Value engineering, target pricing, and target costs. Tiffany ...

[s.tung]

Value engineering, target pricing, and target costs.
 
  Tiffany Cosmetics manufactures, and sells a variety of makeup and beauty products. The company has come up with its own patented formula for a new anti-aging cream The company president wants to make sure the product is priced competitively because its purchase will also likely increase sales of other products. The company anticipates that it will sell 400,000 units of the product in the first year with the following estimated costs:
 
  Required:
  1. The company believes that it can successfully sell the product for 38 a bottle. The company's target operating income is 40 of revenue. Calculate the target full cost of producing the 400,000 units. Does the cost estimate meet the company's requirements? Is value engineering needed?
  2. A component of the direct materials cost requires the nectar of a specific plant in South America. If the company could eliminate this special ingredient, the materials cost would drop by 45. However, this would require design changes of 300,000 to engineer a chemical equivalent of the ingredient. Will this design change allow the product to meet its target cost?
  3. The company president does not believe that the formula should be altered for fear it will tarnish the company's brand. She prefers that the company spend more on marketing and increase the price. The company's accountants believe that if marketing costs are increase by 400,000 then the company can achieve a selling price of 42 per bottle without losing any sales. At this price, will the company achieve its target operating income of 40 of revenue?
  4. What are the advantages and disadvantages of pursuing alternative 2 and alternative 3 above?

Question 2

When a month's transactions have been posted, the Accounts Payable account will only have debit entries.
 a. True
   b. False
   Indicate whether the statement is true or false

[Jordin Calloway]

Answer to Question 1

1.
Product design and licensing 1,000,000
Direct materials 1,800,000
Direct manufacturing labor 1,200,000
Variable manufacturing overhead 600,000
Fixed manufacturing overhead 2,000,000
Fixed marketing 3,000,000
Total cost 9,600,000
Cost per unit (9,600,000  400,000) 24.00
Target cost per unit (38  0.60) 22.80
The original cost estimate of 9,600,000 does not meet the company's requirements. Value engineering will be needed to reduce the cost per unit to the target cost. Tiffany's operating income will be 5,600,000 (38  400,000  9,600,000)

2.
Total cost 9,600,000
Less: Reduction in material costs (1,800,000  45) (810,000)
Add: Increase in design costs 300,000
Total costs of redesigned table 9,090,000
Revised cost per unit (9,090,000  400,000 units) 22.73
Target cost per unit (38  0.60) 22.80
The design change allows the table to meet its goal of target costs less than 60 of revenue and target operating income greater than 40 of revenue. The cost of materials is a locked-in cost because they are designed into the product formula.

3.
Total cost  9,600,000
Add: Increase in marketing costs 400,000
Total costs of redesigned table 10,000,000
Revised cost per unit (10,000,000  400,000 units) 25
Target cost per unit (42  0.60) 25.20
Yes, this proposal does allow the company to meet its goal of target costs less than 60 of revenue and target operating income greater than 40 of revenue.

4. The company has many considerations, both quantitative and qualitative, when deciding between the preceding requirements 2 and 3 . Although both options meet the target costing objectives, they will provide different amounts of income in both the short and potentially long term. In the short term, the alternative in requirement 2 will result in income of (38  400,000)  9,090,000 = 6,110,000. The alternative in requirement 3 will provide a higher income of (42  400,000)  10,000,000 = 6,800,000 and will be preferred.
In the long run, however, there are other considerations that might favor the alternative in requirement 2 and using the chemical equivalent of the nectar obtained from the plant in South America. For example, will the nectar become more expensive in future periods? If so, could the product be reengineered at a later time or are the materials locked-in with the design for the full product life cycle. If the company chemically engineers the material, will this tarnish the quality of the product or more importantly, the company's brand image? How might this affect the price in future periods and/or the sales of other products within the company?

Answer to Question 2

False

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TYSM

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