Zero-based budgeting and target costing are two important accounting concepts that deal with budgeting and planning, respectively. One of the primary goals of both accounting methods is to achieve clarity in managing the expenses a company incurs. Additionally, both target costing and zero-based budgeting help to facilitate the management decision-making process.
Zero-based budgeting is a method for managing a budget that requires accounting of all expenses in a new period. Under zero-based budgeting, every aspect of the budget begins a period at zero. This system takes account of every expense and revenue within the period without relying on a comparison to the previous accounting period. Thus, the emphasis of zero-based budgeting is not to align the current period’s numbers with those of previous periods. Rather, zero-based budgeting treats every period as an independent entity.
Benefits and Drawbacks of Zero-Based Budgeting
One of the main problems associated with zero-based budgeting is the amount of time required to carry it out. Zero-based budgeting is more time consuming than traditional methods of accounting, often requiring the investment of considerable time after the period in question has ended. On the other hand, zero-based accounting also has the ability to lower costs for an organization by sidestepping blanket increases or decreases from previous accounting periods.
Target costing is a tool for managing costs in an organization. The goal of target costing is to control the cost of a product both initially and over the lifetime of the product. Target costing is a method of budget planning intended to meet a company’s profit goals over the long term. Target costing also attempts to lower a company's costs in the manufacturing and maintenance stages and to determine the price of a product without having to go back and spend time renegotiating the price at a later date.
How Does Target Costing Happen?
Compared to traditional pricing methods, target costing is somewhat of a reverse method of pricing a product. Many Japanese companies use target costing. According to “Target Costing: The Next Frontier in Strategic Cost Management,” Nissan, Toyota and Toshiba use target costing. Traditional costing begins with an estimation of costs, including product, administrative, distribution and marketing costs. After estimating these costs, traditional costing arrives at a product price. Target costing, however, begins by determining the selling price of the product and works backward to subtract target income.