Question

How does the target cost concept differ from cost-plus approaches? Under what circumstances is it appropriate to use the target cost concept?

Answer 1

Under Target Cost approach, the maximum cost for the product is back calculated. We have fixed selling price and desired profit percentage, on the basis of which target cost is calculated. Target cost is the maximum cost which should be incurred for achieving the desired profit.

In cost plus approach, selling price is calculated on the basis of cost incurred on making the product and adding the desired profit margin to it. Selling Price is not fixed in this case but derived.

It is appropriate to use the target cost concept in the following circumstances:

1. In the perfect competition market, where selling price cannot be increased

2. Where selling price is fixed on the basis of competitor's price