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Hi sir i would like to ask regarding Target costing
S Company is a manufacturer of multiple products and uses target costing. It has been noted that Product P currently has a target cost gap and the company wishes to close the gap
Which of the following may be used to close the target cost gap of product P?
A. Use overtime to complete work ahead of the planned schedule
B. Substitute current materials with cheaper alternatives of the same quality
C. Increase the selling price of Product P
D. Negotiate a cheaper rent agreement for S Company’s premisesAnswer: B
Reducing the target cost gap should focus on ways to reduce the direct or variable cost of the product. Reducing fixed overhead cost is not a way to reduce the gap.My question is why fixed overheads is not a way to reduce the gap? Wouldn’t by reducing the fixed costs it will still result in lesser cost on a per unit?
Thank you sir
Fixed overheads are not affected by the levels of production and apply to the business as a whole. S makes multiple products and they can share the fixed overheads between products any way they want, but the total is not affected.
Thank you so much for the explanation
But however I am a bit confused, because i thought if we negotiate a cheaper rent wouldn’t the total fixed overheads for the rent reduce? Thus leading to lower cost per unit for the fixed overheads?But negotiating a cheaper rent is something any company will want to do anyway. Whatever rent they end up paying, how they decide to allocate it between all the different products is entirely up to them. There is no ‘accurate’ way of deciding how allocate it between each product.
That is why (when they produce more than one product) it is the variable costs of production that we are concerned with.
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