Analysis of Costing Systems: John Deere Component Works Report

This report provides a comprehensive managerial analysis of the John Deere Component Works, examining its transition from a traditional standard costing system to an Activity-Based Costing (ABC) system. The analysis begins by outlining the challenges faced by JDCW, including declining sales and the need for cost reduction and operational adjustments. It then delves into the limitations of the existing standard costing system, which proved ineffective in accurately allocating overhead costs, leading to discrepancies in bidding and costing individual departments. The report highlights the implementation of the ABC system as a solution, detailing its advantages in allocating overheads more efficiently and providing insights for improved decision-making. The report compares the ABC system to the traditional system, demonstrating the cost differences and the benefits of the ABC system in terms of detailed cost allocation and its ability to consider various factors beyond direct costs. The actions stimulated by the ABC system, such as changes in production size, restructuring of departments, and adoption of just-in-time purchasing, are also discussed. The report concludes with a systematic analysis of the ABC system's implementation and the changes that were implemented to make production less costly and improving the cost allocation of the organization.

Running head: MANAGERIAL ANALYSIS OF JOHN DEREE COMPONENTS WORKS
MANAGERIAL ANALYSIS OF JOHN DEREE COMPONENTS WORKS
Name of the Student
Name of the University
Author Note

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MANAGERIAL ANALYSIS OF JOHN DEREE COMPONENTS WORKS
Table of Contents
John Deere Component Works (A)..............................................................................................2
A.1................................................................................................................................................2
A.2................................................................................................................................................2
A.3................................................................................................................................................3
A.4................................................................................................................................................4
A.5................................................................................................................................................4
John Deere Component Works (B)..................................................................................................4
B.1................................................................................................................................................5
B.2................................................................................................................................................5
B.3................................................................................................................................................5

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MANAGERIAL ANALYSIS OF JOHN DEREE COMPONENTS WORKS
John Deere Component Works (A)
A.1.
John Deere Components Works (JDCW) was established to support the main business of
tractor production in 1970s. The notable change in the competitive environment for the
organization was the decrease in demand due to collapse in farmland products and commodity
prices, which led to a decline in the sales of its product. In order to cope with this situation,
JDWC had to adjust its operations procedures by reducing its operations, decreasing costs in
necessary areas and restructuring its production process. To sustain its business, it also had to
manufacture parts of its products for its competitors and other businesses in the industry.
In different environments like the ones mentioned above, management accounting
systems must provide information about aspects like productivity of the workers, absorption of
the costs, and profitability of the production levels and efficiency of the individual departments
to support effective decision-making1.
A.2.
Existing Cost System
The current system for the turning machine area focused on setting up standards for the
system as a whole. It dealt with aspects like establishing standards based on quality aspects like
labor efficiency, production value and responsibility accounting. Other than these, overheads
1 THE ROLE OF MANAGEMENT AS A USER OF ACCOUNTING INFORMATION: IMPLICATIONS FOR
STANDARD SETTING (Brigitte EIERLE, Wolfgang SCHULTZE, 2013)
S t a n d a r d C o s t Direct Labor (only run
time)
Direct Material
Overhead (Direct +
Period) applied on
direct labor, material
dollars and on ACTS
machine hours

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MANAGERIAL ANALYSIS OF JOHN DEREE COMPONENTS WORKS
were established using various rates like labor hours. These overheads evolved over time by
using relevant items for setting overhead rates like machine hours, material usage and productive
hours. While this system worked well on an overall basis for the organization, it proved to be
ineffective for costing and bidding individual departments. There were major differences
between the costs incurred by other vendors and JDCW due to the standard costing system in
place. This necessitated the implementation of a new system, which would provide more
accurate information related to absorption of overheads.
A.3.
The standard costing system used drivers like direct material and labor for the allocation
of overheads. After 1984, it began to use machine hours for the allocation of overheads. The
major reason behind the failure of this system was the method of allocation of overheads. It
allocated most of the overheads based on labor hours and machine hours. While it worked well
for the organization as a whole, it could not provide the necessary details required for bidding
and costing of individual departments. The evidence for the failure of the system is provided in
the analysis of Williams and Vintila who observed a difference ranging from 50% to 300% in the
vendor quotes. Under the current system, the estimated costs of JDCW exceeded the prices of the
vendor’s by 35% that made the production unprofitable by a high margin. The number of ways
in which overheads were allocated were also very limited to the existing possibilities. Hence, due
to these factors, the standard costing system used by the entity became irrelevant in the late 80s2.
There was a need for a method that would suggest appropriate measures to make production
profitable.
2 Is Standard Costing Still Used? Evidence From Turkish Automotive Industry (A. Cemkut Badem , Emre Ergin &
Colin Drury, 2013)

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MANAGERIAL ANALYSIS OF JOHN DEREE COMPONENTS WORKS
A.4.
Proposed ABC system for the machine area
The limitations of the existing cost system were overcome by the ABC cost system by using
seven overhead rates for allocation and measuring activity, which is significantly more than the
two used by the old system. This improved the efficiency of allocation of overheads resulted in
steps such as eliminating unnecessary aspects like secondary operations, sequencing jobs to
reduce unproductivity and change in designs which increase the production of high-volume
parts3.
A.5.
On comparing the ABC costing system with the traditional costing system, it is evident
that the costs calculated by using the ABC system are more than that calculated by the traditional
costing system. On a rate of costs per 100 products, the product cost is $22.18 when compared to
the cost of $32.20 under the ABC costing system. This is due to the more detailed and efficient
allocation of overheads by the ABC system
John Deere Component Works (B)
3 Activity Based Costing (ABC) In The Public Sector: Benefits And Challenges (Emmanuel K. Oseifuah, 2014)
Proposed
ABC cost
system
Direct Material
Direct Labor
Overheads allocated on the basis of direct labor support,
machine operation, setup hours, production order
activity and administrative costs

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MANAGERIAL ANALYSIS OF JOHN DEREE COMPONENTS WORKS
B.1.
The ABC system of costing provides insights into various aspects like the type of
material to be used in production, quantity that should be produced at one time and the costs that
can be reduced by reducing the number of setups, material handling and improving the
processing to offset the cost of holding materials. Other details include changing the product mix
to improve the efficiency in production. The ABC system provides these insights because of the
advantages that it has over the existing system of cost. When the indirect costs are more in
number and variety than the direct costs, ABC system has proven to be more effective than
traditional systems of cost. Another advantage that the ABC system has is its ability to take
many factors into consideration like the quality of the material being used, efficiency of the
machines, quality of the process and other technical aspects which cannot be taken into
consideration using the traditional systems of cost4. It has been proven that the allocation of
overheads is more efficient using ABC than standard systems of costing5
B.2.
The actions that are being stimulated by ABC include changing the size of the
production. It suggests that the quantity of the production should be increased to gain advantage
of the allocation of the overheads. Other significant changes that have been made due to the
usage of ABC costing system is the proper demarcation of its business into five units and
departments were reorganized from processes to manufacturing units. Adopting just-in-time
purchase system, reducing lead times, improving quality and decreasing costs on an overall
basis. In addition to these, a marketing department was appointed at the factory level. These
changes are aimed at making the process of production less costly and improving the cost
allocation of the organization.
4 Current Trends Of Application Of Activity Based Costing (ABC): A Review (Nitin Kumar, Dalgobind Mahto,
2013).
5 Lean Manufacturing: Costing The Value Stream (Patxi Ruiz‐de‐Arbulo‐Lopez, Jordi Fortuny‐Santos, Lluís
Cuatrecasas‐Arbós)

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MANAGERIAL ANALYSIS OF JOHN DEREE COMPONENTS WORKS
B.3.
William and Vintila’s approach to developing, implementing and insuring of the ABC
cost system can be said to be very systematic. It is done in a scientific manner with enough
emphasis on the areas identified as required for change. The process is carried out in a very
scientific way by initially identifying the limitations of the existing process. The new ABC
method is identified and developed in a manner in which the limitations of the existing system
are overcome.
After going through the process implemented by William and Vintila, it can be inferred
that managing change is a scientific and structured process. It should start with identifying the
need for the change in the existing process6. After which, the new method should be developed
to overcome the limitations of the existing system. Pen ultimately, a comparative analysis should
be undertaken to compare and understand the benefits provided by the new system. If the results
are favorable, then the new system should be implemented.
6 Managing Change In Tourism Destinations: Key Issues And Current Trends (Mariani M, Buhalis D, Longhi C and
Vitouladiti O, 2014).

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MANAGERIAL ANALYSIS OF JOHN DEREE COMPONENTS WORKS
References
“Activity Based Costing (ABC) In The Public Sector: Benefits And Challenges” (Emmanuel K.
Oseifuah, 2014)
Current Trends Of Application Of Activity Based Costing (ABC): A Review (Nitin Kumar and
Dalgobind Mahato, 2013)
Is Standard Costing Still Used? Evidence From Turkish Automotive Industry (A. Cemkut
Badem, Emre Ergin and Colin Drury, 2013)
Lean Manufacturing: Costing The Value Stream (Patxi Ruiz‐de‐Arbulo‐Lopez, Jordi Fortuny‐
Santos, Lluís Cuatrecasas‐Arbós, 2013)
Managing Change In Tourism Destinations: Key Issues And Current Trends (Mariani M,
Buhalis D, Longhi C and Vitouladiti O, 2014)
THE ROLE OF MANAGEMENT AS A USER OF ACCOUNTING INFORMATION:
IMPLICATIONS FOR STANDARD SETTING (Brigitte EIERLE, Wolfgang SCHULTZE1, 2013)