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.
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).
muhammadsubhan says
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.
John Moffat says
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.
lukwesa27 says
60% on first attempt need to do more work
OREBEL says
I do not understand how you arrived at 100 in question 5. Please, can you explain better?
John Moffat says
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 )
Rueh says
on question 2, how did we get 50 isn’t it that we are looking for target cost?
John Moffat says
Yes we are, and $50 is the target cost.
The required profit is 20% x $1,250,000 = $250,000. This is 250,000/1,000 = $250 per unit.
Given a selling price of 300, then in order for them to achieve a profit of 250, the cost has to be 300 – 250 = $50.
Rueh says
Oooooh i see, had made an error. Didn’t read well the question.
John Moffat says
I am pleased that you are now clear about it.
Cmpar says
Scored 100%
chukwudi says
I need clarity on question 5 I must be missing something could you explain it to me
John Moffat says
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).
Taiwogbolagade@yahoo.com says
100% on first attempt.
zunaibkhan says
i got 100% in 1st attempt. awesome
Lanray says
I still cant grasp question 5, why did we use ((100/120)*600)
John Moffat says
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.