Chapter 13 – Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing
CHAPTER 13:
Cost Planning for the Product Life Cycle: Target Costing, Theory of
Constraints, and Strategic Pricing
QUESTIONS
13-1 Target costing is a method by which the firm determines the desired cost for the
13-2 A firm has two options for reducing costs to a target cost level:
a. Reduce costs to a target cost level by integrating new manufacturing
technology, using advanced cost management techniques such as activity-based
b. Reduce cost to a target cost level by redesigning a popular product. This
method is the more common of the two, because it recognizes that design
13-3 The sales life cycle refers to the phase of the product’s sales in the market – from
introduction of the product to decline and withdrawal from the market. In
contrast, the cost life cycle refers to the activities and costs incurred in
developing a product, designing it, manufacturing it, selling it and servicing it. The
phases of the sales life cycle are:
Phase One: Product Introduction. In the first phase there is little competition, and
is increasing competition and prices begin to soften.
Phase Three: Maturity. Sales continue to increase but at a decreasing rate.
13-1
Chapter 13 – Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing
13-4 The strategic pricing approach changes over the sales life cycle of the product. In
the first phase, pricing is set relatively high to recover development costs and to
take advantage of product differentiation and the new demand for the product. In
the second phase, pricing is likely to stay relatively high as the firm attempts to
13-5 At the introduction and into the growth phases, the primary need is for value
chain analysis, to guide the design of products in a cost-efficient manner. Master
budgets (Chapter 10) are also used in these early phases to manage cash flows;
13-6 Value engineering is used in target costing to reduce product cost by analyzing
the tradeoffs between different types and levels of product functionality and total
product cost. There are two common forms of value engineering.
1) Design analysis is a process where the design team prepares several possible
performance on these features and different costs.
2) Functional analysis is a process where each major function or feature of the
product is examined in terms of its performance and cost. Group technology is a
method of identifying similarities in the parts of products a firm manufactures so
desirability to the customer and manufacturing cost, as a means for coming up
with the best design that satisfies customer needs at the desired target cost.
13-7 Target costing is most appropriate for firms that are in a very competitive industry,
so that the firms in the industry compete simultaneously on price, quality and
13-2
13-8 Life-cycle costing considers the entire cost life cycle of the product, and thus
provides a more complete perspective of product costs and product profitability.
13-9 There are five steps in TOC analysis:
Step One: Identify the Constraint
the constraint busy without a build-up of work-in-process inventory.
Possible ways to maximize flow through the constraint:
Step Four: Increase Capacity on the Constrained Resource
This becomes an investment decision: Invest in additional capacity if it will
intended to improve the speed of product flow through the constraint.
13-10 TOC emphasizes the improvement of throughput by removing or reducing the
constraints, which are bottlenecks in the production process that slow the rate of
13-3
Chapter 13 – Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing
13-11 The purpose of the flow diagram is to assist the management accountant in the
13-12 Activity-based costing (ABC) is used to assess the profitability of products, just
as is TOC. The difference is that TOC takes a short-term approach to profitability
analysis, while ABC develops a longer-term analysis. The TOC analysis has a
short-term focus because of its emphasis on materials related costs only, while
ABC includes all product costs. On the other hand, unlike TOC, ABC does not
explicitly include the resource constraints and capacities of production
13-13 TOC is appropriate for many types of manufacturing, service and not-for-profit
firms. It is most useful where the product or service is prepared or provided in a
process which are bottlenecks in the flow of product and profitability.
13-14 Product design is important in life cycle costing because the design of the
product locks in most of the downstream costs – manufacturing, distribution and
service. A well-designed product will be easy and inexpensive to manufacture,
13-15 Life-cycle costing is most appropriate for firms that have high upstream costs (i.e.
design and development) and/or high downstream costs (i.e. distribution and
service costs). Firms with high upstream and downstream costs need to manage
13-16 Strategic pricing is used to help a firm develop and implement its strategy for
success as its products and services mature in the market place. The focus for
13-4
Chapter 13 – Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing
and development, while cost control becomes more important as the product
13-17 Takt time is the ratio of available manufacturing time for a period to the units of
customer demand for that period. Each unit must be produced within the Takt
13-18 Pricing based on the cost life cycle is a common form of pricing. It involves a
markup on full product cost or product life cycle cost. In contrast, pricing based
product is currently in.
13-19 Prices are likely to be highest in the introduction phase because costs are
13-5
Chapter 13 – Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing
BRIEF EXERCISES
13-20 Current profit per unit = $50 – $ 38 – $8 = $4 per unit
13-25 2 days in production (May 19 to May 20) ÷ 20 day cycle time (May 1 to May 20)
= 2 ÷ 20 = .1
13-6
Chapter 13 – Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing
EXERCISES
13-28 Target Costing (15 min)
1. The unit cost is currently $548.60 = $13,715,000÷ 25,000
2. The target cost can probably be achieved by efforts in two areas:
a. The analysis of budgeted versus actual cost shows an
unfavorable materials variance of $500,000 ($7,000,000 –
$6,500,000) or $20 per unit, which is a very significant variance.
b. The standard cost shows an unfavorable direct labor
opportunity for cost savings.
c. The remaining manufacturing costs can be considered non-
value adding costs, since they do not add to the functionality or
quality of the product. Efforts can be made to reduce the total cost of
13-7
Chapter 13 – Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing
13-29. Target Costing; Spreadsheet Application (30 min)
1., 2.
13-8
Chapter 13 – Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing
13-29 (continued -1)
3. The solution uses Goal Seek or trials in the Excel sheet. The number of
parts must be reduced to 101 or fewer to get at least $50 margin.
Alternatively, the current activities using parts as a driver are materials
4. Target costing should be useful to BSI to assist the firm in meeting the
13-9
Chapter 13 – Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing
13-30 Target Costing in a Service Firm (20 min)
1.
Package Specifications COST Unit Cost Qty Cancun Qty Jamaica
Oceanfront room; number of nights 30 6 $180 4 $120
Meals:
Breakfasts 5 7 $35 5 $25
Lunches 7 7 $49 5 $35
Dinners 10 6 $60 0 $0
Scuba diving trips 15 4 $60 2 $30
Water skiing trips 10 5 $50 2 $20
Package Specification Margins Cancun Jamaica
Old Price $750 $690
Costs $624 $490
Margin $126 $200
Margin ÷ Price 16.8% 29.0%
2.
Package Specification Margins Cancun Jamaica
New price $710 $650