One aspect of target costing not yet discussed is consideration of product costs over the life of the product. Life-cycle costing is the consideration of all potential resources consumed by the product over its entire life.
These costs stretch from product development and.R&O costs through warranty and disposal costs. In the Boards and More case, if the new paperboard mix for the soap boxes creates additional disposal costs for the soap consumer, these costs must be considered. For example. Boards and More needs to understand the impact of the new paperboard mix that contains plastic fibers on the ability of consumers to recycle the soap boxes and on their own potential environmental costs.
These additional product life-cycle considerations are a formal part of the target costing .process Team members Involved in the target costing process must consider current and future cash flow effects associated with new product development. For example. if the proposed solution at 130 and More requires new equipment to accommodate the heating and drying of the new paperboard mix
•.the impact of the equipment purchase and of associated changes in future depreciation expenses on cash flows should be considered. Assume the new heating equipment has a purchase pr’ice of· $500.000 and is expected to increase the annual depreciation expense from $100.000 to $150.000 per year. Cash flow consequences will include
(1) the immediate purchase price cash outflow (net of any inflow from disposing of the old equipment) and
(2) the annual tax savings cash inflows that result from $50.000 hig/1er depreciation expense and consequently lower operating income. It Is not clear; however. that cash inflows from higher revenues will occur. The decision to purchase the equipment is a capital budgeting decision. We discuss capital budgeting in man: ‘detail In
Characteristics of the Target Costing Process
‘” Notice several characteristics in our illustration of the target costing process.
First. the· entire value chain is involved in driving cost out while satisfying customer needs. Second, process understanding is the cornerstone of target costing.
A clear understanding of the connection between the key components of the process and the associated costs is critical for focusing value engineering efforts. Third. target costing requires an emphasis on the product’s functional characteristics and their importance to the customer.
Fourth. a primary objective. of the target costing process is to reduce development time.
The cross-functional. cross-organizational team approach allows for simultaneous. rather than sequential. consideration of possible solutions. speeding up new product development time. Finally, ABC information is very useful in determining which process changes will drive costs out of the activities necessary to achieve the target cost.