Cost Accounting Method Recommendation

TO: John Deere Component Works

FROM: White Team 7

DATE: 1/31/2016

SUBJECT: Cost Accounting Method Recommendation 

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The issue with John Deere Component Works (JDCW) is that its bids on tractor components productions is out of line with those of the outsiders. Out of the possible 275 parts, JDCW was successful in bidding for only 58 parts which were low volume parts and in reality didn’t want. This was because of the discrepancy in their current cost accounting system.

The existing cost system is simple and easy to maintain and includes only three cost pools- overhead allocation rate based on direct labor, material dollars and machine hours. However, only using these pools is not accurate as it undermines the other production processes. The system also does not compute material usage variances and only issues reports that show how each area is operating rather than performing.

For JDCW, the production of low volume parts is less efficient than the high volume parts. However, in the standard cost system, it under costs the low volume parts and over costs the high volume parts, hence winning bids for only low volume parts. Thus, JDCW should shift to the ABC method, which costs the products accurately. This can be shown by costing product A103 under both the systems. It costs $22.81 under standard and $32.17 under ABC method. (Appendix)

Activity Based Costing method seems better and more compatible with the company. It is better in the following aspects. First, ABC properly penalizes low-volume products, the company know which business they don’t want. The ABC model could generate costs at either normal or par volume, making it easier to prepare par based quotes for the machining portion of the parts. Under this system, it would win more bids because it could be below the full costs calculated by the existing cost accounting system.