budgeted life profit of 4 850 000 assumed sales of 50 000 units at a planned

# Budgeted life profit of 4 850 000 assumed sales of 50

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budgeted life profit of \$4 850 000 assumed sales of 50 000 units, at a planned selling price of \$297 and a planned cost, including upstream and downstream costs, of \$200 per unit. The selling price was based on the planned cost per unit plus a planned profit mark-up of 48.5 per cent on cost (or 32.65 per cent of selling price). The planned costs were derived from the management accountant’s understanding of the current production technology and facilities available to the company. If the company had used target costing , the preparation of the life cycle budget and the planned level of profit may have been very different. Let’s say that market research indicated to ACDP that to sell 50 000 units the CD Super would have to be priced at \$190. Given this information we can estimate the target cost for CD Super as: Target cost target selling price (target profit margin) \$190 (0.3265 \$190) \$127.96 18 P A R T 3 I N F O R M A T I O N F O R M A N A G I N G R E S O U R C E S target costing a system of profit planning and cost management that determines the life cycle cost at which a proposed product must be produced, to generate the firm’s desired level of profit, given the product’s anticipated selling price EXHIBIT 15.7 Life cycle costs and cost commitment for a typical product Source: Adapted from Burstein (1988, p. 261) Product life cycle costs Product life cycle phases 25% 50% 75% 100% Product planning and concept design Design and development Production Distribution and customer support incurred costs committed costs
Notice that this cost is well below the planned cost of \$200 per unit. (Indeed the target selling price is below the planned cost.) Substantial cost reduction would be required before the CD Super would earn a return of 32.65% on selling price. The target costing process We have used the CD Super to illustrate the basic calculations involved in setting target costs, but it is important that you also understand the processes that would be used to drive the current cost down towards the target cost. Exhibit 15.8 describes the three steps to reducing costs through the target costing process (Cooper & Slagmulder, 1999): 1 market-driven costing; 2 product-level target costing; and 3 component-level target costing. We will continue with the CD Super to illustrate these steps. EXHIBIT 15.8 The target costing process Source: Cooper & Slagmulder (1999, p. 166) Market-driven costing, the target cost in an ideal world Early in the product planning stage, ACDP would have developed a clear picture of the product features required to meet customers’ expectations, and the level of performance required for each feature. This would have involved identifying the size of the CD player, the quality of the sound, the batteries to be used, and so on. The CD Super’s target selling price , which is the anticipated market price for the product, would be based on market considerations, such as customers’ needs and expectations and competitors’ behaviour, as well as the business’s strategic objectives for the product.

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