Cashew Coast Processing: Applying Management by Exception to Three Units
Cashew Coast Processing, Kollam, runs three units and reports monthly variances. The standard is 24 kg of kernels from every 100 kg of raw nuts at ₹9,000 per 100 kg, giving a standard kernel cost of ₹375 per kg. Last month Unit A processed 50,000 kg of nuts, paid ₹9,800 per 100 kg and recovered only 22 kg per 100 kg. Unit B's packing material cost was 3% above budget, but its direct labour was 12% above budget because of weekend overtime. Unit C's export realisation was 6% below budget after the rupee appreciated, although its volume was 15% above budget. The managing director has time to investigate only two issues before the board meeting and has set a tolerance limit of 5% for any variance. Unit managers are paid a bonus linked to favourable variances.
1. Using management by exception and the 5% tolerance, which two variances should the MD investigate? Support your choice with figures.
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Unit A - investigate first (critical point)
- Price variance: extra ₹800 per 100 kg × 500 lots = ₹4,00,000 adverse.
- Yield variance: 2 kg lost per 100 kg × 500 = 1,000 kg of kernels × ₹375 = ₹3,75,000 adverse.
- Total ≈ ₹7.75 lakh adverse, or an actual kernel cost of 49,00,000/11,000 = ₹445.45 against ₹375.
This is far beyond both the 5% tolerance and the materiality of any other item. Yield is the critical point of a cashew unit - a 2 kg fall per 100 kg is an 8.3% loss of the very output being sold.
Unit B - investigate second
- Labour is 12% above budget, outside the 5% tolerance, and overtime is controllable by scheduling and rostering.
- Packing material at 3% is inside tolerance and should be noted, not investigated. Chasing it would waste the MD's time and irritate a manager over noise.
Unit C - do not investigate yet
Realisation is 6% below budget, but the cause is rupee appreciation, an environmental factor. Volume is 15% above budget, so total contribution may still be favourable. Investigating the export manager before checking the net effect would confuse an uncontrollable price effect with performance.
2. For Unit C, is this a case for corrective action or for revising the standard? Consider the bonus scheme.
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Revise the standard and redesign the measure, not a corrective action against the manager.
Reasoning
- The rupee appreciation is external and not controllable at unit level. A manager cannot be expected to influence it, and the principle of responsibility accounting says a manager should be judged on what the manager controls.
- The volume gain of 15% may more than offset the 6% realisation fall. If so, the unit's total contribution is favourable and the reported variance is misleading.
- Because the bonus is tied to favourable variances, penalising C for an exchange-rate effect invites dysfunctional behaviour: refusing profitable export orders, speculating on currency, or delaying shipments to shift the loss into the next month.
Recommended action
- Restate C's performance on contribution and volume, and separate the exchange-rate variance from the operating variance.
- Hedge 50–60% of the forward dollar exposure with bank forwards so the realisation range is known in advance.
- Revise the standard realisation for the next period to reflect the new exchange rate, and disclose the revision and its reason in the variance report.
- Keep the bonus linked only to controllable variances, with uncontrollable items shown separately as a memo item.
3. Critique the current control system and suggest improvements, keeping the MD's limited time in mind.
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Weaknesses
- Monthly only: raw nut prices, yield and overtime move daily. By the time a monthly report is read, the buying decision is already sunk.
- No prioritisation: the report gives equal weight to a 3% packing variance and a ₹7.75 lakh loss at Unit A, which is the opposite of management by exception.
- Punitive bonus linkage: managers have an incentive to hide adverse variances or classify them as uncontrollable, so the data the MD sees may be distorted.
- No root-cause or follow-up: a variance figure without a reason, a responsible person and a review date cannot be corrected.
Improvements
- Daily yield and price report from Unit A; weekly overtime report from Unit B; monthly report for the rest.
- Set tolerance limits by item - zero tolerance on yield loss, 3% on packing, 5% on labour, with exchange-rate items shown separately.
- Use a short exception report: variance, cause, responsibility, action, deadline, owner.
- Link bonus to controllable variances only.
- Investigate the cause at Unit A before punishing: raw-nut quality, machine calibration or worker skill. Corrective action could be a supplier change, calibration or retraining, followed by a review after 30 days. Control must be forward-looking, not a post-mortem.