Target Costing

TARGET COSTING
MEANING
Target cost is an accounting approach that measures the cost of a product that is necessary to
develop a certain quality and functionality for ensuring the desired profit figure.
This cost management tool is used by the company through design, research, engineering,

production, and marketing to reap better profits in this competitive market.
Target costing is an approach to determine a product's life-cycle cost which should be sufficient to

develop specified functionality and quality, while ensuring its desired profit. It involves setting a
target cost by subtracting a desired profit margin from a competitive market price.[1] A target cost is
the maximum amount of cost that can be incurred on a product, however, the firm can still earn the
required profit margin from that product at a particular selling price. Target costing decomposes the
target cost from product level to component level. Through this decomposition, target costing
spreads the competitive pressure faced by the company to product's designers and suppliers. Target
costing consists of cost planning in the design phase of production as well as cost control throughout
the resulting product life cycle. The cardinal rule of target costing is to never exceed the target cost.
However, the focus of target costing is not to minimize costs, but to achieve a desired level of cost
reduction determined by the target costing process.
DEFINITION
Target costing is defined as "a disciplined process for determining and achieving a full-stream cost at
which a proposed product with specified functionality, performance, and quality must be produced
in order to generate the desired profitability at the product’s anticipated selling price over a
specified period of time in the future." This definition encompasses the principal concepts: products
should be based on an accurate assessment of the wants and needs of customers in different market
segments, and cost targets should be what result after a sustainable profit margin is subtracted from
what customers are willing to pay at the time of product introduction and afterwards.
The fundamental objective of target costing is to manage the business to be profitable in a highly
competitive marketplace. In effect, target costing is a proactive cost planning, cost management,
and cost reduction practice whereby costs are planned and managed out of a product and business
early in the design and development cycle, rather than during the later stages of product
development and production.
Target costing is not just a method of costing, but rather a management technique wherein prices
are determined by market conditions, taking into account several factors, such as homogeneous
products, level of competition, no/low switching costs for the end customer, etc. When these factors
come into the picture, management wants to control the costs, as they have little or no control over
the selling price.
Target costing is defined as a management technique that helps the company to decide the prices by
estimating market condition. It includes cost planning in the initial designing stage and also the cost
control that exists throughout the lifecycle of a product.
Although the primary role of target costing is not to surpass target cost, it does not remove its focus
which is not to decrease costs but to achieve cost reduction by process of target costing
PROCESS
1. Conducting Market Research:
The company should determine the customer wants precisely through conducting marketing
research. A new product can be designed or make changes in the existing product on the basis of the
customers’ expectations and perceptions.
2. Identify the Nature of Market:
The market information can be collected in such a way that what type of products are available in
the market, the level of competition prevailing, the number of competitors and the price at which
the existing products are available. Besides, the company should find out the affordable price of the
customers. If so, the target costing is followed.
2. Translation of Customers Requirements into Product Features:

The preference of one customer differs from another. These preferences are collectively called
as customers’ requirements. Now, the bundle of preferences are bringing into a tangible thing
i.e. product.
3. Development of a Product Design:
By considering the engineering analysis of market forces, customer needs, relevant technology,
competitors’ models, product configuration and performance features, design alternatives,
process capabilities, maintenance and service requirements etc., a suitable product design is to
be determined by the company. Such a product design assures a targeted profit and target cost
for each component in total.
4. Determine the Price, Margin and Cost:
Target selling price is determined on the basis of market survey, at which the product can be
sold. The standard margin is also included in the target selling price. If so, it is possible to
determine the target cost
Target Cost = Target Selling Price – Target Profit
5. Conducting Value Engineering Process:

The company can conduct value engineering process to reach target cost. It is a well-known fact
that the difference between target selling price and the target profit is target cost. The target
selling price cannot be changed at any cost; Hence, it is a duty on the part of company is that
takes necessary steps to reach the target cost.
6. Improve the Design to Reach Target Cost:

The company starts a minor trial production. Such a production ensures all product
performances, target cost and target profit margin also. The trial production comes to an end
whenever the product design matches the target cost.
7. Approval of Top Management

A detail report is presented before the top management for getting approval. The report
contains the production process, elements of cost involved with the level of costs to be incurred
and design of the specified product. A formal approval is given for starting commercial
production.
9. Maintenance of Accounts:
A separate accounting records are to be maintained for each product design. It is possible to verify
whether the total expenses exceed the target cost. If the expenses are not controllable at any time,
the product design will be changed. Hence, the maintenance of separate set of books are highly
required under target costing process.
10. Implement the Target Costing:
The company can get the information regarding the expenses incurred for each design separately. A
continuous watching is essential to bring the total cost within the target cost.
ADVANTAGES OF TARGET COSTING
The main advantages of target costing are discussed below.
1. It ensures proper planning of production schedule and even marketing also.
2. The company can win in the competition from the marketing world.
3. The customers can get quality products by fulfilling their requirements at affordable cost.
4. There is a commitment on the part of employees from top to bottom for quality production.
5. There is a possibility of product innovation to achieve some competitive advantages.
6. It uses management control system to support and reinforce manufacturing strategies.
7. It integrates the activities of supplier with the customers requirements to design the right
product.
8. It helps to find the market opportunities. Such market opportunities are used to fix the possible
target selling price at the maximum.
9. The cost of features of a product is based on the customers’ willingness to pay for them.
10. It reduces the period of product development cycle.
11. It reduces the costs of products significantly.
12. The spirit of team work starts from the stage of conceiving the product idea and ends with
distribution of products among the customers and passes through planning, developing,
manufacturing and selling.

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TARGET COSTING

This cost management tool is used by the company through design, research, engineering,

Target costing is an approach to determine a product's life-cycle cost which should be sufficient to

1. Conducting Market Research:

2. Identify the Nature of Market:

2. Translation of Customers Requirements into Product Features:

Target Cost = Target Selling Price – Target Profit

5. Conducting Value Engineering Process:

6. Improve the Design to Reach Target Cost:

7. Approval of Top Management

ADVANTAGES OF TARGET COSTING

The main advantages of target costing are discussed below.

1. It ensures proper planning of production schedule and even marketing also.

5. There is a possibility of product innovation to achieve some competitive advantages.

6. It uses management control system to support and reinforce manufacturing strategies.

10. It reduces the period of product development cycle.

11. It reduces the costs of products significantly.

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