Requirement (c) Target costing is used where a company is forced to accept the market price for its products. The company then deducts from the market price its target return and seeks to produce the item for the difference, i. e. the target cost. If the company cannot produce the item for its target cost over the lifetime of the product, the company should not produce the item. In the scenario, SDF is forced to accept the market price of $85 for its proposed new product. SDF has set a target return of a 15% unit contribution; therefore its target cost is $70 per unit ($85 - $15). The direct material cost and variable overhead cost per unit are expected to be $52 per unit; therefore in order to meet the target the direct labour cost per unit cannot exceed $18 per unit. Initially the direct labour cost per unit is expected to be $240, but this will reduce due to the existence of a learning curve until it stabilises at $16.80 per unit once 200 units have been produced. It can thus be seen that once the steady state has been achieved SDF will meet its target unit cost. However, as the above calculations show, the lifetime target is not achieved within the expected life cycle of 500 units and therefore SDF should not proceed with the product.
Requirement (d) If SDF is to proceed with the product it needs to reduce its costs so that it meets the target contribution of $7,500. Currently its expected contribution is $1,366 below this target. However, this difference represents less than 5% of its expected costs. (i) Value Analysis is a systematic interdisciplinary examination of the factors which affect the cost of a product or service in order to determine the means of achieving the specified purpose in the most economical manner while meeting the required level of quality and reliability. Value Analysis may therefore be viewed as a cost reduction and problem solving technique that analyses an existing product or service in order to identify and reduce, or eliminate, any costs which do not contribute to value or performance. SDF may be able to use Value Analysis to identify cost savings that do not affect the customer, for example, changing to a batch system of production, changing the purchasing pattern of materials to reduce inventory holding costs or ordering costs, particularly since only a small cost saving is required to achieve the target return. (ii) Functional Cost Analysis is a method that can be applied to examine the component costs of a product or service in relation to the value as perceived by the customer. Functional Cost Analysis can be applied to new products and breaks the product or service down into its component parts. The outcome of the analysis is to improve the value of the product whilst maintaining costs and or reduce the costs of the product or service without reducing value. Functional Cost Analysis focuses on the value to the customer of each function of the product or service and consequently allocates resources to those functions from which the customer gains the most value. Since SDF is competing in a market with common products, it is less likely to be able to use Functional Cost Analysis because SDF’s product needs to have the same functions as those of its competitors. (iii) Kaizen Costing is a system of cost reduction based upon the concept of continuous review of systems and procedures to identify and implement small incremental cost savings. It is used in the production phase of a product and employees are both encouraged and empowered to recommend changes that they believe will reduce costs without affecting the quality of our products or otherwise adversely affecting the customer’s perception of our products. SDF may be able to use Kaizen Costing to make small improvements gradually throughout the life cycle of the product. As stated above an overall cost reduction of 4% would mean that SDF would achieve its target return.
Examiner's Answers CPGA
2
November 2011