John Deere Case Analysis

QUESTION 1

What are the strengths and weaknesses of the current costing system (data on exhibit 9)?

ANSWER 1Weakness

• System was ineffective for costing and bidding individual parts.

• The large dispersion (ranging from 50- 60% on some parts and 200-300% on others questions the validity of standard cost system for determining cost of individual parts.

• Machine hours are not based on product unit thus leading to erroneous allocation of costs.

• Budgeted overhead rates computed on actual past charges ( and asking the question whether there will be any changes) this was again not reliable as the production volume was changing year after year.

• Employee benefit based on machine hours.

Strengths

• The strengths of the current costing system lie in its simplicity of allocations. The allocation of overhead is done on the basis of direct labor and direct machine hours.

• Required less computing effort.• Satisfactory at aggregate level due to large volume of products

• With the increased usage of automated machines designed method of adopting ACTS (actual cycle time standard) rate was a good approach.

• System was evolved to take care of period overheads and product overheads.

QUESTION 2

What are the strengths and weaknesses of the suggested costing system (data on exhibit 10)?

ANSWER 2

Weakness

• Requires a complete modification of the existing system. A lot of rework is needed to identify drivers, collect data and implement ABC.

• Still there are some costs (administrative etc.) which cannot be traced down to activity level.

• Too much of details can lead to diffusion of decisions.

• Time consuming.

Strengths

• Overheads can be better allocated based on activities ( DL support, machine operations, setup hours, production order activity, material handling, parts administration and general and administrative overheads.)

• Because of tracking of costs using activities variations in cost allocation can be reduces.

• Drivers for activities can be identified and monitored for better decision making.

• Improve profitability by better depiction of product life cycle costs.

QUESTION 3

Reasons why the contingency situation arises?

ANSWER 3

Contingency situation arises due to the following reasons:

•Improper allocation of costs•Improper allocation of overheads•Wrong identification of cost driver

QUESTION 4

Calculate the cost of A103 based on current cost system and proposed cost system and explain

ANSWER 4

STANDARD METHOD:

Total Cost = Direct Labor + Direct Materials + Overhead

Direct Labor = .185 labour hours x 12.76/hr = 2.36

Direct Materials = 6.44

Overhead = Direct + Period

Direct Labour OH = 2.05 x .185 x 12.76 = 4.89

Machine Hours OH = 27.56 x .310 = 8.54

Materials Handling OH = .097 x 6.44 = 0.62

Total Cost (per 100 parts) = $22.88

ANSWER 4

ABC METHOD:

Total Cost = Direct Labor + Direct Materials + Overhead

Direct Labor = .185 x 12.76 = 2.36

Direct Materials = 6.44

Overhead:

Labour Support OH = 1.11 x .185 x 12.76 =2.62

Machine Operation OH = (8.99 + 6.71) x .031 = 5.15

Machine Setup OH = (33.76 x 4.2 x 2) / 80 = 3.54

Production Order OH = (114.27 x 2) / 80 = 2.86

Materials Handling OH = 19.42 x 4 = 0.97

Parts Admin. = (487 x 1) / 80 = 6.09

General and Admin. = (.091 x 12.76) x (.187) + 21.23 = 2.14

Total Cost (per 100 parts) = $32.21