John Deer

Given the overall excellence of the John Deere Component Works (JDCW) cost accounting system, as indicated by:

1) JDCW already had three cost pools with appropriate cost drivers for each;

2) JDCW distinguished variable ("direct") and non-variable ("period") overhead; and,

3) JDCW did not fall in the trap of charging under-capacity utilization out to current production levels (i.e., they used "normal volume" in the denominators of their rate computations),

its cost accounting system's failure in the new competitive environment tells an even more dramatic story than otherwise. Clearly, just going to more extensive materials and machine hour costing bases did not solve the problems that have been revealed by the bidding process for the John Deere purchased parts!

So, as discussed in class, the key "missing link" in an already solid cost accounting system is that JDCW's cost drivers are ALL UNIT-BASED, WHEREAS MANY OVERHEAD COSTS (as it turns out, 41 % (!) of the total overhead costs) ARE ACTUALLY INDEPENDENT OF UNITS OR VOLUMES (and thus, not "driven" by labor hours, machine hours, or material costs). In order to help some understand the importance of this "dis-connect" or "lack of synchronicity," let me give you the following "stylized" and simplified example, just for conceptual/pedagogical purposes:

Suppose CDE Corp makes two products: X1 and X2. Both products require 1 machine hour per unit to produce. CDE produces 10,000 units of each per annum. So, the total machine hours incurred by CDE is 20,000 per annum. CDE produces X1 in 50 batches of 200 units each, whereas it produces X2 in just 2 batches of 5,000 units each. Setup for X1 and X2 are equally complex, and take 1 hour to complete. Thus, the total setups incurred by CDE is 52 per annum (50 for X1 and 2 for X2). [Expressing setups in terms of the "transaction driver" (i.e., # of setups) or "duration driver" (setup hours) makes no difference here as each setup is equally complex and takes about the same time to pull off.] The total setup cost is $52,000 (as reported by the accounting department).

CDE, however, allocates overhead to products by means of machine hours. Assuming that, for simplifying reasons, the $52,000 setup costs