Unit: 9 Modern Methods of Management Accounting

Objectives:
 Meaning and introduction of Activity-Based-Costing
 Meaning of Target Costing
 Target Costing Gap
 Introduction to Lifecycle Costing
 Costs involved in different stages of Lifecycle

Learning Outcome:
Evaluate and describe the modern methods of management accounting.

9.1 Introduction
As global competition intensifies, companies are producing an increasing variety of products
and services. They are finding that producing different products and services places varying
demands on their resources. The need to measure more accurately how different products
and services use resources has led companies such as American Express, Boeing, General
Motors, and Exxon Mobil to refine their costing systems. Some of the main ways companies
around the globe have refined their costing systems is through activity-based costing, Life-
cycle costing, and target costing.
The ABC is a costing system that places an emphasis on the tasks carried out to create
goods. Costs are first associated to activities, then to goods, according to the ABC method of
costing. This costing system makes the assumption that activities induce costs to be incurred
and generate demands for activities. ABC is typically employed as a tool for comprehending
cost and profitability of products and customers.
Target costing is a cost management technique. The strategy tries to create and market
goods that will guarantee the desired margin. This pricing strategy is used to balance the
needs of customers and the organization's profit objectives. In Japan, this idea is frequently
applied.
Life cycle costing is the practice of gathering all costs an asset's owner or manufacturer will
incur throughout the course of the asset's life cycle. These expenses consist of the initial
expenditure, any additional investments made in the future, and yearly expenses, less any
salvage value. Businesses that prioritize long-term planning employ life cycle costing more
frequently to increase their multi-year earnings.

9.2 Activity Based Costing

9.2.1 Evolution of Activity-Based-Costing:
The ABC System was designed as a result of the numerous shortcomings of traditional cost
schemes. Accurately estimating product costs becomes increasingly challenging as
businesses extend their product offerings and various items require varied amounts of
resources, such as supervision and quality control. The key causes why businesses employ
ABC are:
 Cause and effect relationships cannot be captured by traditional costing.
 The sole purpose of traditional accounting was to provide information at the product
level.
 The existing costing system has established a simple overhead recovery or blanket rat,
but these are improper when used for decision-making

9.2.2 Meaning of Activity-Based-Costing

CIMA defines Activity Based Costing as,
‘Cost attribution to cost units on the basis of benefit received from indirect activities e.g.,
ordering, setting up, assuring quality.’
The two-stage method of product costing known as "activity-based costing" (ABC). It first
assigns costs to activities before allocating them to goods depending on how many activities
each product consumes. Any distinct task that a company performs in order to produce or
provide a good or service is referred to as an activity. The idea behind activity-based costing
is that resources are consumed by activities, which in turn are consumed by products.
The total cost of a product includes all expenses related to its production and delivery. 
Costs are not immediately consumed by products. Money is spent on activities which are
consumed by product/ services. ABC strives to identify as many costs as it can. Any expense
that can be linked to a specific product through its use or activity is considered a direct
expense of the product.
Important Terms in Activity Based Costing
 Activity: An activity is a collection of related tasks that have a specific purpose in
achieving a goal or achieving an objective.
 Resource: Resources are things that are used for accomplishing tasks or factors that
facilitate accomplishing tasks. It includes materials, labor, tools, office supplies, etc.
 Cost: Cost is the sum paid for the resources used in an activity. For example: salaries,
printing stationary, telephone bill etc. It is also known as activity cost pool.
 Cost object: It refers to an item for which cost measurement is required. For example: a
product, a service, or a customer.
 Cost Pool: Costs are grouped into pools according to the activities, which drive them. In this all
costs associated with procurement such as ordering, inspection, storing etc would be included in
this cost pool and cost driver identified.
 Cost Driver: In an ABC system, the allocation basis that are used for applying costs to services or
procedures are called cost drivers.

9.2.3 Objectives of Activity-Based-Costing

The following are the objectives of activity-based costing:
 To find production-related non-value-adding or non-productive activities that could be
eliminated.
 To offer the information necessary for making decisions.
 Encouraging managers to assess the effectiveness of services that are offered internally.
 To lessen the wasteful utilization of shared resources.
 To compute the total cost of goods in order to establish cost-based prices and for
financial reporting purposes.

9.2.4 Stages in Developing Activity-Based-Costing

Step 1. IDENTIFY RESOURCES: Resources are what an organization spends money on. These
costs are the same costs that are shown in conventional accounting, and ABC correlates
these costs to goods, users, or services.
Step2. IDENTIFY ACTIVITIES: Activities represent the work performed in an organization.
ABC accounts for the costs based on what activities caused them to occur. It is therefore
feasible to more precisely relate these costs to consumers, products, and services by
ascertaining the actual activities that take place in various departments.
Step 3. IDENTIFY COST OBJECTS: ABC offers profitability by a single or more cost items. To
identify clients that are losing money, cost object profitability is used to validate distinct
divisions or business units. A crucial component of a successful ABC implement action is
defining the outcomes that will be reviewed.
Step 4. DETERMINE RESOURCE DRIVERS: Resource drivers establish a link between an
organization's costs and the activities performed.
Step 5. DETERMINE COST (ACTIVITY) DRIVERS: The final stage of the model is the
identification of cost drivers. Cost drivers provide a linkage between cost objects and the
cost of performing particular activities.
 Activity Cost Driver Rate = Total Cost of Activity (Cost Pool)/ Activity Cost Driver
Step 6. ASSIGN COSTS TO THE COST OBJECTS: The formula below can be used to allocate
costs to cost objects.
 Costs = Resources Consumed * Activity Cost Driver Rate

9.2.5 Different Types of Activities

Activities are made up of individual tasks or units of work. Activities can be broadly
categorized into four groups according to the manufacturing cost hierarchy.
1. Unit Level Activities: Activities at the unit level are those for which the consumption of
resources can be identified with the number of units produced. It is performed each
time a unit is produced. For example: use of consumables like indirect materials.
2. Batch Level Activities: The quantity of units produced determines how much various
activities cost. These are steps involved in preparing a batch or production run. Every
time a batch is processed, it is carried out. For example: Material purchase order.
3. Product Level Activities: The cost of some activities is driven by the production of new
product lines and their upkeep. For example: designing the product.
4. Facility Level Activities: These are tasks that must be carried out to keep the
manufacturing process running well and cannot be directly linked to particular goods.
For example: Manager’s salary.

9.3.6 Importance and Utility of Activity-Based-Costing

Cost Reduction: Cost-cutting measures are taken by ABC by altering the manufacturing
process or outsourcing the costly tasks after determining how much they cost.
Margin: We are able to ascertain the margins of numerous items, product lines, and entire
subsidiaries with optimal overhead allocation from an ABC system. This can be quite helpful
in determining where to allocate firm resources to generate the highest margins.
Product pricing and decisions: Pricing products and deciding whether to keep a certain
customer or continue producing a product. The general perception of ABC implementers is
that ABC offers more precise cost data than traditional costing. This data can be used by
management to discuss price hikes with customers or to discontinue underperforming
products.
Budgeting and performance evaluation: Management can enhance budgets and evaluate
the effectiveness of divisions and departments by using more precise cost information.

9.3.7 Limitations of Activity-Based-Costing

 ABC system is expensive to maintain and needs significant resources to implement.
 In certain respects, ABC deviates from generally accepted accounting rules.
 In some circumstances, it may be difficult to establish the cause and effect
relationship between a cost driver and costs.
 A complicated system, activity-based costing requires a large amount of records for
calculations.
 When used in decision-making, activity-based costing data must be carefully analysed
because it can be easily misinterpreted.

9.4 Target Costing

Target Costing: Target Costing is defined as “a structured approach in determining the cost
at which a proposed product with specified functionality and quality must be produced, to
generate a desired level of profitability at its anticipated selling price.”
Japan is where this method was developed. Planning for profits is its goal. It is a tool for
maintaining cost and profit control throughout the lifespan of a product. By actively
incorporating every link in the value chain, Target Costing starts cost control from the very
beginning of product creation and applies it throughout the product life cycle.
Target Cost: CIMA – “Target cost is a product cost estimate derived from a competitive
market price”. The difference between target sales and target margin is the target cost.
Thus, it is the gap between the target margin and the anticipated selling price of a given
good with certain functionality and quality.
Target cost per unit = Target Price – Target operating income per unit.
Target profit: Target profit is a commitment agreed by all the people in a firm, who have any
part to play in achieving it.
9.4.1 Steps in Target Costing
1. Customer product Design Specification: Identify the market requirements as regards
design, utility and need for a new product or improvements of existing product. The
functioning and quality of the product must meet the needs of the consumer.
2. Set Target Selling Price: Target Selling Price is based on customer expectations and sales
forecasts. The offers of competitors, the usefulness of the product, prices, volumes, and
margins all have an impact on the price.
3. Set Target Production Volumes: Thae Target Production Volume is based on
relationships between price and volume. Target Volumes are important when calculating
 unit costs.  Given the correlation between price and volume, setting target production
volumes is closely related to setting target selling prices.
4. Establish Target Profit Margin: Target Profit Margin for each product, is based on the
company’s long term profit objectives, projected volumes, and course of action, etc.
Each product or product line is required to earn atleast the Target Profit Margin.
5. Set Target Cost per unit: The difference between the Target Selling Price and Target
Profit Margin indicates the “Allowable Cost” for the product.
Target cost = Target selling price (-) Target profit margin.
6. Determine Current Cost: The current cost of producing the new product is computed
based on available resources and conditions. Direct Costs are determined by reference
to design specifications, materials prices, labour processing time and wage rates.
Indirect Costs may be estimated using Activity Based Costing.
7. Set cost reduction Target: The difference between Current Cost and Target Cost
indicates the required cost reduction. This amount can be divided –
a) Target Cost - Reduction Objective:
b) Strategic Cost - Reduction Challenge
8. Analyse the Cost Reduction Target into various components and identify cost reduction
opportunities using Value Analysis (VA) and Activity Based Costing (ABC).
9. Achieve cost reduction and Target profit by Effective Implementation of Cost Reduction
decisions.
10. Focus on further possibilities of cost reduction.
9.4.2 Phases of Target Costing: Planning, Development, and Production
1. Planning - All competitors' products must be analyzed in terms of price, sales, quality,
technology, and services, among other factors. The target cost must then be established,
and the market share of one product must then be defined.
2. Development - After researching and analyzing various cost reduction techniques and
activity-based costing, the organization's cost structure must be chosen, and a suitable
design must then be created.
3. Production - Production goals are set, and efforts are made to meet them at lowest
cost possible without compromising on factors like quality, technological design, and
production methods, etc.

9.5 Target Cost Gap

The target cost gap is the estimated cost less the target cost.
Target Cost Gap = Estimated Cost – Target Cost
Where there is a difference between the target cost and the current anticipated cost levels,
this difference must be closed. The best chance of success for efforts to close a target cost
gap is during the design phase.
During the pre-production stage, it is much easier to "design out" costs than it is to "control
out" costs during the manufacturing stage.
This gap can be reduced:
 Eliminate elements that increase price but don't considerably improve the product in
the eyes of the consumers.
 To debate and discuss ways to reduce expenses, the organization should bring together
representatives of the marketing, design, assembly, and distribution departments.
 Review every step of the supply chain from beginning to end, with the help of staff
surveys, to find potential areas for cost reductions.
 Reducing waste or idle time should make it possible to increase efficiency as well.
Illustration:
A company manufactures camper van and would like to calculate the target cost gap for the
new camper van.
Estimated Selling Price: Rs.550000
Target Profit Required: 20% on Estimated sell price
Estimated Cost: Rs.475000
Solution:
Target Cost = Estimated Selling Price - Target Profit Required
Target Cost = Rs.550000 – (Rs.550000 *20/100) = Rs.440000
Target Cost Gap = Estimated Cost – Target Cost
Target Cost Gap = Rs.475000 – Rs.440000 = Rs.35000

9.6 Lifecycle Costing

The goal of life cycle costing is to estimate cost of a product, project, etc. over its anticipated
lifespan. The practice of gathering all costs an asset's owner or manufacturer will incur
throughout the course of the asset's life cycle is known as life cycle costing. These expenses
consist of the initial expenditure, any additional investments made in the future, and yearly
expenses, less any salvage value.
It is a system that tracks and compiles the actual expenses and income related to cost
objects (i.e., products) from their conception through their discontinuation. A method for
accurately recording all costs related to the product from its inception to completion is life
cycle costing.
Product Life Cycle is a pattern of expenditure, sale level, revenue and profit over the period
from new idea generation to the deletion of product from product range.
Phases in Product Life Cycle:
1. Introduction Stage: For a business introducing a new product, this cycle stage could be
the most expensive. Because there is a tiny market for the product, sales are low but are
expected to rise. Contrarily, the price of things like research and development,
consumer testing, and the marketing required to launch the product can be extremely
costly, especially if it is in a competitive industry.
2. Growth Stage: During this stage, sales and profits often increase significantly.
Additionally, because the company can now start to take advantage of production
economies of scale, profit margins and overall profits will also rise. As a result, firms are
able to spend more money on advertising strategies to fully use this growth stage.
3. Maturity Stage: During the maturity stage, the product is well-established, and the
manufacturer's goal is to hold onto the market share they have gained. Given how
intensely competitive the market is right now for the majority of items, companies must
make appropriate marketing investments. They must also take into account any product
modifications or production process improvements that can provide them a competitive
edge.
4. Decline Stage: Decline Stage: When a product's market eventually starts to contract, it
enters the decline stage. This decline in demand could be the result of either consumers
switching to a new kind of goods or all the potential buyers have already made
purchases of the product.  Even though this decline may be unavoidable, businesses may
still be able to turn a profit by shifting to less costly production techniques and markets.

Phases Introduction Growth Maturity Decline

Sales Steady increase in Decline in the
Initial stages, hence Sales reach a
low. sales volumes. rate of sales peak before
growth. starting to fall.
Price High levels to pay Retention of high- Because of the The difference
start-up costs and level prices, influence of between price
advertising costs. barring special the and cost is
circumstances. competition, getting less.
prices are
closer to their
cost.
Promotional Most effort is The ratio of Sales Ratio achieves Lower sales
Expense required to and Distribution a typical sales promotions
inform potential Overhead to Sales level. This since there is
clients, introduce decreases as a average level less demand for
items, deliver to result of the becomes the the goods.
customers, growth in Sales, industry
etc. hence, the but Total standard.
promotional Expenses stay
 expense is same.
the highest.
Competition Negligible and Entry of a large Strong Starts to vanish
insignificant. number of Competition as a result of
competitors. product
withdrawal.
Profits Due of high initial Increase at a Since costs and Profits are
expenditures, rapid pace. prices have declining
profits are zero. been because of
normalized, pricing
the profit rate competition,
is normal. new products,
etc.

9.6.1 Costs Involved at different stages of life cycle

1) Development
During the product's research and development phase, expenses are incurred but no profit
is generated.
A significant amount of setup expenses, such as those for product design, research and
development, and the construction of manufacturing facilities, will be incurred during this
phase.
2) Introduction.
The product is introduced to the market. The company may need to invest more in
advertising to bring the product or service to the market's attention because potential
customers won't be aware of it.
As a result, this phase will cost a lot to market and promote. The high development
expenditures may be recovered by changing the high prices.
3) Growth.
The market for the product expands as demand rises. A profit is made on the product as
sales revenues rise. Throughout this phase, marketing and promotion will continue.
As fixed costs are recovered over higher volumes, unit costs tend to decline. The
corporation could need to lower pricing to stay competitive as the market becomes more
competitive.
4) Maturity.
The product's demand will eventually stop growing as quickly and enter a stage of relative
maturity. It will keep turning a profit. Profitability will begin to decline, nevertheless, due to
product differentiation and price rivalry. In order to maintain demand, the product may be
altered or enhanced.
5) Decline.
The market will eventually reach a "saturation point" when it has acquired enough of the
market share. Prices will begin to decline along with demand. The organization should
decide to discontinue selling the good or service when it eventually turns into a loss maker.
A replacement product will need to be created in the interim, adding new tiers of research
and development costs to the overall setup costs.
9.6.2 Advantages of Product Lifecycle Costing
 Results in earlier actions to generate revenue or to lower costs than otherwise might be
considered.
 Ensures better decisions are made based on an estimate of revenues and costs that is
more precise and realistic, at least within a certain stage of the life cycle.
 Encourages long-lasting rewards.
 Offers a comprehensive framework for taking into account total incremental expenses
over the course of the product's life.
Note:
 Maintaining high prices during the growth phase will help business to make the most
revenue as possible.
 Price reduction will not be implemented unless:
(a) the low pricing will result in market penetration.
(b) The company's production capacity is adequate to handle the increased sales
volume.
Offers a comprehensive framework for taking into account total incremental expenses
over the course of the product's life.
(c) The market is entered by rivals.

9.8 Conclusion
The Activity Based Costing is a costing system that puts great emphasis on the tasks carried
out to produce goods. Costs are first linked to activities, then to goods, according to the ABC
method of costing. Due to the numerous shortcomings of Traditional Cost methods, ABC
was established. But, Activity-based costing is more expensive to implement than traditional
costing. ABC improves control over overhead costs.
Costs are categorized based on what motivates or precipitates them. Each activity has its
own cost pool, and these activities are connected to each type of product in order to
calculate the cost of that particular product.
Activity based costing has revolutionized product costing, planning, and forecasting in the
last decade. It is based on a philosophy of estimation that: “it is better to be approximately
right, than precisely wrong.” In summary, activity-based costing is a management decision-
making tool.
Target costing can be defined as “a structured approach for determining the cost at which a
proposed product with specified functionality and quality must be produced to generate a
desired level of profitability at its anticipated selling price”.
The fundamental objective of target costing is to enable management to use proactive cost
planning, cost management and cost reduction practices whereby, costs are planned and
managed out of a product and business, early in the design and development cycle, rather
to a during the later stages of product development and production.
It emphasizes understanding the markets and competition; it focuses on customer
requirements in terms of quality, functions and delivery, as well as price; it recognizes the
necessity to balance the trade-offs across the organization, and establishes teams to address
them early in the development cycle.
Life Cycle Costing aims at cost ascertainment of a product, project etc. over its projected
life. Product Life Cycle spans the time from initial R&D on a product to when customer
servicing and support is no longer offered for the product. For products like motor vehicles,
this time-span may range from 5 to 7 years. For some basic pharmaceuticals, the time-span
be 7 to 10 years. The 4 identifiable phases in the product Life Cycle are — (a) Introduction
(b) Growth (c) Maturity and (d) Decline.
Product Life Cycle Costing focuses on recognizing both production and non-production
costs.
Product Life Cycle Costing can promote long-term rewarding in contrast to short-term
profitability rewarding. It provides an overall framework for considering total incremental
costs over the entire life span of a product, which in turn facilitates analysis of parts of the
whole where cost effectiveness might be improved.

9.9 Glossary
Activity: An activity means an aggregate of closely related tasks having some specific
functions which are used for completion of goal or objectives.
Resource: Resources are elements that are used for performing the activities or factors
helping in the activities.
Cost: Cost is amount paid for resource consumed by the activity. For example, salaries,
printing stationary, telephone bill etc.
Cost object: It refers to an item for which cost measurement is required. e.g., a product, a
service, or a customer.
Cost pool: A cost pool is a term used to indicate grouping of costs incurred on a particular
activity which drives them.
Cost driver: Any element that would cause a change in the cost of activity is cost driver.
Actually, cost drivers are basis of charging cost of activity to cost object. Cost drivers are
used to trace cost to product by using a measure of resources consumed by each activity.
Target Costing: “A structured approach in determining the cost at which a proposed product
with specified functionality and quality must be produced, to generate a desired level of
profitability at its anticipated selling price.”
Target Cost Gap: The target cost gap is the estimated cost less the target cost.
Target Cost: CIMA – “Target cost is a product cost estimate derived from a competitive
market price”.
Target profit: Target profit is a commitment agreed by all the people in a firm, who have any
part to play in achieving it.
Product Life Cycle: Product Lifecycle Costing is a pattern of expenditure, sale level, revenue
and profit over the period from new idea generation to the deletion of product from
product range.

9.10 Self-Assessment Questions

1) How are activities classified under Activity Based Costing System? Explain.
2) Target costing is used by Aquafresh Ltd., a producer of numerous consumer goods. The
company wants to close the target cost gap that exists for Product Bull as of right now.
Describe the best way to close this gap.
3) A manufacturing company that produces a variety of goods has created a budget for the
lifespan of a new Product Altra. The following table contains details that only apply to
Product Altra:

Particulars Lifetime total Per unit

Design costs Rs.10,00,000
Direct material and labor cost Rs.25
Depreciation costs Rs.4,50,000
Decommissioning costs Rs.35,000
Machine hours 4 hours
Production and sales units 2,80,000 units
Annual budgets for the company's total fixed production overheads are
Rs.20,00,000 and budgeted machine hours is 1,50,000 hours. The business pays for
overhead expenses per machine hour.
What is the budgeted life-cycle cost per unit for Product Altra?

9.11 Questions for discussion forum

1) The fundamental objective of target costing is to enable management to use proactive
cost planning, cost management and cost reduction practices. Discuss the phases.
2) Each unit of Product Pixi is priced at Rs. 1000, and 800 units are anticipated to be sold in
the following year. A 25% return on the Rs.10,00,000 investment in Product X will be
needed. Calculate the Target Cost per unit of Product Pixi.

9.12 Case Study

The Great Hindustan Ltd. produces two products that computer parts: Hard drive and
mobile device. The business operates under a normal cost system, and it uses a plant-wide
overhead rate based on direct worker hours to distribute overhead costs. However, experts
have advised the business to charge overhead to products using activity-based costing.
In 2022, the company plans to make 4,000 mobile device and 6,000 hard drive. Each hard
drive requires two hours of direct labor, but the production of a mobile device only takes a
half-hour. The following are the expenses for direct materials and direct labor used in the
two products:
 Particulars Hard drive Mobile Device
Direct Material cost per unit (Rs.) Rs.45 Rs.20
Direct Labor cost per unit (Rs.) Rs.18 Rs.4.5

Budgeted Overheads and Estimated volume

Particulars Budgeted Overheads Estimated Volume
Production set ups Rs.125000 25 set ups
Material handling and storage Rs.750000 3000 lbs
Packaging and distribution Rs.150000 5000 boxes
Total Overheads Rs.350000

The two products would require these activities as follows in 2022

Particulars Hard Drive Mobile Device Total
Production Set ups 15 10 25
Material Handling 1000 2000 3000 lbs
Packaging and distribution 3500 1500 5000 boxes

Required:
1. Calculate the cost of each product using a plant-wide rate based on direct labor hours.
2. Calculate the activity cost rates for:
(a) setups, (b) material handling, and (c) packaging and distribution
3. Cost out the two products using an activity-based costing system.

9.13 Multiple Choice Questions

1) The key cause why businesses employ ABC:
a) ABC system is expensive to maintain and needs significant resources to implement.
b) A complicated system, activity-based costing requires a large amount of records for
calculations.
c) Japan is where this method was developed.
d) Cause and effect relationships cannot be captured by traditional costing.
Explanation: The key cause why businesses employ ABC is
- Cause and effect relationships cannot be captured by traditional costing.
2) Costs are first associated to activities, then to goods. Identify the technique.
a) Activity Based Costing
b) Target Costing
c) Lifecycle Costing
d) Standard Costing
Explanation: Costs are first associated to activities, then to goods, according to the ABC
method of costing.
3) Choose which amongst the following is not an Activity:
a) Set ups
b) Batches
 c) Material Handling
d) Packaging Overheads
Explanation: Batch is the volume of Activity level.
4) If the estimated cost is Rs.150000 and the target selling price is Rs.180000 is 25% more
than its target cost, what is the target cost gap?
a) (-) 6000
b) (+) 5000
c) (+) 6000
d) (-) 5000
Explanation: Target Cost Gap = Estimated Cost – Target Cost
Target Cost = 180000/125 *100 = Rs.144000
Target Cost Gap = Rs.150000 – Rs.144000 = (+) Rs.6000
5) The two-stage method of product costing is known as:
a) Lifecycle Costing
b) Target Costing
c) Activity Based Costing
d) Standard Costing
Explanation: The two-stage method of product costing known as "activity-based costing"
(ABC).
6) The difference between target sales and target margin is:
a) Target Cost Gap
b) Target Cost
c) Target Profit
d) Target Sell Price
Explanation: “Target cost is a product cost estimate derived from a competitive market
price”. The difference between target sales and target margin is the target cost.
7) Calculate Activity Rate if budgeted distribution overhead is Rs.250000 and there are
1200 boxes.
a) 208.33
b) 210
c) 280.34
d) 283.03
Explanation: Activity Rate = Budgeted Distribution Overhead/ Activity Volume Level
Activity Rate = Rs.250000/ 1200 boxes = Rs.208.33
8) Japan is where this method was developed.
a) Lifecycle Costing
b) Target Costing
c) Activity Based Costing
d) Standard Costing
Explanation: Target Costing technique has been developed in Japan. It aims at profit
planning. It is a device to continuously control costs and manage profit over a product’s life
cycle.
9) __________ provide a linkage between cost objects and the cost of performing
particular activities.
a) Cost Pool
b) Cost Object
c) Cost Driver
d) Cost Unit
Explanation: Cost drivers provide a linkage between cost objects and the cost of performing
particular activities.
10) Activities can be broadly categorized into:
a) Four
b) Two
c) Three
d) Five
Explanation: Activities can be broadly categorized into four groups according to the
manufacturing cost hierarchy.
11) Operational Manger’s salary is categorised as:
a) Unit level
b) Batch level
c) Product level
d) Facility level
Explanation: These are tasks that must be carried out to keep the manufacturing process
running well and cannot be directly linked to particular goods, are categorised as Facility
level activities.
12) During this stage, sales and profits often increase significantly. Which stage of lifecycle
costing is this:
a) Introduction stage
b) Growth stage
c) Maturity stage
d) Decline stage
Explanation: During Growth stage, sales and profits often increase significantly.
13) When a product's market eventually starts to contract, it enters:
a) Introduction stage
b) Growth stage
c) Maturity stage
d) Decline stage
Explanation: When a product's market eventually starts to contract, it enters the decline
stage.
14) What is the correct sequence of the phases of product lifecycle?
 Introduction, Maturity, Growth, and Decline.
a) Introduction, Growth, Maturity, and Decline
b) Growth, Maturity, Introduction, and Decline
c) Introduction, Maturity, Growth, and Decline
d) Introduction, Decline, Maturity, and Growth
Explanation: Phases in Product Life Cycle: Introduction, Growth, Maturity, and Decline
15) Which of the following can be applied to reduce the target cost gap for a product?
a) Increase the selling price
b) Work longer hours to achieve tasks faster
c) Replace present raw materials with less expensive alternatives
d) Strike a better rental agreement.
Explanation: This gap can be reduced by eliminating elements that increase price but don't
considerably improve the product in the eyes of the consumers.
16) Individual activities are designated as the cost objects in the costing system is called
a) Target Costing
b) Lifecycle Costing
c) Unit level costing
d) Activity Based Costing
Explanation: The costing system in which individual activities are identified as the cost
object is considered as Activity Based Costing
17) The decline stage is also known as
a) Introduction
b) Maturity
c) Saturation point
d) Growth
Explanation: The market will eventually reach a "saturation point". The organization should
decide to discontinue selling the good or service when it eventually turns into a loss maker.
18) Price reduction will not be implemented unless:
a) the low pricing will result in market penetration.
b) The company's production capacity is adequate to handle the increased sales
volume.
c) The market is entered by rivals.
d) All the above
Explanation: Price reduction will not be implemented unless:
i. the low pricing will result in market penetration.
ii. The company's production capacity is adequate to handle the increased sales
volume. Offers a comprehensive framework for taking into account total incremental
expenses over the course of the product's life.
iii. The market is entered by rivals.
19) The expenses for each activity related to a certain good or service are categorized as
a) Batch Level
b) Unit level
c) Product level
d) Facility level
Explanation: Activities at the unit level are those for which the consumption of resources
can be identified with the number of units produced.
20) The probability of eliminating the goal cost gap is greatest at which stage:
a) Production Stage
b) Development Stage
c) Design Stage
d) Selling Stage

Explanation: The best chance of success for efforts to close a target cost gap is during the
design phase.

Answer 3:
Overhead Recovery Rate for fixed production overheads
(Rs.20,00,000/ 25,00,000 hours) = Rs.0.80 per hour
Total manufacturing costs (2,80,000 units x Rs.25) = Rs.70,00,000
Total design, depreciation and decommissioning costs = Rs.14,85,000
Total fixed production overheads
(2,80,000 units x 4 hours x Rs.0.80 per hour) = Rs.8,96,000
Total life-cycle costs = Rs.93,81,000
Life-cycle cost per unit (Rs.93,81,000/2,80,000 units) = Rs.33.50

Case Study (Answer)

1. The Cost of Each Product Using a Plant-Wide Rate Based on Direct Labour Hours:
Step 1: Calculation of plant-wide overhead rate:
Total budgeted DLH =
6000 Hard drives x 2 direct labor hours per unit + 4000 mobile devices x 0.5 direct labor
hours per unit = 14000 direct labor hours
Overhead Rate = Total Budgeted Overhead /Total Budgeted Direct Labor Hours
= Rs.350000 / 14000 direct labor hours
= Rs.25 per direct labor hour
Step 2: Calculation of each product’s cost using a plant-wide rate:
Particulars Hard drive Mobile device
 Direct material Rs.45 Rs.20
Direct labor Rs.18 Rs.4.5
Overhead cost per labor hour Rs.50 Rs.12.5
Total cost per unit Rs.113 Rs.37

2. Calculating Activity Rates

Activity Budgeted Overheads Estimated Volumes Activity Rates
Set ups Rs.125000 25 set ups Rs.5000 per set up
Material Handling Rs.75000 3000 lbs Rs.25 per lbs
Packaging and Rs.150000 5000 boxes Rs.30 per box
distribution

3. Product costs as per Activity Based Costing

Particulars Hard drive Mobile device
Output level 6000 units 4000 units
Direct material cost Rs.270000 Rs.80000
Direct labor cost Rs.108000 Rs.18000
Production set up cost Rs.75000 Rs.50000
Material Handling cost Rs.25000 Rs.50000
Packaging and distribution Rs.105000 Rs.45000
Total Manufacturing cost Rs.583000 Rs.243000
Total cost per unit Rs.97.17 Rs.60.75