Question

For many years, Leno Corporation has used a straightforward cost-plus pricing system, marking its goods up approximately 25 percent of total cost. The company has been profitable; however, it has recently lost considerable business to foreign competitors that have become very aggressive in the marketplace. These firms appear to be using target costing. An example of Leno's problem is typified by item no. 8976, which has the following unit-cost characteristics: Direct material Direct labor Manufacturing overhead Selling and administrative expenses $ 90 220 140 70 The going market price for an identical product of comparable quality is $570, which is significantly below what Leno is charging. 3. If Leno used target costing for item no. 8976, what must happen to costs if the company desires to meet the market price and maintain its current rate of profit on sales? By how much? Reduce its cost by

Answer 1

Current total cost per item no. 8976 = Direct material + Direct labor + Manufacturing overhead + Selling and administrative overheads = $90 + $220 + $140 + $70 = $520

Current mark-up = 25% on cost

Selling price = Total cost per item + 25% of total cost = $520 + 25% of $520 = $650

Profit per item = $650 - $520 = $130

Profit % on sales = ( Profit per item / Selling price ) * 100 = ( $130 / $650) * 100 = 20% on sales.

Target selling price = $570

Profit to be maintained @ 20% on sales. Therefore, profit per item = 20% of $570 = $114.

Target cost desired by the company = Target selling price - Desired profit = $570 - $114 = $456.

Difference between target cost and current cost = $520 - $456 = $64

Therefore, Leno Corporation should - reduce its cost by $64.