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Traditional Costing Method vs Target Costing Method
Traditional Costing Method
Under traditional method of costing the manufacturers use the cost details in such a way that cost plus approach to estimate the product price. They may conduct market research to find the preferences of customers and determine products’ characteristics and demand. Then, the product design is to be finalized. Thereafter, manufacturing process is determined.
Costs are recorded at every stage of manufacturing process. Finally, the cost components are summed up to determine the selling price. If the management thinks that selling price and total cost are too high, the product design and manufacturing processes are changed till an acceptable total cost is reached, after which, production will begin.
Target Costing Method
Under the target costing, allowable product cost i.e. target cost is derived by conducting market research and predict the target selling price which is willing to pay for the product with specific characteristics.
The management can determine the desired profit margin. Then, the desired profit margin is subtracted from the predicted target selling price to arrive target cost which is the maximum.
Now, the target cost is compared with expected cost. If the target cost is higher than the expected cost, the company has the several options to reduce target cost.
The first option is that the product design has to be changed. In this context, the company may constitute a planning team. The members of planning team are the suppliers, engineers, production manager and the marketing manager. They are expected to analyze the cost components and find the ways to reduce the cost. Whenever the target cost is reached, standards can be set and product will enter the manufacturing phase.
The second option is that the management can accept the less desired profit margin. In this case, the management can earn less profit in the short run and earn more profit in the long run.
The third option is that the management can given up the production of a specific product.
In nutshell, the use of target costing forces managers to change their way of thinking with regard to the relationship among cost, selling price and profitability.