Target Costing And Life Cycle Costing: Addressing Flaws In Conventional Costing Methods

Target Costing and Life Cycle Costing

Question 1

Part A

According to Garret (2015), there are flaws associated with conventional costing methods. Conventional costing considers the cost of production while factoring in the cost of resources that are already utilized. The costs include variable costs of material, labor and variable overheads as well as fixed production costs.  This approach is flawed since while the product price is based on the cost there is not guarantee that people will want to purchase at that particular price. This is because consumers may not associate value with certain features of the product and may prefer competitors’ products which come at a cheaper price. Target costing addresses this issue by associating costs with the identified target market and its desired product features.

Secondly, the conventional costing method only considers current costs whereas there might be other costs which are left out such as research and development costs. This means that the price only considers short term cost component. It is important that in the long term, the product provides a high level of profit that can cover the overall associated costs. Lifecycle costing addresses this issue by taking into consideration the costs associated in each stage of a product lifecycle (Garret, 2015).

Target costing is therefore implemented with a consideration of the selling price element of the product and working its way up to the cost element. The company has to find ways for not exceeding the cost with its selling price. Life cycle costing begins with an analysis of the product life cycle, establishing associated and linked costs and evaluating the cost element with the required price levels.

Target costing is linked to lifecycle costing in the sense that target costs can be managed when the costs associated with a particular life cycle are minimized.

Part B

1. b) According to the ISO 14040 (ISO 2006) the Life cycle costing considers the eco-friendly aspects and the probable environmental impact throughout the life of a product. It therefore considers the stages from the acquisition of raw materials, production, use, end of life treatment, recycling and final disposal (Meyhoff and Aumônier S, 2010).
2. c) The waste hierarchy reveals which forms of most treatment have the most positive value. Prevention, minimization and reuse are the most favored options, while recycling, energy recovery and disposal are the least favored options.

In the case of milk retailing light weighting provides significant environmental savings given the milk container was still viable for after use. In addition recycling proved to have considerable environmental savings.

1. d) The main recommendations indicate that the company should consider light weighting and recycling as a main means of obtaining environmental savings. However, energy recovery and disposal methods can be considered as waste management options (Meyhoff and Aumônier S, 2010).
2. e) First, while the study was to consider an assessment of the packaging systems available in the UK market, it was not possible to obtain data from all the parties to be considered on the market. For this reason, the results of the study cannot be said to reflect market average performance. In addition there were data gaps with regard to the distribution and retail stages of the life cycle. Therefore the study may not be useful as a basis for the assessment of efficient packaging formats for the retail market (Meyhoff and Aumônier S,2010).

Part C

Life Cycle of a T shirt

The first stage is raw material acquisition where cotton is planted and harvested from cotton farms. A company may therefore obtain the cotton from a country from which the prices are relatively low. The next stage is the processing state in which the cotton is converted into yarn or fabric. Also, this process is done in foreign countries that specialize in cotton processing. The cotton is cleaned, separated and turned into rope. The silver is then converted into yarn or fabric (Drury, 2013). In addition, some of the fiber is dyed in order to change the color and texture of the fabric. The next step in the cycle is manufacturing where the fabrics and yarn are cut into the appropriate sizes, printed on and further manipulated with the use of chemicals, dyes and paints (Jiang and Hansen, 2016). Also this step is mostly done in foreign countries where it is far much cheaper. The work in progress can be transported to the home country for further finishing details alternatively the t-shirt can be finished in the foreign country before it is shipped to the home country. Next, the t shirts are packaged and transported to various retailing points in which they are purchased by consumers (Saunders and Cornett, 2014).  The t-shirt is exposed to environmental factors when in the ownership of an individual trough washing, drying and application of body lotions and deodorants. In addition, the t shirt is exposed to wear and tear from movement and friction depending on the activities engaged by the individual (Simon & Xie, 2001).

The Life Cycle of a T-shirt

Once an individual feels that they have worn the t shirt enough times, they have to make the decision of throwing it away, giving it to charity or passing it down, or recycling it (Guinée, 2002). Trashing the t shirt would lead to high levels of waste, giving it to charity elongates the life of the t shirt while recycling it aims to give the t-shirt economic value even after it had already been used (Horngreen, 2009).

Life cycle of a t-shirt (Source;

QUESTION 2			Sales Budget for July
	Fish Tanks	Tank Fillers	Fish Food	Live Stock
Sales Units	320	380	600	800
Price per Unit	$        150.00	$          40.00	$          30.00	$          20.00
Total Sales	$  48,000.00	$  15,200.00	$  18,000.00	$  16,000.00

Purchases Budget for July
	Fish Tanks	Tank Fillers	Fish Food	Live Stock
Budgeted Sales Units	320	380	600	800
Desired Ending Inventory	99	117	180	246
Beginning Inventory	-90	-115	-180	-250
Finished goods to be purchased (Budgeted sales units + desired ending inventory – beginning inventory)	509	612	960	1296
Inventory Loss				12.5
Total Budgeted Purchases	509	612	960	1308.5

Budgeted Income Statement for July
	$	$
Budgeted Sales		$  97,200.00
Less: Cost of Sales
Purchases		$  77,900.00
Gross Profit		$  19,300.00
Less: Operating Expenses
Wages – sales staff	$    6,000.00
Advertising	$    1,200.00
Supplies used	$        150.00
Rent for month	$    2,000.00
Telephone & electricity	$        300.00
Depreciation of fixtures	$        200.00
Total Operating Expenses		$    9,850.00
Operating Income		$    9,450.00

Cash Budget for July
Beginning Cash Balance	$  (6,000.00)
Add: Budgeted Cash Receipts:	$  87,480.00
Add Accounts Receivables	$    9,100.00
Total Cash Available for Use	$  90,580.00
Less: Cash Disbursements
Accounts Payables	$  40,945.00
Operating Expenses	$    9,700.00
Total Disbursements	$  50,645.00
Cash Surplus/(Deficit)	$  39,935.00
Budgeted Ending Cash Balance	$  39,935.00

Question 3

1. a) Budgeted Contribution per Unit

Contribution = Budgeted Sales per Unit – Budgeted Variable costs per Unit

 = $80, 000 – $56, 000

Budgeted Contribution Margin per 10, 000 units = $24,000

Budgeted Contribution Margin per Unit = $24

1. b) Flexible Budget

	8000 Units
Sales	64000
Variable costs
Direct Materials	27200
Direct labour	16800
Variable overheads	800
Total Variable Costs	44800
Contribution margin	19200
Fixed overheads	15000
Budgeted profit	4200

1. c) Flexed Budget

It is important to draw a comparison since it reveals how the output affects the final profit levels with the expected costs and level of activity. It therefore demonstrates the impact of output on budgeted profit (Drury, 2013).

		8000 Units	10000 Units	Variance
Sales		64000	80000	-16000	Adverse
Variable costs
Direct Materials		27200	34000	-6800	Favorable
Direct labour		16800	21000	-4200	Favorable
Variable overheads		800	1000	-200	Favorable
Total Variable Costs		44800	56000	-11200	Favorable
Contribution margin		19200	24000	-4800	Favorable
Fixed overheads		15000	15000	0	0
Budgeted profit		4200	9000	-4800	Adverse

1. d)  i. Sales volume variance

Budgeted contribution margin per unit × (Actual units sold – Static-budget units sold)

$24 * (8,000 – 10, 000)

= – $48, 000 (Adverse)

1. Materials price variance

Materials Price variance = (Actual price of material – Budgeted price of material) × Actual quantity of material

Direct Materials Static = 170 * 10, 000 = 1,700,000 g

Cost of Materials = 34000/1700000

= $ 0.02

Direct Materials Actual = 180 * 8000 = 1,440,000 g

Cost of Materials = 21600/1,440,000

= $ 0.015

 = ($0.02 – $0.015) * (8000*180g)

= $7200 (Favorable)

1. Materials efficiency/quantity variance

Materials Efficiency variance = (Actual quantity of material used – Budgeted quantity of material allowed for actual output) × Budgeted price of material) (Drury, 2013)

(1, 440, 000- 1,700, 000) * 0.02

=   $5200 (Favorable)

1. Direct labour price/rate variance

Labor Price variance = (Actual price of labor – Budgeted price of labor) × Actual quantity of labor used (Drury, 2013)

Quantity of Labor static = 6 *10000 = 60, 000 min

Price of labor static = 21000/ 60 000

= 0.35 per minute

Quantity of labor actual = 5.7 * 80000 = 45, 800 min

Price of labor actual = 16720/45 800

 = 0.365 per minute

= (0.365 – 0.35) * 45800

= $ 687 (Adverse)

1. Direct labour efficiency/quantity variance

Labor Efficiency variance = (Actual quantity of labor used – Budgeted quantity of labor allowed for actual output) × Budgeted price of labor) (Drury, 2013)

(45800 – 60000) * 0.35

Sales and Purchases Budget for July

 = – $4970 (Favorable)

1. Budgeted variable overhead cost rate per unit (1 mark)

 = Budgeted Variable Overhead Cost/ Budgeted quantity

= $1000/ 10 000

= $0.1 per Unit

1. Variable overhead spending and efficiency variances

Variable overhead spending variance = (Actual variable overhead cost per unit of cost-allocation base – Budgeted variable overhead cost per unit) × Actual quantity of variable overhead cost) (Drury, 2013)

Actual variable cost per unit = Actual variable cost/ Actual Quantity

 = $ 836/ 80 000

= 0.01 per unit

= (0.1 – 0.01) * 80 000

 = 0.09 * 80000

= 7200 (Favorable)

Variable Overhead efficiency variances = (Actual quantity of variable overhead – Budgeted variable overhead allowed for actual output) × Budgeted cost of variable overhead) (Zimmerman and Yahya-Zadeh, 2011)

1000/60000 = 0.016

(45800 – 60 000) * 0.016

= $-227.2 (Favorable)

1. Overall Fixed overhead variance (note that standard costing for fixed overheads has not been used, so there is only a spending variance).

Fixed overhead spending variance = (Actual fixed overhead cost per unit of cost-allocation base – Budgeted fixed overhead cost per unit) × Actual quantity of fixed overhead cost) (Bebbington and O’Dwyer, 2014)

 Budgeted Fixed overhead = 15000/ 10000

 = 1.5 per unit

Variable Fixed Overhead = 16000/ 8000

= 2 per unit

(2 – 1.5) * 8000

= $4000 (Adverse)

1.  

	$	$	$
Static-budget operating profit			9000
Unfavorable sales-volume variance for  profit			-48000
Flexible-budget operating profit			-39000
Favorable Selling price variance			10046
Flexible-budget variances for profit
Direct materials variances
Price variance	7200
Efficiency variance	5200
Favorable direct materials variance		12400
Direct labour variances
Price variance	-687
Efficiency variance	4970
Favorable direct labour variance		4283
Favorable variable overhead variance		7427.2
Unfavorable fixed overhead variance		-4000
Favorable flexible-budget variance for profit			20110.2
Actual operating profit			-8843.8

References

Garret, K 2015, Target Costing and Lifecycle Costing, ACCA Technical article, updated 2 March 2015, Association of Chartered Certified Accountants, viewed 28 March 2017,

Meyhoff Fry, J, Hartlin, B, Erika Wallén E, and Aumônier S 2010, Life cycle assessment of example packaging systems for milk, Environmental Resources Management Limited for WRAP, viewed 28 March 2017,

Simon, M., Bee, G., Moore, P., Pu, J.S. and Xie, C., 2001. Modelling of the life cycle of products with data acquisition features. Computers in Industry, 45(2), pp.111-122.

De Vries, M., Van Middelaar, C.E. and De Boer, I.J.M., 2015. Comparing environmental impacts of beef production systems: A review of life cycle assessments. Livestock Science, 178, pp.279-288.

Guinée, J.B., 2002. Handbook on life cycle assessment operational guide to the ISO standards. The international journal of life cycle assessment, 7(5), pp.311-313.

Jiang, L. and Hansen, C.Ø., 2016. Target Costing as a Strategic Tool to Commercialize the Product and Service Innovation.

DRURY, C.M., 2013. Management and cost accounting. Springer.

Saunders, A. c, M.M., 2014. Financial institutions management. McGraw-Hill Education,

Bebbington, J., Unerman, J. and O’Dwyer, B., 2014. Sustainability accounting and accountability. Routledge.

Horngren, C.T., 2009. Cost accounting: A managerial emphasis, 13/e. Pearson Education India.

Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control. Issues in Accounting Education, 26(1), pp.258-259.

In the Life of a T?Shirt [Online] (updated 4 Feb. 2015) Available at: [Accessed 2 May. 2017].