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How can you use target costing to calculate job costs?

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Target costing is a method of setting prices based on customer expectations and market conditions, rather than based on production costs. It can help you improve your profitability, competitiveness, and customer satisfaction. But how can you use target costing to calculate job costs, especially if you use job order or process costing systems? In this article, we will explain the basics of target costing, the steps involved in applying it to job costs, and the benefits and challenges of this approach.

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Asha Kanta Sharma

Manager - Finance & Accounts @ Opendoors Fintech | Financial Accounting

1 What is target costing?

Target costing is a proactive and strategic way of managing costs and profits. It starts with identifying the target price that customers are willing to pay for a product or service, and then deducting the desired profit margin to get the target cost. The target cost is the maximum amount that you can spend on producing and delivering the product or service, while still achieving your profit goal. Target costing requires you to align your design, engineering, manufacturing, and marketing processes with the customer value and the market situation.

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Asha Kanta Sharma

Manager - Finance & Accounts @ Opendoors Fintech | Financial Accounting
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Target costing is a cost management approach that sets a target cost for a product or service based on market conditions and customer expectations. It involves determining the target selling price, desired profit margin, variable and fixed costs, contribution margin, and breakeven point. Regularly reviewing and adjusting actual costs against target costs is essential for effective target costing. Applying target costing to job costs requires involving cross-functional teams to maintain competitiveness and achieve profitability.

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2 How to apply target costing to job costs?

To use target costing to calculate job costs, you need to begin by determining the target price and target profit for each product or service, based on customer research, competitor analysis, and market trends. Subtract the target profit from the target price to calculate the target cost. Next, estimate the current cost of producing and delivering the product or service using your existing job order or process costing system. This includes direct materials, direct labor, and overhead costs. Compare the current cost with the target cost and identify any cost gaps. Analyze the cost drivers and value drivers of the product or service to find ways to eliminate or minimize non-value-added activities, improve efficiency, quality, and innovation, as well as optimize resource use. Finally, implement the cost reduction measures and monitor and evaluate the results.

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cma Madan Mohan Bhattacharyya

Qualified Member of Chartered Public Finance and Accountants(UK)
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a)Target costing starts with the market survey and analysing the most realistic sale price of the product, ie setting of targeted sale price. b) Thereafter targeted cost price can be calculated by deducting the desired profit margin from the targeted sales price. c) After getting the targeted cost price of the product, we will have to calculate the actual price in the present scenario. d)Next step is to short out, how we can reduce the gap between the targeted cost and actual cost without compromising the quality of the product. This is the crucial part of the target costing. We will have to find out the fixed cost, variance cost per unit. We will have to reduce the variable cost with the most innovative ways and reducing the waste.

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3 What are the benefits of target costing for job costs?

Using target costing to calculate job costs can offer several advantages, such as increasing your competitive advantage by offering products or services that meet customer expectations at a reasonable price. It can also help to boost your profitability by controlling costs and maintaining your profit margin. Additionally, target costing can improve quality and innovation by focusing on value-added activities and eliminating waste and inefficiency. It can also help to align your internal processes with external market and customer needs, as well as encourage cross-functional collaboration between design, engineering, manufacturing, and marketing teams.

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4 What are the challenges of target costing for job costs?

Though target costing can be a useful tool for calculating job costs, it is not without its challenges. Estimating the target price and profit accurately and realistically requires reliable and up-to-date market data and customer feedback. Additionally, it is difficult to achieve the target cost without compromising quality, functionality, and reliability. Furthermore, managing trade-offs and conflicts among different departments and stakeholders can be difficult when making design changes or cutting costs. It is also essential to adapt to changing customer preferences, technological advancements, and competitive pressures, while also measuring and verifying the actual cost savings and customer satisfaction resulting from your target costing efforts.

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5 How to improve your target costing skills?

Target costing is a beneficial skill for any accountant who wants to contribute to their organization's strategic and financial objectives. To develop your target costing abilities, you can learn from the best practices of companies that use target costing, like Toyota, Sony, and IKEA. Additionally, you can apply the principles and techniques of target costing to your own projects and products, while also seeking feedback from your supervisors and colleagues. Keeping up with the latest trends and developments in your industry and market can help you refine your target costing assumptions and calculations. Lastly, taking online or offline courses, workshops, or certifications that cover target costing and related topics such as cost management, value engineering, and customer analysis can be beneficial.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you use target costing to calculate job costs?

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1 What is target costing?

2 How to apply target costing to job costs?

3 What are the benefits of target costing for job costs?

4 What are the challenges of target costing for job costs?

5 How to improve your target costing skills?

6 Here’s what else to consider

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