TARGET COSTING

AND LIFE CYCLE COSTING

 ORIGIN

qT h e c o n c e p t o f T a r g e t C o s t i n g w a s i n v e n t e d i n
Japan by Toyota in 1960.
q
qIn Japan, target costing is widely practiced in more than 80% of
the companies in the assembly industries and more than 60%
of the companies in processing industries.
q
qA range of specialized tools, including functional analysis, value
engineering, value analysis and concurrent engineering were
introduced to support the target costing. This made Japanese
companies particularly effective in the area of product design
and development.
DEFINITION
Ø
Target costing can be defined as a
structured approach to determine the cost at
which a proposed product with specified
functionality and quality must be produced to
generate a desired level of profitability at its
anticipated selling price.
Ø
Ø
q
Target costing can also be defined as:

qTarget costing is a management technique aimed at

reducing a product’s life cycle costs.
Ø
qTarget costing is a disciplined process that uses data and
information in a logical series of steps to determine and
achieve a target cost for the product. In addition, the
price and cost are for specified product functionality,
which is determined from understanding the needs of
the customer and the willingness of the customer to pay
for each function.
Ø
Ø
 Target costing is a formal process that attempts to
match a proposed product’s feature (benefits) with a viable
market price that achieves the company’s profitability
goals by:
qDetermining a price point (or range of prices) for an
approximate combination of features and benefits.


qSubtracting a desired profit from the market price to determine

the maximum bearable level of costs.


qIterating the product design eliminating or reducing unnecessary

attributes with costs that can’t be recovered in higher prices
until the cost target is apt.


qRevising the market price for the redesigned product in view of

changed market conditions.

 Make the Decision
Begin

Value 
engineering

Achi
Repea
Close eve
Yes t No No
enou targe
value
gh? t
engr.?
cost?
Yes Yes
No

Abort
project

Release 
design
for production
Traditional Method
Traditionally, manufacturers would make use of the cost
plus approach to estimate the product price. A starting point
for them would be to conduct market research to determine its
market segment’s preferences and hence its product’s
characteristics that will meet the customer’s needs. This will
be followed by the design of the product.

Next manufacturer’s process is determined. Vendors will then

be contacted to identify the total costs of the components
which are required by the design and engineering departments.
Finally, cost components are summed up and a selling price is
set based on the costs and profit.
Target Costing
 Target costing derives an allowable product cost by first carrying
out market research to predict what the market segment is
willing to pay for the desired product with specific
characteristics.
 Subtracting the desired profitmargin set by the management
from the predicted selling price, maximum target cost is arrived
at. This target cost is then compared to an expected product cost
and if it is higher than the expected product cost, the company
has several options like:


qFirst, to lower costs, the product design and or the engineering

process can be changed.
qSecondly, the management might consider accepting a less than
desired profit margin.
qThird, alternative would be to abandon that particular product.

Basic Approach
Customer requirements


Future cost structures

q
Product design

Continuous improvement

 TARGET-COSTING PRINCIPLES
1. Price-led costing: Market prices are used to determine allowable--or target--costs. Target
costs are calculated: market price - required profit margin = target cost.

2. Focus on customers: Customer requirements for quality, cost, and time are simultaneously
incorporated in product and process decisions and guide cost analysis. The value of any
feature and functionality built into the product must be greater than the cost of providing
those features and functionality.

3. Focus on design: Cost control is emphasized at the product and process design stage.
Therefore, engineering changes must occur before production begins, resulting in lower
costs and reduced "time-to-market" for new products.

4. Cross-functional involvement: Cross-functional product and process

teams are responsible for the entire product from initial concept through final production.

5. Value-chain involvement: All members of the value chain--e.g., suppliers, distributors,

service providers, and customers--are included in the target costing process.

6. A life-cycle orientation: Total life-cycle costs are minimized for both the producer and the
customer. Life-cycle costs include purchase price, operating costs, maintenance, and
distribution costs.
 Establishing the Target Cost
Gradual decline as 
volume increases

Competitors enter market, 
straining supply of resources

Unexpected events affect 
cost of resources
Unit 
Cost

Product Life  13
Stage
Objectives of Target Costing
 Its main objective is to check the cost early in the
design and development cycle, rather than during the
later stages of product development and production. Its
emphasis are:


 To lower the costs of new products so that the required

profit level can be ensured.

 The new products meet the levels of quality, delivery
timing and price required by the market.

 To motivate all company employees to achieve the target
profit during new product development by making
target costing a company wide profit management
activity.
Advantages of Target Costing

1. It reinforces top to bottom commitment process and product

innovation, and is aimed at identifying issues to be resolved, in
order to achieve some competitive advantages.


2. It helps to create a company’s competitive future with market-

driven management for designing and manufacturing products
that meet the price required for the market success.


3. It uses management control system to support and reinforce

manufacturing strategies; and to identify market opportunities
that can be converted into real saving to achieve the best value
rather than simply the lowest cost.

4. Assure that products are better matched to their customers’ needs.


5. Align the costs of features with customers’ willingness to pay for



them.


6. Reduce the development cycle of a product.



7. Reduce the costs of products significantly.



8. Increase the teamwork among all internal organizations associated



with conceiving, marketing, planning, developing, manufacturing,

selling, distributing and installing a product.


9. Engage customers and suppliers to design the right product and to



more effectively integrate the entire supply chain.


 Disadvantages of Target Costing
 Target Costing has a few problems that one should be aware of and
guard against. These problems are as follows:


q TIME CONSUMING LENGTHY PROCESS.

q
qDISCONTENT AMONG EMPLOYEES OF OVERBURDENED
DEPARTMENTS.
q
qDIFFICULT TO REACH CONSENSUS.


qPOSSIBLE MISUSE OF TECHNIQUE.

q


q
 Impact of Target Costing on
Profitability
 Target costing can have a large positive impact on profitability,
depending on the commitment of management to its use, the
constant involvement of cost accountant in all phases of a
product’s life cycle, and the type of strategy a company follows.
 Target costing improves profitability in two ways :
q
qIt places such a detailed continuing emphasis on product
costs throughout the life cycle.
q
qIt improves profitability through precise targeting of the correct
prices at which the company feels it can place a profitable
product in the market place that will sell in a robust manner.
q
q
Kaizen Costing
 It was developed in quality assurance
technology.
 The time preceding kaizen costing is called
Target costing.
 Collectively, these two concepts make up LCC.

 It is also maintenance of the present cost

levels for products currently being
manufactured via systematic efforts to
achieve the desired cost level.
Kassal Manufacturing
Pvt Ltd
Plot No: 156/10
Phase 2 Industrial
Area, Chandigarh
Kassal Manufacturing Pvt Ltd is a
diverse company, which is involved in
various businesses. One of its
competencies is in the production of
nuts and bolts which include Castle,
Slotted and Nylock with different
dimensions.
Product Characteristics:
Target Selling Price = Rs 599/kg
Desired Profit = Rs 100/kg
Hence, target cost should be Rs 499/kg

Characteristic
Price (Rs/kg.) Ours
600 Target
599

Material Cost Rs. 125*80=10000

Labour Cost Rs.1420*7=9940

Burden Cost Rs.4320

Electricity and Misc. Cost Rs. 5680

Total product cost Rs. 29940

Material cost is Rs 125/kg and a batch of 60kgs takes approximately 7 days and 80kgs of raw material to
manufacture.

Labour Cost:

Unskilled Labour:
Rate = Rs 180/day
Number of hours used = 8 hours
Number of workers = 3
Total unskilled labour charges = Rs 540

Skilled Labour:
Rate= 220/day
Number of hours used = 8 hours
Number of workers = 4
Total skilled labour charges = Rs 880
Total labour charges =Rs 1420
For a batch of 60 kgs the labour works for 7 days.

Burden Cost:
It includes Quality control, tool room, machine maintenance, material control, production supervision and freight
charges.

Electricity and Misc. Cost: It includes cost of electricity for the production and other expenses.
Electricity Cost: Rs 4959
Per unit cost of electricity: Rs 4.5
Number of units consumed: 1102 units
Misc Cost: Rs 721
Life Cycle Costing
 Life cycle costing is a system that
tracks and accumulates the actual costs
and revenues attributable to cost object
from its invention to its abandonment.
Life cycle costing involves tracing cost
and revenues on a product by product
basis over several calendar periods.
The Life Cycle Cost (LCC)

The Life Cycle Cost (LCC) of an
asset is defined as:
 “The total cost throughout its life
including the planning, design,
acquisition and support costs and any
other costs directly attributable to
owning or using the asset”.

In essence, Life Cycle Costing is a means of estimating all the
costs involved in procuring, operating, maintaining and
ultimately disposing a product throughout its life.
It is also known as managing costs “from the cradle to the
grave”.
Stages of Total-Life-Cycle Costing
qResearch Development and Engineering Cycle
qManufacturing Cycle
qPost-Sale Service and Disposal Cycle

Research Development and Engineering Cycle

The research development and engineering (RD&E) cycle has three
stages:

q Market research, where emerging customer needs are assessed and
ideas are generated for new products.

q
q Product design, in which scientists and engineers develop the
technical aspects of products.

q
q Product development, in which the company creates features critical
to customer satisfaction and design prototypes, production processes,
and any special tooling required.
 By some estimates, 80% to 85% of a product’s total life costs are
committed by decision made in the RD&E cycle of the product’s life.

 For Example: Decisions made in this cycle are critical, because an
Manufacturing Cycle


 After the RD&E cycle, the company begins the

manufacturing cycle in which costs are incurred in the
production of the product.


 Over the past decade, in an effort to reduce costs, companies

have used management accounting methods such as activity-
based cost management to identify and reduce non value-added
activities.



Post-Sale Service and Disposal
Cycle
 Disposal occurs at the end of a product’s life and lasts until the
customer retires the final unit of a product.


q Stages of the
Total Life Cycle

Costs Research development and Manufacturing Post-sale

engineering cycle service and
disposal

100%

80% Cost committed

60%

40%

20% Cost incurred

0%
Life Cycle Costing Process
 It is a three staged process. The first stage is life cost
planning which includes planning LCC, Selecting and
Developing LCC model, applying LCC Model and finally
recording and reviewing the LCC results. The second stage is the
life cost analysis preparation stage followed by third stage
implementing and monitoring life cycle cost analysis. The three
stages are:


LCC Life cost Implement and

Planning analysis monitor life cycle
preparation cost analysis

stage 1 2 3
Stage 1: LCC Planning

Life Cycle cost planning concerns the assessment
and comparison of option/alternatives during the
design/acquisition phase.


Recording & reviewing LCC Step 4

q Results
Step 3
q Implement LCC Model

Step 2
q Select LCC Model

q Development of Plan Step 1

q
qConsiders all cost components within the asset’s life.
q
qDoes not directly consider benefits or revenue streams
that are generally assumed to be equal amongst the
options being compared (benefits and revenues are
Stage 2: Life Cost Analysis
Preparation

 The operation of Life Cost Analysis involves

review and development of the LCC Model
as a “real-time” or actual cost control
mechanism. Estimates of capital costs will
be replaced by the actual prices paid.
Charges may also be required to the cost
breakdown structure and cost elements to
reflect the asset components to be
monitored and the level of detail required.

Stage 3: Implementing and
Monitoring

 Implementation of Life Cost Analysis involves

the continuous monitoring of the actual
performance of an asset during its operation
and maintenance to identify areas in which
cost savings may be made and to provide
feedback for future life cost planning
activities


 For example, it may be better to replace an

expensive building component with a more
efficient solution prior to the end of its useful
life than to continue with a poor initial
decision.
 Benefits of Product Life Cycle Costing
 
q It results in earlier action to generate revenue or lower costs than otherwise might be
considered. There are a number of factors that needs to be managed in order to
maximize returns in a product.
q
q
q
q
q
q
q
q
q
q
q Better decisions should follow a more accurate and realistic assessment of revenues
and costs with in a particular life cycle stage.
q
q It can promote long term rewarding in contrast to short term profitability rewarding.



 IDS INFOTECH Pvt Ltd
C-138, phase-8, Industrial area,
Mohali


qIDS infotech is an IT company dedicated for providing IT, ITes,

publishing, healthcare, software and engineering services. It
has its international offices located in Europe and USA.
q
qIn this data we have the information about the total cost incurred
during the life cycle of an air conditioner. This price was
observed by the company after taking into account of prices of
various AC manufacturing companies and best suited to their
environment.
q
qThe company does this as it plans to build a new office in IT
park where installation of few AC’s would be required. We
have compared window and split AC of different ratings.
According to the need the appropriate AC would be installed.
q
 Air Conditioner A B C D
Type window window Split Split
Capacity 1.5 ton 1.5 ton 1.5 ton 1.5 ton
Rating * ** * **
Purchase Price (Rs) 15,000 17,500 25,000 27,500
VAT @ 4% 600 700 1000 1100
Freight 200 200 200 200
Installation 300 300 1000 1000
Warranty 12 months 12 months 12 months 12 months
Running per day 10 hours 10 hours 10 hours 10 hours
Average Electricity Cost per unit for 7 4.5 4.5 4.5 4.5
years (commercial)(Rs)
Units Consumed per month (25 600 500 600 500
working days)
Units Consumed per year (7 months 4,200 3,500 4,200 3,500
working Apr-Oct)
Uptime (95%) 3,990 3,325 3,990 3,325
Cumulative units consumed @10% 35,702 29,752 35,702 29,752
increase/annum for 7 years
Electricity Expenses (Rs) 1,60,659 1,33,884 1,60,659 1,33,884
AMC (Rs) 1,200 1,200 2,000 2,000
Cumulative cost of AMC inclusive of 9,325 9,325 15,541 15,541
10% increase every year for six years
Depreciation @ 20%/year for 7 years 12,340 14,397 20,566 22,623
(Rs)
Salvage Value (Rs) 3,260 3,803 5,434 5,977
Total Value 1,82,824 1,58,106 1,97,966 1,73,248

In this case we will select B if there is provision for a window AC otherwise 
we’ll go for D.
ACCUTRONICS
(SCO 145-146,
Sector 8 C,
Chandigarh)
Accutronics are engaged in supply of a wide range of medical products.
Precision designed in sync with international quality standards.
Getting established in the year 1989, ACCUTRONICS was established to
undertake, various works with Private Institutions, Govt. and Semi Govt.
Departments i.e. to make presentations, to prepare and submit proposals, follow
up, liaison with all concerned and to provide support to the products sold, during
the warranty and the Post warranty period. The benchmark was the performance.

Product Range
Synonymous with reliability, quality and functionality, our complete range of
medical equipments caters to the demands of following:
•Respiratory Humidification Products
•Neurosurgery products
•Radiology
•Ultrasound Machines
•ENT Products
•IT Services
Current Present Expected Expected Expected Expected Target Delta with Expected
Product Cost Cost Wk1 Cost Wk5 Cost Wk9 Cost Cost Expected Cost
Wk13

I-Assay 2,035.98 2,035.98 2,035.98 2,035.98 1,800 1,600 200 1,800

CLA 1,559 1,900 1,650 1,650 1,650 1,650 0 1,650
CLA Adaptor NA 30 30 10.5 10.5 10 0.5 10.5
Control Board 53.2 120 120 120 116.5 100 16.5 116.5
Interface NA 150 150 150 110 120 10 110
Board
PCB Assembly NA 20 20 15 15 15 0 15
Material

Cable from NA 10 10 10 2 5 3 2
Cameras to IP
Cover 156.23 100 100 100 100 75 25 100
Misc. 86.54 50 50 50 50 50 0 50
Balance Weigh NA 25 25 25 25 25 0 25

Labour Costs 356.45 100 100 100 115 100 0 100

Subsystem
Total 4,257 4541 4291 4266.5 3994 3,750 229 3,979

All prices in USD
Thank You…

                  Any Queries??

Presented By:
                                                                     
Abhinav Madra
Ankush Singla
Aurnob Chakraverty
ZEN ENTERPRISES
Zen Enterprises
Industrial Area, Phase-II, Chandigarh
Zen Enterprises is located in Industrial Area, Phase-II, Chandigarh. It
started from manufacturing of Plugs from year 1996. These are made
of Bakelite by the process of heating under controlled pressure. These
are produced under the License from Bureau of Indian Standard (BIS).
These are supplied to Delhi, Hoshiarpur, Chandigarh, Panchkula for
usage in Electrical gadgets. Further addition to the manufacturing has
been added by the production of Leeds and Rotary Switch for Iron,
Fans, Toasters and other electrical appliances.
TARGET COST CALCULATION WORKSHEET MONTHLY:
Estimated cost per piece = Rs. 6/-

SIGN PRICE/COST ELEMENT ESTIMATE %FACTOR AMOUNT IN (Rs.)

Selling Price to Retailer 55776

- Distribution Cost/Mark-up 15 8366
- Shipping/Logistic Cost to Distribution Centre 0

= Manufacturer’s Selling Price 47410

- Profit Margin 10 4741
- Warranty Cost 0
- Corporate Allocation 5 2370.50
- Business Unit Selling, General & Administrative 10 4741

Non-Recurring Development Cost 1,00,000

Estimated Production Volume 11,620 Pcs.
- Allocated Non-Recurring Development Cost 50

= Business Unit Target Cost 35507.50

- Overhead 20 7101.6
= Direct Target Cost(Labour & Material) 28406