Analysis+of+Polysar

(1)

Harvard Business School

Teaching Case

Polysar Ltd.

(2)

AGENDA

Polysar Ltd.

• Introduction to Polysar

• Standard Costing

• Variance Analysis for Variable

Costs

• Fixed Overhead Volume Variance

• Transfer Pricing

(3)

AGENDA

Polysar Ltd.

• Introduction to Polysar

• Standard Costing

• Variance Analysis for Variable

Costs

• Fixed Overhead Volume Variance

• Transfer Pricing

(4)

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)

(5)

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,

(6)

POLYSAR

S

A

R

N

I A

1 P

L A

N

T

H

a l o b u t y l

S

A

R

N

I A

2 P

L A

N

T

B

u t y l

N

A

S

A

N

T W

E

R

P

L A

N

T

B

u t y l &

H

a l o b u t y l

E

R

O

W

R

U

B

E

R

G

R

O

U

P

(7)

AGENDA

Polysar Ltd.

• Introduction to Polysar

• Standard Costing

• Variance Analysis for Variable

Costs

• Fixed Overhead Volume Variance

• Transfer Pricing

(8)

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.

(9)

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

(10)

POLYSAR

1a) What evidence do we have that

Polysar is on a

(11)

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.

(12)

POLYSAR

1b) Interpret the amount $22,589 on

Exhibit 2, for variable costs.

(13)

Exhibit 2

N

A

SA

RU

BBER D

IV

ISION

Regular Butyl Rubber

Statem

ent of N

et Contribution

Septem

ber 1986

9 Months ended Sept. 30, 1986 Actual (‘000's) Budget (‘000's) Deviation (‘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 65,872 160 66,032 - 2,793 63,239 -22,589 54 241 -22,294 40,945 -25,060 168 498 -11,375 -35,769 5,176 - 4,163 - 222 208 - 4,177 999 -1,875 - 876 61,050 210 61,260 - 2,600 58,660 -21,450 - - -21,450 37,210 -23,100 80 - - 6,125 -29,145 8,065 - 4,000 - 210 50 - 4,160 3,905 -1,900 2,005 4,822 - 50 4,722 - 193 4,579 - 1,139 54 241 - 844 3,735 -1,960 88 498 -5,250 -6,624 -2,889 - 163 - 12 158 - 17 -2,906 25 - 2,881

(14)

Exhibit 2

N

A

SA

RU

BBER D

IV

ISION

Regular Butyl Rubber

Statem

ent of N

et Contribution

Septem

ber 1986

Delivery Cost Net Sales Revenue Variable Costs Standard

Business Contribution Interest on Working Capital Net Contribution 65,872 160 66,032 - 2,793 63,239 -22,589 54 241 -22,294 40,945 -25,060 168 498 -11,375 -35,769 5,176 - 4,163 - 222 208 - 4,177 999 -1,875 - 876 61,050 210 61,260 - 2,600 58,660 -21,450 - - -21,450 37,210 -23,100 80 - - 6,125 -29,145 8,065 - 4,000 - 210 50 - 4,160 3,905 -1,900 2,005 4,822 - 50 4,722 - 193 4,579 - 1,139 54 241 - 844 3,735 -1,960 88 498 -5,250 -6,624 -2,889 - 163 - 12 158 - 17 -2,906 25 - 2,881

(15)

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)?

(16)

POLYSAR

1c) Interpret the amount $21,450 on

Exhibit 2, for variable costs.

(17)

Exhibit 2

N

A

SA

RU

BBER D

IV

ISION

Regular Butyl Rubber

Statem

ent of N

et Contribution

Septem

ber 1986

Delivery Cost Net Sales Revenue Variable Costs

Standard

Business Contribution Interest on Working Capital Net Contribution 65,872 160 66,032 - 2,793 63,239 -22,589 54 241 -22,294 40,945 -25,060 168 498 -11,375 -35,769 5,176 - 4,163 - 222 208 - 4,177 999 -1,875 - 876 61,050 210 61,260 - 2,600 58,660 -21,450 - - -21,450 37,210 -23,100 80 - - 6,125 -29,145 8,065 - 4,000 - 210 50 - 4,160 3,905 -1,900 2,005 4,822 - 50 4,722 - 193 4,579 - 1,139 54 241 - 844 3,735 -1,960 88 498 -5,250 -6,624 -2,889 - 163 - 12 158 - 17 -2,906 25 - 2,881

(18)

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).

(19)

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.

(20)

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.

(21)

AGENDA

Polysar Ltd.

• Introduction to Polysar

• Standard Costing

• Variance Analysis for Variable

Costs

• Fixed Overhead Volume Variance

• Transfer Pricing

(22)

POLYSAR

1d) Evaluate NASA’s performance

relative to budget for sales price

and volume.

(23)

Exhibit 2

N

A

SA

RU

BBER D

IV

ISION

Regular Butyl Rubber

Statem

ent of N

et Contribution

Septem

ber 1986

9 Months ended Sept. 30, 1986 Actual (‘000's) Budget (‘000's) Deviation (‘000's)

Sales Revenue - Third Party

Delivery Cost

Net Sales Revenue

Variable Costs Standard

Business Contribution Interest on Working Capital Net Contribution 65,872 160 66,032 - 2,793 63,239 -22,589 54 241 -22,294 40,945 -25,060 168 498 -11,375 -35,769 5,176 - 4,163 - 222 208 - 4,177 999 -1,875 - 876 61,050 210 61,260 - 2,600 58,660 -21,450 - - -21,450 37,210 -23,100 80 - - 6,125 -29,145 8,065 - 4,000 - 210 50 - 4,160 3,905 -1,900 2,005 4,822 - 50 4,722 - 193 4,579 - 1,139 54 241 - 844 3,735 -1,960 88 498 -5,250 -6,624 -2,889 - 163 - 12 158 - 17 -2,906 25 - 2,881

(24)

Exhibit 1

N

A

SA

RU

B

BE

R D

IV

ISION

Regular B

utyl Rubber

Statistics and A

nalyses

Septem

ber 1986

9 M

onths ended Septem

ber 30, 1986

V

olum

e - Tonnes

A

ctual

(‘000's)

Budget

D

(‘000's)

eviation

Sales

Production

Transfers

to

ERO

W

from

ERO

W

35.8

47.5

12.2

2.1

33.0

55.0

19.5

1.0

2.8 -7.5

-7.3

1.1 Production Costs

($ ‘000's)

Fixed Cost - D

irect

- A

llocated Cash

- A

llocated N

on-C

ash

Fixed Cost to Production

Transfers to/from

FG Inventory

Transfers to

ERO

W

Transfers from

ERO

W

Fixed Cost of Sales

-21,466

- 7,036

-15,625

-44,127

1,120

8,540

-1,302

-35,769

-21,900

- 7,125

-15,600

-44,625

2,450

13,650

-620

-29,145

434

89 - 25

498 -1,330

-5,110

- 682

-6,624

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.

(25)

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)

(26)

POLYSAR

1e) Evaluate NASA’s performance

relative to budget for plant

efficiency, raw materials prices,

fixed manufacturing expenses,

and non-manufacturing

expenses.

(27)

Exhibit 2

N

A

SA

RU

BBER D

IV

ISION

Regular Butyl Rubber

Statem

ent of N

et Contribution

Septem

ber 1986

Cost Adjustments Efficiency Variance

Total

Business Contribution Interest on Working Capital Net Contribution 65,872 160 66,032 - 2,793 63,239 -22,589 54 241 -22,294 40,945 -25,060 168 498 -11,375 -35,769 5,176 - 4,163 - 222 208 - 4,177 999 -1,875 - 876 61,050 210 61,260 - 2,600 58,660 -21,450 - - -21,450 37,210 -23,100 80 - - 6,125 -29,145 8,065 - 4,000 - 210 50 - 4,160 3,905 -1,900 2,005 4,822 - 50 4,722 - 193 4,579 - 1,139 54 241 - 844 3,735 -1,960 88 498 -5,250 -6,624 -2,889 - 163 - 12 158 - 17 -2,906 25 - 2,881

(28)

Exhibit 2

N

A

SA

RU

BBER D

IV

ISION

Regular Butyl Rubber

Statem

ent of N

et Contribution

Septem

ber 1986

Cost Adjustments

Efficiency Variance Total

(29)

Price and Efficiency Variances for

Feedstocks, Chemicals and Energy

S.P.

A.P.

A.Q.* S.Q.*

$22,294K

ACTUAL COST

$241K

FAV.

$54K FAVORABLE

“COST ADJUSTMENT”

E

FF

IC

IE

N

C

Y

V

A

R

IA

N

C

E

*For actual output

The outer box represents the flexible

budget amount of $22,589.

(30)

Exhibit 1

N

A

SA

RU

BBE

R D

IV

ISION

Regular Butyl Rubber

Statistics and A

nalyses

Septem

ber 1986

9 M

onths ended Septem

ber 30, 1986

V

olum

e - Tonnes

A

ctual

(‘000's)

B

udget

D

(‘000's)

eviation

Sales

Production

Transfers

to

ERO

W

from

ERO

W

35.8

47.5

12.2

2.1

33.0

55.0

19.5

1.0

2.8 -7.5

-7.3

1.1 Production Costs

($ ‘000's)

Fixed Cost - D

irect

- A

llocated Cash

- A

llocated N

on-Cash

Fixed Cost to Production

Transfers to/from

FG Inventory

Transfers to

ERO

W

Transfers from

ERO

W

Fixed Cost of Sales

-21,466

- 7,036

-15,625

-44,127

1,120

8,540

-1,302

-35,769

-21,900

- 7,125

-15,600

-44,625

2,450

13,650

-620

-29,145

434

89 - 25

498 -1,330

-5,110

- 682

-6,624

(31)

Exhibit 2

N

A

SA

RU

BBE

R D

IV

ISION

Regular Butyl Rubber

Statem

ent of N

et Contribution

Septem

ber 1986

9 Months ended Sept. 30, 1986 Actual

(‘000's) (‘000's)Budget Deviation(‘000's) Sales Revenue - Third Party

Gross Profit - $

Period Costs

Other Income/Expense Total

Business Contribution Interest on Working Capital Net Contribution 65,872 160 66,032 - 2,793 63,239 -22,589 54 241 -22,294 40,945 -25,060 168 498 -11,375 -35,769 5,176 - 4,163 - 222 208 - 4,177 999 -1,875 - 876 61,050 210 61,260 - 2,600 58,660 -21,450 - - -21,450 37,210 -23,100 80 - - 6,125 -29,145 8,065 - 4,000 - 210 50 - 4,160 3,905 -1,900 2,005 4,822 - 50 4,722 - 193 4,579 - 1,139 54 241 - 844 3,735 -1,960 88 498 -5,250 -6,624 -2,889 - 163 - 12 158 - 17 -2,906 25 - 2,881

(32)

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.

(33)

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

(34)

Exhibit 2

N

A

SA

RU

BB

ER D

IV

ISION

Regular Butyl Rubber

Statem

ent of N

et Contribution

Septem

ber 1986

9 Months ended Sept. 30, 1986 Actual

(‘000's) (‘000's)Budget Deviation(‘000's) Sales Revenue - Third Party

Delivery Cost Net Sales Revenue

V

ariable C

osts

Standard

C

ost Adjustm

ents

Efficiency V

ariance

Total

Other Income/Expense Total Business Contribution 65,872 160 66,032 - 2,793 63,239

-22,589

54

241 -22,294

40,945 -25,060 168 498 -11,375 -35,769 5,176 - 4,163 - 222 208 - 4,177 999 61,050 210 61,260 - 2,600 58,660

-21,450

-

-21,450

37,210 -23,100 80 - - 6,125 -29,145 8,065 - 4,000 - 210 50 - 4,160 3,905 4,822 - 50 4,722 - 193 4,579

- 1,139

54

241 - 844

3,735 -1,960 88 498 -5,250 -6,624 -2,889 - 163 - 12 158 - 17 -2,906

(35)

AGENDA

Polysar Ltd.

• Introduction to Polysar

• Standard Costing

• Variance Analysis for Variable

Costs

• Fixed Overhead Volume Variance

(36)

POLYSAR

2. Calculate NASA’s rate for

allocating manufacturing

overhead costs to Butyl.

(37)

POLYSAR

Fixed Manufacturing Overhead

Demonstrated Capacity

=

$44,625K

.

85,000 tons per year x 9/12

=

(38)

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

(39)

POLYSAR

Fixed Costs of Sales on Exhibit 2

Actual:

$700/tonne x 35.8K tonnes = $25,060K

Budgeted:

(40)

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

(41)

POLYSAR

Transfers to EROW on Exhibit 1

Actual:

$700/tonne x 12.2K tonnes = $8,540K

Budget:

(42)

POLYSAR

4. Does Polysar close out variances to

Cost of Goods Sold, or allocate

variances between Cost of Goods Sold

and Inventory?

(43)

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.”

(44)

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?

(45)

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.

(46)

POLYSAR

6. What do the budgeted and

actual volume variances of

$6,125 and $11,375

represent?

(47)

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

(48)

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

(49)

POLYSAR

Fixed Manufacturing Overhead

Budgeted Production

=

$44,625K

.

55,000 tons

(50)

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

(51)

AGENDA

Polysar Ltd.

• Introduction to Polysar

• Standard Costing

• Variance Analysis for Variable

Costs

• Fixed Overhead Volume Variance

(52)

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?

(53)

POLYSAR

8a. What type of transfer price does

Polysar use?

(54)

Transfer Pricing Options

• Market-Based Transfer Price

• Cost-Based Transfer Price

• Negotiated Transfer Price

• Dual Transfer Price

(55)

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.

(56)

POLYSAR

• Polysar uses a cost-based transfer

price.

(57)

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.

(58)

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.

(59)

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).

(60)

POLYSAR

8b. What is the transfer price for

butyl?

(61)

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.

(62)

Exhibit 5

POLYSAR

LIM

ITED – CONTROLLER’S GUIDE

DEFINITIONS

Demonstrated capacity

is the actual annualized production of a plant which was

required to run full out within the last fiscal year for a sufficiently long period to

assess production capability after adjusting for abnormally low or high unscheduled

shutdowns, scheduled shutdowns, and unusual or annualized items which impacted

either favourably

or unfavourably

on the period’s production. The resulting

adjusted historical base should be further modified for changes planned to be

implemented within the current fiscal year.

a)

Where a plant has not been required to run full out within the last fiscal

year, production data may be used for a past period afer adjusting for

changes (

debottleneckings

/inefficiencies) since that time affecting

production.

b)

Where a plant has never been required to run full out, demonstrated

capacity could be reasonably considered as “name plate” capacity after

adjusting for

i)

known invalid assumptions in arriving at “name plate”

ii)

changes to original design affecting “name plate”

iii)

a reasonable negative allowance for error

(63)

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.

(64)

POLYSAR

8c. What is the effect on NASA when

EROW takes less butyl than

planned, if NASA produces for

actual demand?

(65)

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.

(66)

POLYSAR

8d. What is the effect on NASA when

EROW takes less butyl than

planned, if NASA produces for

budgeted demand?

(67)

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.

(68)

POLYSAR

8c. What is the best butyl sourcing

strategy for Polysar?

(69)

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

(70)

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

(71)

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

Variable Costs

Standard

Purchase Price Variance Inventory Revaluation Efficiency Variance Total

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 47,850 ($’000's) 94,504 - 4,584 89,920 - 28,662 203 - 46 32 - 28,473 61,447 - 4,900 - 16,390 - 21,290 - 775 - 7,238 - 29,303 32,144 - 7,560 24,584 - 1,923 22,661 Notes: Fixed costs are allocated between regular butyl production (above)

(72)

POLYSAR

EROW’s variable cost per ton is

approximately $595.

NASA’s variable cost per ton is

approximately $623.

(73)

POLYSAR

8f. What is the best butyl sourcing

strategy for EROW, given the

current accounting treatment,

and the bonus scheme?

(74)

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

(75)

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?

(76)

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.

(77)

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. …

(78)

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.

(79)

POLYSAR

What are EROW’s incentives in the

budgeting process?

What happens if EROW estimates

greater demand for butyl than EROW

actually needs?

(80)

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 …”

(81)

Exhibit 6

Schedule of Regular Butyl Shipm

ents from

NASA to

EROW

A

ctual

Budget

Tonnes

1985

21,710

23,500

1984

12,831

13,700

1983

1,432

4,000

1982

792

600 1981

1,069

700

(82)

PR

O

D

U

C

T

C

O

ST

IN

G

A

N

D

T

R

A

N

SFER

PR

IC

ES

-A

purchase price variance (w

ere input prices above or below

standard

prices?) and an efficiency variance (did production require m

ore or less inputs than

standard?) w

ere calculated for variable costs each accounting period.

Fixed costs com

prised three categories of cost. D

irect costs included direct

labor, m

aintenance, chem

icals required to keep the plant bubbling, and fixed

utilities. A

llocated cash costs included plant m

anagem

ent, purchasing departm

ent

costs, engineering, planning, and accounting. A

llocated non-cash costs represented

prim

arily depreciation.

Fixed costs w

ere allocated to production based on a plant’s “dem

onstrated

capacity” using the follow

ing form

ula,

Standard Fixed

=

Estim

ated A

nnual Total Fixed Costs

Costs per Tonne A

nnual D

em

onstrated Plant Capacity

To apply the form

ula, production estim

ates w

ere established each fall for the

upcom

ing year. Then, the am

ount of total fixed costs applicable to this level of

production w

as estim

ated. The am

ount of total fixed cost to be allocated to each

tonne of output w

as calculated by dividing total fixed cost by the plant’s

dem

onstrated capacity. Exhibit 5 reproduces a section of the Controller’s G

uide

that defines dem

onstrated capacity.

Each accounting period, tw

o variances w

ere calculated for fixed costs. The

first w

as a spending variance calculated as the sim

ple difference betw

een actual

total fixed costs and estim

ated total fixed costs. The second variance w

as a volum

e

variance calculated using the form

ula:

V

olum

e V

ariance = Standard Fixed Cost per Tonne

x (A

ctual Tonnes Produced - D

em

onstrated Capacity)

Product transfers betw

een divisions for perform

ance accounting purposes

w

ere m

ade at standard full cost, representing, for each tonne, the sum

of standard

variable cost and standard fixed cost.

(83)

Exhibit 2

N

A

SA

RU

BBER D

IV

ISION

Regular Butyl Rubber

Statem

ent of N

et Contribution

Septem

ber 1986

(84)

Exhibit 1

N

A

SA

RU

B

BE

R D

IV

ISION

Regular B

utyl Rubber

Statistics and A

nalyses

Septem

ber 1986

9 M

onths ended Septem

ber 30, 1986

V

olum

e - Tonnes

A

ctual

(‘000's)

Budget

D

(‘000's)

eviation

Sales

Production

Transfers

to

ERO

W

from

ERO

W

35.8

47.5

12.2

2.1

33.0

55.0

19.5

1.0

2.8 -7.5

-7.3

1.1 Production Costs

($ ‘000's)

Fixed Cost - D

irect

- A

llocated Cash

- A

llocated N

on-C

ash

Fixed Cost to Production

Transfers to/from

FG Inventory

Transfers to

ERO

W

Transfers from

ERO

W

Fixed Cost of Sales

-21,466

- 7,036

-15,625

-44,127

1,120

8,540

-1,302

-35,769

-21,900

- 7,125

-15,600

-44,625

2,450

13,650

-620

-29,145

434

89 - 25

498 -1,330

-5,110

- 682

-6,624