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Greetings sir.
I hope you are in good health.
I had two confusions, I do need your good assistance.
43) I chose option 1. The answer turned out to be the last. If we cant clear the target cost gap, it seems senseless to continue on – I thought. How come could this last one not be true then ? I’d like to request a proper explanation for both the falsehood of the first option and the validity of the last option.
46) I got the target cost right, $96, after that I trailed off in guess work and trial and error and reached the answer of choice 3 – 11,042 units, because I lost the logic of the correct process as the question seemed quite difficult and confusing. Please educate graciously.
43.
The last statement is the correct one because it is not true for 2 reasons. First, the whole objective of target costing is to look for ways of removing the cost gap. The statement does not say that the cost gap cannot be removed. Secondly, even if the cost gap cannot be removed, the product may still be profitable (just a lower profit than that wanted), and (as I do say in my free lectures) they may decide to reduce the profit desired rather than discontinue completely.
The first statement is not the correct choice because it is a true statement. It is easier to look for ways of reducing variables costs than it is to find ways of reducing fixed costs.
46
The budgeted total fixed costs are 10,000 x $60 = $600,000 and by definition the total will remain at $600,000 whatever the actual level of production.
Changing the production level will not change the variable cost per unit, and so the variable cost will stay at $46 per unit. So to achieve the target cost of $96 per unit, the fixed cost per unit will have to be $50 per unit.
For the $600,000 to be absorbed as $50 per unit, the production will have to be 600,000/50 = 12,000 units.
43) Thankyou sir. Fantastically cleared.
46) Again, well explained. I finally understood how we reached this answer. I forgot some of my basic fundamental knowledge.
However, I may still have not have understood the question itself, especially the “minimum production” part. That is why perhaps I still dont understand why my answer of option 3 was wrong.
Sir, I would like some further clarification from you, I chose option 3. I divided the actual total cost (46 + 96 = 106 x 10,000 units) $1,060,000, by the target cost per unit : $96, to arrive at the answer 11,042 units. What’s wrong with this method.
Could you please elaborate upon the flaw in the process ?
And could you please further help understand this question ? Why the minimum production should be more than the budgeted output of 10,000 units ? Shouldn’t minimum mean to be less than 10,000 units ?
The variable cost of $46 per unit will be the same whatever the level of production is. It is only the fixed cost per unit that will change with the level of production.
At the budgeted output of 10,000, they will not achieve the target profit. To achieve the target cost (and therefore the target profit) they either have to find ways of reducing costs or (in this case) have to increase the production.
Sorry for a late reply.
Thankyou sir for the help.
I have grasped it. It makes sense now.Either reduce the cost (total fixed cost or variable cost per unit) or increase production (ie reduce fixed cost per unit) in order to achieve that profit markup, and close the target gap.
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