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Standard and Target Costing

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Standard and Target Costing

 

Introduction

With the ramified economic changes, every organization have been using different costing methods and system to record the costing in the process system of the organization. The target costing and standard costing both are used by organization for the bifurcation and recording of the costing in the different process and system model.

Relevance and challenges of Standard and Target Costing

1.    Features of standard costing as a planning and control system

Standard costing is an alternative cost accounting method for the historical costs based traditional cost accounting method. Standard costing is cost accounting method in which expected costs of the goods or services are pre-determined and estimated for each of the expense under normal conditions, even before the starting of the production or rendering of such goods or service starts; and subsequently records the variances from the actual costs.

Features of the standard costing as a planning and control system:

Assigning cost and profit responsibilities to each practical level of supervision – Standard costing segregates the costs for lowest practical level of the supervision and identify and assign the profit responsibilities to such every supervision level. This segregation and profit responsibilities helps the organization to plan and control the cost and profit from the particular supervision level and further improves the control system of in the production line.

Comparing and measuring the actual results and engineered standards – Standard costing assigns the responsibilities among the departments and cost centers, after the commencement of the production, the cost accounting method monitors and records the actual data and calculates the variances by comparing the engineered standard and the actual costing; which provides the organization a complete details of scope of cost centers and departments or supervision levels where the deviation is concerning.

Providing up to the per minute contribution data for decision making – The cost accounting method provides the data of contribution up to the level of per minute to the management which takes the form of tool for analysis and planning for improving the cost structure while monitoring the results and effects of the decisions taken during the period.

Providing the realistic planning and vigorous control for each level of the management – As the standard costing provides the pre-determined cost data as per engineered standards as well the actual costs and profits of the products and services, further analyses the variances for each of the supervision level like material, labor, and overheads and segregates the variances on the basis of efficiency, idle time, purchase prices, labor rate, and usage of the material; it provides the realistic planning and vigorous control structure for all level of the management. This helps in the finding the reason for the variances and provides the control over each of the expense exceeding from the pre-determined costing for normal conditions.

Enabling the management for taking the remedial steps for unfavorable variances – standard costing, by analysis and reporting the variances for the each element of the operation - material, labor, and overhead and further identifying the cause for each of the unfavorable variance like price variance or efficiency variance, it helps the management to take the remedial steps for such unfavorable variances. Form this, the organization producing the similar output on the repetitive basis, benefits by taking such remedial steps and by communicating such steps to the employees.

Features and process of standard costing can be understood with the help of below inserted graph –

Image result for standard costing

Source: https://businessjargons.com/standard-costing.html

2.    Relevance of standard costing as a planning and control system in X Wire and Cable Company

The standard costing can prove to be most relevant and efficient cost accounting method for organization providing similar output. Standard costing is relevant for the organizations due to the importance of the method in following areas –

Increase in the efficiency – the organization involved in the manufacturing activities having the various elements of cost of the final output and involving a complex production process, can improve the efficiency by adopting the standard costing which would provide a engineered standards for such cost elements and proper communication in the employee hierarchy would increase the efficiency of the cost accounting, labor, and monitoring of the production process. X Wire and Cable Company is manufacturing company, so the standard costing would help the company with an increased efficiency.

Budgeting and decision making – standard costing is important while the budgeting as the standard costing uses the engineered standards for each cost element which later supports in making an appropriate budget. As the standard costing provides the comprehensive data about the whole production system and cost elements, it helps management in decision making and taking the decision by analyzing the whole details summarized in the most efficient manner.

Cutting the clerical costs – Standard costs communicates the standard cost and standard production for the normal conditions to the employees and labors which reduces the clerical costs of managing the whole cost elements separately in a manufacturing company like X Wire and Cable Company. This reduction in clerical costs helps the organization to come out form the profit squeeze.

Identifying the price-cost relationship – Standard costing helps the organization in decision making as this method of costing accounting helps the organization to understand the price cost relationship by segregating the cost elements with the most practical supervision level. X Wire and Cable Company benefited by the standard costing as the company was earlier struggling in understanding the actual profitability with respect to the sales as said by the sales manager of the company.

Integration of planning and control element – standard costing is relevant for the X Wire and Cable Company and the relevant for the likewise company as this helps the company in making profit plans and monitoring the same by integrating the same. The X Company was unable to accurately assess the profitability of the investment of the $40,000 in Teflon tape line due to inefficient cost accounting method, standard costing can handle these situations in an efficient manner and help in making profit plans (Ahn, Clermont, & Schwetschke, 2018).

As reported in the article and discussed above, it can be concluded that the standard costing had satisfied the features for X wire and cable company by satisfying the management in various areas like, pricing decision, better cost control, and profit planning. It can be said after observing the inefficiency of earlier cost accounting system as the sales and production managers were unable to assess the profitability of the Teflon tape line, understand the product costs, and find the relationship between the sales and the profitability as reported in the article. After implementing the direct standard costing, the management was able to make pricing decision after taking the helps of some aids which were based on the direct standard costing only; further management found that they need to double the utilization of the Teflon tape line to generate a fair rate of return on investment (Almeida, & Cunha, 2017). Furthermore standard costing helped the management in taking the profit decisions by defining sales responsibilities and providing a better forecasts and budget which also changed the defensive attitude of the management taken toward the usual budget.

3.    Target costing and standard costing

Meaning of target costing –Target costing is method of costing under which the company determines the life-cycle cost of the product after considering the desired level of profit margin, sales prices in the competitive market, and the specified features and quality of the product. It can be defined as a management technique also in which company plans for product life cycle in planning and designing levelof new product after considering the several factors like market price forced by competitiveness, features and qualities required for product, margins and return on sales. After considering these factors, company gets the target cost by subtracting the target cost form the expected market price, the cost which company can afford to achieve the targeted profit. Target costing involves market research, designing and product level costing, and component level costing (Altawati, et al. 2018).

Target Cost Concept IllustrationSource: https://corporatefinanceinstitute.com/resources/knowledge/accounting/target-costing/

Key features of target costing –

In target costing, selling price of the product is taken after taking into account the market conditions; the company accepts and plan as per this price rather than quoting its own price.

Desired return on sale is taken in account at the time of planning, and then the required reduction in the cost is calculated without compromising with the features and functionaries of the product.

Cost reduction target is being formed after considering all the product specifications, customer expectations, and design at the time of planning only.

To integrate all the production cycle activities like designing, manufacturing, and marketing; a team is formed (Aris Machmud, Ak, & Siti Rustiana Hamidah MSi, 2016,).

Advantages of target costing –

Company gains competitive advantage due to the management’s commitment and involvement in the product innovation and improvisation.

With the market driven approach of designing and manufacturing, company manufactures market driven products and helps the company to seize the market opportunities, and benefit by economies of scale.

Customer feels more valued it considers the customer expectations; and it successfully motivates the employees and enforces the cost management plans.

Process of target costing –

Target costing process can be divided in three major sections – market driven costing, product level target costing, and component level target costing. Market driven target costing consist of establishing company’s long term profit and sales goals, deciding the appropriate product mix, identifying the selling price after market research of the product, identifying the return on sale of each product, and calculate the maximum allowable cost (Becker, & Gaivoronski, 2018).

https://upload.wikimedia.org/wikipedia/commons/thumb/6/62/Target_costing_process_redraw.png/700px-Target_costing_process_redraw.png

Source: https://en.wikipedia.org/wiki/Target_costing

Product level target costing focuses on the product design after considering the results of the first step. Product level target costing considers the company’s in house designing capabilities and decides the cost reduction target. The product target costing can be summarized in chart as in the one inserted below (Bock,  & Pütz, 2017).

https://upload.wikimedia.org/wikipedia/commons/thumb/7/7f/Product-level_target_costing_redraw.png/440px-Product-level_target_costing_redraw.png

Source: https://en.wikipedia.org/wiki/Target_costing

Component level target costing decomposes the production cost to each of the component and function level. After identifying the cost reduction targets, this process finds way to achieve them with engineering methods like value engineering (VE)  (Brown, Stella, & Simons, 2019).

Target costing and standard costing –

Standard costing

Target costing

Standard cost is unit cost under normal condition predetermined with the engineered standard, applies to existing production and working conditions.

Target costing provides target for cost reduction after considering the desired profit, which may require changes in the existing working conditions (Clifton, et al. 2019).

Standard costing involves the forward calculation and usage the enterprise data for calculations (Cooper, 2017).

In target costing, calculations are based on external and market data and backward calculation is done to set the cost reduction targets and achieve the desired profit.

Standard costing is useful for existing and similar products and usually computed for existing products and services.

Target costing is used at the planning and designing phase of the product.

 

Standard costing are meant to determine the cost of commodity in future while target costing helps to help a company survive and succeed in the long-term market (Potkány, Novák, Kováč, & Hitka, 2017). The Standard cost approach is used to track costs wherever possible. While target cost is a method for minimizing existing-level costs as well as planning and organizing the different stages of a product life cycle. The difference between standard cost and estimation cost. Estimates cost are opinion expressions based on past experiences while standard costs are based on standard rates, which are produced very carefully and set as scientifically as possible Target costing show the dedications of management to operational changes and product innovation to achieve competitive advantages. On other hand, standard costing is provide useful information for decision making and strategic planning, measurement of inventory is simpler and reasonable and saving in record-keepings (Yun, et al. 2016).



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