Performance Management · Target costing

How to Close the Target Cost Gap in ACCA PM

Updated 11 October 2026 · Fact-checked

The target cost gap is estimated cost minus target cost. You close it by cutting cost without hurting the features customers value. Main routes are redesign, cheaper materials, process changes and supplier negotiation. In the exam, quantify the gap, suggest specific actions, and check the effect on quality and customers.

Understand Closing the Target Cost Gap

Target costing starts with the price customers will pay. You take that selling price, subtract the profit the business needs, and the result is the target cost. The firm then works backwards to make the product at that cost.

Often the first cost estimate is too high. The difference is the target cost gap: estimated cost minus target cost. A positive gap means the product is not yet profitable enough. The firm must close the gap, or drop the product.

Closing the gap does not mean cutting everything. Price is fixed by the market, so the firm focuses on cost reductions customers will not notice or will not mind. Cutting a feature customers value may lower sales and defeat the purpose.

The main tool is value engineering. It looks at each component and function and asks what it costs and what value the customer gets. Common actions are:

Redesign: fewer parts, standard parts, simpler assembly, easier manufacture.
Cheaper materials: switch to lower-cost materials or components of acceptable quality.
Process changes: reduce waste, rework and idle time, automate, or use a more efficient method.
Supplier negotiation: bulk discounts, long-term contracts, or involving suppliers early in design.

Other routes include removing features customers do not value, using cost analysis such as ABC to find non-value-added activities, and learning curve effects as labour becomes more efficient. If the gap cannot be closed, the firm may accept a lower profit margin or abandon the product.

Key rules to remember

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.

How to solve Closing the Target Cost Gap questions

Use this method for any question on closing the cost gap. It works for both calculations and written advice.

1Calculate the target cost: target selling price minus required profit per unit.
2Calculate the gap: current estimated cost minus target cost. Express it per unit and, if useful, as a percentage.
3List the cost elements: materials, labour, overheads, and any others. Note which are largest.
4Match each action to a cost element: redesign or cheaper materials for materials, process changes for labour and overhead, negotiation for purchase prices.
5Quantify the savings from each action using the data given. Be careful to apply percentages to the right cost base.
6Add the savings and compare with the gap. State whether the gap is closed, and by how much it is over or short.
7Comment on risks: quality, customer perception, supplier reliability, implementation time and one-off costs. Recommend what to do.

Quickest way: Gap first, then savings against the gap

When to use it: Use this for objective test questions and for the calculation part of a constructed response when time is short.

Write: Target cost = price − profit. Compute it at once.
Write: Gap = estimate − target.
For each saving, compute the per-unit figure only. Ignore anything not asked for.
Sum the savings and subtract from the gap. A remaining positive figure is the shortfall.
For written parts, give one action per cost element with a one-line reason and one risk.

Common mistakes in Closing the Target Cost Gap

Calculating the gap the wrong way round
Students subtract the estimate from the target, or forget which is higher.
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
Wording such as margin versus mark-up is read quickly.
Fix: Margin is on selling price, mark-up is on cost. Underline the base before calculating.
Applying a percentage saving to total cost instead of the relevant element
Students rush and use the total unit cost.
Fix: A 10% saving on materials applies to the material cost only. Write the base next to each percentage.
Suggesting cuts that harm quality or features customers value
Students focus on cost and forget the price is set by the market.
Fix: Say the saving must keep functions customers value. Mention customer research or testing.
Giving generic written answers with no link to the scenario
Students recall a list of methods and copy it down.
Fix: Tie each action to a named cost in the question and give a number or a specific risk.
Ignoring one-off costs of the changes
Savings are easy to compute; costs of redesign or retooling are overlooked.
Fix: Mention tooling, design and testing costs and whether the saving pays for them over the product's life.

Worked examples

Example 1

A firm plans a new product to sell at ₹800 per unit. It needs a profit margin of 25% on selling price. The current estimated cost is ₹690 per unit, made up of materials ₹360, labour ₹150 and overheads ₹180. Calculate the target cost and the cost gap. Management proposes: (a) cheaper material cutting material cost by 10%; (b) a process change reducing labour cost by 8%. Does this close the gap?

Show the solution

Target profit = 25% × ₹800 = ₹200.
Target cost = ₹800 − ₹200 = ₹600.
Gap = ₹690 − ₹600 = ₹90 per unit.
Material saving = 10% × ₹360 = ₹36.
Labour saving = 8% × ₹150 = ₹12.
Total savings = ₹36 + ₹12 = ₹48.
Remaining gap = ₹90 − ₹48 = ₹42 per unit.

Answer: Target cost is ₹600 and the gap is ₹90 per unit. The proposals save ₹48, so a gap of ₹42 per unit remains. Further action is needed, such as overhead reduction, supplier negotiation or redesign.

Example 2

A product has a target selling price of ₹1,500 and a required profit of ₹300 per unit. Estimated cost is ₹1,350: materials ₹700, labour ₹300, overheads ₹350. Redesign cuts materials by ₹90 per unit. Supplier negotiation reduces the price of the remaining materials by 5%. Overheads fall by ₹60 through removing a non-value-added activity. Is the target met? Comment on the result.

Show the solution

Target cost = ₹1,500 − ₹300 = ₹1,200.
Gap = ₹1,350 − ₹1,200 = ₹150 per unit.
Material cost after redesign = ₹700 − ₹90 = ₹610.
Negotiation saving = 5% × ₹610 = ₹30.50.
Overhead saving = ₹60.
Total savings = ₹90 + ₹30.50 + ₹60 = ₹180.50.
Revised cost = ₹1,350 − ₹180.50 = ₹1,169.50, which is ₹30.50 below the target cost.

Answer: The gap of ₹150 is closed, with ₹30.50 per unit to spare. Revised cost is ₹1,169.50 against a target of ₹1,200. Before proceeding, management should confirm the redesign keeps quality, check that the supplier discount is achievable, and consider one-off redesign costs.

Exam tips

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.
Say that target costing involves cross-functional teams and early supplier involvement. It earns credit when the question asks how the gap is closed.
If the gap cannot be closed, state the options: accept lower profit, further redesign, or abandon the product.

Practice questions from Target costing

Closing the Target Cost Gap in other exams

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

CMA FinalSetting Target Price, Profit and Cost Gap

Closing the Target Cost Gap: frequently asked questions

What is the target cost gap in ACCA PM?

It is the estimated cost of the product minus the target cost. A positive gap means the product costs too much to meet the required profit at the market price. The firm must find savings to close it.

How is value engineering used to close the gap?

Value engineering reviews each component and function to see what it costs and what value the customer gets. It looks for cheaper designs, parts or methods that keep the features customers value. Savings from this are set against the gap.

What if the gap cannot be closed?

The firm can accept a lower profit, keep searching for savings, or abandon the product. The decision depends on strategy, risk and whether the product has wider benefits. In an exam, state these options and recommend one.

Should I raise the selling price to close the gap?

In target costing the price is set by the market, so the firm works on cost instead. Raising price may cut demand and break the logic of the approach. You can mention it as a last resort, but focus on cost reduction.