Traditional Costing Versus Target Costing

Published Date: 02 Nov 2017

Nowadays, the current business environment particularly the automotive industry has been using target costing as a strategic cost management tool. The South African Motor Industry is the great example to illustrate that the target costing is one of the strategic cost management approaches better applicable to consolidate a company’s competitiveness in countering the current business challenges (Slater M., 2010). South African Motor Industry is a world-wide base manufacturer for the produce and export of all the cars and assembly. The industry is widely placed in two sates, the Eastern Cape(coastal) and Gauteng(inland). Those production plant companies in South Africa are located to take benefit of the low production cost and together with access to new markets as a result of trade agreements with the European Union and the Southern African Development Community free trade area (South Africa, 2012).

Toyota Motor Corporation is one of the motor vehicle manufacturers in South Africa which can be a great example to present the implication of target costing. In fact, the target costing was created by the market and cost researchers working for Toyota in the year of 1960 (Cato J., n.d.). Basically, Toyota uses cost planning to lower costs at the design stage. By using this approach, Toyota sets goals for cost reduction, after that tries to attain these new targets through design changes that will fulfill the cost reduction goal. In the procedures, Toyota carries out a bold testing stage to decide the costs of the new design in comparison with the old one, so that they can guarantee a cost reduction after implementation of the new technique (Alvarez D., 2001). The approach using by Toyota is similar with the target costing. The following is the product planning implemented by Toyota: first decides what the new market price for the automobile by taking the old price and adding the value of any new functions, then the sales division will give the proposed production quantity; by taking past numbers and indexing them to market trends and the state of competitors, after that concentrate exchanges to cost planning which is based on the product plan and the targets for market price and production quantity, at the end sets up a profit target that is deducted to determine their cost. Toyota does not simply put in all the costs of the upgraded model when it predicts the general costs of a new model; instead it adds the cost variations of the new model and the old one. As a result, Toyota takes away variable costs both models incurred like indirect costs, after that they can base their decisions merely on costs that change between the design and production quantity.

In fact, traditional costing (or cost-plus costing) has been implementing by many businesses for many decades and most businesses are preferred of it. The reason why many businesses like traditional costing is because of its simplicity. It is required only a little data for cost-plus pricing, and then later adjustments to the price can be made more smoothly and easily than with target costing. However, everything has two sides. Traditional costing has been criticized for its inefficiency including underestimate or overestimate of profits. According to articles of Jeremy Cato, for process-oriented business that uses to nonstop production is better suited to traditional costing.

One of the traditional costing systems is absorption costing which is very popular and commonly use by many businesses. It involves the utility of volume-based overhead absorption bases such as labor hour and machine hour. In fact, there are some limitations of this method such as it combines various cost drivers into unit cost causes difficulty to identify the cost saving in overheads, blind reduction of overhead costs which is probably to induce a reducing in quality of products and so on. Thus, the utility of absorption costing may probably cause misleading or inaccurate measurement of production costs. However, absorption costing is still popular in current business practice because it can avoid virtual losses being reported and provides a logical profit calculation. The other reason is that it can lower the potential impact of the accounting information from outer report on share price. In shorts, although there are many limitations of absorption costing, it is still relevant to the current business practice due to the benefits. Traditional costing is also significant tools for performance management because they can avoids virtual losses being given and show higher profit in accounting report.

After discussing both traditional costing and target costing, we can see that both systems also have its advantage towards a company. It cannot be declared that either one system should be eliminated or out-dated in current business environment. Therefore, a company should choose and implement a costing system which is suited for them based on their management systems.

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