The following scenario relates to questions 26–30.
Helot Co develops and sells computer games. It is well known for launching innovative and interactive role-playing games and its new releases are always eagerly anticipated by the gaming community. Customers value the technical excellence of the games and the durability of the product and packaging.
Helot Co has previously used a traditional absorption costing system and full cost plus pricing to cost and price its products. It has recently recruited a new finance director who believes the company would benefit from using target costing. He is keen to try this method on a new game concept called Spartan, which has been recently approved.
After discussion with the board, the finance director undertook some market research to find out customers’ opinions on the new game concept and to assess potential new games offered by competitors. The results were used to establish a target selling price of $45 for Spartan and an estimated total sales volume of 350,000 units. Helot Co wants to achieve a target profit margin of 35%.
The finance director has also begun collecting cost data for the new game and has projected the following:
Production costs per unit $
Direct material 3·00
Direct labour 2·50
Direct machining 5·05
Set-up 0·45
Inspection and testing 4·30
Total non-production costs $’000
Design (salaries and technology) 2,500
Marketing consultants 1,700
Distribution 1,400
Which of the following statements would the finance director have used to explain to Helot Co’s board what the benefits were of adopting a target costing approach so early in the game’s life-cycle?
(1) Costs will be split into material, system, and delivery and disposal categories for improved cost reduction analysis
(2) Customer requirements for quality, cost and timescales are more likely to be included in decisions on product development
(3) Its key concept is based on how to turn material into sales as quickly as possible in order to maximise net cash
(4) The company will focus on designing out costs prior to production, rather than cost control during live production
Target costing does encourage looking at customer requirements early on so that features valued by customers are included, so Statement 2 is correct. It will also force the company to closely assess the design and is likely to be successful if costs are designed out at this stage rather than later once production has started, so Statement 4 is correct.
Statement 1 explains a benefit of flow cost accounting. Statement 3 explains the concept of throughput accounting.
What is the forecast cost gap for the new game?
Target price is $45 and the profit margin is 35% which results in a target cost of $29·25. The current estimated cost is $31·30 which results in a cost gap of $2·05.
The board of Helot Co has asked the finance director to explain what activities can be undertaken to close a cost gap on its computer games.
Which of the following would be appropriate ways for Helot Co to close a cost gap?
(1) Buy cheaper, lower grade plastic for the game discs and cases
(2) Using standard components wherever possible in production
(3) Employ more trainee game designers on lower salaries
(4) Use the company’s own online gaming websites for marketing
Using more standardised components and using its own websites for marketing will reduce processing and marketing costs.
Using cheaper materials and trainee designers will reduce costs but could impact the quality and customer perception of the product which would impact the target price.
The direct labour cost per unit has been based on an expected learning rate of 90% but now the finance director has realised that a 95% learning rate should be applied.
Which of the following statements is true?
The change in the learning rate will increase the current estimated cost which will increase the cost gap.
The target cost will be unaffected as this is based on the target selling price and profit margin; neither of which are changing.
Helot Co is thinking about expanding its business and introducing a new computer repair service for customers. The board has asked if target costing could be applied to this service.
Which of the following statements regarding services and the use of target costing within the service sector is true?
Services do use more labour relative to materials.
The other three statements are incorrect as uniformity is not a characteristic of services, there is no transfer of ownership and although it is difficult to standardise a service due to the human influence, target costing can still be used.