Strategic Management Accounting · Module 6: Tools for creating and managing value
25% of What?
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Chapters
- 0:00Question
- 0:27Breakdown
- 1:16Rule
In short
Target costing starts from the price the market will pay and subtracts the required profit. If the profit must be 25% of cost, the target cost is the price divided by 1.25: a $250 price gives a $200 target cost, so a product costing $212 needs $12 taken out of each unit.
- Markup on cost: divide the price by 1 + markup.
- Margin on price: multiply the price by 1 − margin.
- Cost gap = current cost − target cost.
Transcript
0:00Question
Three wrong answers here, and each one misreads the same 25%. Tallowwood Audio wants to sell a new speaker for $250. It needs a profit of 25% of cost, and the engineers say it costs $212 today. How much cost has to come out of each unit? Pick one.
0:27Breakdown
Target costing works backwards, from the price customers will pay. Profit is 25% of cost, so the price is cost times 1.25. That makes the target cost $250 divided by 1.25: $200. Today it costs $212. So take out $12 a unit. B reads 25% as a share of the price. That's a margin, not a markup. Cross out B. C is today's profit: $250 minus $212. Cross out C. D is 25% of the price. That's a profit, not a cost gap. Cross out D. A, $12 a unit.
1:16Rule
Profit on cost? Divide the price by 1.25. Profit on price? Multiply it by 0.75. Want more traps like this? Follow for the next one.
Try a question on this lesson
From the EstatePass Strategic Management Accounting bank. Answer it, then read the explanation.
Tallowwood Audio Pty Ltd plans a wireless speaker. Market research sets the target selling price at $250. The company requires a profit equal to 25% of cost on every product. The engineering estimate of the speaker's current cost is $212 per unit. What cost reduction per unit is needed to reach the target cost?
Sources
- Cooper and Slagmulder (1997), Target Costing and Value Engineering
- CPA question bank: cpa-sma-0631
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