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Under What Scenarios Is Target Costing Useful? Are There Any Problems With Target Costing?

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Target costing is most useful in those situations where the majority of product costs are locked in during the product design phase. This applies to most manufactured products, but few services. In the services arena, such as consulting, the bulk of all activities can be reconfigured for cost reduction during the ‘‘production’’ phase, which is when services are being provided directly to the customer. In the services environment, the ‘‘design team’’ is still present, but is more commonly concerned with the streamlining of the activities conducted by those employees who are providing the service, which can continue to be enhanced at any time, not just when the initial services process is being laid out.

For example: a design team can lay out the floor plan of a fast-food restaurant, with the objective of creating an arrangement that allows employees to walk the shortest possible distances while preparing food and serving customers; this is similar to the design of a new product. However, unlike a product design, this layout can be readily altered at any time if the design team can arrive at a better layout, so that the restaurant staff can continue to experience high levels of productivity improvement even after the initial design and layout of the restaurant facility. In this situation, costs are not locked in during the design phase, so there is less need for target costing.

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Another situation in which target costing results in less value is the production of raw materials, such as chemicals. In this case, there are no design features for a design team to labor over; instead, the industrial engineering staff tries to create the most efficient possible production process, which has little to do with cost reduction through the improvement of customer value through the creation of a product with a high ratio of features to costs.

 

Are There Any Problems With Target Costing?

Though the target costing system results in clear and substantial benefits in most cases, there are a few problems with it that one should be aware of, and guard against.

The first problem is that the development process 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 will meet the target cost and margin criteria. This occurrence is most common when the project manager is unwilling to pull the plug on a design project that cannot meet its costing goals within a reasonable time frame. Usually, if there is no evidence of rapid progress toward a specific target cost within a relatively short time frame, then it is better to either ditch the project or at least shelve it for a short time and then try again, on the assumption that new cost-reduction methods or less-expensive materials will be available in the near future that will make the target cost an achievable one.

Another problem is that a great deal of mandatory cost cutting can result in finger pointing between various parts of the company, especially if employees in one area feel that 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, while the purchasing staff is not required to make any cost reductions through supplier negotiations. Avoiding this problem requires strong interpersonal and negotiation skills on the part of the project manager.

Finally, having representatives from a number of departments on the design team can sometimes make it more difficult to reach consensus on the proper design, because there are too many opinions on the team regarding design issues. This is a particular problem if there are particularly stubborn people on the design team who are holding out for specific product features. Resolving this problem requires a strong team manager, as well as a long-term commitment on the part of a company to weed out those people from design teams who are not willing to act in the best interests of the team.

For every problem area outlined here, the dominant solution is that of retaining strong control over the design teams, which calls for a good team leader. This person must have an exceptional knowledge of the design process, good interpersonal skills, and a commitment to attaining both time and cost budgets for a design project.

Have you read these:

  • How Does Target Costing Work? and What Is Value Engineering?
  • Improve Profitability With Target Costing
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