ACCA Applied Skills · Performance Management

Target Costing for ACCA Performance Management

Target costing starts with the price the market will pay. You subtract the profit you require to get the target cost. Then you compare it with the current estimated cost. The difference is the target cost gap, and you close it through design, materials, process and supplier changes before launch.

What this chapter covers

Target costing is a market-led way to control cost. Most firms build a cost first, add a margin and hope customers pay. Target costing reverses this. You set the selling price from the market, deduct the required margin, and treat the result as the maximum cost allowed. The product team then works to meet it.

The chapter has four parts. First, the concept and the calculation: target price, target profit, target cost and cost gap. Second, the ways to close the gap, such as value engineering, cheaper components, simpler processes and supplier negotiation. Third, how learning curve effects reduce labour cost per unit and so change the estimated cost. Fourth, how target costing compares with other approaches such as cost-plus, life cycle costing and kaizen costing, and how to judge its strengths and limits.

It connects to much of the PM paper. It sits with the other modern costing methods, such as activity-based costing, life cycle costing, throughput accounting and back-flush accounting. It uses the learning curve from the decision-making area. It also links to pricing, value for money and performance measurement. Examiners like to join these ideas in one scenario.

Target costing is a favourite for both objective questions and the 20-mark constructed response questions. Calculation items are short and reward careful, ordered working, so they are good marks if you practise. Written parts test whether you can apply ideas to a scenario instead of listing theory. Because objective questions are all or nothing, a slip in the cost gap or learning curve step costs the full mark. Strong command of this chapter also supports your answers on pricing, life cycle costing and cost reduction.

Target costing: topics in the order to study them

1Target Costing Concept and ProcessStart here. You need the logic of target price, target profit, target cost and cost gap before anything else makes sense.
2Closing the Target Cost GapOnce you can find the gap, learn how to close it. This is the main written application in the exam.
3Target Costing with Learning Curve EffectsThis is the main calculation twist. It needs the basic process and an understanding of what costs the learning effect applies to.
4Target Costing vs Other Costing Approaches and EvaluationLeave this to last. Comparing methods and judging them is easier once you know how target costing works in detail.

How to prepare Target costing

Aim to be able to do the numbers fast and also write short, applied points. Build in that order.

Learn the core relationship: target cost = target selling price − target profit. Cost gap = estimated cost − target cost. Do five simple examples until it is automatic.
Practise setting out the working in a fixed layout: price, required profit, target cost, estimated cost, gap. Use the same layout every time.
List the ways to close a gap under headings such as design, materials, labour, process and supplier. For each, write one practical example and one risk, such as lower quality.
Practise learning curve questions on their own first. Note which cost the learning rate applies to, usually labour, and whether the question gives cumulative average time per unit. Then add the target costing step.
Write short comparisons of target costing with cost-plus, life cycle costing and kaizen costing. Use a two-line format: how it differs and when it suits.
Do mixed objective questions under time pressure, then one full constructed response question. Check your answer for conclusions that refer to the scenario.
Revise from a one-page summary of formulas and key points the day before the exam.

Common mistakes in Target costing

Calculating the target cost by adding profit to cost, or applying the margin to the wrong base.
Fix: Read whether profit is a percentage of selling price or of cost. For a margin on price, deduct it from price to get cost.
Getting the sign of the cost gap wrong or not stating what it means.
Fix: Always write estimated cost minus target cost and say whether cost must fall or already meets the target.
Applying the learning curve to all costs instead of only the affected cost, usually labour.
Fix: Split the cost into elements first. Apply the learning rate only to labour time, then recombine.
Mixing up cumulative average time with the time for a single unit or batch.
Fix: Work out total time for the cumulative output, then subtract the earlier total to get the time for the extra units.
Listing generic cost-cutting ideas that are not tied to the scenario.
Fix: Choose two or three methods that suit the product given and explain their effect on cost and customer value.
Presenting only advantages when asked to evaluate target costing.
Fix: Give both sides, such as customer focus and early cost control against pressure on staff, supplier strain and quality risks, then reach a conclusion.

Last-day revision: Target costing

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.

Target costing practice questions

Target costing in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Target costing: frequently asked questions

What is the difference between target cost and target cost gap?

The target cost is the most you can spend per unit and still earn the required profit at the market price. The target cost gap is the difference between the current estimated cost and that target. If the gap is positive, you must find savings.

How does the learning curve link to target costing?

The learning curve lowers labour time per unit as cumulative output rises. That lowers the estimated cost per unit. It can therefore reduce or close the cost gap without a design change. You must apply it to the correct cost and the correct output level.

Is target costing used for existing products?

It is mainly used at the design and development stage of new products, where most cost can still be changed. It can also be used for existing products when the market price falls. Kaizen costing usually suits cost reduction during ongoing production.

How do I score well on target costing in the exam?

Use a fixed layout for the calculation and show each step. In written parts, tie every point to the scenario. For objective questions, check the margin base and the sign of the gap before you answer, because there are no part marks.