Cima P2 Exam Question 28

Question No 28:

Explain how target costing could be of benefit to the company.
Target Costing is useful in a competitive market such as this where a company is not dominant in the market and is forced to accept the market price for its products or services.
Thus Target Costing focuses on the achievement of a unit cost which will earn the company the financial return that it requires.

The starting point for the operation of Target Costing is the unit selling price of the company's product or service. From this is deducted the required profit (to yield the company's required financial return) and the result is the target unit cost that is to be achieved. This target cost is then compared with the expected unit cost to see if the target cost is already being met or if the company needs to consider making changes which will result in a lowering of unit costs.

It may be that the effects of the learning and experience curves will reduce the present cost to the level of the target cost; or it may be that the company can achieve other cost savings provided they do not diminish the quality of the product or service as perceived by the customer.

If these cost savings cannot be made the company may have to lower its required return from the product or service or decide that it is not financially viable for it to sell this product or service in the market.
Thus Target Costing would benefit this company by forcing it to consider its internal processes and costs and to conduct these as efficiently as possible. If despite making theseas efficient as possible the required return from the product cannot be achieved, then the company should cease to make a product that is not viable and therefore would be able to focus its resources on alternative sources of income.