Question

Target Price	$144.00
Less: Desired profit (25% of price)	36.00
Target Cost	$108.00
Current Cost:
Materials	$54.00
Labor	27.00
Overhead	33.75
Selling	10.00
General & administrative	15.00
Total current cost	$139.75
Cost Gap	$31.75
% cost gap to current cost	22.7%

The managers of the various department have evaluated the activities related to this product and have provided the following suggestions to narrow the cost gap.

1. From the design department - the drive engine is the most expensive If we redesign the product we can eliminate $5 of direct labor, $15 of direct materials and $6.25 of overhead. The redesign would cost $600,000 which we would want to recoup over the first 100,000 units (or $6 per unit).

2. From the marketing department - we can cut selling (marketing costs) by 30% as we have strong distribution channels and relationships in place from out other products.

3. From the accounting department - the customer service costs for can be reduced by 60%. The original estimates were done based on existing channels and customers which can be improved.

Required: Is the organization in the establishment or the attainment stage of target costing? Use the changes suggested above to develop a new estimate of the cost and cost gap. How much further do they need to go in order to achieve the desired profit?

Answer 1

Answer with working is given below