Page 8 - MCS August Day 1 Suggested Solutions

CIMA AUGUST 2018 – MANAGEMENT CASE STUDY

Budgeting for labour costs should therefore take this into account and not use the unit cost of the
prototype, but a cost that is more representative of the main production.

If the business uses cost plus pricing there would be a knock on effect on the price charged for the
product. A price based on the labour time and cost for the prototype unit would be too high
compared to that of the main production units. This could lead to an uncompetitive pricing
position if used.

If work were scheduled based on the time taken for the prototype then too much time would be
allocated for production and workers would end up with a lot of idle time.

It is also worth noting that there could also be a learning effect on the materials costs. Production
of the prototype could use more material, due to higher wastage levels, than would be expected
for the main production. This would also need to be taken into account for future costing and
budgeting.

3. TARGET COSTING

Target costing is a pro‐active cost control system. The starting point is to determine a price for a
product that is acceptable for the market. It is therefore an externally focused approach. From
this market price, a required profit element is deducted to reach a target cost.

Many businesses will require a minimum return from their products, for instance it may be
necessary for a business to earn a 5% margin. This value is calculated and used as the deduction
to reach the target cost.

The target cost therefore represents the maximum cost per unit that the business can afford to
spend, whilst earning their minimum return.

The target cost can then be compared to the expected unit cost to see if the product is viable at
present cost expectations.

If it is not, i.e. if there is a cost gap where the target cost is lower than the expected production
cost, then the business must look to reduce costs to the target cost or below to make the product
viable.
If Montel were forced to reduce the price of one of its models in order to remain competitive and
maintain market share, this would have a knock on effect on the target cost and the potential
viability of the product in the market.

As an existing product, the model would currently be viable in the market, but a reduction in price
and therefore the target cost may lead to a cost gap.

Montel would therefore have to re‐look at the production costs and find ways of cutting them to
remove the cost gap.

The company would have to be very careful when looking to reduce costs. Montel’s primary
strategy is based around the quality of its products. It cannot afford to compromise on quality
when cutting costs. In addition to the potential impact on changing customer perception of its
products and affecting the Montel brand, it would also mean that the sales price that it had been

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