Performance Management

Topic: Target costing

Compass Furniture Co. (Compass) manufactures and sells many types of furniture, both for office and home use. They are looking into a contemporary design for massaging mattress that is innovative and still able to meet customers' demands. It will have many useful massaging features and functions that can relief stress and body pain. This newly designed massaging mattress will be called the 'Magical Mattress' (MM).

They have carried out a market survey and using a target costing approach had targeted a competitive market price of $5,000 per unit of MM. The company's shareholders expect a 50% return on investment. Since, Compass Furniture Co. has many products in hand and so, they belief that the return expected by their shareholders can be met from the company's overall profit for the year. However, the profit margin expected from this new product, MM is only 40%.

Compass Furniture Co. wants to ensure that the actual cost of sales of each unit of MM meets the target cost calculated. If there is any discrepancy between the calculated estimated cost and target cost, then the management will take the necessary steps to close the cost gap at least before the maturity stage of the product's life cycle.

The massaging machine that will be embedded into the mattress will be bought from an external supplier for a price of $1,400.00 per unit. Compasses' skilled labor force will then do the upholstery of the mattress with good quality material and spring before dispatching to wholesalers. Two types of materials are used foam and cotton. Each completed units of MM requires 20 kg of foam and 10 meters of cotton material. The company's regular supplier has agreed to supply the foam and cotton materials at a price of $36 per kg and $25 per meter respectively. In the process of upholstery, the company expects 10% of foam to be wasted.

Other costs to be incurred in the manufacture of MM are as follows:

i. Spring material - 5 rolls per MM and each cost $50 per roll.

ii. Indirect material (skrew, thread, piping) - $100.00 per MM.

iii. Skilled labor - each MM will need three and a half hours and they are paid at a flat rate of $70.00 per hour.

iv. Semi-skilled labor - the manufacture of a unit of MM will need an hour of the semi-skilled labor time and their rate is $20.00 per hour.

v. Variable production overhead - will be incurred at a rate of $14.00 per total labor hour.

vi. Fixed production overhead - will be absorbed at a rate of $12 per skilled labor hour.

vii. The budgeted monthly selling, admin and distribution overhead costs are $100,000.

viii. The anticipated level of activity is 12,000 units of MM in a year and it is expected to be produced evenly throughout the year

Required:

a) Calculate the expected cost for each unit of MM based on the information given above. (10 marks)

b) Identify any cost gap that may exist. (5 marks)

c) Suggest FIVE ways to close the cost gap that may exist. (5 marks)

(Total: 20 Marks)