CMA Final · Strategic Cost Management

Target Costing for CMA Final Strategic Cost Management

Target costing starts from the price the market will pay, subtracts the profit you need, and treats the remainder as the allowable cost. Target Cost = Target Selling Price − Target Profit. If the current cost is higher, the difference is the cost gap, which you close through value engineering, design changes and cost reduction.

What this chapter covers

Target costing is a market-driven way of managing cost. Traditional costing adds a profit margin to cost to get a price. Target costing reverses this. You start with what customers will pay and what profit the firm needs. The cost you are allowed to incur follows from those two figures. Cost is then designed into the product before it is made.

The chapter moves in a clear line. First you learn the concept and the stages of the process. Then the principles that make it work, such as price-led costing, a focus on customers and cross-functional teams. Then you do the numbers: target price, target profit, allowable cost and cost gap. After that come the methods used to close the gap, mainly value engineering and value analysis. The chapter ends by linking target costing with Kaizen and life-cycle costing.

In Paper 16 this chapter sits with the other modern cost management topics, such as life-cycle costing, activity-based costing and the Theory of Constraints. These share a common theme: cost decisions should support strategy and the customer, not just record expenditure. Expect a mix of short objective questions and a decision-oriented numerical or case question in which you compute the gap and recommend how to close it.

Target costing is one of the more scoring chapters in Paper 16 because its numbers are short and the logic is consistent. A typical question needs a few lines of arithmetic and a clear recommendation. The theory also produces easy 2-mark MCQs on definitions, features and differences from traditional costing. Examiners favour application, so a student who can compute the cost gap and then suggest sensible, product-specific cost reductions gains marks that recall alone does not give. The chapter also reinforces ideas you use in other chapters, so the effort pays back twice.

Target Costing: topics in the order to study them

1Target Costing Concept and ProcessStart here to understand the price-led logic and the stages, because every later topic builds on it.
2Principles and Features of Target CostingThese explain why the process works and supply the points needed for theory answers and MCQs.
3Setting Target Price, Profit and Cost GapThis is the numerical core, so study it once the concept is clear and before the cost reduction methods.
4Value Engineering and Cost Reduction TechniquesYou need the cost gap in hand first, since these techniques are the tools used to close it.
5Target Costing with Kaizen and Life-Cycle CostingStudy this last because it connects target costing to ongoing improvement and whole-life cost, and it assumes the earlier topics.

How to prepare Target Costing

Prepare this chapter in a mix of short theory and repeated numerical practice. Most of the marks come from being able to compute the gap and then explain what to do about it.

Read the concept and process once and write the stages in your own words, from market research to target price to cost reduction to production.
List the principles and features as a short checklist, and note how each differs from cost-plus pricing.
Practise the core relationships: Target Cost = Target Selling Price − Target Profit, and Cost Gap = Current (Estimated) Cost − Target Cost. Do at least five numerical problems, including ones where profit is given as a percentage of selling price and ones where it is a percentage of cost.
For each problem, finish with a recommendation: whether the gap can be closed, by which actions, and whether to proceed with the product.
Learn value engineering by example. For a product, note which functions customers value, which cost items add nothing, and what a cheaper material or simpler design could change.
Link Kaizen and life-cycle costing to target costing in a short note: Kaizen cuts cost after launch in small steps, and life-cycle costing keeps the whole-life cost within the target.
Finish with timed MCQs on definitions and distinctions, then one full written question under exam time.

Common mistakes in Target Costing

Adding profit to cost to find the price
Fix: Write the formula Target Cost = Target Selling Price − Target Profit before you start, and begin every problem from the price.
Mixing up profit on sales and profit on cost
Fix: Underline the base. For profit on sales, profit = % × price. For profit on cost, cost = price ÷ (1 + %).
Stopping at the cost gap figure
Fix: Add a recommendation: which cost elements to attack, the techniques to use, and whether to launch if the gap stays open.
Treating value engineering as simple cost cutting
Fix: State that value engineering keeps or improves the functions customers value while reducing cost. Cutting quality that customers care about defeats the purpose.
Confusing Kaizen costing with target costing
Fix: Remember the timing: target costing acts at design and planning, Kaizen costing acts during production through continuous small improvements.
Giving generic theory answers with no case link
Fix: Use the product, material and customer in the question in every point, and keep bullets short and specific.

Last-day revision: Target Costing

Target costing works backward from market price, not forward from cost.
Target Cost = Target Selling Price − Target Profit.
Cost Gap = Current Estimated Cost − Target Cost; a positive gap means cost must come down.
If profit is a percentage of sales, take it off the price. If it is a percentage of cost, divide the price by (1 + percentage).
Cost is designed in at the planning and design stage, where most of it gets locked in.
Cross-functional teams of design, production, marketing and finance work on the target together.
Value engineering reviews design and function before production to remove cost the customer does not value.
Value analysis does the same review for existing products.
Kaizen costing delivers small, continuous cost cuts during the production stage.
Life-cycle costing tracks cost from design to disposal, so savings in one stage should not raise cost in another.
Always end a numerical answer with a clear recommendation.

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 formula for target cost?

Target Cost = Target Selling Price − Target Profit. The selling price comes from the market and the profit from the firm's required return. The cost gap is then the current estimated cost minus this target cost.

How is target costing different from traditional costing?

Traditional costing builds up cost and adds a margin to set the price. Target costing takes the market price as given and works back to the cost the firm can afford. It also acts at the design stage rather than after production begins.

Is target costing asked as a numerical or a theory question?

Both appear. Definitions, features and comparisons suit the 2-mark MCQs, while the cost gap and recommendation suit a written question. Prepare both, with more time on the numerical and decision part.

How do value engineering and Kaizen differ?

Value engineering reviews the design and functions before production to remove unneeded cost. Kaizen costing reduces cost in small, continuous steps once production is under way. Target costing often uses both to close the cost gap.