For many years, Oxmoor Corporation has used a straightforward cost-plus pricing system, marking its goods up approximately 20% of total cost. The company has been profitable; however, it has recently lost considerable business to foreign competitors that have become very aggressive in the marketplace. These firms appear to be using target costing.An example of Oxmoor's woes is typified by item no. 710, which has the following unit-cost characteristics: direct materials, $50; direct labor, $90; manufacturing overhead, $40; and selling and administrative expenses, $20. The going market price for an identical product of identical quality is $210, which is below what Oxmoor is charging.Required:A. Contrast cost-plus pricing and target costing.B. What is Oxmoor's current selling price for item
no. 710?C. If Oxmoor used target costing for item no. 710, what must happen to costs if the company desired to meet market prices and maintain its current rate of profit on sales? By how much?
What will be an ideal response?
A. Cost-plus pricing begins by computing an item's cost and then adds a markup. The result is the item's selling price. In contrast, target costing begins by determining an appropriate selling price. A target profit is next subtracted from that price to yield the cost (i.e., the "target cost") that must be achieved.
B. The current selling price is $240: ($50 + $90 + $40 + $20 = $200; $200 × 120% = $240).
C. Oxmoor's markup is $40 ($240 - $200), which is 16.67% of the current $240 selling price ($40 ÷ $240). To achieve a 16.67% markup on a $210 selling price, the company must reduce its costs by $25.
| Selling price | $210 |
| Less: 16.67% markup ($210 × 16.67%) | 35 |
| Target cost | $175 |
| ? | ? |
| Current cost | $200 |
| Less: Target cost | 175 |
| Required cost reduction | $ 25 |
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