ACCA Applied Skills · Performance Management

Target costing: formula sheet

Full chapter guide

Key formulas

Target cost: Target cost = Target selling price − Required profit; Required profit can be given as an amount per unit or as a percentage of selling price. If it is a percentage of cost, convert it carefully.
Target cost gap: Target cost gap = Estimated cost − Target cost; A positive figure means cost must fall. If it is negative, the estimate is already below target.
Profit as a percentage of selling price: Required profit = Selling price × margin %; Use this when the question gives a margin on sales.
Profit as a mark-up on cost: Target cost = Selling price ÷ (1 + mark-up %); Use this when the profit is given as a percentage of cost, not of price.
Target cost: Target cost = Target selling price − Target profit; Profit may be given as a margin on price or as a required return. Read the wording carefully.
Target cost gap: Cost gap = Estimated cost − Target cost; A positive figure is a shortfall that must be closed. A negative figure means the target is already met.
Gap as a percentage: Cost reduction needed % = Cost gap ÷ Estimated cost × 100; Use this to judge how hard the gap is to close and to spread reductions across components.
Revised estimated cost: Revised cost = Original estimate − Savings from each action; Check whether the total savings are at least equal to the gap.
Target cost: Target cost = Target selling price − Target profit; Profit may be given as a margin on price or as a required return. Read which.
Target cost gap: Gap = Estimated cost − Target cost; A positive figure is a shortfall that needs closing. Do this per unit or in total, but be consistent.
Learning curve: Y = a × X^b; Y = cumulative average time (or cost) per unit for X units. a = time for the first unit. X = cumulative units.
Index of learning: b = log r ÷ log 2; r is the learning rate as a decimal, for example 0.8 for 80%. b is negative.
Doubling shortcut: Average after doubling = Previous average × r; Works only when output doubles: 1, 2, 4, 8, 16 and so on. Use it to avoid logs.
Total time: Total time for X units = Cumulative average time × X; Multiply by the labour rate per hour to get total labour cost.
Incremental time: Time for units (m+1) to n = Total for n units − Total for m units; Use this when the question asks about a later batch, not all units from the start.
Finding the rate: r = Average time at 2n units ÷ Average time at n units; Use the doubling relationship. If output rises four-fold, r² = ratio of averages.
Target cost: Target cost = Target selling price − Target profit; Target profit may be a margin on price or a mark-up on cost. Read the question to see which.
Target cost gap: Cost gap = Estimated cost − Target cost; A positive figure means the cost must be reduced. Zero or negative means the target is already met.
Cost-plus price: Price = Full cost + (Full cost × mark-up %); Mark-up is on cost. A margin is on selling price. Do not mix them.
Margin to mark-up: Profit margin of m% on price equals a mark-up of m ÷ (100 − m) on cost; For example, a 20% margin on price equals a 25% mark-up on cost.

Quick revision

Target cost = target selling price − required profit.
Cost gap = current estimated cost − target cost. A positive gap means cost is too high.
Target costing is market-led: price comes first, cost is the thing to be managed.
The process starts at design stage, when most of a product's cost is committed.
Ways to close the gap: value engineering, cheaper materials, simpler design, fewer components, process change, supplier negotiation.
Value engineering aims to remove cost without reducing value the customer pays for.
Learning curve effects usually reduce labour time per unit, so labour cost in the estimate falls as output grows.
Check whether the learning rate applies to cumulative average time or to marginal time as the question states.
Target costing differs from cost-plus, which builds price up from cost and margin.
Kaizen costing seeks continuous small savings during production, while target costing acts mainly before launch.
Evaluate: it focuses on customers and cost early, but it can cause stress, delay and lower quality if the gap is too hard.
In a written answer, apply points to the scenario's product and figures.

Common mistakes

Treating a profit mark-up on cost as a margin on selling price. Fix: Read the base. Margin on price: deduct % of price. Mark-up on cost: divide price by (1 + %).
Calculating the gap as target cost minus estimated cost. Fix: Always use estimated cost minus target cost. A positive result means a shortfall to be closed.
Calculating the gap the wrong way round Fix: Always write estimated cost minus target cost. A positive answer means a problem.
Treating profit as a percentage of cost when it is a percentage of price Fix: Margin is on selling price, mark-up is on cost. Underline the base before calculating.
Applying the learning rate to the total cost, including materials. Fix: Apply the curve to labour hours only. Add materials and fixed overheads at their normal amounts unless told otherwise.
Treating 80% as a fall of 80%, so multiplying the time by 0.2. Fix: An 80% rate means the average becomes 80% of the previous figure each time output doubles. Multiply by 0.8.
Treating a profit margin as a mark-up on cost. Fix: A margin is a percentage of price. A mark-up is a percentage of cost. Re-read the wording and convert if needed.
Saying target costing starts with the cost of the product. Fix: Remember that the price comes first. Cost is the result, not the starting point.

Exam tips

Check at once whether profit is a margin on price or a mark-up on cost. Examiners use both.
In OT questions, work out the target cost first and then the gap, because the options often include the wrong subtraction.
In written answers, link each cost-reduction idea to the scenario. Say what it does to cost and what risk it carries for quality or sales.
Be ready to explain why target costing suits competitive markets, and that it focuses on the design stage.
Show the layout in Section C: price, profit, target cost, estimated cost, gap. Method marks are available even if a figure is wrong.
Do the target cost and gap calculation first, even if the question seems to ask only for discussion. It anchors your answer.
Check whether a percentage is applied to price, cost, or one cost element. Many marks are lost on the wrong base.
In written parts, link each method to a cost in the scenario and state a risk, such as lower quality or supplier dependence.