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budgeted life profit of $4 850 000 assumed sales of 50 000 units, at a planned selling priceof $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 of48.5 per cent on cost (or 32.65 per cent of selling price). The planned costs were derivedfrom the management accountant’s understanding of the current production technologyand facilities available to the company. If the company had used target costing, the preparation of the life cycle budget and theplanned level of profit may have been very different. Let’s say that market researchindicated 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)$127.9618PA R T3 •IN F O R M A T I O NF O RMA N A G I N GRE S O U R C E Starget costinga system of profitplanning and costmanagement thatdetermines the lifecycle cost at whicha proposed productmust be produced,to generate thefirm’s desired levelof profit, given theproduct’s anticipatedselling priceEXHIBIT 15.7Life cycle costs and cost commitment for a typical productSource: Adapted from Burstein (1988, p. 261)Product lifecycle costsProduct life cyclephases25%50%75%100%Product planningand conceptdesignDesign anddevelopmentProductionDistributionand customersupportincurred costscommitted costs
Notice that this cost is well below the planned cost of $200 per unit. (Indeed the targetselling price is below the planned cost.) Substantial cost reduction would be requiredbefore the CD Super would earn a return of 32.65% on selling price.The target costing processWe have used the CD Super to illustrate the basic calculations involved in setting targetcosts, but it is important that you also understand the processesthat would be used to drivethe current cost down towards the target cost. Exhibit 15.8 describes the three steps toreducing costs through the target costing process (Cooper & Slagmulder, 1999):1market-driven costing;2product-level target costing; and3component-level target costing. We will continue with the CD Super to illustrate these steps.EXHIBIT 15.8The target costing processSource: Cooper & Slagmulder (1999, p. 166)Market-driven costing, the target cost in an ideal worldEarly in the product planning stage, ACDP would have developed a clear picture of theproduct features required to meet customers’ expectations, and the level of performancerequired 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 sellingprice, which is the anticipated market price for the product, would be based on marketconsiderations, such as customers’ needs and expectations and competitors’ behaviour, aswell as the business’s strategic objectives for the product.