Cost Accounting

Flaws in Traditional Costing System

There are two flaws in traditional costing. One is that, in traditional costing, the selling price of a product depends solely on the costs.

The problem with such a method of pricing is that the customers may not find the resulting price acceptable. Also, the competitors may have lower prices or offer better quality for the same price or less.

This flaw can be addressed by target costing, which seeks to estimate a target price at which the customers are willing to pay for a certain product and derives a target cost from there. The organisation will then have to apply value engineering to ensure that the actual cost will not exceed the target cost.

Another flaw is that conventional costing only considers current costs when there are the past and future costs that are relevant, in one way or another, to the product such as research and development costs. This flaw, on the other hand, can be addressed by lifecycle costing.

Lifecycle costing considers all costs relevant to the product, even those incurred before and after production. The link between target and lifecycle costing is that both use value engineering to reduce costs.

Both try to identify the parts of the product or the processes which do not add value to the customers and reduce the expenses in those areas. In that way, the organisation gets to maximise value and cut costs.

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