducing material moving distances between the point of usage point and receiving the deliveries. Several moves were analyzed to cut down the distances. Simultaneously, the purchasing group of PCBM entered a long negotiation process with the suppliers, in order to persuade them to lower their prices. Consequence of the improvement activities was reducing of another $1 per unit cost.
The combined reduction in cost per unit of $3, a total of $300,000, brought the cost to $3,900,000.
Although still higher than the allowable cost which is $150,000 ($4,200,000 - $3,900,000), but the top management thought this reduce cost is considerable.
Management asked the marketing team to look back the $50,00 selling price after the successful implementation of the target costing project. Since the customer was satisfied with the quality of the product, they were responsive to the request by PCBM for a review of the $50,00 price. The customer's representative tried to justify the fair level of the current price by pointing out that no tab plate edge was required, which would cut down manufacturing costs.
Since PCBM had already designed and implemented an activity-based costing(ABC) system, it was rather easy to demonstrate the cost impact of each component.
PCBM's ABC system, which had five process centers, indicated the following costs of options:
The cost of solder mask option: $2,00
The cost of component legend option: $1.00
Since the customer's PCBM didn't require tab plating, so the ABC system response that no cost to charged for the tab plating option. This helped PCBM earn credibility from the customer regarding the price quotes and at the end the customer agreed to consider a price increase in the near future.
The Real Weapon
The real power of target costing is that it allows companies to successfully motivate employees and enforce cost management action plans. Target costing is a disciplined approach to managing costs and improving processes and products. Target costing, as briefly illustrated here, is also very compatible with the emerging ABC, which can provide necessary cost information for implementing target costing. And target costing can be as effective in U.S. industry, as it has been in Japan.