Question

Problem 5-19B

Target pricing and target costing with ABC

Klein Corporation manufactures two models of watches. Model Wonder displays

cartoon characters and has simple features designed for kids. Model Marvel has

sophisticated features such as dual time zones and an attached calculator. Klein’s

product design team has worked with a cost accountant to prepare a budget for the two

products for the next fiscal year as follows.

Direct Cost

Wonder (W)

Marvel (M)

Direct

materials

$10 per unit

$20 per unit

Direct labor

$25/hour × 0.3 hour production

time

$25/hour × 0.7 hour production

time

Category

Estimated Cost

Cost

Driver

Use of Cost Driver

Materials

handling

$ 183,000

Number of parts

W: 700,000; M: 520,000

Machine

setups

90,000

Number of setups

W: 50; M: 40

Product

testing

14,000

Number of units

tested

W: 1,000; M: 400

Facility

depreciation

180,000

Number of

machine hours

W: 3,200; M: 4,000

Total

$467,000

Wonder watches have 35 parts, and Marvel watches have 65 parts. The budget calls for

producing 20,000 units of Wonder and 8,000 units of Marvel. Klein tests 5 percent of

its products for quality assurance. It sells all its products at market prices.

Required

a. Compute the cost per unit for each product.

b. The current market price for products comparable to Wonder is $28 and for

products comparable to Marvel is $85. What will Klein’s profit or loss for the next

year be?

c. Klein likes to have a 25 percent profit margin based on the current market price for

each product. What is the target cost for each product? What is the total target

profit?

d. The president of Klein has asked the design team to refine the production design to

bring down the product cost. After a series of redesigns, the team recommends a new

process that requires purchasing a new machine that costs $200,000 and has five

years of useful life and no salvage value. With the new process and the new machine,

Klein can decrease the number of machine setups to four for each product and cut

the cost of materials handling by 60 percent. The machine hours used will be 4,500

for Wonder and 6,500 for Marvel. Does this new process enable Klein to achieve its

target costs?

Answer 1

a) Computation of cost per unit

Wonder Watch Marvel Watch 2,00,000 1,60,000 1,50,000 1,40,000 1,05,000 78,000 50,000 40,000 Nature of cost Cost driver Computation formula Direct materials Per unit Cost per unit. No of units Direct Labour Per unit No of units Production time per unit Rate per hour No of parts for Wonder/No of parts combined Total Material handling cost Number of parts Material handling cost No of setup for Wonder/No of setup combined Total Machine setup cost Number of setup Machine setup cost No of units tested for Wonder/No of units tested Product testing cost Number of Units tested combined Total product testing cost No of machine hours for Wonder/No of machine hours Facility depreciation No of Machine hours combined Total depreciation Total Cost No of Units budgeted Cost per unit 10,000 4,000 80,000 5,95,000 20,000 29.75 1,00,000 5,22,000 8,000 65.25

b) Klein's profit/Loss for next year

Particulars	Wonder Watch	Marvel Watch	Total
Sales Revenue	5,60,000	6,80,000	12,40,000
Cost of goods sold	-5,95,000	-5,22,000	-11,17,000
Net Profit/(Loss) for the year	-35,000	1,58,000	1,23,000

c) Targeted cost and profit

Particulars	Computation formula	Wonder Watch	Marvel Watch	Total
Sales Revenue/unit at current market prices	Current market prices	28.00	85.00
Targeted profit @ 25% of Selling price	Market price * 25%	7.00	21.25
Targeted cost/unit	Market price - Targeted profit	21.00	63.75
Total Target profit	Targeted profit/Unit * No of units	1,40,000	1,70,000	3,10,000

d) Computation of new cost per unit and check whether the target costs are acheived

Due to this change in process, the following figures have changed:-

• Facility depreciation has increased by $ 40,000 ($ 200,000/5 Years) with additional machinery
• Machine setup cost per setup was $ 1,000 per setup, which was earlier $ 90,000 for 90 setups. Now it has reduced to $ 8,000 due to reduction in no of setups to 4 per product ($ 1,000 * 8 Setups)
• Material handling costs has been reduced by 60%. Hence new cost is $ 73,200 ($ 183,000 * 40%)
• Change in machine hours to 4,500 hours for Wonder watch and 6,500 hours for Marvel watch.

Now We will calculate new Cost per unit, which is as follows:-

Wonder Watch 2,00,000 Marvel Watch 1,60,000 1,50,000 1,40,000 42,000 31,200 4,000 4,000 Nature of cost Cost driver Computation formula Direct materials Per unit Cost per unit No of units No of units Production time per unit Rate Direct Labour Per unit per hour No of parts for Wonder/No of parts Material handling cost Number of parts combined Total Material handling cost No of setup for Wonder/No of setup Machine setup cost Number of setup combined Total Machine setup cost No of units tested for Wonder/No of units Product testing cost Number of Units tested tested combined Total product testing cost No of machine hours for Wonder/No of machine hours combined Total Facility depreciation No of Machine hours depreciation Total Cost No of Units budgeted Cost per unit 10,000 4,000 90,000 4,96,000 20,000 24.80 1,30,000 4,69,200 8,000 58.65

As can be seen from the above new cost per unit, the target cost for Wonder watch is still not acheived, whereas the target cost for Marvel watch is very well acheived.