John Deere Component Works (JDCW) has been subject to a number of unsuccessful competitive bids due to the inherent deficiencies of their existing costing system. This has illustrated the importance of obtaining a thorough understanding of costs, and desirability of implementing a superior costing system.
This report contains:
* A general overview of the problems confronted by JDCW
* An analysis of the current standard costing system
* An exposition of Activity Based Costing (ABC)
* An evaluation of the strengths and weaknesses of each system * Recommendations
Deere & Company is an iconic American corporation, renowned for being the world’s leading manufacturer of agricultural equipment. Founded in 1837 by John Deere, the company has transcended its humble beginnings to become entrenched in the global commercial landscape of industrial manufacturing.
The buoyant economic conditions of the 1970s propelled the demand for Deere’s products following World War II. In response to this, the company invested over $1 billion in plant modernisation, expansion and equipment. Deere also diversified into off-road industrial equipment.
In order to create additional production space, Deere & Company separated elements of tractor production and relocated these divisions to new plants. John Deere Component Works was established as a subdivision of Deere & Company and used to produce a variety of component parts for the equipment divisions. JDCW was comprised of three divisions, including the Gear and Special Products Division.
Following the 1980s agricultural crisis, the Gear and Special Products Division bid on a subset of the 635 machine parts offered by Deere & Company in order to fill excess capacity. However, due to uncompetitive pricing, it was awarded only a fraction of the parts for which it bid.
This revelation was used as a platform from which to launch an analysis of the current standard costing system and the shortcomings inherent therein. The results obtained were used to support the proposition that the implementation of a more accurate alternative system of costing, such as activity based costing, is required.
The agricultural crisis rendered unstable the environment in which JDCW operated. Farmers were adversely impacted as their farm valuations and commodity prices plummeted. An inevitable concomitant of this was a decrease in the demand for JDCW’s products.
By the mid-1980s, JDCW’s production of parts was significantly reduced, compared to production levels in the 1970s. Excess capacity due to inefficient utilisation of the machines ensued, as the machines operated most effectively at high levels of production. As a result of the high costs imposed by spare capacity, JDCW consistently lost bids to outside suppliers because their pricing became comparatively uncompetitive.
Additional logistical problems were encountered as JDCW was not positioned in a geographically desirable location compared to its rivals. As such, JDCW had to incur expensive shipping costs which further reduced its profitability.
Internal transfer pricing between divisions also surfaced as an issue. The majority of sales made by JDCW were interdepartmental and transferred at full cost. A make-buy policy existed which mandated that in the event of excess capacity, internal bids should be assessed against external bids at direct, not full costs. This policy created discontent as divisions refused to purchase JDCW’s parts if the price exceeded that of external vendors.
The Gear and Special Products Division, undeterred by the capacity concerns, submitted a bid for 275 of the 635 parts offered by Deere & Company. However, they were only awarded 58 of the lower volume parts because of their high costs in relation to the other Deere divisions and outside suppliers....