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The Chemical Free Clean Co (C Co) provides a range of environmentally-friendly cleaning services to business customers, often providing a specific service to meet a client’s needs. Its customers range from large offices and factories to specialist care wards at hospitals, where specialist cleaning equipment must be used and regulations adhered to. C Co offers both regular cleaning contracts and contracts for one-off jobs. For example, its latest client was a chain of restaurants which employed them to provide an extensive clean of all their business premises after an outbreak of food poisoning.

The cleaning market is very competitive, although there are only a small number of companies providing a chemical free service. C Co has always used cost-plus pricing to determine the prices which it charges to its customers but recently, the cost of the cleaning products C Co uses has increased. This has meant that C Co has had to increase its prices, resulting in the loss of several regular customers to competing service providers.

The finance director at C Co has heard about target costing and is considering whether it could be useful at C Co.

Required:

(a) Briefly describe the main steps involved in deriving a target cost. (3 marks)

(b) Explain any difficulties which may be encountered and any benefits which may arise when implementing

target costing at C Co. (7 marks)

ACCA考试

Answer：

(a) Target costing steps

Deriving a target cost

Step 1: A product or service is developed which is perceived to be needed by customers and therefore will attract adequate sales volumes.

Step 2: A target price is then set based on the customers’ perceived value of the product. This will therefore be a market based price.

Step 3: The required target operating profit per unit is then calculated. This may be based on either return on sales or return on investment.

Step 4: The target cost is derived by subtracting the target profit from the target price.

Step 5: If there is a cost gap, attempts will be made to close the gap. Techniques such as value engineering may be performed, which looks at every aspect of the value chain business functions with an objective of reducing costs while satisfying customer needs.

Step 6: Negotiation with customers may take place before deciding whether to go ahead with the project.

(b) Application at C Co

Difficulties in implementation

– C Co is a service company and in service companies, it is often more difficult to find a precise definition for some of the services. In order for target costing to be useful, it is necessary to define the service being provided. C Co actually provides a range of services to clients including specialist care wards at hospitals. This means that the definition of the services being provided will vary. Different target costs will need to be derived for the different services provided.

– C Co has two types of clients: regular clients and one-off clients. Since the service for regular clients is being repeated,it should be relatively easy to set a target cost for these jobs. However, for the one-off jobs, there may not be any comparative data available and therefore setting the target cost will be difficult.

– Similarly, some of the work available is very specialist. For example, cleaning restaurants and kitchens after an outbreak of food poisoning will require specialist techniques and adherence to a set of regulations with which C Co may not be familiar. It may be difficult to establish the market price for a service like this, thus making it difficult to derive a target cost.

Benefits to C Co

– Target costing is useful in competitive markets where a company is not dominant in the market and therefore has to accept a market price for their products. C Co is operating in a competitive market and whilst the service offered by C Co is more specialist, it is clear from the recent drop in sales that price increases do lead to loss of customers. C Co cannot therefore ignore the market price for cleaning services and simply pass on cost increases as it has done. Target costing would therefore help C Co to focus on the market price of similar services provided by competitors, where this information is available.

– If after calculating a target cost C Co finds that a cost gap exists, it will then be forced to examine its internal processes and costs more closely. It should establish why the prices of the products it uses have increased in the first place. If it cannot achieve any reduction in these prices, it should consider whether it can source cheaper non-chemical products from alternative suppliers. So, target costing will benefit C Co by helping it to focus on cost reduction and consequently customer retention.

Note: More points could be made and would earn marks.