Performance Management · Target costing

Target Costing Concept and Process in ACCA PM

Updated 11 October 2026 · Fact-checked

Target costing starts with the price the market will accept. You subtract the profit margin you require to get the target cost. You then compare the target cost with the estimated current cost. The difference is the target cost gap, which the business must close through redesign or cost reduction.

Understand Target Costing Concept and Process

Most firms set price by adding a profit margin to cost. Target costing reverses this. In a competitive market the firm cannot simply pass its costs on to customers. So it asks what price customers will pay and works backwards.

The process starts with market research. The firm decides the product's features, its likely market share and the selling price needed to achieve that share. It then deducts the required profit margin. What is left is the target cost: the most the product can cost to make and still earn the required profit.

Next the firm estimates what the product would cost using current methods and designs. This is the estimated cost. If the estimated cost is above the target cost, there is a target cost gap. The gap is the amount by which cost must fall.

The gap is closed before production starts. Typical tools are value engineering, cheaper materials, simpler design, fewer components, better processes and negotiation with suppliers. The focus is on design, because most of a product's cost is committed at the design stage. If the gap cannot be closed, the firm may drop the product.

Target costing suits markets with strong competition, short product life cycles and many similar products, such as electronics and cars. It also works well when the firm can influence design. It is a planning tool, not a way of costing past output.

Key rules to remember

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.

How to solve Target Costing Concept and Process questions

Use this order for any target costing question. It works for numerical and written parts.

1Identify the target selling price. It may be given or you may need to derive it from market data.
2Find the required profit per unit. Check whether the percentage is on selling price or on cost.
3Calculate target cost = selling price − required profit.
4Calculate the estimated cost per unit from the data, including all relevant cost elements given. Add up materials, labour, overheads and any other costs.
5Calculate the target cost gap = estimated cost − target cost. Show the units and the sign.
6If asked, suggest ways to close the gap, such as value engineering, cheaper components, redesign, process improvement and supplier negotiation.
7Comment on the result. State whether the product is viable and what the firm should do if the gap cannot be closed.

Quickest way: Three-line target cost check

When to use it: Use this in Section A or OT case questions where you need a quick number and there is no time for a full layout.

Write: Price − Profit = Target.
Check how profit is defined. If it is a % of cost, divide the price by (1 + %) instead.
Write: Estimated − Target = Gap. Read the question to see whether it asks for the gap per unit or in total, and multiply by units if needed.

Common mistakes in Target Costing Concept and Process

Treating a profit mark-up on cost as a margin on selling price.
Both are described as a percentage profit and students rush.
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.
Students reverse the subtraction and lose the meaning of the sign.
Fix: Always use estimated cost minus target cost. A positive result means a shortfall to be closed.
Starting from cost and adding profit to find price.
Cost-plus pricing is more familiar.
Fix: In target costing the price comes first. Cost is the result, not the starting point.
Giving a total gap when the question asks per unit, or the reverse.
Students stop once they have a number.
Fix: Underline the unit basis in the question. Multiply or divide by the number of units only at the end.
Writing vague ways to close the gap, such as 'cut costs'.
Students do not link the answer to the scenario.
Fix: Give specific actions tied to the product, such as fewer components, a cheaper material or supplier negotiation, and say what effect each might have on quality.
Saying target costing is applied to products already in production.
Students confuse it with cost reduction programmes.
Fix: State that it is mainly used at the design and planning stage, before production, when costs can still be shaped.

Worked examples

Example 1

A company plans a new product. Market research suggests a selling price of ₹800 per unit. The company requires a profit margin of 25% on selling price. The estimated cost using current methods is ₹650 per unit. Calculate the target cost and the target cost gap per unit.

Show the solution

Required profit = 25% × ₹800 = ₹200.
Target cost = ₹800 − ₹200 = ₹600.
Target cost gap = estimated cost − target cost = ₹650 − ₹600 = ₹50.
The gap is positive, so cost must fall by ₹50 per unit, which is 7.7% of the estimated cost.

Answer: Target cost is ₹600 per unit and the target cost gap is ₹50 per unit.

Example 2

A firm expects to sell 10,000 units of a new gadget at ₹1,500 each. It needs a mark-up of 20% on cost. Estimated unit costs are materials ₹520, labour ₹280 and overheads ₹400. Calculate the target cost per unit and the total target cost gap, and suggest one way to close it.

Show the solution

Mark-up is on cost, so target cost = ₹1,500 ÷ 1.20 = ₹1,250.
Check: profit = ₹1,500 − ₹1,250 = ₹250, and ₹250 ÷ ₹1,250 = 20%.
Estimated cost = ₹520 + ₹280 + ₹400 = ₹1,200.
Gap per unit = ₹1,200 − ₹1,250 = −₹50. This is negative, so there is no shortfall.
Total margin of cost below target = ₹50 × 10,000 = ₹5,00,000.
The estimated cost is already below target, so the product meets the required return. The firm could still look at value engineering to protect margin if prices fall.

Answer: Target cost is ₹1,250 per unit. The estimated cost of ₹1,200 is ₹50 per unit below target, so there is no gap to close. In total the estimate is ₹5,00,000 below the target cost.

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.

Practice questions from Target costing

Target Costing Concept and Process 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 Concept and Process: frequently asked questions

What is the target cost formula?

Target cost = target selling price − required profit. The price is set by the market. The profit is what the company needs to earn per unit.

How do you calculate the target cost gap in ACCA PM?

Subtract the target cost from the estimated cost using current methods. A positive answer is the amount by which cost must be reduced. A negative answer means the product already meets the target.

How is target costing different from cost-plus pricing?

Cost-plus starts with cost and adds profit to set the price. Target costing starts with a market price and works back to the cost allowed. It suits competitive markets where the firm cannot dictate price.

When is target costing used?

It is used at the design and planning stage of a new product, especially where competition is strong and product life cycles are short. This is when costs can still be changed.