Scenario:

Penco is excited by the results of your previous work and has asked you to review operations at Exciteco where it is an institutional investor.

Exciteco manufactures electronic components for export worldwide, from factories in Finland, for use in smartphones and hand-held gaming devices. These two markets are supplied with similar components by two divisions, Phones Division (P) and Gaming Division (G). Each division has its own selling, purchasing, IT and research and development functions, but separate IT systems. Some manufacturing facilities, however, are shared between the two divisions.

Exciteco's corporate objective is to maximise shareholder wealth through innovation and continuous technological improvement in its products. The manufacturers of smartphones and gaming devices, who use Exciteco's components, update their products frequently and constantly compete with each other to launch models which are technically superior.

Exciteco has a well-established incremental budgeting process. Divisional managers forecast sales volumes and costs months in advance of the budget year. These divisional budgets are then scrutinised by the main board and revised significantly by them in line with targets they have set for the business. The finalised budgets are often approved after the start of the accounting year. Under pressure to deliver consistent returns to institutional shareholders such as Penco, the board does not tolerate failure by either division to achieve the planned net profit for the year once the budget is approved. Last year's results were poor compared to the annual budget. Divisional managers, who are appraised on the financial performance of their own division, have complained about the length of time that the budgeting process takes and that the performance of their divisions could have been better but was constrained by the budgets which were set for them.

In P Division, managers had failed to anticipate the high popularity of a new smartphone model incorporating a large screen designed for playing games and had not made the necessary technical modifications to the division's own components. This was due to the high costs of doing so, which had not been budgeted for. Based on the original sales forecast, P Division had already committed to manufacturing large quantities of the existing version of the component and so had to heavily discount these in order to achieve the planned sales volumes.

A critical material in the manufacture of Exciteco's products is silver, which is a commodity which changes materially in price according to worldwide supply and demand. During the year supplies of silver were reduced significantly for a short period of time and G Division paid high prices to ensure continued supply. Managers of G Division were unaware that P Division held large inventories of silver which they had purchased when the price was much lower. Initially, G Division accurately forecasted demand for its components based on the previous years' sales volumes plus the historic annual growth rate of 5%. However, overall sales volumes were much lower than budgeted. This was due to a fire at the factory of their main customer, which was then closed for part of the year.

Reacting to this news, managers at G Division took action to reduce costs, including closing one of the three R&D facilities in the division.

However, when the customer's factory reopened, G Division was unwilling to recruit extra staff to cope with increased demand; nor would P Division re-allocate shared manufacturing

facilities to them in case demand increased for its own products later in the year. As a result, Exciteco lost the prestigious preferred supplier status from their main customer who was unhappy with G Division's failure to effectively respond to the additional demand. The customer had been forced to purchase a more expensive, though technically superior, component from an alternative manufacturer.

Penco's institutional shareholders' representative, recently appointed to the board, has asked you as a Performance Management Expert for your advice:

'We need to know whether Exciteco's budgeting process is appropriate for the business, and how this contributed to last year's poor performance.'

However, the shareholder representative did also acknowledge that external factors had contributed to Exciteco's poor performance in the last year and suggested that it would be useful if Exciteco's performance reports distinguished between variances which had resulted from its own operational performance as opposed to external circumstances which could not have been anticipated when the budgets were produced.

You noted that many organisations address this issue by analysing variances into planning and operational elements.

Critically discuss key concepts, features and importance of cost accounting,

Evaluate the weaknesses in Exciteco's current budgeting system and whether it is suitable for the environment in which Exciteco operates.

Evaluate the extent to which Exciteco's poor performance for the last year can be attributed to external factors.

Discuss the potential benefits to Exciteco of analysing variances into planning and operational elements.