Question Two

Taonga$$s research and development staff have recently completed design work on a new product

$($the HOOK$),$ and a target costing exercise is now being carried out by a cross$-$functional team of

management and staff. The researched market price would be K$88$ and the expected return $30\%$

margin.

$$Component A$$ for the HOOK would be bought from an outside supplier for K$1\mathrm{.}44$ per unit and

$25\%$ of all units of this component purchased would be wasted. Each HOOK would require $7\mathrm{.}5$

units of Component A $($before taking account of the wasted units$).$ Each HOOK would also require

one unit of $$Component B$,$ which would be produced in$-$house by Taonga. The production costs

for Component B would be K$6$ per unit $($variable$)$ plus a set$-$up cost of K$36,000$ per $8,000$ units

of the component. Labour input per HOOK would be $1\mathrm{.}5$ direct labour hours at an hourly wage

rate of K$9.$ All production overhead costs are charged to products on a direct labour hour basis.

Fixed and variable overheads are charged at separate hourly rates. The fixed overhead rate is

determined on the basis of the normal monthly average activity level, which is $12,500$ direct labour

hours. The following data is available for the two months of last year which represented the highest

and lowest levels of activity in that year:

July October

Direct labour hours $10,00018,000$

Production overheads K$252,500$ K$404,500$

Required

Prepare a memo for the Chief Executive Officer in which you:

a$.$ Identify the target cost gap in relation to the HOOK, on the basis of the target costing

system in use at Taonga.

b$.$ Make recommendations as to how the target costing system should be modified.

c$.$ Point out why target costing may be preferred method of determining the cost of a product

or service compared to the traditional way of determining the cost of a product.

$20$ Marks