The ahead section concentrates on making use of differential analysis to assess pricing for special orders. Organizations likewise use other approaches to develop prices, such together cost-plus pricing and also target costing. Us cover this two approaches next.

You are watching: The target cost approach assumes that:


Cost-Plus Pricing

Questions: suppliers that produce custom products, such as residences or landscaping for commercial buildings, often have a difficult time identify a reasonable sector price. Prices for these assets can be identified using cost-plus pricing. How is cost-plus pricing used to arrive at a reasonable price?

Answer: Cost-plus pricing starts v an estimate of the costs incurred to build a product or provide a service, and a details profit percent is included to establish the price. Because that example, a defense contractor working through the federal government assumes the cost to construct a new fighter jet is $60 million. Together there is no open industry price because that this product, the contractor have to come increase with an approach to developing the price the does not count on sector pricing. Based upon industry-wide standards and also negotiations v the government, the contractor request a 10 percent markup ~ above cost. If the federal government accepts this proposal, the contractor will obtain $66 million for each plane delivered <$66 million = $60 million + ($60 million × 10 percent)>.

The ide of cost-plus pricing sounds simple. However, the challenge is in determining which expenses should it is in included. Are only variable product expenses included? need to fixed manufacturing overhead be included? What about selling costs? The answers come these questions depend ~ above the negotiations in between buyer and seller, and should be plainly defined in the agreement. When using cost-plus pricing, the is important to establish in breakthrough which costs are come be had for pricing purposes.


Target Costing

Question: establishments are constantly make the efforts to discover ways to become more efficient and reduce costs. However, once production firms style a product and begin production, it is daunting to make far-ranging changes that will mitigate costs. How deserve to target costing help with this issue?

Answer: Target costing is technique that mitigates cost efficiency problems connected with introducing new products by completely the product design, wanted price, wanted profit, and also desired price into one procedure beginning in ~ the product breakthrough stage. Target costing has 4 steps:

Step 1. Architecture a product that provides the features and price inquiry by customers.

Step 2. Identify the company’s preferred profit.

Step 3. Derive the target cost by individually the desired profit (from action 2) indigenous the preferred price (from step 1).

Step 4. Engineer the product to accomplish the target expense (from step 3). If the wanted target expense cannot be achieved, the company must go earlier to step 1 and also reevaluate the features and also price.

For example, mean Hewlett-Packard designs a laser printer with features that customers have actually requested and also wants to sell it for $240; this is action 1. Management requires a profit equal to 40 percent the the marketing price, or $96 (= $240 × 40 percent); this is action 2. The target price is $144 (= $240 − $96); this is action 3. The product designers must now architecture this product in information to attain or to win the target expense of $144; this is action 4.


Key Takeaway

Cost-plus pricing starts with an estimate of the expenses incurred to develop a product, and also a particular profit percentage is added to develop the price. Companies frequently use this method when the is daunting to recognize a reasonable sector price. Target costing integrates the product design, desired price, wanted profit, and desired cost into one procedure beginning at the product advancement stage.

Review trouble 7.7

Suppose Nike, Inc., has emerged a brand-new shoe that can be marketed for $140 a pair. Monitoring requires a profit same to 60 percent the the offering price. Determine the target cost of this product.

See more: Austin Fraternal Order Of Police Texas State Lodge Tx0St, Austin Fraternal Order Of Police > Home

Solution come Review difficulty 7.7

The target price of $56 is uncovered by individually the target benefit from the target selling price. This calculation is as follows.