DEVELOPMENTS IN MANAGEMENT ACCOUTING

1. TARGET COSTING
This is a pricing method used by firms to determine the target cost which is the maximum
amount of cost that can be incurred on a product when the firm wants to earn a given profit
margin from that product at a particular selling price.

In the traditional cost-plus pricing method, materials, labour and overhead cost are measured and
a desired profit then added to determine the selling price.

Target costing on the other hand involves setting a target cost by subtracting a desired profit
margin from a competitive market price.

Target costing can therefore be used as a basis for improving the level of efficiency in dealing
with cost and is particularly applicable when firms cannot dictate market prices and are price
takers instead.

Traditional Costing
Direct materials xxx
Direct labour xxx
Variable overhead xxx
Fixed overhead xxx
Total cost xxx
Add: profit mark- xxx
up
Selling price xxx

Target Costing
Selling price (market determined) xxx
Less: desired profit margin (xxx)
Target cost xxx

Target costing has the following main advantages or benefits:

1. Proactive approach to cost management.

2. Orients organizations towards customers.
3. Breaks down barriers between departments.
4. Implementation enhances employee awareness and empowerment.
5. Foster partnerships with suppliers.
6. Minimize non-value-added activities.
7. Encourages selection of lowest cost value added activities.
8. Reduced time to market.

Target costing approach has the following main disadvantages or limitations:

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 1. Effective implementation and use requires the development of detailed cost data.
2. its implementation requires willingness to cooperate
3. Requires many meetings for coordination
4. May reduce the quality of products due to the use of cheap components which may be of
inferior quality.

Question One-Target Costing

Mangrove enterprises ltd is operating in a very competitive market selling standardized Beads
and Sequins in an industry with many other players. The prevailing market price for one pack of
Beads and Sequins is ksh 800.

The cost structure of the company for the product is as follows:

Ksh.
Direct materials 250
Direct labour 300
Variable overhead (50% of direct labour) 150
Total Variable cost 700

The company has always had a policy of 12.5% profit margin but recent developments in the
business environment have led to the following changes in the cost structure:

Cost % Increase
Direct material 20%
Direct labour 30%

In view of these cost increases, the selling price for the industry has also increased to ksh. 900
per pack.
The company uses target costing and has revised its profit margin to 10% on the face of all these
changes in the industry.

Required:
a) Prepare a standard statement showing the total cost per pack after the changes
b) Determine the cost gap (if any) that would exist after the changes in cost
c) Compute the minimum selling price for the industry that would secure the original
amount of profit for the company on the increased costs

Question Two-Target Costing

Jua Kali Ltd. sells a wide range of products. The company is considering extending its product
range to include a product branded “Zed”. The company intends the product to compete with
that of a rival company whose features are comparable to that of “Zed”

In order to penetrate the market of the rival product, Jua Kali Ltd, intends to use the target
costing approach for its product.

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The following information relates to the operations of Jua Kali Ltd. and the production of “Zed”.
1. The selling price per unit of product “Zed” has been set at sh.44,000. The price is
competitive compared to that of its rival product.
2. The acceptable profit margin [after allowing for all production costs] of the
company is 20%.
3. Production overheads are currently absorbed into products cost on an assembly
labour hour basis.
4. Production of “zed” will be through the assembly of various components as
follows:
 Component 1- These will cost of Sh.4,100 per unit of Zed.
 Component 2- 25 centimetres of the component is required per unit
of “Zed” produced. A metre of the component costs sh.500.
 Other components- The cost of other components per unit of “Zed”
is Sh.8,100
5. The company’s skilled labour will be engaged in the assembly of “Zed”. It takes
30 minutes to assemble a unit of “Zed”.
6. The total assembly labour cost per hour is Sh.12,600.
7. A review of the historic production overhead costs has revealed the following
data:

Total production Total assembly

overheads labour hours
Ksh.000
Month 1 620,000 19,000
Month 2 700,000 23,000
8. Fixed production overheads are absorbed on assembly hour basis. The average
annual assembly hours available are 240,000.

Required

Calculate the expected cost per unit of product “Zed” and identify any cost gap that may exist.

2. LIFE CYCLE COSTING

This is also called whole-life costing which is a structured approach that estimates all the cost
that are supposed to be incurred on a product in its entire life from introduction to decline stage.
Costs are analyzed and classified into one-off costs and recurring costs, then an analysis is done
which estimates the cost that should be allocated to one unit. From this analysis, the organization
is therefore able to have an estimate of the likely profit that the product will generate in its entire
life.
However the recurring costs are likely to change due to changing circumstances, but life cycle
costing is still a useful forecasting technique.

Question 3-Life Cycle Costing

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A company manufactures iPhones. It is planning to introduce a new model and development will
begin very soon. It expects the new product to have a life cycle of 3 years and the following costs
have been estimated.

Year 0 Year 1 Year 2 Year 3

Units manufactured and sold 25,000 100,000 75,000
Price per unit [ksh. 000] 90 80 70
R&D costs [ksh. 000] 850,000 90,000 ------- -------
Production costs;
Variable cost per unit [ksh. 000] 30 25 25
Fixed cost [ksh. 000] 500,000 500,000 500,000
Marketing costs;
Variable cost per unit [ksh. 000] 5 4 3
Fixed cost [ksh. 000] 300,000 200,000 200,000
Distribution cost;
Variable cost per unit [ksh. 000] 1 1 1
Fixed cost [ksh. 000] 190,000 190,000 190,000
Customer service costs per unit [ksh. 000] 3 2 2

Required
Calculate the cost per unit looking at the whole life cycle and comment on the price to be
charged.

3. BENCHMARKING
This is the process of comparing an organizations operations and internal processes against those
of other organizations within and outside its industry.

The other organizations against which the comparisons are made are known as “bench-mark
partners” and are usually those that are perceived to be the best performers in the particular areas
of concern.
The purpose of bench marking is to identify and adopt best known practices that can lead to
superior performance.
Bench marking must be performed on a specific area of activity or operation e.g. staffing,
information technology, distribution systems, budgeting etc.
In general bench marking partners can be classified into 4 categories:
 Internal partners which pertains to departments within the same organization
 Competitive partners which refers to benchmarking with direct competitors
 Functional partners which pertains to best-in-class organizations
 Generic partners which refers to benchmarking with leading organizations from various
fields and industries

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 4. THE KAIZEN PHILOSOPHY

Introduction

This refers to a system of continuous improvement in quality, technology, processes, company

culture, productivity, safety and leadership.

Kaizen is a system that involves every employee - from higher level management to the lower
level staff. Everyone is encouraged to come up with small improvement suggestions on a regular
basis. In most cases these are not ideas for major changes. Kaizen is based on making little
changes on a regular basis: always improving productivity, safety and effectiveness while
reducing waste.

The foundation of the Kaizen method consists of 5 founding elements:

1. Teamwork,
2. Personal discipline,
3. Improved morale,
4. Quality circles, and
5. Suggestions for improvement.

Benefits of Kaizen
Kaizen involves every employee in making change--in most cases small, incremental changes. It
focuses on identifying problems at their source, solving them at their source, and changing
standards to ensure the problem stays solved. These continual small improvements add up to
major benefits listed below:

 Kaizen Reduces Waste in areas such as inventory, waiting times, transportation, worker
motion, employee skills, over production, excess quality and in processes.
 Kaizen Improves space utilization, product quality, use of capital, communications,
production capacity and employee retention.
 Kaizen provides immediate results. Instead of focusing on large, capital intensive
improvements, Kaizen focuses on creative investments that continually solve large
numbers of small problems. Large, capital projects and major changes will still be
needed, and Kaizen will also improve the capital projects process, but the real power of
Kaizen is in the on-going process of continually making small improvements that
improve processes and reduce waste.
 Kaizen leads to improved productivity and improved quality.
 Kaizen leads to better safety
 It leads to faster delivery
 It leads to lower costs
 It leads to greater customer satisfaction.

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  On top of these benefits to the company, employees working in Kaizen-based companies
generally find work to be easier and more enjoyable--resulting in higher employee morale
and job satisfaction, and lower turn-over.

5. JUST IN TIME INVENTORY SYSTEMS:

JIT involves a continuous commitment to pursuit of excellence in all phases of manufacturing
systems design and operations. The aims of JIT are to produce the required items, of the required
quality and in the required quantities, at the precise time they are required. In particular JIT seeks
to achieve the following goals:
 Elimination of non-value added activities
 Zero inventories
 Zero defects
 Batch sizes of one
 Zero breakdowns
 A 100% on-time delivery services

The above goals represent, and are most unlikely to be achieved in practice. They do however
offer targets and create a climate for continuous improvement and excellence.

Note:
1. Elimination of non-value added activities
JIT manufacturing is dedicated to eliminating waste. Waste is anything that does not add value to
a product e.g. inspection, storage etc.

2. Batch size equal to one

The JIT philosophy is to reduce and eventually to eliminate set up times between batches. This
can be achieved by investing in production technologies that adjust machines automatically
instead of manually. Alternatively, some set up times can be eliminated by redesigning products
so that machines don’t have to be reset each time a new product is to be made.
If set up times are approaching zero, it means that there are no advantages of producing in
batches, therefore the optimal batch size can be one.
With a batch size of one, the work can flow smoothly to the next stage without the need for
storage and to schedule the next machine to accept this item.

JIT purchasing arrangements

This is an arrangement whereby the delivery of materials immediately precedes their use. By
arranging with suppliers for more frequent deliveries, stocks can be cut to a minimum.
Considerable savings in stock handling costs can be obtained by requiring suppliers to inspect
materials before their delivery and to guarantee their quality. This improved service is obtained
by giving more business to fewer suppliers and placing long term purchasing orders. Therefore,
the suppliers have an assurance of long term sales and can plan to meet this demand.

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Advantages of JIT purchasing:
 It leads to substantial savings in stock holding costs
 Elimination of waste
 Savings in factory and warehouse space which can be used for other profitable activities
 Reduction in obsolete stock
 There may be large quantity discounts due to large purchase orders
 Savings in the time for negotiating purchase or materials because fewer suppliers are
dealt with
 Reduced investment in raw materials
 Considerable reduction in paper work arising from issuing blanket long term orders to a
few suppliers rather than individual purchase order to many suppliers

Disadvantages of JIT purchasing:

 Additional investment in new machinery, changes in plant layout and good services may
affect the cash flow of the organization
 Difficulty of predicting daily or weekly demand which is a key feature of the JIT
philosophy
 Increased chances of stock-out situations

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