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PM Chapter 2 Questions Target costing

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  1. Mark up is on Cost
    SP $600
    Cost X
    Mark – up (20% of X)

    Mathematically
    SP-Cost = Mark-up
    600-x = 20% * X
    {600-X}=20X/100
    {600-X} = X/5
    By cross multiplication
    5{600-X} = X
    3000-5X = X
    Collect like terms
    3000 = X+5X
    6X = 3000
    Divide both side by 6
    X = $500

    Target Cost is $500

    • It depends whether you are told the mark-up which is the profit as a % of the cost (unless the question specifically says different) or the margin (which is the profit as a % of selling price (unless again the question specifically says different).

      If you have forgotten the difference between the two then do look back at the Paper FA lecture on mark-ups and margins.

  3. In Question no 5:

    Selling price per unit = $600
    Expected sales volume = 5,000 units
    Mark-up percentage = 20% of cost
    Expected production cost per unit = $520

    Markup = Mark-up percentage * Cost
    = 20% * $520
    = $104

    Target cost = Selling price – Markup
    = $600 – $104
    = $496

    Target cost gap = Target cost – Expected production cost
    = $496 – $520
    = -$24
    So, the target cost gap is $24 per unit.

    Why $24 is not the target cost gap? Please clear my confusion.

    • Given that the selling price has been set at $600, if they are to achieve a mark-up of 20% of cost then they need the cost to be 100/120 x $600 = $500.
      If they can get the cost down to $500 then they will get a mark-up of $100 which is 20% of cost. So $500 is the target cost that they are aiming for.

      At the moment they expect the cost to be $520 (and at that cost they will not be making a mark-up of 20% given that the selling price is set at $600). So the need to find ways of reducing the cost by $20 does to $500, and this $20 is the cost gap.

      Please do watch my free lectures on target costing.

    • Hi Muhammad,
      you took the markup of the expected cost, $520. But in fact you have to calculate the markup of the target cost.
      Selling price = target cost + 20% markup
      600 = x + 0.2x
      600 = 1.2x
      600/1.2 = x
      500 = x
      $500 is your target cost. $520 is the expected cost. The cost gap is $20.

    • Use any figure you like – 100 is a good one to choose because it makes the numbers easier.

      For every $100 cost, the mark-up is $20 and therefore the selling price is $120.

      So for every $120 selling price, the cost is $100.

      So if the selling price is $600 then the cost is 100/120 x $600.

      (This part of the question is revision from Paper FA 馃檪 )

    • The selling price is to be $600 per unit. In order to achieve a mark-up of 20% of the cost, it means that the cost will have to be 100/120 x $600 = $500. So $500 is the target cost.
      The expected cost is $520, which is $20 more than the target of $500, and so the cost gap is the difference of $20 (and this is how much they need to reduce the production cost by as is explained in my free lectures on target costing).

    • The mark-up is 20% of cost. So for every $100 cost they add on $20 and the selling price is $120.

      Therefore the cost is $100 for every $120 of selling price. So for a selling price of $600 they need the cost to be 100/120 x $600.

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