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ACCA Applied Skills · Performance Management · Target costing

Which statement best describes how target cost is determined under a target costing approach?

Target cost is found by starting with the market price customers will accept and deducting the required profit margin. This is a market-led, top-down approach, unlike cost-plus pricing, which begins with the cost and adds a mark-up to arrive at a price.

  1. ATotal production cost is estimated first, and a mark-up is then added to reach the selling price
  2. BThe target selling price that the market will accept is set first, and the required profit margin is deducted from itCorrect
  3. CThe cost of the previous product generation is reduced by a fixed percentage each year
  4. DVariable costs are totalled and fixed overheads are then added on an absorption basis

Explanation

Target costing starts from the price customers are willing to pay. The required profit margin is deducted from that price to give the target cost. Option A describes cost-plus pricing, which works in the opposite direction.

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