# Outlining target costing

Objective

After completing this lesson, you will be able to describe calculating target costs for cost centers

## Outlining Target Costing

### Target Costing

You want to evaluate the performance of your cost centers. You notice that the comparison of the planned costs with the actual costs shows whether planned costs have been exceeded. But the question arises: are the actual costs incurred justified? Do the actual costs represent the effort required to complete the tasks that the employees performed and fulfill the cost centers business purpose?

• Activity types can be assigned to cost centers for which resources can be identified and are used. Valid activity types can be, for example, employee time, machine time, energy consumption, or building space used. Consumption of these resources incur costs.
• There are two categories of costs:
• Fixed costs if increasing activity does not lead to increased resource consumption. This is the case, for example, with a meeting room regularly used or different types of insurance.
• Variable costs if more resources are used as output increases. This is usually the case for energy or maintenance, for example.

The relationship between the activity of a cost center(measured in hours) and theresulting costs is displayed in a coordinate system. Remember:

• Fixed costs do not change when the activity changes.
• Variable costs change proportionally to the change of the activity quantity.

Fixed and variable costs add up to the total costs.

During cost planning for a cost center, the system determines how much activity is to be performed in this cost center during a month. From the chart, you can easily see the planned costs for this plan activity.

The cost center allocates an actual quantity that may differ from the planned quantity for the activity. The fixed costs do not change.

However, the variable costs will change in proportion to the activity.

The sum of fixed plan costs and the adjusted variable plan costs gives the target costs for the actual activity as shown in the equation in the figure above.

Target costs calculated this way are the correct scale on which the actual costs are measured since they take into account that a changed activity quantity also changes the consumption of the resources and therefore the costs.

The difference between target costs and actual costs is the variance. It is comprised of different categories, such as quantity variance and price variance. By analyzing the variance categories, measures can be derived to improve the cost center's efficiency.