Taonga's research and development staff have recently completed design work on a new product (the HOOK), and a target costing exercise is now being carried out by a cross-functional team of management and staff. The researched market price would be K88 and the expected return 30% margin.
“Component A” for the HOOK would be bought from an outside supplier for K1.44 per unit and 25% of all units of this component purchased would be wasted. Each HOOK would require 7.5 units of Component A (before taking account of the wasted units). Each HOOK would also require one unit of “Component B”, which would be produced in-house by Taonga. The production costs for Component B would be K6 per unit (variable) plus a set-up cost of K36, 000 per 8, 000 units of the component. Labor input per HOOK would be 1.5 direct labor hours at an hourly wage rate of K9. All production overhead costs are charged to products on a direct labor hour basis. Fixed and variable overheads are charged at separate hourly rates. The fixed overhead rate is determined on the basis of the normal monthly average activity level, which is 12,500 direct labor hours. The following data is available for the two months of last year which represented the highest and lowest levels of activity in that year:

July October
Direct labor hours 10,000 18,000
Production overheads K252,500 K404,500

Required
Prepare a memo for the Chief Executive Officer in which you:
a. Identify the target cost gap in relation to the HOOK, on the basis of the target costing system in use at Taonga.
b. Make recommendations as to how the target costing system should be modified.

c. Point out why target costing may be preferred method of determining the cost of a product or service compared to the traditional way of determining the cost of a product.

Answer rating: 100% (QA)

ANSWERS a The target cost gap is the difference between the target cost and the current cost In this ... View the full answer