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Hera Co is developing a new product using a target costing approach. Market research indicates that to achieve a sales volume of 200,000 units, the selling price should be $23.50.
Hera Co wishes to obtain an average profit margin of 20% on sales.
The following data has been estimated for the product:
Direct material $10.45 per unit
Hourly production volume 20 units
Direct labour cost $64 per hour
Variable overheads $82 per hour (absorbed on a direct labour hour basis)
Fixed costs to produce 200,000 units are estimated to be $680,000.
What reduction in the cost per unit is required to achieve the target cost per unit?
To achieve the target cost per unit, we need to calculate the target cost per unit first. The target cost per unit is calculated by subtracting the desired profit margin from the selling price. In this case, the selling price is $23.50 and the desired profit margin is 20%, so the target cost per unit is $18.80 ($23.50 x (1-20%)).
The current cost per unit is the sum of the direct material cost per unit, direct labor cost per unit, and variable overhead cost per unit.
So the current cost per unit is $10.45 + ($64/20) + ($82/20) = $14.85.Then calculate the reduction in the cost per unit required to achieve the target cost per unit. The reduction required is $18.80 – $14.85 = $3.95 per unit. Therefore, Hera Co needs to reduce the cost per unit by $3.95 to achieve the target cost per unit.
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