Formula for Success :

Target Costing for Cost-Plus Pricing Companies

By Group 3
 Pratiwi Bestari Ratu Shavira Rayhan Zuhra R
1610532017 1610532025 16105320

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Team
Topic Discussion
01 Executive Summary

02 Defining Target Costing and Cost-Plus

Costing

03 Integrating Target Costing and Cost-

Plus Pricing

04 Evaluating Target Costing Method

05 Cost-Plus Pricing Using the Deductive

Method

06 Conclusion
 Target costing results in lowering cost which will change mark up in cost-plus
pricing. This will make the target price and the ultimate sales price changes
too, while the sales price is needed to determine the target cost, but in the
other side the determination of this sales price is the focus of the cost plus
pricing mechanism.

EXECUITVE SUMMARY
 Defining Target Costing and Cost-Plus Pricing

Cost-Plus Pricing Target Costing

Using cost-plus pricing more useful when

Target costing is a powerful and persuasive
market prices are impractical or do not exist
technique to enhance efficiency to control
So the price can be determine
expenditure and to minimize the
• Based on actual cost, plus a fixed fee that
manufacturer’s actual costs
the manufacturer incurs
• Based on estimated cost, plus a fixed fee
Target costing method
Addictive method
In Cost-Plus Pricing method, the sales price
(equation 1)
determined by
Tci=Ci1+Ci2+…+Cin
(equation 3)
Deductive method
Pi=Ci+rCi
(equation 2)
Tci=pi-mi
 Toyota uses prime costs consisting of
direct material and direct labor costs as its
alternative basis for product pricing and for
applying target costing, thereby avoiding
the complications of allocating indirect
variable and fixed cost. This prime-cost
system can be called “engineering target
costing,” because the prime-cost
component generally contain cause-and-
effect relationship between input and
output cost.
uses variable manufacturing cost-direct
materials, direct labor and variable
manufacturing overhead-as the general
basis for target-costing applications. To
differentiate this system from the
engineering target-costing system, the
former is labeled “the variable
manufacturing target-costing” system.
reason for excluding fixed
manufacturing cost from target costing
even though these costs are included in
the most popular form of the cost-plus
pricing methods. Fixed manufacturing cost
represent significant funds normally
committed for long periods of time, and
they cover a plant’s or division’s overall
productions capacity. These cost are not
subject to value-engineering procedures
that focus on the product’s specific parts or
component. Accordingly, the variable
manufacturing cost and the prime cost
bases for cost (TC) is substituted for the
cost-plus pricing unit cost (Ci)
Integrating Target Costing and Cost Plus Pricing

Combining the target costing deductive and the The measurement of makrup (r)
cost-plus pricing method with subtituted TC for C (equation 6)

(equation 4)
Pi=TCi+rTCi
Substituting the value of markup
(equation 5) (equation 7)
Pi=Tci(1+r)

The markup (r) consist of:

1. The cost other than the variable manufacturing
costs, including fixed manufacturing and
downstream (administrative and marketing)
expenses; and
2. Target profit
EVALUATING TARGET COSTING METHOD

Based on the observation that emerge from the equations 1,2,3, and
7. at first glance, from the additive method, it does not show any
mechanism to tie individual product components’ costs to management’s
target profits. On the other side, the deductive method appears
inapplicable to cost plus pricing system because, in this method the sales
price must be given, but in cost-plus pricing, determining the price is the
goal.
COST-PLUS PRICING USING THE
DEDUCTIVE METHOD

Equation 7 applies the target-costing deductive method to the cost

plus pricing system. The equation’s five variables:
Unit Price (Pi)
Target Cost (TCi)
Product quantity (Qi)
Fixed Manufacturing overhead(C’i)
Target Profit (Mi)

Strategically, target profit (Mi) is the most important among these

variables.
 Next in order of importance comes the fixed manufacturing overhead
that are among the costs other than target cost (C’i).

In modern manufacturing company covers the factory layout, robotic

assets, and flexible manufacturing systems. This component iis the result
of a long term, infrastructure strategy that some companies- particularly
Japanese companies- carefully design and hold intact outside the target
costing system.

Based on target profit, fixed manufacturing overhead as given, target

costing through sensitivity analysis may effectively determine unit price
and target cost
Exhibit 3. Sensitivity Analysis for Determining Key Variables

Target Fixed Target

Analysis Variables Given Variables Cost Manufacturing Profit Unit Price
Level Unknown (TCi) overhead (C’i) (Mi) (Pi)
1 TCi, C'i, Mi Pi 820 500 400 1720
2 TCi, C'i, Mi Pi 800 500 400 1700
3 TCi, C'i, Pi Mi 800 500 420 1720
4 TCi, C'i, Mi Pi 800 500 410 1710
5 Pi, C'i, Mi TCi 800 500 500 1800
6 Pi, C'i, Mi TCi 770 480 450 1700

(figures are in thousands)

Sensitivity analysis is an analysis carried out to determine the effects of changes in
production parameters on changes in production system performance in generating
profits.

By carrying out a sensitivity analysis, the possible consequences of these changes

can be known and anticipated before.
Exhibit 2. Computation of target cost and target sale price at analysis level 1

Variable manufacturing costs (TCi) = Direct Materials + Direct Labor + Variable Overhead
= 100+400+320 820
Other Costs (C'i) = Fixed Overhead + Downstream Costs
= 150+150+100+100 500
Investment allocated to the contract = 8000 x 25% 2000
Target ROI on the contract = 2000 x 20% 400
Target Sale Price (pi) = 820 [ 1 + ( 500+400) / 820 ] 1720
Thank you