General View of Target Costing in Accounting

General View of Target Costing in Accounting

Currently, the world economy undergoes transformation that is caused primarily by macroeconomic processes clearly intensified due to the economic crisis. Under these conditions, scholars and experts are focused on finding tools of ensuring relevancy of decision making in a system of accounting and analytical support of business structures in various sectors and spheres of economic activity. Calculation systems, such as target costing, became more common in the practice of accounting management of enterprises that can significantly improve the degree of efficiency of business process management of the economic entity through the system of strategic cost management. Target costing, like many other promising calculation systems, originated in Japan and became widespread there. Later on, it was also successfully put into practice in the operation of the U.S. companies. Target costing is recognized as a management framework that supports the strategy to reduce costs and realize the functions of planning production of new products, preventive cost control and calculation of target cost in accordance with market realities. All these facts make it possible to assume the importance of target costing as an accounting method, thereby defining the relevance of conducted research.

An examination of the literature on managerial accounting shows that companies usually optimize costs by reducing the cost on production and sale of finished products while financial professionals often do not take into account the value of the development costs of new products. Therefore, a task to develop a product the cost of which would be low enough to ensure that the required level of profit becomes paramount. All these can be achieved with implementation of the target costing system.

Target costing system is based on the postulate, according to which successful business needing to sell a product at a price not exceeding the market one must determine the cost of future production by setting the price for it. This idea is reinforced by realities of the market economy, where there is a sufficiently high competition between manufacturers and price reduction on a particular product, which does not allow winning this competition or makes it impossible due to the limited resource potential.

The development of a new product should occur with the involvement of all departments of the enterprise: design, finance, production, marketing and others. In this case, the main task is to determine the cost of products to get the planned profit with the price rigidly set by the market. Qualitative characteristics of developed products must comply with all requirements of the market. Through the application of target costing method, it is possible to identify consumer demand for products, and calculate the profit that the company will receive from the introduction of its goods as well as cash flows.

An important advantage of the target costing system is the possibility of assessing the costs until their actual payment, i.e. predetermine the price, for which the consumer can buy the product, the effective demand for it, as well as the likelihood of producing goods with specified consumer properties, based on such prices. The allowable size of the cost, according to the target costing method, is calculated as the difference between the market prices of the product and desired profit from its sales.

The process of setting the target price of the product involves the use of a three-level analysis: quality of the product – functional characteristics of the product – price of the product, where the price is set both by the market in general, and direct consumers. This price is based on the market research and is the expected market price of the product. Gross profit margin the company needs to develop and meet the needs of its owners is a target profit.

The concept of target costing differs from the idea of planned costing, which is also often used in business practices. The main difference lies in the fact that the planned costing calculation is based on the rules and regulations existing in a particular company. In this case, target cost is the cost being acceptable by the market conditions.

Principles of target costing system are as follows:

1. Primary and continuous focus on the demands of the market and customers;
2. The achievement of desired predetermined profit in the current market conditions through the calculation of target costs for new products and their components;
3. Consideration of the effect on the cost of production by customers’ requirements for quality and production time;
4. Using the concept of the product life cycle.

On one hand, correct definition of the target cost of the product or service is possible only through deep research of current market conditions and prospects, and on the other, bringing in an estimated cost to compliance with the target cost implies management talent of accounting professionals, whose purpose is the elimination of the difference between the estimated cost and target cost.

Quantitative calculation of the target cost reduction is implemented in four phases: definition of possible sales price per unit (element) for the considered product or service; identification of the target cost of products (per unit and in general); comparison of target and estimated cost of products in order to determine the desired (target) cost reduction; redesign of the product and simultaneous improvements of the manufacturing process in order to achieve the target cost reduction. As a result, the entire production process, from the stage of conception of a new product, acquires innovative character, without departing from the pre-established cost limits.

As part of the organizational life cycle, target costing system must have precise tools in order to implement the necessary actions by the leadership of the economic entity and its business units to develop the most profitable management decisions among selected groups of costs and justify their behavior in short and long-term. All the tools of target costing should be adapted to the stage of life cycle of the company. This need stems from the fact that at each stage of development of the economic subject, there is a need of costs regulation, as well as their evaluation. Application tools at each stage of the life cycle will reveal the costs and revenues from economic activities, the potential cost savings, as well as behavior of prices, depending on the marketing strategies for a given period. The most important aspect in this case becomes stabilization of the organization, i.e. prevention of losses at each stage of its life cycle. In this regard, at each stage of the life cycle of the organization it is required to ensure good governance for areas of profits and losses at the optimum time. The implementation of target costing tools helps to streamline the incorporation of specific transactions and calculation of production cost, to increase the profitability of costs, and to identify, at which stages the life cycle of the organization costs must be increased in order to raise income of the economic subject.

As a conclusion, it can be said that target costing is one of the most promising accounting methods, having the following advantages:

1. Iterative approach to developing a new product, which is provided by the gradual understanding of all the nuances regarding cost. In situations, where it is necessary to approach the target cost using innovative thinking, managers and employees often find new creative solutions;
2. Under the constant need to have a specific target cost, managers are shielded from temptation to use more expensive technology or material because it will inevitably lead to a new round of redesigning the product;
3. While using target costing system, coordination and control of the entire production of the company are carried out in accordance with an important strategic goal – the target cost;
4. The possibility of calculation system to be combined with budgeting, profit planning, formation of responsibility centers, different pricing strategies and evaluation procedures.
5. Support for a strategy to reduce costs at the design stage of product makes the concept of target costing strategic rather than purely operational tool;
6. The focus on both external and internal factors. Through a system of target costing, an opportunity for decision-making by the marketing department is given, based on the level of costs and parameters of the market sphere;
7. Target costing assists in motivating employees’ behavior orientation to the market, pointing to the cost that is acceptable in terms of the market that in turn must be recognized if the company has a desire to get profit in a competitive environment.

Thus, in contrast to the traditional ways of accounting, target costing system calculates the cost of the product based on pre-set selling price. It can be applied in almost all sectors of the economy, assuming price reduction to a level acceptable for the consumer. However, the use of this method is the most promising in calculation of the cost of new (innovative) products as well as in the service sector. The future of modern strategic management is impossible without the cost management system, implemented by using the target costing method.

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