A focus on the planning and design stage of a new product: Conventional costing records costs only as they are incurred, but recording those costs is different to controlling those costs. Performance management depends on cost control, not on cost measurement. Cost of the new product may be a strategic advantage over the rival company. If some product is designed such that it is unnecessarily costly to produce, it does not matter how efficient the manufacturing process is, it would forever be a struggle to generate satisfactory profits. In this topic I am going to show an example of target costing and life cycle costing to the viewers so that they can easily understand the essence of the topic.
A NUMERICAL EXAMPLE OF TARGET AND LIFE CYCLE COSTING
Madison Electric is going to launch a new consumer product. It has carefully researched the market demand and other necessary analysis before introducing the upcoming product. According to market research data, the new product should be sold 10,000 units at $21.00 per unit. Madison Electric thinks to make a decided markup of 40% of its product cost. It is expected that the life-cycle costs of the new product would be as under:
- Design and development costs $50,000
- Manufacturing costs $10/unit
- End of life costs $20,000
Madison Electric estimates that if the company were to spend an additional £15,000 on design, manufacturing costs/unit could be reduced.
Required
(a) What is the target cost of the new product?
(b) What is the original life cycle cost per unit and is the product worth making on that basis?
(c) If the additional amount were spent on design, what is the maximum manufacturing cost per unit that could be tolerated if the company is to earn its required mark-up?
Solution
The target cost of the product can be calculated as follows:
(a) Selling price= Cost + Mark-up =
140% = 100% + 40%
$21 = $15 + $6
(b) The original life cycle cost per unit = ($500,000 +(10,000 x $10) + $20,000)/10,000 = $17
This cost/unit is above the target cost per unit, so the product is not worth making.
(c) Maximum total cost per unit = $15. Some of this will be caused by the design and end of life costs:
($50,000 + $15,000 + $20,000)/10,000= $8.50
Therefore, the maximum manufacturing cost per unit would have to fall from $10 to ($15 – $8.50)
= $6.50.
(Collected from ACCA)
