PGPMA MANAGEMENT ACCOUNTING – TERM 2. Costing techniques.pdf · Target costing approach Competitive market price • Set according to what the competition is charging Or • If

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PGPMAMANAGEMENT ACCOUNTING –

TERM 2

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COSTING TECHNIQUES

MANAGEMENT ACCOUNTING



Target Costing

Traditional approach to product costing• Develop a product• Determine the expected standard production cost• Set a selling price (probably based on cost)

• Resulting profit• Costs are controlled through variance analysis at monthly

intervals



Target Costing

Target costing approach Competitive market price • Set according to what the competition is charging Or• If the product is new set using market research or functional

analysis/pricing by functionDesired profit margin • As determined by the organisation’s strategic profit plans• Target cost = Competitive market price less desired profit

margin • This is the resulting cost that must be achieved



Set target selling prices based on customer expectations and sales forecasts

Establish target profit, based on long-term profit objectives and projected volumes

Determine the target cost per unit

Compare with Establish cost reduction targets for each component and production activity, using value engineering and value analysis

Estimated “current cost” of the new product

Steps in target costing process

Service industries are mostly not design driven

Too much focus on cost may take attention away from quality

Little room for gradual improvement in cost

The target costing process takes a long time

Service industries are mostly not design driven

Too much focus on cost may take attention away from quality

Little room for gradual improvement in cost

Difficulties of using target costing in the service industry



A target cost gap might be closed

Target Cost gap = Target Cost– Estimated cost (based on current material, labour, OH)

Example

A specifically designed Integrated Circuits (I.C.), the standard cost of Target Plc wasestimated at $360,000.

However, the target cost for 10,000 units of I.C. derived by deducting target profit($110,000) from target price ($440,000) was $330,000.

It clearly indicates that the target costing gap for the company was $30,000 (i.e., $360,000 –$330,000). The financial goal of the company would be to close the gap.





Target Costing

Target cost • When a product is first manufactured, the target cost may be

well below currently achievable cost • But management will set benchmarks for improvement

towards the target cost by specified dates • These will be incorporated into the budgeting process• Value analysis can be used to reduce costs if and when

targets are missed (covered in later slides)



Options available to reduce cost • Develop the product in an atmosphere of

continuous improvement• Apply value engineering techniques• Collaborate closely with suppliers• Change production methods• Improve technologies/processes• Cut out non-value added activities

Target costing





Target costing v standard costing How costs are controlled • Target costing - no cost slashing but continual

pressure to ensure costs are kept to a minimumStandard costing • Costs must be kept within predetermined standard

costs• Variances are calculated to check that this has

happened

Target costing



Target costing v standard costing continuedRelationship between product concept, cost and price• Target costing – Product design concept then selling

price - the target cost leading to profit margin • Standard costing – Predetermined product design

then cost leading to profit

Target costing



Target costing v standard costing continuedLink with strategic plans• Target costing – The product concept and target profit

margin take into account medium-term strategic plans• Standard costing – None. The approach is short-term

cost control through variance analysisTime frame for cost control • Target costing – Continual cost reduction. Target costs

are revised monthly• Standard costing – Standards are usually revised

annually

Target costing



• Value analysis (VA) is a planned, scientific approach to cost reduction

• It reviews the material composition of a product and the production design

• Modifications and improvements can be made which do not reduce the value of the product to the customer/user

Benefits • Lower costs • Better products • Higher profits

Value analysis 1



The benefits of value analysis are achieved by: – Cost elimination/prevention– Cost reduction– Improving product quality and so selling more at

the same price– Improving product quality and so increasing

selling price

Value analysis 2



Aspects of a product’s value to consider • Cost value – cost of producing / selling it• Exchange value – its market value• Use value – what it does• Esteem value – prestige customer attaches to it

Conventional cost reduction techniques v value analysis • Conventional cost reduction techniques – to achieve

the lowest production cost for a specific product design• Value analysis – tries to find the least cost method of

making a product that achieves its desired function

Value analysis 3



Typical consideration in VA• Can a cheaper (but as good or better) substitute

material be found?• Can unnecessary weight or embellishments be

removed without reducing the product’s attractiveness/desirability?

• Is it possible to use standardised or fewer components?

Value analysis 4



Steps in a VA study • Select a product/service for investigation• Obtain and record information about it• Analyse this information and evaluate the product,

considering each aspect of value in turn• Consider alternatives• Select the least-cost alternative for recommending to

management• Make a recommendation• If accepted, implement the recommendation• After a period, evaluate the outcome and measure the

cost savings

Value analysis 5



Functional analysis• This is most commonly applied during the development

stage of products • It uses the functions of a product/service (such as ‘to

make a mark’ for a pen) as the basis for cost management

• The steps in functional analysis are similar to those in VAValue engineering • The application of similar techniques to those of VA to

new products • The aim is to design and develop new products of a

given value at minimum cost

Value analysis 6



Life cycle costing 1



Stages in the life cycle• Introduction• Growth• Maturity• Decline

The stage a product is at in its life cycle will affect the returns expected




Performance measures Introduction • Cash – net user • Return on capital employed – not important • Growth – vital • Profit – not expected Growth • Cash – net user • Return on capital employed – not important • Growth – vital• Profit – important




Performance measures continued Maturity• Cash – generator • Return on capital employed – important • Growth – grow with new uses• Profit – important Decline • Cash – generator• Return on capital employed – important • Growth – negative growth• Profit – very important




Life cycle costing • The profiling of cost over a product’s life, including the

pre-production stage




How to maximise the return over the product life cycle

• Design costs out of products• Minimise the time to market• Minimise breakeven time• Maximise the length of the life span• Minimise product proliferation




Impact on marketing strategies • As a product progresses through its life cycle, it

faces different challenges and opportunities • These will require changes in the marketing mix and

alternative marketing strategies• Example: During the maturity stage, incentives

should be given to entice competitors’ customers to switch




Traditional management accounting systems v life cycle costing Traditional management accounting systems • Based on the financial year and so dissect the product life

cycle into a series of annual sections • Profitability is thus assessed on an annual basis• Such systems total all non-production costs and record them

as a period expense• They write off R&D expenditure against revenue from

existing products • Therefore existing products seem less profitable and are

scrapped too quickly




Traditional management accounting systems v life cycle costing continued Life cycle costing • This approach tracks and accumulates a product’s

actual costs and revenues over the entire product life cycle

• This means that a product’s total profitability can be determined

• It traces non-production costs to individual products over complete life cycles




Benefits of life cycle costing • Full understanding of individual product profitability• More accurate feedback information• Cost reduction/minimisation and revenue expansion

opportunities more apparent• Increased visibility of non-production costs




Customer life cycle • Aim is to extend the life cycle of a particular

customer• Do this by encouraging loyalty (e.g. loyalty cards)• Customers become more profitable over their life

cycle (e.g. bank customers)




Questions to be done from Kaplan P2 Study Text (Chapter 3)

1. Objective test question 22. Objective test question 33. Data set question4. Case Style Question



Questions

Classwork:P2 May 2010: Section A Question 3P2 May 2012: Section A Question 4

Homework:P2 Nov 2013: Section A Question 2


PGPMA MANAGEMENT ACCOUNTING – TERM 2. Costing techniques.pdf · Target costing approach Competitive market price • Set according to what the competition is charging Or • If

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