(a) Target costing steps
Deriving a target cost
Step 1: A product or service is developed which is perceived to be needed by customers and therefore will attract adequate sales volumes.
Step 2: A target price is then set based on the customers’ perceived value of the product. This will therefore be a market based price.
Step 3: The required target operating profit per unit is then calculated. This may be based on either return on sales or return on investment.
Step 4: The target cost is derived by subtracting the target profit from the target price.
Step 5: If there is a cost gap, attempts will be made to close the gap. Techniques such as value engineering may be performed, which looks at every aspect of the value chain business functions with an objective of reducing costs while satisfying customer needs.
Step 6: Negotiation with customers may take place before deciding whether to go ahead with the project.
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