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The following report is a consultation analysis of John Deere Component Works costing structure.

Included is a discussion of the existing cost system as well as a comparison with the proposal of the Activity ased Costing system. The solutions to the re!uired discussion issues have "een thoroughly prepared and are here"y included.

Problem Statement:
The demand for John Deere Component Works (JDCWs) products has suffered due to the collapse of farmland value and commodity prices. A number of continuous failures in JDCWs competition for bids have placed an onus upon mana ement to !uestion its current costin methods. As a result" an analysis must be made re ardin the current costin methods in order to determine their validity and to aid the company in adoptin a more sound costin system.

John Deere Component Works #as a subdivision of John Deere and Company #hich dealt e$clusively #ith the manufacturin of tractor component parts. %y the mid &'()s" JDCW found that its available e$cess capacity #as increasin . To neutrali*e this problem JDCW attempted to take advanta e of the efficiencies of its ne#ly ac!uired automatic turnin machines by biddin on parts offered from #ithin the company. This lead to a direct bid of +,- of the ./- parts offered by John Deere and Company. 0ut of the possible +,- parts" JDCW #as successful in the biddin of only -( parts" #hich happened to be lo# volume parts. This became a concern for JDCW because its aim #as to attain the bids that offered the hi her volume parts" as to allo# it to take advanta e of its machines hi h volume efficiency. 1n reality" the problem for JDCW #as not the number of bids they received" but the alarmin discrepancy #ithin its bid prices and that of its competitors. JDCW reali*ed that somethin #as #ron in their accountin system" and decided to revie# its current cost structures. The e$istin cost system is stron in that it is simple and easy to maintain. 0verhead allocation #as based on direct labor hours" machine hours and material dollars. The use of standard costs allo#s JDCW to compare actual labor overhead costs #ith bud eted rates in order to determine the follo#in years overhead costs. 1n fact" the old cost structure #orked !uite #ell in the past since the company produced a speciali*ed line of products that #as periodically consistent. This in the aspect that the products differed little or not at all in both unit and volume. 2o#ever" this cost method does not provide the best system for JDCWs cost allocation. %y usin only three overhead rates the present system rossly undermines the true production costs since other activities of the production process are not ackno#led ed. The system also fails to compute material usa e variances" #hich only further discredits the accuracy of the accountin cost structure. 3or more accurate measure of material usa e" the !uality assurance department must include this variance calculation in its #eekly report. A further #eakness is that the accountin department issues reports that only indicate ho# each area operates" rather than evaluatin the performance of each area" #hich #ould prevent a constriction in cost efficiency. These #eaknesses prevent JDCW from accurately accessin its true costs. 4ssentially" #ith the current cost system" mana erial analyses is hi hly fla#ed due to a lack of crucial in5depth cost information. 3ailures in the e$istin cost system are due to several factors. 3irst of all" #hen JDCW calculates its standard direct labour" direct machine hours" and total overhead" the volumes are calculated on a lon 5term basis. 2o#ever" if the actual production volume is not for the lon term it becomes a problem" this in the sense that it is difficult to modify the system as to accommodate for any increases or decreases in the production demand. 6econdly" #hen JDCW updates its overhead rates for the upcomin year" its forecasts are based on the previous years fi ures. This system is oin to result in serious inaccuracies" especially #hen the company attempts to tackle production volumes that are completely 7alien8 to the companies historical production trends. An e$ample bein the biddin attempt on the +,- parts. This reflects the companys constricted cost system that revolves around a limited


product diversity trend" instead of allo#in for a correct forecast of diverse products that more realistically represent the volatile demand of the industry. 2ence" it #ould only be lo ical to state that the JDCWs yearly updated overhead rates are inaccurately calculated. As foreshado#ed" the standard accountin cost system used by the company is si nificantly out of date. This is because the system #as ori inally desi ned to handle a direct labor intensive production process #ith little overhead costs. 2o#ever" #hen the company chan ed its production process to a more automated system" it simultaneously increased its overhead costs. This dramatic overhead increase #as embodied throu h increases in supervision" maintenance" electricity" and setups. 6ince more overhead costs #ere no# bein incurred" a ne# system had to be implemented to adapt to this ne# environment. These #eaknesses further support the fact that JDCWs bids #ere continuously miscalculated in relation to their competitors. 9sin the e$istin system" mana ement at JDCW continually under5costs its lo#5volume parts and over5costs its hi h volume parts. 1f its bids #ere to be based on the A%C method" JDCWs costs #ould be more accurate" and it #ould most likely ac!uire a hi her number of bids. 6ince the production of lo# volume parts is less efficient than hi h volume parts" it is in the interest of JDCW to attain hi her volume bids. 2o#ever" since its 6tandard Cost system is fla#ed" the bid proposals submitted by JDCW are also fla#ed. To clearly illustrate this point" a comparison of the t#o cost systems for part A&)/ hi hli hts the discrepancy. 9nder the 6tandard Cost system" part A&)/ costs :++.() #hile under the A%C method" the part costs :/+.&(. (6ee Appendi$ %)

1t is imperative that JDCW chan e from 6tandard Costin to Activity %ased Costin . This is essential because the 6tandard Cost system only #orks #ell in a stable production environment. With the advent of ne# technolo ies bein employed at JDCW" the 6tandard Cost system is incompatible and therefore makes it difficult for JDCW to attain precise fi ures. The A%C method" on the other hand" provides mana ement #ith more accurate cost allocations" enablin it to make bids that truly represent its production costs. 6ince the standard system bases its costs on volume related overhead rates" costs that are product5related" batch5related or facility sustainin are not accurately allocated. 1f total overhead costs are based solely on a volume5related basis" distortions #ill result because not all costs are driven by production volume. (6ee Appendi$ A) With the A%C method" this problem is rectified. 6ince the A%C approach assumes that overhead costs can be traced directly to products" the total overhead costs are better allocated to the products" ivin JDCW a closer indication of the behaviour of its overhead costs. The A%C method allo#s overhead costs to be assi ned to products accordin to the proportion of demand that each product places on that activity. 2ence" creatin more accurate product cost estimates. 1n implementin an A%C system" man ers #ill be motivated to consider a different set of actions from that of the old cost system. They #ill be removed from relyin solely on previous years fi ures and #ill most likely be involved in a more unstable production environment. 6pecifically" mana erial decisions #ill include modifications of pricin " product mi$es" and customer mi$es; enhancin supplier and customer relations; improvin the desi n of products and services; and performin activities more efficiently. 0verall" mana ers that s#itch to an A%C approach #ill find the e$tra burden of plannin and maintainin a #ider variety of cost pools.


The issue that made JDCW !uestion its cost structure is the fact that its bids on part productions #ere out of line #ith those of its competitors. A closer look at the problem reveals that indeed the 6tandard Cost system currently in place is outdated. A more accurate system is needed to remain competitive" and in this situation" the A%C approach is most commendable.

The John Deere Company has been operatin in the farm e!uipment industry for &.+ years. John Deere Component Works #as established as a separate division of the John Deere Company durin the &',)s as continued ro#th created the need for increased production space. JDCW had been structured to be a captive producer of parts for Deeres e!uipment divisions" particularly tractors. Thus it had to produce a #ide variety of parts #hose volume #as relatively lo#. Due to lo# capacity durin the mid &'()s" the <ear and 6pecial =roducts Division of JDCW decided that comple$ machined parts offered a promisin niche. 6ince this process re!uired more automated machines" more overhead costs #ere to be incurred. As part of the strate y of the <ear and 6pecial =roducts Division" it set out to market machine parts to the outside #orld. 1n order to obtain production orders <ear and 6pecial =roducts decided to bid on +,- out of the ./- parts that Deere and Company offered. They soon found out" ho#ever" that its bid prices #ere not in line #ith those of its competitors" and since the key to successful competition in the outside #orld is price" JDCW had to rethink its pricin strate ies.

ANTECEDENTES La !om"a#$a %o&n Deere &a esta'o o"eran'o en la in'(stria 'e ma)(inaria a*r$!ola "ara +,- a#os. %o&n Deere Obras 'e !om"onentes se estable!i/ !omo (na 'i0isi/n se"ara'a 'e la !om"a#$a %o&n Deere '(rante la '1!a'a 'e +234 !omo (n !re!imiento !ontin(o !rea'o la ne!esi'a' 'e mayor es"a!io 'e "ro'(!!i/n . %DC5 se "roye!t/ "ara ser (n "ro'(!tor !a(ti0o 'e "ie6as "ara las 'i0isiones 'e e)(i"os 'e Deere 7 es"e!ialmente tra!tores. Por lo tanto7 ten$a )(e "ro'(!ir (na am"lia 0arie'a' 'e "artes !(yo 0ol(men era relati0amente ba8a . Debi'o a la ba8a !a"a!i'a' a me'ia'os 'e +294 7 la Di0isi/n 'e Pro'(!tos Es"e!iales 'e %DC5 ear y 'e!i'i/ )(e las "ie6as me!ani6a'as !om"le8as o:re!en (n ni!&o "romete'or. Da'o )(e este "ro!eso re)(iere m;)(inas m;s a(tomati6a'as 7 m;s *astos *enerales 'eb$an ser e:e!t(a'os . Como "arte 'e la estrate*ia 'e la Di0isi/n 'e Pro'(!tos Es"e!iales ear y se 'is"(so a 0en'er "ie6as 'e la m;)(ina !on el m(n'o e<terior . Con el :in 'e obtener (na or'en 'e "ro'(!!i/n 'e en*rana8es y Pro'(!tos Es"e!iales 'e!i'i'o &a!er (na o:erta en -3= 'e las ,>= "ie6as )(e Deere an' Com"any o:re!i'os. Pronto se 'es!(bri/ 7 sin embar*o7 )(e los "re!ios 'e o:erta )(e no estaban en l$nea !on los 'e s(s !om"eti'ores 7 y 'a'o )(e la !la0e "ara !om"etir !on 1<ito en el m(n'o e<terior es el "re!io7 %DC5 teni'o )(e re"lantear s(s estrate*ias 'e "re!ios

APPENDI? A O@ERAEAD COST POOLS Direct >abor ?achine 0perations ?achine 6etups =roduction 0rder ?aterials 2andlin =arts Administration <eneral and Administrative 9nit 9nit %atch %atch %atch =roduct56ustainin 3acility56ustainin

APPENDI? B STANDARD @ERSUS ABC COSTIN STANDARD METAOD Total Cost A Direct >abor B Direct ?aterials B 0verhead Direct >abor A .&(- labour hours $ &+.,.Chr A Direct ?aterials A 0verhead A Direct B =eriod Direct >abour 02 A +.)- $ .&(- $ &+.,. A ?achine 2ours 02 A +,.-. $ ./&) A ?aterials 2andlin 02 A .)', $ ..@@ A Total Cost C"er +44 "artsD ABC METAOD Total Cost A Direct >abor B Direct ?aterials B 0verhead Direct >abor A .&(- $ &+.,. A Direct ?aterials A 0verheadD >abour 6upport 02 A &.&& $ .&(- $ &+.,. A ?achine 0peration 02 A ((.'' B ..,&) $ .)/& A ?achine 6etup 02 A (//.,. $ @.+ $ +) C () A =roduction 0rder 02 A (&&@.+, $ +) C () A ?aterials 2andlin 02 A &'.@+ $ @ A =arts Admin. A (@(, $ &) C () A +..+ -.&/.-@ +.(. ).', ..)' +./. ..@@ @.(' (.-@ )..+ E--.99 +./. ..@@ BOR PART A+4>

<eneral and Admin. A (.)'& $ &+.,.) $ (.&(,) B +&.+/ A Total Cost C"er +44 "artsD

+.&@ E>-.-+