The last post explained to us the meaning of target costing,
this post, will be illustrating target costing proper;
Mincol Plc. is planning on introducing a
new product to the market. The management estimated the total cost of product at
50,000 units to be as follows;
Cost to Produce

₦‘000’

Bought in parts (100
components)

50,000

Direct labour
(assembly of components) 10 hours x ₦500 per hour

5,000

Machine costs
(750,000,000 ÷ 50,000)

15,000

Ordering and receiving(500
orders x 100 components x ₦500 per order) ÷ 50,000units

500

Quality assurance (10
hours x ₦800 per hour)

8,000

Rework costs10%
(probability of failure) x ₦10,000 (cost of rework)

1,000

Nonmanufacturing
costs


Distribution

10,000

Warranty costs
10% (probability of
recall) x ₦15,000 (cost to
correct)

1,500

Total Estimated Cost

91,000

Target selling price

100,000

Target margin 20%


Target profit (.20 x
1,000,000)

(20,000)

Target cost

80,000

CostGap (91,00080,000)

11,000

The company has undertaken market research
which found that several proposed features of the new product were not valued
by customers. Redesign to remove the features leads to a reduction in the
number of components down to 80 components and a direct material cost reduction
of12%.
The reduction in complexity has other
impacts:
1. Assembly time will be reduced by 20%.
2. Quality assurance will only require 6
hours.
3. The probability of a failure at the
inspection stage will fall to 5%.
4. The probability of an aftersales
failure will also fall to 5%.
5. Cost of warranty corrections will fall
by ₦2,000.
6. Reduced weight of the product will
reduce shipping costs by ₦1,000 per unit.
Adapted from ICAN PM Study pack
You are required to prepare revised projected costs which
would now be;
Manufacturing cost

₦‘000

Bought in parts (12%*
50,000= 6,000) 50,0006,000

44,000

Direct labour
(assembly of components) 8hours x ₦500 per hour

4,000

Machine costs
(750,000,000 ÷ 50,000)

15,000

Ordering and receiving(500
orders x 80 components x ₦500 per order) ÷ 50,000units

400

Quality assurance (6
hours x ₦800 per hour)

4,800

Rework costs 5%
(probability of failure) x ₦10,000 (cost of rework)

500

Nonmanufacturing
costs


Distribution
(10,0001000)

9,000

Warranty costs (15,0002,000)
x 5%

650

Revised Estimated Cost

78,350

Target selling price (₦)

100,000

Target profit (.20 x 100,000)

(20,000)

Target cost

80,000

*Note that the revised estimated cost is
now lesser than the target cost, which has taken care of the Costgap.
I hope this made sense to someone, if you
have any question on any accounting course as a student of accounting in any of
our tertiary institution in Nigeria, please drop it at the comment section and I
will attend to it.
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