Which of the following best describes target costing?
Setting a cost by subtracting a desired profit margin from a competitive market price
Setting a price by adding a desired profit margin to a production cost
Setting a cost for use in the calculation of variances
Setting a selling price for the company to aim for in the long run
Cost set by government regulation
Answer and explanation
Correct Answer: A
Explanation:
Target costing is a market-driven pricing strategy. A company starts with the price customers are willing to pay in a competitive market, then subtracts the desired profit margin to arrive at the maximum allowable (target) cost to produce the product. This is the reverse of cost-plus pricing (option B), which adds a margin to cost to determine price.
Target costing is especially useful in competitive markets where the selling price is largely determined externally, making internal cost management critical to profitability.