Target Costing And Life Cycle Costing_305951881.docx

Managerial Accounting Group Assignment

Target Costing and Life Cycle Costing Submitted to:

Dr. Meena Bhatia By: GIRISH PAI 15DM056 KANUPRIYA 15DM072 MANU GUPTA 15DM082 NEERAJ NIDRE 15DM090 NIKET MALIK 15DM091 NIKKITA BAKSHI 15DM093

In partial fulfilment of the requirement for Post Graduate Diploma in Management 2015-2017 1

INDEX PART I 1.Introduction…………………………………………………...….3 2.Value Chain………………………………………………………4  Meaning……………………………...............................................4  Categorization………………………………..…............................4  Objective…………………………………………..………….…...4  Steps in value chain……….…………………...……………..5  Benefits…………………………………………………………….5

3.Target Costing…………………………………………………….6    

Meaning……………………………………...……………………6 Objective………………………………………………….………,6 Steps in target costing…………………………………….………7 Monitoring the target costing process…………………...……….7

PART II 4. Decision…………...……………………………………………..8 5. Target Costing...…………………………………………………8  Sdj 6. Conclusion……………………………………………………… 7. Biblography

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Part I INTRODUCTION The performance of the given company is found to be unsatisfactory due to the existing traditional managerial accounting practices. So being the Management Consultant we advice the Board of Directors of the company to implement any one of the two following contemporary managerial accounting practices in the business of optimise the performance: 1. Value Chain 2. Target Costing The following report deals with describing what Value Chain and Target Costing is all about and what are developments which could benefit us and a detailed discussion on Target Costing will be carried out which will include methodology, steps in implementing target costing for a product, its benefits and what could be the challenges that we can face.

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VALUE CHAIN MEANING A value chain is a full range of the activities including design, production, marketing and distribution that creates and builds value at every step. The total value delivered by the company is the sum total of the value built up all throughout the company. CATEGORIZATION

OBJECTIVE The process of actually organizing all of these activities so they can be properly analyzed is called value chain management. The goal of value chain management is to ensure that those in charge of each stage of the value chain are communicating with one another, to make sure that the product is getting in the hands of customers as quickly as possible and that all of these activities should be run at optimum level if the organization is to gain any real competitive advantage. If they are run efficiently, the value obtained should exceed the costs of running them — for example, customers should return to the company and transact freely and willingly.

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STEPS IN VALUE CHAIN 1. Draw process diagrams and write descriptions to map out your inbound logistics and purchasing systems. Map out your transportation system, and make a list of all productive activities and employees involved in the receiving and storage of goods and materials. Describe how the system is used and by whom.

2. Involve any process that brings your raw materials one step closer to finished goods after you receive and store raw materials. Describe the way you handle inventory and move it to store shelves for a retail or wholesale operation. Describe the way inputs are turned into customer value for a service operation.

3. Repeat the process for your outbound logistics. Outbound logistics involves getting your finished goods into the hands of your customers. 4. Write a thorough analysis of your sales and customer service activities. Analyze your marketing activities, the in-store customer experience and the after-sale customer experience.

5. Identify inefficiencies and non-value-adding activities in each area.

Examples of operational inefficiencies include redundant activities, over staffing, inadequate tools or diminishing productivity. Identify bottlenecks by looking for activities that take excessive amounts of time to complete or which delay subsequent activities. 6. Bring together a diverse group of employees and strategize possible solutions to any identified issues. Include employees from all relevant departments and organizational levels.

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BENEFITS  It reduces the delivery time.  Optimizes the inventory levels.  Improves the relationship with the customers.  Enhances revenues and profits

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TARGET COSTING MEANING Target Costing is a cost management tool that is being used for pricing with the motive of reducing the overall cost of the product without compromising any of its profits.

OBJECTIVE The main objective of target costing is to enable the management in managing business profitably in a highly competitive environment. In fact, it is a cost planning and cost reduction practice in which costs of a product are planned and managed early in the design and development cycle only, rather than during development or production stage but it can be applied to product modifications as well.

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STEPS IN TARGET COSTING 1. Establishing target price: This involves few considerations: what are the market wants and needs presently and in the coming future; how much customers are really willing to pay for alternative features; and what are competitor offerings and may be in the future. 2. Determine target profit margin and allowable cost :This target margin comes from the company’s long-term strategic and financial objectives resulting from the company’s profit planning efforts. Usually the company’s management takes decision on the desired profit from a new product. The difference between the target price and the target profit margin is the final allowable cost that the company can decide on. 3. Determining current cost and target cost: In case proposed product is a modification of an existing , a firm has a cost basis from which it can determine the potential costs of the proposed new product if the new product’s specifications and method of manufacture are similar. 4. Perform functional cost analysis: It focuses on individual functions of each of the product separately. It involves designing in such a way that each function is reviewed individually so as to lower the cost to the desired target cost.

MONITORING THE TARGET COSTING PROCESS  As the target costing process continues, it is of utmost importance to track whether the objectives—both nonfinancial and financial—are being achieved or not. Also whether the customers’ wants and needs being satisfied? This requires continued input from existing and potential customers via surveys, focus groups, and other means.  Maintaining an accurate assessment of current costs is equally important, as they serve both as the foundation for the target cost determination, and as a report on how well the allowable costs are being achieved.

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Part II DECISION After going through both the methods, i.e. value chain and target costing, we have finally decided to implement target costing in the organization. Target costing will result in the improvement of the operational efficiency with a significant reduction of costs, hence leading to a higher profit margin. In the long run this process will result in efficiency and margin will keep on increasing, reducing the unsatisfactory performances and helping the company in achieving their objectives. Moreover in the process of target costing, value chain itself will take place while performing function cost analysis, hence more effective.

TARGET COSTING Methodology: Kaizen Costingis a term closely associated with Target Costing. The word kaizen is a Japanese word which means ‘improvement’.It stresses on the need for continuous improvement. The purpose ofkaizen goes beyond simple productivity improvement. It is a process which, when implemented correctly eliminates overly hard workand teaches people how to perform experiments on their work using the scientific methods and how to learn to spot and eliminate waste in business processes. The width or scale for kaizen can be individual, small group or a large group. Kaizen on a broad, inter-departmental scale in companies generates total quality management efforts by improving productivity using machines and computing power.

In today’s competitive environment there is a greater need for the sellers to take account of the competitors, so if a company want to achieve maximum penetration into the market it must lower the prices while improving the quality. “Give much more for much less”. Target costing enables to have a better understanding of markets, competition as well as the customer needs at the same time.

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Target costingis a detailed process for achieving a full-fledged cost at which a proposed product with specified functions, performance, and quality must be produced in order to generate the desired profits after the product’s anticipated sale over a specified period of time.It involves setting a target cost by subtracting a desired profit margin from a competitive market price. Trying to reduce the cost once a product reaches final stages of production is difficult therefore the company should focus on the costs right from the initiation. Each process including design, input materials and investment decisions are needed to be brainstormed before the product design is finalised. These concepts are supported by the four basic steps of Target Costing:

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STEP 1 - Determine the target price, which the customer is willing to pay for the product: This step involves the consideration of the market requirements, how much the customers are willing to pay for the product and what are the competitors offering. Most of the companies obtain the competitor’s product and disassemble it to examine what they are made of to estimate the cost of even the smallest part used. This process is known as “Reverse engineering”. The target price is based upon the market research, competitor’s offering and the company’s plan.

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STEP 2 - Determine a target profit margin from the target price to determine the target cost: Each company launches a product so that it must be profitable enough to yield satisfactory returns. The company must be able to determine the return which a company expects from an individual unit of the product. Different product lines have different target profit margins depending upon the market, the need of the product, level of investment etc. Difference between the target price and target profit margin gives us the allowable cost up to which the total cost of the product can be ascertained.

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STEP 3 - Estimate the actual Cost of the product: Target price – Target profit margin = Target cost Target cost can be broken down by allocating the target costs differently to individual components of the product which results in a new product which would be quite similar in characteristics to the previous models. Target cost can also be allocated according to the different functional areas of the product. This process involves proper assessment of the product’s functions and allocating target costs to each function.

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STEP 4 - If estimated actual cost exceeds the target cost, investigate ways of driving down the actual cost to the actual cost: To achieve the cost objectives it is necessary to use a cross functional team comprising of the members of all the departments which results in the reduction of costs in the early stages of product designing. The emphasis on the team shows the inter dependence of marketing, designing, development and manufacturing on each other. The accountant needs to provide rapid feedback on the implications of various techniques and decisions being implemented. The principal technique to achieve the target cost the company needs to close down the gap between current cost and allowable cost.

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OBJECTIVES OF TARGET COSTING The fundamental objective of target costing is to enable management to manage the business to be profitable in a very competitive marketplace. In effect, target costing is a proactive cost planning, cost management, and cost reduction practice whereby costs are planned and managed out of a product and business early in the design and development cycle, rather than during the later stages of product development and production.

BENEFITS OF TARGET COSTING  Cost Optimization Target Costing enables you to analyse the best way to make or acquire products at the lowest costs. Minimizing costs is a common financial goal of any business, irrespective of whether they offer high, medium or low prices and it gives a company financial flexibility to focus on achieving high profit margins or to enter the market at low price points to attract a large customer base.  Systematic Target costing involves consideration of all equipment, processes, labour and materials needed to make goods, or the costs to acquire goods and get them ready to sell to your customers.Thus, target costing is a formal and systematic way to focus on cost optimization.  Reduced Development Cycle Target costing helps in minimizing product cycle time. This is the amount of time it takes from conception to finished product. A reduced cycle time means unnecessary steps or waste that take time and don't add value to the end product for the customer have been eliminated. A shorter cycle time is a competitive advantage as well, since it is possible present the product to the market sooner, perhaps as the first mover.  Profitability 12

Target costing increases the profitability of the business. It takes into account both factors in profit: the costs and the price. Many companies start by developing products and base pricing on costs. By starting with market pricing first, it is ensured that the business ends up with a product that has benefits and a price point customers will value.

LIMITATIONS OF TARGET COSTING

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The development process It 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 meets the target cost and margin criteria.

 Blame Game A large amount of mandatory cost cutting can result in finger-pointing in various parts of the company, especially if employees in one area feel 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.

 Conflicts in opinions Representatives from number of departments on the design team can sometimes make it more difficult to reach a consensus on the proper design because there are too many opinions regarding design issues.

TOOLS FOR IMPLEMENTING TARGET COSTING: 1. Kaizen Costing:Kaizen Costing implies continuous improvement in the business efficiency by reducing costs and increasing profitability. The improvement need not be very significant, but it should be continuous. The purpose of kaizen goes beyond simple productivity improvement. It is a process which, when implemented correctly, humanizes the workplace, eliminates overly hard work, and teaches people how to 13

perform experiments on their work using the scientific method and how to learn to spot and eliminate waste in business processes. It may also be designed to address a particular issue. This is usually done over the course of a week and is referred to as a "kaizen blitz" or "kaizen event". These are limited in scope, and issues that arise from them are typically used in later blitzes.

2. Value Engineering:Value engineering starts with the customers’ wants and needs, and how we relate them to product design, buy or make decisions, and process engineering and manufacturing—all in the context of services, quality, speed, and cost. The concept is that all manufacturing activities are inextricably bound together with costs and have to be dealt with simultaneously. Supporting value engineering are tools such as cost structure analysis and functional analysis. The former divides the overall product into subassemblies and attaches current costs and target costs to that framework so that costs may be reduced substructure-by-substructure and component-by component. Functional analysis relates the value of the several functions to the costs associated with them. Important functions usually support the most costs, and less important functions ought to cost less.

BIBLIOGRAPHY For this report, we got our primary and secondary data from the following sources:  Cost and Management Accounting – Colin Drury  Kaplan, R. (1984). The evolution of management accounting, Accounting Review, 59 (3): 390-418.  Kaplan, R. (1994). Management accounting (1984-1994): Development of new practice and theory, Management Accounting Research, 5: 247-260.  Slideshare.com  Wikipedia.com  Implementing Target Costing – Statements on Management Accounting (Strategic Cost Management) published by Institute of Management Accountants 14