Target costing

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Target costing is a pricing method used by firms. It is defined as "a cost management tool for reducing the overall cost of a product over its entire life-cycle with the help of production, engineering, research and design". A target cost is the maximum amount of cost that can be incurred on a product and with it the firm can still earn the required profit margin from that product at a particular selling price.

In the traditional cost-plus pricing method materials, labor and overhead costs are measured and a desired profit is added to determine the selling price.

[edit] What is target costing?

Target costing involves setting a target cost by subtracting a desired profit margin from a competitive market price.

To compete effectively, organizations must continually redesign their products ( or services) in order to shorten product life cycles. The planning, development and design stage of a product is therefore critical to an organization's cost management process. Considering possible cost reduction at this stage of a product's life cycle (rather than during the production process) is now one of the most important issues facing management accountants in industry.

Here are some examples of decisions made at the design stage which impact on the cost of a product. 1. The number of different components 2. Whether the components are standard or not 3. The ease of changing over tools

Japanese companies have developed target costing as a response to the problem of controlling and reducing costs over the product life cycle.