JAY Ltd. manufactures specialised engineering products. The company?s product development staff recently completed design work on a new product (the “FREEZE”). Comparison with competitors? products indicates that $20 per unit is a realistic selling price for the FREEZE. The company requires a 35% margin on selling price from all products in order to ensure an adequate companywide return on investment. Production and sales of FREEZE are estimated at 13,000 units per annum.
According to the design specifications, the FREEZE is to be produced in batches of 500 units and packaged in batches of 25 units. Overhead costs amount to $2,000 for each batch of 500 units produced and a further $125 for each batch of 25 units packaged.
The design specifications also indicate that the manufacture of each unit of FREEZE will require 3 units of Component #1 and 5 units of Component #2. Component #1 is a new item which JAY Ltd. will have to manufacture at a cost of $0.20 (variable) each plus $4,000 for each batch of 10,000 units of this component. Component #2 is used regularly by the company and can be purchased in any desired quantity from a reliable supplier for $0.55 each. The labour cost of fitting these components in the manufacture of FREEZE is estimated at $0.45 per unit of Component #1 and $0.15 per unit of Component #2.
(a) Prepare calculations to indicate whether JAY Ltd. will achieve the target cost for the FREEZE on the basis of the data provided. (9 marks)
(b) Now assume that a “target costing task force” has suggested the following changes in order to help reduce the cost of the FREEZE:
1. Increase the production batch size so that each year?s total output of FREEZE would be produced in just 24 batches;
2. Increase the packaging batch size to 75 units of FREEZE;
3. Modify the design of the FREEZE, such that 2 units of Component #1 would be replaced by the same number of units of Component #2 in each FREEZE.
Calculate the total annual cost savings if all of these changes are implemented, and indicate whether the target cost would be achieved. (12 marks)
(c) The Managing Director points out that no consideration has been given to the cost of delivering the product to customers. Discuss whether the company needs to give consideration to delivery costs as part of the target costing exercise. (N.B. Calculations are not required in your answer to this part) (4 marks).