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1 Explain the statement that target costing is a cost management tool? 2 The Smiths Falls Times assembles sports watches. The watches consist of three main components, Quartz mechanism, the case and the strap. SFC sources components from outside and assembles the watches in its factory. Extensive customer survey have established that there are three main functions for the watches in the niche that SFT has chosen; time, water resistance and style. Time is provided by the quartz mechanism; water resistance and style are provided by the case ad the strap. Replaceable batteries power all the watches. However, once the case is opened to replace the waterproof nature of the watch is usually lost. Market surveys have established three price points for the three new watches that SFT now has in its design stage: (1) $30 for a basic watch (2) $50 for a basic chronograph and (3) $120 for a multifunctional watch. SFT ha determined, given its facility-sustaining costs and its cost of capital, that three watches must provide a margin of $4, $8 and $15 to be acceptable. Based on initial specification the supplier of quartz mechanisms has quoted price of $8, $15 and $40 for the three watches. Because these mechanisms use standard components and well-known technology, planners at SFT consider these costs to be as low as they can be. The implication is that any needed target cost reduction will not be wrung out of the quartz mechanism. There are many sources for the wrap straps, and the prices vary widely based functionality, which include appearance, composition and wear. Suppliers' quoted price ranges for the three watches are as follows: $2-$7, $6-$9 and $20-$30. For any given level of functionality chosen there is little price variation among suppliers because the watchstraps are commodity products produced cost effectively. The case provides two critical functions - style and water resistance. All cases have to be guaranteed to a depth of 50m minimums and customer focus group show that they find a guaranteed depth of 100 meters more desirable. Depending upon style and degree of water resistance the supplier quoted the following price ranges for the watchcases: $5 -$15, $10 - $25 and $20 - $35. Both style and water resistance increased in the product price. Conversations with factory personnel indicated that the estimated costs of assembling, packaging, and shipping each watch were about $5, $7 and $15. For an investment estimated at about $5,000,000 SFT could provide management advice to one of its suppliers. This advice would be related to developing better manufacturing methods. These improved methods would likely reduce the cost of each case supplied by about 25%. Required: a. Compute the cost ranges for the three watches b. Identify how you would choose the specific strap and case for each watch. c. How would you decide whether to make the investment to improve the efficiency of the case supplier? d. Factory personnel indicate that for an investment of about $10,000,000 the existing factory layout could be altered to accommodate more-efficient production. The result would be to reduce assembly, packaging and shipping costs by about $2 per unit. How would you decide whether to make this investment? 3. Why is it important to identify take-back costs? 4. What are the potential concerns in implementing a target costing system? 1. Explain the statement that target costing is a cost management tool? Target costing is also known as cost plus costing, it is a cost management tool for reducing the total cost of a product its development cycle. It is a market driven cost that is computed before a product is produced. The method is used by management to get a competitive selling price. It is executed by ascertaining the cost of production then adding the preferred profit margin and the resulting figure can be taken to be the selling price. A target cost is the maximum amount of cost that can be incurred on a product and with it the producer can still earn the required profit from the product at a particular selling price. The fundamental rule of target costing is never exceed the target cost. It is a pro-active approach to cost management as it orients the organization towards customers, minimizes non value added activities and encourages selection of lowest cost value added activities. 2. The Smiths Falls Times assembles sports watches. The watches consist of three main components, Quartz mechanism, the case and the strap. SFC sources components from outside and assembles the watches in its factory. Extensive customer survey have established that there are three main functions for the watches in the niche that SFT has chosen; time, water resistance and style. Time is provided by the quartz mechanism; water resistance and style are provided by the case and the strap. Replaceable batteries power all the watches. However, once the case is opened to replace the waterproof nature of the watch is usually lost. Market surveys have established three price points for the three new watches that SFT now has in its design stage: (1) $30 for a basic watch (2) $50 for a basic chronograph and (3) $120 for a multifunctional watch. SFT ha determined, given its facility-sustaining costs and its cost of capital, that three watches must provide a margin of $4, $8 and $15 to be acceptable. Based on initial specification the supplier of quartz mechanisms has quoted price of $8, $15 and $40 for the three watches. Because these mechanisms use standard components and well-known technology, planners at SFT consider these costs to be as low as they can be. The implication is that any needed target cost reduction will not be wrung out of the quartz mechanism. There are many sources for the wrap straps, and the prices vary widely based functionality, which include appearance, composition and wear. Suppliers' quoted price ranges for the three watches are as follows: $2-$7, $6-$9 and $20-$30. For any given level of functionality chosen there is little price variation among suppliers because the watchstraps are commodity products produced cost effectively. The case provides two critical functions - style and water resistance. All cases have to be guaranteed to a depth of 50m minimums and customer focus group show that they find a guaranteed depth of 100 meters more desirable. Depending upon style and degree of water resistance the supplier quoted the following price ranges for the Watchcases: $5 -$15, $10 - $25 and $20 - $35. Both style and water resistance increased in the product price. Conversations with factory personnel indicated that the estimated costs of assembling, packaging, and shipping each watch were about $5, $7 and $15. For an investment estimated at about $5,000,000 SFT could provide management advice to one of its suppliers. This advice would be related to developing better manufacturing methods. These improved methods would likely reduce the cost of each case supplied by about 25%. Required: a. Compute the cost ranges for the three watches Total costs per watch in the low range. Wrap Straps Case Assembling, Packaging and Shipping costs $2 $5 $5 = 1. Quartz $8 Total $20 2. $15 $6 $7 $10 = $38 3. $40 $20 $15 $20 = $95 Total costs per watch in the high range. Wrap Straps Case Assembling, Packaging and Shipping costs $7 $5 $15 = Total $35 1. Quartz $8 2. $15 $9 $7 $25 = $56 3. $40 $30 $15 $35 = $120 Cost ranges are as follows: Watch type Cost range 1. $20- $35 2. $38- $56 3. $95- $120 b. Identify how you would choose the specific strap and case for each watch. To identify how to choose the specific strap and case, we will use the limiting factor analysis. In management accounting the limiting factor is the constraints in availability of production resource that may prevent maximum production or sales. In this case the limiting factor is the production cost which will determine the quality of the watch produced. According to the information given the management of Smith Falls company has a target cost per watch, which must not be exceeded when producing. To ascertain this cost, we will subtract the desired margin from the selling point prices. This will be as follows: Watch Type 1 Selling price $30 - Margin $4 Target cost = $26 2 $50 - $8 = $42 3 $120 - $15 = $105 Using the target cost we will allocate the costs to the main components to the order of importance and depending on the cost range flexibility. This means that the Quartz component will get its share in full since it is currently being supplied at the lowest price possible, the assembling, packaging, and shipping costs are fixed, meaning they must be given the priority when allocation is being done, to make sure the customer focus group report is taken care of, we allocate the cases more money to guarantee the depth of the case to the maximum possible, this means wrap straps will take the lowest price in there range. This will help to specify the strap and case. This table shows the allocation of cost hence determines the specific component to use. Watch Type Quartz cost A, P&S cost Case cost Wrap costs Target cost 1 $8 $5 $11 $2 =$26 2 $15 $7 $14 $6 =$42 3 $40 $15 $30 $20 =$105 c. How would you decide whether to make the investment to improve the efficiency of the case supplier? This decision can be made by use of cost benefit analysis, this is basically analysis of the cost verses benefit of taking a certain decision. The cost of making this kind of decision will be the investment of $5,000,000 versus the anticipated benefit in the cost of case, a reduction by 25% of the current cost. If the payback period is allowed, then the investment can be made. d. Factory personnel indicate that for an investment of about $10,000,000 the existing factory layout could be altered to accommodate more-efficient production. The result would be to reduce assembly, packaging and shipping costs by about $2 per unit. How would you decide whether to make this investment? This decision can also be made by use of cost benefit analysis. The cost of making this kind of decision will be the investment of $10,000,000 versus the anticipated benefit in the reduction of cost of assembly, packaging and shipping, a reduction by $2 of the current cost. The decision will be based on how much saving is made using the total number of units produced and the payback period of the investment. 3. Why is it important to identify take-back costs? Extended Producer Responsibility (EPR) initiatives may require a manufacturer to be responsible in the future for taking back the products it produces today. Several issues arises when a firm is required to take back whatever it produces today in future. These issues makes it important for a firm to identify the take back costs that it may incur. These costs may impact firms' decisions regarding product durability, it may force a business to include the cost of product take-back in the price of their goods. The take-back principle inspires businesses to use less materials and other resources in the production process, which reduces energy usage, environmental damage and other costs. From a social view, as products are remanufactured, recycled or reused, they become more eco-friendly. Guidelines are being introduced that create corporate responsibility for the final disposal of product waste. Accountants and managers need to quantity and report this information for better decisions. 4. What are the potential concerns in implementing a target costing system? Target costing system as a cost management tool, has several advantages and disadvantages that forms the potential concerns in implementing it. The concerns includes: a. Its effective implementation and use requires the development of detailed cost data. b. Its implementation requires willingness to co-operate c. It requires many meetings for coordination. d. It may reduce the quality of products due to the use of cheap components which may be of inferior quality as evident in the case of Smith Falls Times Company in the choice of wrap straps