Managerial Accounting

Group Assignment

Target Costing and Life Cycle Costing

Submitted to:
Dr. Meena Bhatia

By:
GIRISH PAI 15DM056
KANUPRIYA 15DM072
MANU GUPTA 15DM082
NEERAJ NIDRE 15DM090
NIKET MALIK 15DM091
NIKKITA BAKSHI 15DM093
In partial fulfilment of the requirement for
Post Graduate Diploma in Management
2015-2017
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 INDEX
PART I
1.Introduction…………………………………………………...….3
2.Value Chain………………………………………………………4
 Meaning……………………………...............................................4
 Categorization………………………………..…............................4
 Objective…………………………………………..………….…...4
 Steps in value chain……….…………………...……………..5
 Benefits…………………………………………………………….5
3.Target Costing…………………………………………………….6
 Meaning……………………………………...……………………6
 Objective………………………………………………….………,6
 Steps in target costing…………………………………….………7
 Monitoring the target costing process…………………...……….7
PART II
4. Decision…………...……………………………………………..8
5. Target Costing...…………………………………………………8
 Sdj
6. Conclusion………………………………………………………
7. Biblography

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 Part I

INTRODUCTION
The performance of the given company is found to be unsatisfactory due to the
existing traditional managerial accounting practices. So being the Management
Consultant we advice the Board of Directors of the company to implement any
one of the two following contemporary managerial accounting practices in the
business of optimise the performance:
1. Value Chain
2. Target Costing

The following report deals with describing what Value Chain and Target
Costing is all about and what are developments which could benefit us and a
detailed discussion on Target Costing will be carried out which will include
methodology, steps in implementing target costing for a product, its benefits and
what could be the challenges that we can face.

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VALUE CHAIN
MEANING
A value chain is a full range of the activities including design, production,
marketing and distribution that creates and builds value at every step. The total
value delivered by the company is the sum total of the value built up all
throughout the company.

CATEGORIZATION

OBJECTIVE
The process of actually organizing all of these activities so they can be properly
analyzed is called value chain management. The goal of value chain
management is to ensure that those in charge of each stage of the value chain
are communicating with one another, to make sure that the product is getting in
the hands of customers as quickly as possible and that all of these activities
should be run at optimum level if the organization is to gain any real
competitive advantage. If they are run efficiently, the value obtained should
exceed the costs of running them — for example, customers should return to the
company and transact freely and willingly.

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STEPS IN VALUE CHAIN

1. Draw process diagrams and write descriptions to map out your inbound
logistics and purchasing systems. Map out your transportation system,
and make a list of all productive activities and employees involved in the
receiving and storage of goods and materials. Describe how the system is
used and by whom.

2. Involve any process that brings your raw materials one step closer to
finished goods after you receive and store raw materials. Describe the
way you handle inventory and move it to store shelves for a retail or
wholesale operation. Describe the way inputs are turned into customer
value for a service operation.

3. Repeat the process for your outbound logistics. Outbound logistics

involves getting your finished goods into the hands of your customers.

4. Write a thorough analysis of your sales and customer service activities.

Analyze your marketing activities, the in-store customer experience and
the after-sale customer experience.

5. Identify inefficiencies and non-value-adding activities in each area.

Examples of operational inefficiencies include redundant activities, over

staffing, inadequate tools or diminishing productivity. Identify
bottlenecks by looking for activities that take excessive amounts of time
to complete or which delay subsequent activities.
6. Bring together a diverse group of employees and strategize possible
solutions to any identified issues. Include employees from all relevant
departments and organizational levels.

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BENEFITS
 It reduces the delivery time.
 Optimizes the inventory levels.
 Improves the relationship with the customers.
 Enhances revenues and profits

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TARGET COSTING
MEANING
Target Costing is a cost management tool that is being used for pricing with the
motive of reducing the overall cost of the product without compromising any of
its profits.

OBJECTIVE
The main objective of target costing is to enable the management in managing
business profitably in a highly competitive environment. In fact, it is a cost
planning and cost reduction practice in which costs of a product are planned and
managed early in the design and development cycle only, rather than during
development or production stage but it can be applied to product modifications
as well.

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STEPS IN TARGET COSTING
1. Establishing target price: This involves few considerations: what are the
market wants and needs presently and in the coming future; how much
customers are really willing to pay for alternative features; and what are
competitor offerings and may be in the future.

2. Determine target profit margin and allowable cost :This target margin
comes from the company’s long-term strategic and financial objectives
resulting from the company’s profit planning efforts. Usually the
company’s management takes decision on the desired profit from a new
product. The difference between the target price and the target profit
margin is the final allowable cost that the company can decide on.

3. Determining current cost and target cost: In case proposed product is a

modification of an existing , a firm has a cost basis from which it can
determine the potential costs of the proposed new product if the new
product’s specifications and method of manufacture are similar.

4. Perform functional cost analysis: It focuses on individual functions of

each of the product separately. It involves designing in such a way that
each function is reviewed individually so as to lower the cost to the
desired target cost.

MONITORING THE TARGET COSTING PROCESS

 As the target costing process continues, it is of utmost importance to track
whether the objectives—both nonfinancial and financial—are being
achieved or not. Also whether the customers’ wants and needs being
satisfied? This requires continued input from existing and potential
customers via surveys, focus groups, and other means.
 Maintaining an accurate assessment of current costs is equally important,
as they serve both as the foundation for the target cost determination, and
as a report on how well the allowable costs are being achieved.

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 Part II
DECISION
After going through both the methods, i.e. value chain and target costing, we
have finally decided to implement target costing in the organization. Target
costing will result in the improvement of the operational efficiency with a
significant reduction of costs, hence leading to a higher profit margin. In the
long run this process will result in efficiency and margin will keep on
increasing, reducing the unsatisfactory performances and helping the company
in achieving their objectives. Moreover in the process of target costing, value
chain itself will take place while performing function cost analysis, hence more
effective.

TARGET COSTING
Methodology:
Kaizen Costingis a term closely associated with Target Costing. The word
kaizen is a Japanese word which means ‘improvement’.It stresses on the need
for continuous improvement.
The purpose ofkaizen goes beyond simple productivity improvement. It is a
process which, when implemented correctly eliminates overly hard workand
teaches people how to perform experiments on their work using the scientific
methods and how to learn to spot and eliminate waste in business processes.
The width or scale for kaizen can be individual, small group or a large group.
Kaizen on a broad, inter-departmental scale in companies generates total quality
management efforts by improving productivity using machines and computing
power.

In today’s competitive environment there is a greater need for the sellers to take
account of the competitors, so if a company want to achieve maximum
penetration into the market it must lower the prices while improving the quality.
“Give much more for much less”. Target costing enables to have a better
understanding of markets, competition as well as the customer needs at the
same time.

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Target costingis a detailed process for achieving a full-fledged cost at which a
proposed product with specified functions, performance, and quality must be
produced in order to generate the desired profits after the product’s anticipated
sale over a specified period of time.It involves setting a target cost by
subtracting a desired profit margin from a competitive market price.

Trying to reduce the cost once a product reaches final stages of production is
difficult therefore the company should focus on the costs right from the
initiation. Each process including design, input materials and investment
decisions are needed to be brainstormed before the product design is finalised.
These concepts are supported by the four basic steps of Target Costing:

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 STEP 1 - Determine the target price, which the customer is willing to
pay for the product: This step involves the consideration of the market
requirements, how much the customers are willing to pay for the product and
what are the competitors offering. Most of the companies obtain the
competitor’s product and disassemble it to examine what they are made of to
estimate the cost of even the smallest part used. This process is known as
“Reverse engineering”. The target price is based upon the market research,
competitor’s offering and the company’s plan.

 STEP 2 - Determine a target profit margin from the target price to

determine the target cost: Each company launches a product so that it must
be profitable enough to yield satisfactory returns. The company must be able
to determine the return which a company expects from an individual unit of
the product. Different product lines have different target profit margins
depending upon the market, the need of the product, level of investment etc.
Difference between the target price and target profit margin gives us the
allowable cost up to which the total cost of the product can be ascertained.

 STEP 3 - Estimate the actual Cost of the product:

Target price – Target profit margin = Target cost

Target cost can be broken down by allocating the target costs differently to
individual components of the product which results in a new product which
would be quite similar in characteristics to the previous models. Target cost
can also be allocated according to the different functional areas of the
product. This process involves proper assessment of the product’s functions
and allocating target costs to each function.

 STEP 4 - If estimated actual cost exceeds the target cost, investigate

ways of driving down the actual cost to the actual cost: To achieve the cost
objectives it is necessary to use a cross functional team comprising of the
members of all the departments which results in the reduction of costs in the
early stages of product designing. The emphasis on the team shows the inter
dependence of marketing, designing, development and manufacturing on
each other. The accountant needs to provide rapid feedback on the
implications of various techniques and decisions being implemented. The
principal technique to achieve the target cost the company needs to close
down the gap between current cost and allowable cost.

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OBJECTIVES OF TARGET COSTING

The fundamental objective of target costing is to enable management to manage

the business to be profitable in a very competitive marketplace. In effect, target
costing is a proactive cost planning, cost management, and cost
reduction practice whereby costs are planned and managed out of a product and
business early in the design and development cycle, rather than during the later
stages of product development and production.

BENEFITS OF TARGET COSTING

 Cost Optimization
Target Costing enables you to analyse the best way to make or acquire
products at the lowest costs. Minimizing costs is a common financial goal
of any business, irrespective of whether they offer high, medium or low
prices and it gives a company financial flexibility to focus on achieving
high profit margins or to enter the market at low price points to attract a
large customer base.

 Systematic
Target costing involves consideration of all equipment, processes, labour
and materials needed to make goods, or the costs to acquire goods and get
them ready to sell to your customers.Thus, target costing is a formal and
systematic way to focus on cost optimization.

 Reduced Development Cycle

Target costing helps in minimizing product cycle time. This is the amount
of time it takes from conception to finished product. A reduced cycle time
means unnecessary steps or waste that take time and don't add value to
the end product for the customer have been eliminated. A shorter cycle
time is a competitive advantage as well, since it is possible present the
product to the market sooner, perhaps as the first mover.

 Profitability

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 Target costing increases the profitability of the business. It takes into
account both factors in profit: the costs and the price. Many companies
start by developing products and base pricing on costs. By starting with
market pricing first, it is ensured that the business ends up with a product
that has benefits and a price point customers will value.

LIMITATIONS OF TARGET COSTING

 The development process

It can be lengthened to a considerable extent since the design team may
require a number of design iterations before it can devise a sufficiently
low cost product that meets the target cost and margin criteria.

 Blame Game
A large amount of mandatory cost cutting can result in finger-pointing in
various parts of the company, especially if employees in one area feel
they are being called on to provide a disproportionately large part of the
savings. For example, the industrial engineering staff will not be happy if
it is required to completely alter the production layout in order to generate
cost savings.

 Conflicts in opinions
Representatives from number of departments on the design team can
sometimes make it more difficult to reach a consensus on the proper
design because there are too many opinions regarding design issues.

TOOLS FOR IMPLEMENTING TARGET COSTING:

1. Kaizen Costing:Kaizen Costing implies continuous improvement in the
business efficiency by reducing costs and increasing profitability. The
improvement need not be very significant, but it should be continuous.

The purpose of kaizen goes beyond simple productivity improvement. It

is a process which, when implemented correctly, humanizes the
workplace, eliminates overly hard work, and teaches people how to

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 perform experiments on their work using the scientific method and how
to learn to spot and eliminate waste in business processes. It may also be
designed to address a particular issue. This is usually done over the
course of a week and is referred to as a "kaizen blitz" or "kaizen event".
These are limited in scope, and issues that arise from them are typically
used in later blitzes.

2. Value Engineering:Value engineering starts with the customers’ wants

and needs, and how we relate them to product design, buy or make
decisions, and process engineering and manufacturing—all in the context
of services, quality, speed, and cost. The concept is that all manufacturing
activities are inextricably bound together with costs and have to be dealt
with simultaneously.

Supporting value engineering are tools such as cost structure analysis and
functional analysis. The former divides the overall product into
subassemblies and attaches current costs and target costs to that
framework so that costs may be reduced substructure-by-substructure and
component-by component. Functional analysis relates the value of the
several functions to the costs associated with them. Important functions
usually support the most costs, and less important functions ought to cost
less.

BIBLIOGRAPHY

For this report, we got our primary and secondary data from the following
sources:

 Cost and Management Accounting – Colin Drury

 Kaplan, R. (1984). The evolution of management
accounting, Accounting Review, 59 (3): 390-418.
 Kaplan, R. (1994). Management accounting (1984-1994):
Development of new practice and theory, Management
Accounting Research, 5: 247-260.
 Slideshare.com
 Wikipedia.com
 Implementing Target Costing – Statements on Management
Accounting (Strategic Cost Management) published by
Institute of Management Accountants

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