Managerial Accounting: Case Study – John Deere Overhead Allocation/Costing John Deere Component Works A 1. How did the competitive environment change for JDCW between the 1970s and 1980s? After three decades of massive growth in products, volumes, manufacturing and footprint, John Deere faced a rapidly changing environment. The 70’s were a time of diversification and expansion with a primary strategy of manufacturing all components internally.
This growth and critical mass allowed for a simple costing system to be developed over time. This system worked ok for their needs of the day, it appeared that it did not impede their ability to optimize manufacturing and efficiency. Entering the 80’s the world changed for Deere, farm land prices and agricultural commodity prices dropped significantly, in fact it was the worst and most sustained agricultural crisis since the great depression. This situation was exacerbated with a high US dollar impacting export sales.
Sales and production was reduced dramatically, volumes cut more than in half. John Deere had to react to this market change with significant staffing cuts, massive reorganization and a survival mode. 2. What caused the existing cost system to fail in the 1980s? What are the symptoms of the cost system failure? The original system was built when Deere was growing and only focused on supporting that growth through vertical integration, supplying all of their own components.
The system itself originally only had two cost drivers for overhead allocation, direct labor and materials based overhead, both further broken out into direct (variable) and period (fixed). Later in 1984 they added machine hours to allocate overhead as they optimized their operations and many multi-machines per operator. This costing system was also structured around annual reviews for historical volumes (normal volumes) that smoothed out the variation in build volumes and a process study that also used the annual volumes.
This system had serious limitations, applying 34% of all overhead based on labor hours in a business where the direct labor did not in fact represent the actual drivers of the costs. The other 66% of overhead was allocated using machine hours, the fact that such large values were allocated in so few categories left room for error and using historical volumes did not accurately cost the current environment. There were a few important symptoms of this costing failure; losing high volume work and winning the low volume work, internal divisions started buying outside as they were not competitive.
They measured the business on the whole rather than at a part level. 3. How were the limitations of the existing cost system overcome by the ABC system? The ABC system did a much better job of accurately allocating costs based on the activities on the shop floor that caused the costs. The ability to accurately separate the actual costs of direct manufacturing from all the support activities in a business where support (set ups, orders, mat’ l handling, admin, etc. is significant. The ABC system used experienced managers input and good data, it allowed the management of the factory to not just better represent their costs and compete but also to better manage machine and group loading, to better predict and control the specific drivers of costs in greater detail. 4. Make a cost sheet which compares the cost of product A103 under the existing cost system and under the ABC approach. In the old system the part was over costed significantly.
