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ACCA Applied Knowledge · Management Accounting · Cost reductions and value enhancement

A company uses target costing for a new product. The market research suggests a selling price of $80 per unit, and the company requires a profit margin of 25% on selling price. The estimated cost using current methods is $68 per unit. What is the cost gap that must be closed?

The cost gap is $8. Target cost is the $80 price less a 25% margin of $20, giving $60. The current estimated cost is $68, so the cost must be reduced by $8 per unit to achieve the required profit.

  1. A$8Correct
  2. B$12
  3. C$20
  4. D$0

Explanation

Target cost = selling price less required margin = $80 - (25% x $80 = $20) = $60. Cost gap = estimated cost $68 - target cost $60 = $8. Choosing $20 uses the margin alone, ignoring the estimated cost; $12 compares price with cost, ignoring the required margin.

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