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

Orla Co uses kaizen costing. A product has a current unit cost of $200. The company aims for a 2% reduction in cost each month, compounding on the prior month's cost. What is the target unit cost at the end of month 3, to the nearest cent?

The target cost is $188.24. A 2% monthly compounding reduction means multiplying $200 by 0.98 three times, which equals 0.941192, giving $188.24. Deducting 2% of the original $200 each month would wrongly give $188.00.

  1. A$188.00
  2. B$188.24Correct
  3. C$190.00
  4. D$192.16

Explanation

Month 3 cost = 200 x 0.98^3. 0.98^3 = 0.941192, so cost = $188.24. Using a straight-line 2% of original cost each month gives $188.00, which ignores compounding. $192.16 is only two months of reduction.

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