How is target costing implemented?
The target costing process begins by establishing a selling price, based on
market research, for the new product. From this target selling price, the
desired (target) profit is subtracted to determine the target cost. In all
likelihood, this target is below the company’s current manufacturing cost.
Teams from many departments then perform functional cost analysis in an
attempt to reach the target cost. If the current cost estimate is at the target,
the firm must decide whether or not to introduce the new product. If the
current cost estimate is above the target, functional cost analysis is used to
make changes and prepare another cost estimate.
As an aid to understanding, the target costing process is summarized in
Figure 1. The following discussion is keyed to each step in the Figure.
Establish a target profit for the product
Marketing plays a crucial role in the determination of the target cost. The
starting point for a target cost is the estimated selling price for the product
determined by market analysis. Sales volume is also estimated and, from the
total estimated sales revenue, the desired profit is subtracted. Management