Though Vershire Company does not have explicit problems, it has a number of weaknesses in its systems. First is in the style of their budget preparation. Their sales budget preparation had little flexibility when it was already approved before the start of the year and were already fixed objectives.
This kind of system has an advantage of pushing its managers to strive and meet the objective budgets.
However, it is a disadvantage when there are unforeseen relevant costs that are inevitable and must be incurred during the year since there is a meticulous process in covering these costs, which also requires an explanation to the bosses why the budgets have not been met. Second is how the company treats its Plant/Manufacturing Department – being a Profit Center. This department only accomplishes orders that the Sales Department dictate, manufacturing the quality products at the lowest reasonable cost possible considering the nature of the competitive industry.
However, their performance is evaluated through the profits that the department generates via its cost standards and cost reduction targets which is determined by the Industrial Engineering department. The assignment of the department as a cost center may be inconsistent with its objectives since the department itself is not the one determining the price and selling the products. Third is how the performance of the plant managers are evaluated. Since the Plant Department is treated as a profit center, the plant managers’ promotion and compensation is based on their profit performance.
There can be a misalignment in the objectives in this setup because while the plant managers strive to put down the cost to achieve higher profits given the price set, they may sacrifice quality by choosing the lowest cost of materials or labor for production. In essence, the cost can be varied based on the price. Moreover, the performance of the plants are compared to each other regardless of their differences in their production. This is an inappropriate method of comparison and evaluation since one cannot totally compare plants with different objectives and environment operating in because there is no basis or a standard performance.
Options and Recommendation Vershire Company can revise its budgeting system to an Incremental Budgeting System wherein an initial estimated budget is presented at the start of the year and can be flexible enough to accommodate changes within the year if necessary. Another option is to continue on the current budgeting system, however make necessary adjustments such as providing allocation or an allowance for contingency costs and allowing proposals for changes in the budgets for the next period to be presented during regular performance reports/reviews.
This is a better option since it will still motivate the managers to adhere to the budget while allowing for some flexibility for unforeseen changes in the budget. Another action that Vershire Company could take is changing how the Plant Department is treated, from being a Profit Center to an Expense Center to more appropriately match its objectives in lowering the company’s expenses as the product quality allows. Measurement of performance is not anymore how much profit the plant generates but how fast it manufactures the products, how low the cost of the materials and labor are, and the quality of its products.
Treating the Plant Department as an Expense Center can give way to the Sales Department to be treated as a Profit Center wherein they can price the product in accordance to the costs set by the plant. Incentives along with this are the promotion and compensation of the sales managers tied with their profit performance. Such can align each department in its appropriate objectives and will be motivated to achieve it, having their goals congruent to that of the company’s.