ACCA Performance Management (F5) Certification Practice Exam

What does target costing involve?

1. Setting production limits based on demand

2. Estimating the cost based on historical data

3. Setting target cost by subtracting desired profit from market price

4. Calculating inventory costs

The correct answer is: Setting target cost by subtracting desired profit from market price

Target costing is a pricing strategy in which a company determines the desired profit margin and then works backwards to set a target cost for a product. This method begins with the market price that customers are willing to pay for a product. From this price, the desired profit is subtracted to arrive at the target cost. This approach is especially useful in competitive markets where prices are often dictated by customer expectations rather than by production costs. By calculating the target cost this way, companies are encouraged to design products that can be produced within these cost constraints. This promotes efficiency in production, cost reduction, and innovation, as businesses seek to meet the target cost while still delivering quality products. Target costing thus aligns product development with market expectations and profitability goals. The other options do not capture the essence of target costing. For instance, while setting production limits based on demand is an aspect of production planning, it does not pertain to the cost determination processes inherent in target costing. Estimating costs based on historical data might play a role in other costing methods, but it does not influence target costing directly, as this approach is more focused on market-driven pricing rather than historical expenditures. Lastly, while calculating inventory costs is essential for overall financial management, it is not specifically related to