Target Costing (5 marks)

Able to explain target costing

Traditional costing systems:
1. Calculate unit cost
2. Add profit margin
3. Equals Selling price

This means that a product is designed, the unit costs calculated and price set without
reference to the market, or what the customer is prepared to pay.

Target costing:
Works backwards:
1. Set desired selling price with reference to the market/ customer
2. Subtract the required profit margin
3. Gives Target Cost

The target cost will usually be very much lower than the initial cost estimate for a
product. In target costing the emphasis is on closing the gap between the two.

Emphasis is on cost reduction at the design stage.
Although there are many ways this can be achieved, two in particular can
dramatically reduce products costs:
- Reduce component count
- Reduce production complexity

Standard Cost
A predetermination of what a product is expected to cost under specific working
conditions. The preparation of standards is more successful where the process of
producing products (or services) is repetitive and already in operation. Preparation of
the Standard follows the steps:

Materials: Price and Usage
Labour: Rate and Efficiency
Variable OH: Expenditure and Efficiency


Types of standard (4 marks)
Attainable A standard that includes expected losses, inefficiencies, machine
breakdowns and idle time. In essence, the standard is realistic and based upon a
tough but achievable target.
Use A target for managers in budgetary control.

Ideal A standard assuming perfect working conditions ie no losses, inefficiencies etc.
This standard is not used for planning or budgetary control purposes because they
are considered unrealistic and demotivational.
Use A long-term organization goal.




























Budgeting is a quantitative plan prepared for a specific time period. It is normally
expressed in financial terms and prepared for one year. (6marks)

Aims of budgeting (Purposes, Benefits, Advantages)

We can identify the aims of a budget in six ways.
1. Planning
A budgeting process forces a business to look to the future. If a business does not
look to the future it will fail in the short, medium or long term. It will fail because
the organization will become out of kilter with its environment.
2. Control
The budget acts as a comparator against which the actual results may be
compared.
3. Communication
The budget may form the basis of the reporting hierarchy. It is a formal
communication channel that allows junior and senior managers to converse.
4. Co-ordination
The budget allows the business to co-ordinate all diverse actions towards a
common corporate goal.
5. Evaluation
The budget may be used to evaluate the results of a part of the business such as
a cost centre. It may further be used to evaluate the actions of a manager within
the business. The costs and revenues appraised must be within the control that
we are evaluating.
6. Motivation
The budget may be used as a target for managers to aim for.












Decision making (relevant cost and opportunity cost) (4 marks)
Able to make effective decisions in a variety of situations.

The choice between two or more alternatives, decision making normally considers
only the short term consideration of maximizing profitability at this point in time. It
may also include use of discounted cash flow when considering investment appraisal.
We base our decisions on relevant costs.

Relevant cost: Future cash flow arising as a direct result of the decision.

Non-relevant costs:
- Sunk costs costs incurred (not future, not arising from decision).
- Committed costs future expenditure which will/ can not be affected by the
decision.
- Non cash flows any cost which does not reflect cash flow eg. Depreciation.
- Overheads absorbed does not necessarily reflect cash flow, only overheads
incurred may be relevant.
Relevant costs include:
- Opportunity cost
- Avoidable cost
- Variable cost
- Incremental cost

Opportunity cost:
The benefit foregone by choosing one alternative in preference to the next best
alternative. In many decisions there is more than a simple do nothing alternative.
In such circumstances the benefit/ cost of one course of action will be determined by
other possible course of action.

Opportunity costs only apply to the use of scarce resources. Where resources are not
scarce, no sacrifice exists from using these resources.