Harvard Business School
Teaching Case
Polysar Ltd.
AGENDA
Polysar Ltd.
• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing
AGENDA
Polysar Ltd.
• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing
POLYSAR
• Canada’s largest chemical company.
• The Rubber Group accounts for 46% of
Polysar’s sales.
• Primary products for this group are butyl
and halobutyl.
• Principal customers for these products
are tire manufacturers.
• Rubber Group has two divisions
– NASA (North America & South America)
– EROW (Europe & elsewhere)
POLYSAR
• Butyl is manufactured by NASA at its
Sarnia 2 plant, and by EROW at its
Antwerp plant.
• Sarnia 2 is a relatively new facility,
dedicated entirely to butyl production.
• The Antwerp plant makes both butyl and
halobutyl.
• EROW’s demand exceeds its
manufacturing capacity, so EROW “buys”
butyl from NASA.
POLYSAR
RUBBER GROUP
NASA
SARNIA 1 PLANT
Halobutyl
SARNIA 2 PLANT
Butyl
EROW
ANTWERP PLANT
Butyl & Halobutyl
AGENDA
Polysar Ltd.
• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing
POLYSAR
1a) What evidence do we have that
Polysar is on a standard costing system?
1b) Interpret the amount $22,589 on
Exhibit 2, for variable costs.
1c) Interpret the amount $21,450 on
Exhibit 2, for variable costs.
POLYSAR
1d) Evaluate NASA’s performance relative
to budget for sales price and volume.
1e) Evaluate NASA’s performance relative
to budget for plant efficiency, raw
materials prices, fixed manufacturing
expenses, and non-manufacturing
expenses.
POLYSAR
1a) What evidence do we have that
Polysar is on a standard costing
system?
Product Costing and Transfer Prices –
Butyl rubbers were costed using standard
rates for variable and fixed costs.
Variable costs included feedstocks, chemicals, and
energy. Standard variable cost per ton of butyl was
calculated by multiplying the standard utilization factor
(i.e., the standard quantity of inputs used) by a standard
price established for each unit of input. Since feedstock
prices varied with worldwide market conditions and
represented the largest component of costs, it was
impossible to establish standard input prices that
remained valid for extended periods. Therefore, the
company reset standard costs each month to a price that
reflected market prices. Chemical and energy standard
costs were established annually.
POLYSAR
1b) Interpret the amount $22,589 on
Exhibit 2, for variable costs.
Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(‘000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue
Variable Costs
Standard
Cost Adjustments
Efficiency Variance
Total
Gross Margin - $
Fixed Costs
Standard
Cost Adjustments
Spending Variance
Volume Variance
Total
Gross Profit - $
Period Costs
Administration, Selling, Distribution
Technical Service
Other Income/Expense
Total
Business Contribution
Interest on Working Capital
Net Contribution
Budget
(‘000's)
Deviation
(‘000's)
65,872
160
66,032
- 2,793
63,239
61,050
210
61,260
- 2,600
58,660
4,822
50
4,722
- 193
4,579
-22,589
54
241
-22,294
-21,450
-21,450
- 1,139
54
241
- 844
40,945
37,210
3,735
-25,060
168
498
-11,375
-35,769
5,176
-23,100
80
- 6,125
-29,145
8,065
-1,960
88
498
-5,250
-6,624
-2,889
- 4,163
222
208
- 4,177
- 4,000
210
50
- 4,160
999
-1,875
- 876
3,905
-1,900
2,005
-
-
163
12
158
17
-2,906
25
- 2,881
Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(‘000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue
Variable Costs
Standard
Cost Adjustments
Efficiency Variance
Total
Gross Margin - $
Fixed Costs
Standard
Cost Adjustments
Spending Variance
Volume Variance
Total
Gross Profit - $
Period Costs
Administration, Selling, Distribution
Technical Service
Other Income/Expense
Total
Business Contribution
Interest on Working Capital
Net Contribution
Budget
(‘000's)
Deviation
(‘000's)
65,872
160
66,032
- 2,793
63,239
61,050
210
61,260
- 2,600
58,660
4,822
50
4,722
- 193
4,579
-22,589
54
241
-22,294
-21,450
-21,450
- 1,139
54
241
- 844
40,945
37,210
3,735
-25,060
168
498
-11,375
-35,769
5,176
-23,100
80
- 6,125
-29,145
8,065
-1,960
88
498
-5,250
-6,624
-2,889
- 4,163
222
208
- 4,177
- 4,000
210
50
- 4,160
999
-1,875
- 876
3,905
-1,900
2,005
-
-
163
12
158
17
-2,906
25
- 2,881
1b) Interpret the amount $22,589 on
Exhibit 2, for variable costs.
The $22,589 is in the “actual” column, and is the
variable cost at standard. Therefore, it is based
on the actual volume of output (i.e., sales), but
uses the budgeted cost of the inputs (feedstocks,
chemicals, and energy) per ton of output.
The standard cost per ton for raw materials,
averaged over the 9 months,was $631 per ton
($22,589/35.8).
The $22,589 is equivalent to a flexible budget
amount. It is the answer to the question: What
should our input costs have been for our actual
level of output (sales)?
POLYSAR
1c) Interpret the amount $21,450 on
Exhibit 2, for variable costs.
Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(‘000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue
Variable Costs
Standard
Cost Adjustments
Efficiency Variance
Total
Gross Margin - $
Fixed Costs
Standard
Cost Adjustments
Spending Variance
Volume Variance
Total
Gross Profit - $
Period Costs
Administration, Selling, Distribution
Technical Service
Other Income/Expense
Total
Business Contribution
Interest on Working Capital
Net Contribution
Budget
(‘000's)
Deviation
(‘000's)
65,872
160
66,032
- 2,793
63,239
61,050
210
61,260
- 2,600
58,660
4,822
50
4,722
- 193
4,579
-22,589
54
241
-22,294
-21,450
-21,450
- 1,139
54
241
- 844
40,945
37,210
3,735
-25,060
168
498
-11,375
-35,769
5,176
-23,100
80
- 6,125
-29,145
8,065
-1,960
88
498
-5,250
-6,624
-2,889
- 4,163
222
208
- 4,177
- 4,000
210
50
- 4,160
999
-1,875
- 876
3,905
-1,900
2,005
-
-
163
12
158
17
-2,906
25
- 2,881
1c) Interpret the amount
$21,450 on Exhibit 2, for
variable costs.
This is the static budget number for variable
costs (feedstocks, chemicals, energy). Since it
is the static budget, it is based on the original,
projected level of sales. From Exhibit 1, the
projected level of sales was 33,000 tons.
Hence, the standard cost per ton for variable
costs, as of the beginning of the year, was $650
per ton ($21,450/33).
POLYSAR
How can the standard cost per ton
for variable costs differ from the
beginning of the year to the end of
the year?
I.e.: $650 per ton vs. $631 per ton.
POLYSAR
Product Costing and transfer Prices –
Butyl rubbers were costed using standard rates
for variable and fixed costs.
Variable costs included feedstocks, chemicals, and
energy. Standard variable cost per ton of butyl was
calculated by multiplying the standard utilization factor
(i.e., the standard quantity of inputs used) by a standard
price established for each unit of input. Since feedstock
prices varied with worldwide market conditions and
represented the largest component of costs, it was
impossible to establish standard input prices that
remained valid for extended periods. Therefore, the
company reset standard costs each month to a price that
reflected market prices. Chemical and energy standard
costs were established annually.
AGENDA
Polysar Ltd.
• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing
POLYSAR
1d) Evaluate NASA’s performance
relative to budget for sales price
and volume.
Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(‘000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue
Variable Costs
Standard
Cost Adjustments
Efficiency Variance
Total
Gross Margin - $
Fixed Costs
Standard
Cost Adjustments
Spending Variance
Volume Variance
Total
Gross Profit - $
Period Costs
Administration, Selling, Distribution
Technical Service
Other Income/Expense
Total
Business Contribution
Interest on Working Capital
Net Contribution
Budget
(‘000's)
Deviation
(‘000's)
65,872
160
66,032
- 2,793
63,239
61,050
210
61,260
- 2,600
58,660
4,822
50
4,722
- 193
4,579
-22,589
54
241
-22,294
-21,450
-21,450
- 1,139
54
241
- 844
40,945
37,210
3,735
-25,060
168
498
-11,375
-35,769
5,176
-23,100
80
- 6,125
-29,145
8,065
-1,960
88
498
-5,250
-6,624
-2,889
- 4,163
222
208
- 4,177
- 4,000
210
50
- 4,160
999
-1,875
- 876
3,905
-1,900
2,005
-
-
163
12
158
17
-2,906
25
- 2,881
Exhibit 1
NASA RUBBER DIVISION
Regular Butyl Rubber
Statistics and Analyses
September 1986
9 Months ended September 30, 1986
Vo lume - Tonnes
Actual
(‘000's)
Budget
(‘000's)
Deviation
(‘000's)
Sales
35.8
33.0
2.8
Production
47.5
55.0
-7.5
Transfers
to EROW
from EROW
12.2
2.1
19.5
1.0
-7.3
1.1
Production Costs
Fixed Cost - Direct
- Allocated Cash
- Allocated Non-Cash
Fixed Cost to Production
Transfers to/from FG Inventory
Transfers to EROW
Transfers from EROW
Fixed Cost of Sales
($ ‘000's)
($ ‘000's)
($ ‘000's)
-21,466
- 7,036
-15,625
-44,127
-21,900
- 7,125
-15,600
-44,625
1,120
8,540
-1,302
2,450
13,650
-620
-1,330
-5,110
- 682
-35,769
-29,145
-6,624
-
434
89
25
498
Note: as indicated on p. 1 of the case, financial data have been disguised
and do not represent the true financial results of the company.
Evaluate NASA’s performance relative
to budget for sales price and volume.
Sales Volume:
Budgeted: 33,000 tons
Actual:
35,800 tons
Sales Price per Tonne:
Budgeted: $1,850 ($61,050/33)
Actual:
$1,840 ($65,872/35.8)
POLYSAR
1e) Evaluate NASA’s performance
relative to budget for plant
efficiency, raw materials prices,
fixed manufacturing expenses,
and non-manufacturing
expenses.
Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(‘000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue
Variable Costs
Standard
Cost Adjustments
Efficiency Variance
Total
Gross Margin - $
Fixed Costs
Standard
Cost Adjustments
Spending Variance
Volume Variance
Total
Gross Profit - $
Period Costs
Administration, Selling, Distribution
Technical Service
Other Income/Expense
Total
Business Contribution
Interest on Working Capital
Net Contribution
Budget
(‘000's)
Deviation
(‘000's)
65,872
160
66,032
- 2,793
63,239
61,050
210
61,260
- 2,600
58,660
4,822
50
4,722
- 193
4,579
-22,589
54
241
-22,294
-21,450
-21,450
- 1,139
54
241
- 844
40,945
37,210
3,735
-25,060
168
498
-11,375
-35,769
5,176
-23,100
80
- 6,125
-29,145
8,065
-1,960
88
498
-5,250
-6,624
-2,889
- 4,163
222
208
- 4,177
- 4,000
210
50
- 4,160
999
-1,875
- 876
3,905
-1,900
2,005
-
-
163
12
158
17
-2,906
25
- 2,881
Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(‘000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue
Variable Costs
Standard
Cost Adjustments
Efficiency Variance
Total
Gross Margin - $
Fixed Costs
Standard
Cost Adjustments
Spending Variance
Volume Variance
Total
Gross Profit - $
Period Costs
Administration, Selling, Distribution
Technical Service
Other Income/Expense
Total
Business Contribution
Interest on Working Capital
Net Contribution
Budget
(‘000's)
Deviation
(‘000's)
65,872
160
66,032
- 2,793
63,239
61,050
210
61,260
- 2,600
58,660
4,822
50
4,722
- 193
4,579
-22,589
54
241
-22,294
-21,450
-21,450
- 1,139
54
241
- 844
40,945
37,210
3,735
-25,060
168
498
-11,375
-35,769
5,176
-23,100
80
- 6,125
-29,145
8,065
-1,960
88
498
-5,250
-6,624
-2,889
- 4,163
222
208
- 4,177
- 4,000
210
50
- 4,160
999
-1,875
- 876
3,905
-1,900
2,005
-
-
163
12
158
17
-2,906
25
- 2,881
Price and Efficiency Variances for
Feedstocks, Chemicals and Energy
S.P.
$54K FAVORABLE
“COST ADJUSTMENT”
A.P.
$22,294K
ACTUAL COST
*For actual output
$241K
FAV.
A.Q.*
EFFICIENCY
VARIANCE
The outer box represents the flexible
budget amount of $22,589.
S.Q.*
Exhibit 1
NASA RUBBER DIVISION
Regular Butyl Rubber
Statistics and Analyses
September 1986
9 Months ended September 30, 1986
Vo lume - Tonnes
Actual
(‘000's)
Budget
(‘000's)
Deviation
(‘000's)
Sales
35.8
33.0
2.8
Production
47.5
55.0
-7.5
Transfers
to EROW
from EROW
12.2
2.1
19.5
1.0
-7.3
1.1
Production Costs
Fixed Cost - Direct
- Allocated Cash
- Allocated Non-Cash
Fixed Cost to Production
Transfers to/from FG Inventory
Transfers to EROW
Transfers from EROW
Fixed Cost of Sales
($ ‘000's)
($ ‘000's)
($ ‘000's)
-21,466
- 7,036
-15,625
-44,127
-21,900
- 7,125
-15,600
-44,625
1,120
8,540
-1,302
2,450
13,650
-620
-1,330
-5,110
- 682
-35,769
-29,145
-6,624
-
434
89
25
498
Note: as indicated on p. 1 of the case, financial data have been disguised
and do not represent the true financial results of the company.
Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(‘000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue
Variable Costs
Standard
Cost Adjustments
Efficiency Variance
Total
Gross Margin - $
Fixed Costs
Standard
Cost Adjustments
Spending Variance
Volume Variance
Total
Gross Profit - $
Period Costs
Administration, Selling, Distribution
Technical Service
Other Income/Expense
Total
Business Contribution
Interest on Working Capital
Net Contribution
Budget
(‘000's)
Deviation
(‘000's)
65,872
160
66,032
- 2,793
63,239
61,050
210
61,260
- 2,600
58,660
4,822
50
4,722
- 193
4,579
-22,589
54
241
-22,294
-21,450
-21,450
- 1,139
54
241
- 844
40,945
37,210
3,735
-25,060
168
498
-11,375
-35,769
5,176
-23,100
80
- 6,125
-29,145
8,065
-1,960
88
498
-5,250
-6,624
-2,889
- 4,163
222
208
- 4,177
- 4,000
210
50
- 4,160
999
-1,875
- 876
3,905
-1,900
2,005
-
-
163
12
158
17
-2,906
25
- 2,881
POLYSAR
• Sales price per ton is slightly below budget.
• Sales volume is almost 10% above budget.
• The efficiency variance for variable costs is very
small.
• The price variance for variable costs is very
small, due in part to the fact that standards are
revised monthly.
• Fixed manufacturing expenses are within 2% of
budget.
• Non-manufacturing expenses are within 1% of
budget.
POLYSAR
• Why do 80% of manufacturing companies use
Standard Costing Systems?
• Survey data shows that the most important
reason is to help control costs.
• How does a standard costing system help
Polysar control costs?
• In a standard costing system, all variances flow
through the accounting system, and appear on
the monthly income statements.
Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(‘000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue
Variable Costs
Standard
Cost Adjustments
Efficie ncy Variance
Total
Gross Margin - $
Fixed Costs
Standard
Cost Adjustments
Spending Variance
Volume Variance
Total
Gross Profit - $
Period Costs
Administration, Selling, Distribution
Technical Service
Other Income/Expense
Total
Business Contribution
Budget
(‘000's)
Deviation
(‘000's)
65,872
160
66,032
- 2,793
63,239
61,050
210
61,260
- 2,600
58,660
4,822
50
4,722
- 193
4,579
-22,589
54
241
-22,294
-21,450
-21,450
- 1,139
54
241
- 844
40,945
37,210
3,735
-25,060
168
498
-11,375
-35,769
5,176
-23,100
80
- 6,125
-29,145
8,065
-1,960
88
498
-5,250
-6,624
-2,889
- 4,163
222
208
- 4,177
- 4,000
210
50
- 4,160
999
3,905
-
-
163
12
158
17
-2,906
AGENDA
Polysar Ltd.
• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing
POLYSAR
2.
Calculate NASA’s rate for
allocating manufacturing
overhead costs to Butyl.
POLYSAR
Fixed Manufacturing Overhead
Demonstrated Capacity
=
$44,625K
85,000 tons per year x 9/12
=
$700 per ton
.
POLYSAR
3.
Use the rate calculated above to
show that the following amounts
have been calculated correctly:
– Fixed Costs of Sales on Exhibit 2
– Transfers to Finished Goods Inventory on
Exhibit 1
– Transfers to EROW on Exhibit 1
POLYSAR
Fixed Costs of Sales on Exhibit 2
Actual:
$700/tonne x 35.8K tonnes = $25,060K
Budgeted:
$700/tonne x 33.0K tonnes = $23,100K
POLYSAR
Transfers to Finished Goods Inventory on
Exhibit 1
Actual:
$700 x (47.5 + 2.1 - 35.8 - 12.2) =
$700 x 1.6K tonnes = $1,120K
Budgeted:
$700 x (55 + 1 - 33 - 19.5) =
$700 x 3.5K = $2,450K
POLYSAR
Transfers to EROW on Exhibit 1
Actual:
$700/tonne x 12.2K tonnes = $8,540K
Budget:
$700/tonne x 19.5K tonnes = $13,650K
POLYSAR
4.
Does Polysar close out variances to
Cost of Goods Sold, or allocate
variances between Cost of Goods
Sold and Inventory?
POLYSAR
In the previous question, we were able to
recalculate the fixed cost component of butyl
added to ending inventory, and butyl transferred
to EROW, using the budgeted $700 per ton rate.
Therefore, no variances are included in these
amounts, and all variances closed out to the
income statement (Exhibit 2). These variances
appear on the line items for “Cost Adjustments,”
“Spending Variance,” and “Volume Variance.”
POLYSAR
5.
Using the information on Exhibit 1,
identify EROW’s rate for applying
fixed manufacturing costs to Butyl.
What might explain the difference in
the fixed overhead rates of the two
divisions?
POLYSAR
From the Budgeted column on Exhibit 1,
we know that NASA planned to take 1K
tonnes of butyl from EROW, at a cost (i.e.,
fixed cost component) of $620K, or $620
per ton.
EROW’s fixed cost rate of $620 is lower
than NASA’s rate of $700, probably
because EROW’s facility is older. Note
that the difference in rates cannot be due
to differences in capacity utilization.
POLYSAR
6.
What do the budgeted and
actual volume variances of
$6,125 and $11,375
represent?
POLYSAR
Budget
Capacity for 9 mo.s of 63,750 tons
Budgeted production of 55,000
(63,750 - 55,000) x $700 = $6,125K
Actual
Capacity for 9 months of 63,750 tons
Actual production of 47,500
(63,750 - 47,500) x $700
= 16,250 x $700 = $11,375K
POLYSAR
7.
Now assume NASA decided to use
budgeted utilization in the
denominator for calculating the
fixed cost rate. What would the
rate be now? What would the
actual and budgeted volume
variances now be.
POLYSAR
Fixed Manufacturing Overhead
Budgeted Production
=
$44,625K
55,000 tons
.
= $811 per ton
POLYSAR
Using this $811 per ton rate:
There would be no budgeted volume
variance, since
$811/ton x 55K tons = $44,625K
Actual volume variance would be
$811 x (55,000 - 47,500) = $6,085
AGENDA
Polysar Ltd.
• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing
POLYSAR
8a) What type of transfer price does Polysar use?
8b) What is the transfer price for butyl?
8c) What is the effect on NASA when EROW takes
less butyl than planned, if NASA produces for
actual demand?
8d) What is the effect on NASA when EROW
takes less butyl than planned, if NASA produces
for budgeted demand?
8e) What is the best butyl sourcing strategy for
Polysar?
8f) What is the best butyl sourcing strategy for
EROW?
POLYSAR
8a. What type of transfer price does
Polysar use?
Transfer Pricing Options
• Market-Based Transfer Price
• Cost-Based Transfer Price
• Negotiated Transfer Price
• Dual Transfer Price
Product Costing and Transfer Prices –
… Product transfers between divisions for
performance accounting purposes were
made at standard full cost, representing,
for each ton, the sum of standard variable
cost and standard fixed cost.
POLYSAR
• Polysar uses a cost-based transfer
price.
COST-BASED TRANSFER PRICE
• Can be variable cost or full cost.
• Whether variable or full, can be
actual costs or budgeted costs.
• Whether variable or full, can
include a “mark-up” to allow profit
for the “selling” division.
POLYSAR
Interview with Pierre Choquette (Vice
President of NASA Rubber Division) –
“Our transfers to EROW are still a problem. Since
the transfers are at standard cost and are not
recorded as revenue, these transfers do nothing
for our profit. Also, if they cut back on orders,
our profit is hurt through the volume variance.
Few of our senior managers truly understand the
volume variance.
POLYSAR
• Polysar uses a cost-based transfer price.
• It is a full cost transfer price (i.e., it
includes both variable and fixed costs).
• It is based on budgeted (i.e., standard
costs).
• It does not include a mark-up.
POLYSAR
8b. What is the transfer price for
butyl?
Product Costing and Transfer Prices –
… Fixed costs were allocated to production based
on a plant’s “demonstrated capacity” using the
following formula,
standard fixed cost per ton =
estimated annual total fixed cost ÷
annual demonstrated plant capacity
To apply the formula, product estimates were
established each fall for the upcoming year.
Exhibit 5
POLYSAR LIMITED – CONTROLLER’S GUIDE
DEFINITIONS
Demonstrated capacity is the actual annualized production of a p lant which was
required to run full out within the last fiscal year for a sufficiently long period to
assess production capab ility after ad justing for abnormally low or high unscheduled
shutdowns, scheduled shutdowns, and unusual or annualized items which impacted
either favourab ly or unfavourab ly on the period’s production. The resulting
ad justed historical base should be further modified for changes planned to be
implemented within the current fiscal year.
a)
Where a p lant has not been required to run full out within the last fiscal
year, production data may be used for a past period afer ad justing for
changes (debottleneckings/inefficiencies) s ince that time affecting
production.
b)
Where a p lant has never been required to run full out, demonstrated
capacity could be reasonably considered as “name plate” capacity after
adjusting for
i)
ii)
iii)
known invalid assumptions in arriving at “name p late”
changes to original design affecting “name plate”
a reasonable negative allowance for error
CALCULATION OF TRANSFER
PRICE FOR BUTYL
Total Fixed Costs were budgeted at $44,625K
(from Exhibit 1).
Denominator is “demonstrated capacity.” This is
85,000 tons per year, or 63,750 tonnes for 9
months.
$44,625K/63,750 = $700 per ton
POLYSAR
8c. What is the effect on NASA when
EROW takes less butyl than
planned, if NASA produces for
actual demand?
POLYSAR
Each ton of butyl transferred to EROW
has $700 in fixed costs attached to it.
EROW covers $700 of NASA’s fixed costs
with each ton “purchased” from NASA.
When EROW takes less butyl than
planned, and NASA cuts back on
production accordingly, NASA’s volume
variance increases, and its net
contribution (i.e., income) decreases,
relative to plan.
POLYSAR
8d. What is the effect on NASA when
EROW takes less butyl than
planned, if NASA produces for
budgeted demand?
POLYSAR
If NASA produces at budgeted demand,
and EROW purchases less butyl than
planned, NASA will increase its ending
inventory.
In this case, the fact that EROW takes
less butyl than planned will have no
effect on NASA’s net contribution. The
$700 per ton in fixed costs that NASA
thought would be covered by EROW, will
now be capitalized in ending inventory.
POLYSAR
8c. What is the best butyl sourcing
strategy for Polysar?
POLYSAR
Polysar should allocate production of butyl and
halobutyl to EROW and NASA to minimize total
production and shipping costs, while still
meeting customer demand.
In making this determination, fixed costs are
irrelevant, since they are either sunk costs, or
are unavoidable unless the plant is closed down.
Polysar should manufacture butyl as long as the
sales price is more than the variable costs of
production and distribution.
Product Costing and Transfer Prices –
… Fixed costs comprised three categories of cost.
Direct costs included direct labor, maintenance,
chemicals required to keep the plant bubbling,
and fixed utilities. Allocated cash costs included
plant management, purchasing department
costs, engineering, planning, and accounting.
Allocated non-cash costs represented primarily
depreciation.
Exhibit 7
EROW RUBBER DIVISION
Regular Butyl Rubber
Condensed Statement of Net Contribution
September 1986
9 Months Ended September 30, 1986
Sales Volume -- Tonnes
Sales Revenue
Delivery Cost
Net Sales Revenue
47,850
($’000's)
94,504
- 4,584
89,920
Variable Costs
Standard
Purchase Price Variance
Inventory Revaluation
Efficiency Variance
Total
- 28,662
203
46
32
- 28,473
61,447
Gross Margin - $
Fixed Cost to Production
Depreciation
Other
Transfers to/from F.G. Inventory
Transfers to/from NASA
Gross Profit - $
Period Costs
Business Contribution
Interest on Working Capital
Net Contribution
Notes:
- 4,900
- 16,390
- 21,290
775
- 7,238
- 29,303
32,144
-
7,560
24,584
- 1,923
22,661
Fixed costs are allocated between regular butyl production (above)
and halobutyl production (reported separately).
POLYSAR
EROW’s variable cost per ton is
approximately $595.
NASA’s variable cost per ton is
approximately $623.
POLYSAR
8f. What is the best butyl sourcing
strategy for EROW, given the
current accounting treatment,
and the bonus scheme?
POLYSAR
From EROW’s point of view, the $700 per
tonne allocation of fixed costs is a
variable cost. If EROW can manufacture
an extra ton of butyl in Antwerp, instead
of buying the butyl from NASA, EROW
saves $700.
EROW should manufacture as much butyl
in Antwerp as possible, before buying
butyl from NASA.
POLYSAR
If EROW can sell one more ton of butyl,
at a price equal to NASA’s variable costs,
plus shipping, plus $699, will they want
to?
In the above situation, will the company
want EROW to make the sale?
POLYSAR
Compensation
Management –
For managers, the percent of remuneration
received through annual bonuses was greater
than 12% and increased with responsibility
levels.
The bonuses of top Division management in 1985
were calculated by a formula that awarded 50%
of bonus potential to meeting or exceeding
Divisional profit targets and 50% to meeting or
exceeding corporate profit targets.
POLYSAR
Product Scheduling
Although NASA served customers in North and South
America and EROW served customers in Europe and the
rest of the world, regular butyl could be shipped from
either the Sarnia 2 or Antwerp plant. NASA shipped
approximately 1/3 of its regular butyl output to EROW.
Also, customers located in distant locations could receive
shipments from either plant due to certain cost or
logistical advantages. For example, Antwerp sometimes
shipped to Brazil and Sarnia sometimes shipped to the
Far East. …
POLYSAR
Product Scheduling
… In September and October of each year, NASA and
EROW divisions prepared production estimates for the
upcoming year. These estimates were based on estimated
sales volumes and plant loadings (i.e., capacity
utilization). Since the Antwerp plant operated at capacity,
the planning exercise was largely for the benefit of the
managers of the Sarnia 2 plant, who needed to know how
much regular butyl Antwerp would need from the Sarnia
2 plant.
POLYSAR
What are EROW’s incentives in the
budgeting process?
What happens if EROW estimates
greater demand for butyl than EROW
actually needs?
POLYSAR
Interview with Pierre Choquette (Vice
President of NASA Rubber Division) –
“Our transfers to EROW are still a problem. Since
the transfers are at standard cost and are not
recorded as revenue, these transfers do nothing
for our profit. Also, if they cut back on orders,
our profit is hurt through the volume variance.
Few of our senior managers truly understand the
volume variance …”
Exhibit 6
Schedule of Regular Butyl Shipments from NASA to EROW
Actual
To nnes
Budget
Tonnes
1985
21,710
23,500
1984
12,831
13,700
1983
1,432
4,000
1982
792
600
1981
1,069
700
PRODUCT COSTING AND TRANSFER PRICES A purchase price variance (were input prices above or below standard
prices?) and an efficiency variance (did production require more or less inputs than
standard?) were calculated for variab le costs each accounting period.
F ixed costs comprised three categories of cost. Direct costs included d irect
labor, maintenance, chemicals required to keep the plant bubbling, and fixed
utilities. Allocated cash costs included p lant management, purchasing department
costs, engineering, planning, and accounting. Allocated non-cash costs represented
primarily depreciation.
F ixed costs were allocated to production based on a p lant’s “demonstrated
capacity” using the following formula,
Standard Fixed
Costs per Tonne
=
Estimated Annual Total Fixed Costs
Annual Demonstrated P lant Capacity
To apply the formula, production estimates were estab lished each fall for the
upcoming year. Then, the amount of total fixed costs applicab le to this level of
production was estimated. The amount of total fixed cost to be allocated to each
tonne of output was calculated by dividing total fixed cost by the p lant’s
demonstrated capacity. Exhibit 5 reproduces a section of the Controller’s Guide
that defines demonstrated capacity.
Each accounting period, two variances were calculated for fixed costs. The
first was a spending variance calculated as the simple difference between actual
total fixed costs and estimated total fixed costs. The second variance was a volume
variance calculated using the formula:
Vo lume Variance
=
x
Standard Fixed Cost per Tonne
(Actual Tonnes Produced - Demonstrated Capacity)
Product transfers between divisions for performance accounting purposes
were made at standard full cost, representing, for each tonne, the sum of standard
variab le cost and standard fixed cost.
Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(‘000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue
Variable Costs
Standard
Cost Adjustments
Efficiency Variance
Total
Gross Margin - $
Fixed Costs
Standard
Cost Adjustments
Spending Variance
Volume Variance
Total
Gross Profit - $
Period Costs
Administration, Selling, Distribution
Technical Service
Other Income/Expense
Total
Business Contribution
Interest on Working Capital
Net Contribution
Budget
(‘000's)
Deviation
(‘000's)
65,872
160
66,032
- 2,793
63,239
61,050
210
61,260
- 2,600
58,660
4,822
50
4,722
- 193
4,579
-22,589
54
241
-22,294
-21,450
-21,450
- 1,139
54
241
- 844
40,945
37,210
3,735
-25,060
168
498
-11,375
-35,769
5,176
-23,100
80
- 6,125
-29,145
8,065
-1,960
88
498
-5,250
-6,624
-2,889
- 4,163
222
208
- 4,177
- 4,000
210
50
- 4,160
999
-1,875
- 876
3,905
-1,900
2,005
-
-
163
12
158
17
-2,906
25
- 2,881
Exhibit 1
NASA RUBBER DIVISION
Regular Butyl Rubber
Statistics and Analyses
September 1986
9 Months ended September 30, 1986
Vo lume - Tonnes
Actual
(‘000's)
Budget
(‘000's)
Deviation
(‘000's)
Sales
35.8
33.0
2.8
Production
47.5
55.0
-7.5
Transfers
to EROW
from EROW
12.2
2.1
19.5
1.0
-7.3
1.1
Production Costs
Fixed Cost - Direct
- Allocated Cash
- Allocated Non-Cash
Fixed Cost to Production
Transfers to/from FG Inventory
Transfers to EROW
Transfers from EROW
Fixed Cost of Sales
($ ‘000's)
($ ‘000's)
($ ‘000's)
-21,466
- 7,036
-15,625
-44,127
-21,900
- 7,125
-15,600
-44,625
1,120
8,540
-1,302
2,450
13,650
-620
-1,330
-5,110
- 682
-35,769
-29,145
-6,624
-
434
89
25
498
Note: as indicated on p. 1 of the case, financial data have been disguised
and do not represent the true financial results of the company.