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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
R U B B E R G R O U P

N A S A E R O W

S A R N I A S1 A P R L NA IN A T A 2 N P T L W A NE TR
H a l o b u t y l B u t y l B u t y l & H
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
NA SARU BB ERD IVISIO N
RegularB utylRubber
StatementofN etContribution

Septem
ber1986
9MonthsendedSept. 30,1986
A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
SalesR evenue-T hirdParty 65,872 61,050 4,822
-D iversifiedProduct Group 160 210 - 50
-Total 66,032 61,260 4,722
DeliveryC ost -2,793 -2,600 - 193
Net SalesR evenue 63,239 58,660 4,579

VariableC osts
Standard -22,589 -21,450 -1,139
C ost Adjustm ents 54 - 54
EfficiencyV ariance 241 - 241
Total -22,294 -21,450 - 844

GrossMargin -$ 40,945 37,210 3,735

FixedC osts
Standard -25,060 -23,100 -1,960
C ost Adjustm ents 168 80 88
SpendingV ariance 498 - 498
V olum eV ariance -11,375 -6,125 -5,250
Total -35,769 -29,145 -6,624
G rossProfit - $ 5,176 8,065 -2,889

PeriodC osts
A dm inistration, Selling, Distribution -4,163 -4,000 - 163
Technical Service - 222 - 210 - 12
O therIncom e/Expense 208 50 158
Total -4,177 -4,160 - 17

B usinessC ontribution 999 3,905 -2,906


Interest onW orkingC apital -1,875 -1,900 25
N et Contribution -876 2,005 -2,881
Exhibit 2
NA SARU BB ERD IVISIO N
RegularB utylRubber
StatementofN etContribution

Septem
ber1986
9MonthsendedSept. 30,1986
A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
SalesR evenue-T hirdParty 65,872 61,050 4,822
-D iversifiedProduct Group 160 210 - 50
-Total 66,032 61,260 4,722
DeliveryC ost -2,793 -2,600 - 193
Net SalesR evenue 63,239 58,660 4,579

VariableC osts
Standard -22,589 -21,450 -1,139
C ost Adjustm ents 54 - 54
EfficiencyV ariance 241 - 241
Total -22,294 -21,450 - 844

GrossMargin -$ 40,945 37,210 3,735

FixedC osts
Standard -25,060 -23,100 -1,960
C ost Adjustm ents 168 80 88
SpendingV ariance 498 - 498
V olum eV ariance -11,375 -6,125 -5,250
Total -35,769 -29,145 -6,624
G rossProfit - $ 5,176 8,065 -2,889

PeriodC osts
A dm inistration, Selling, Distribution -4,163 -4,000 - 163
Technical Service - 222 - 210 - 12
O therIncom e/Expense 208 50 158
Total -4,177 -4,160 - 17

B usinessC ontribution 999 3,905 -2,906


Interest onW orkingC apital -1,875 -1,900 25
N et Contribution -876 2,005 -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
NA SARU BB ERD IVISIO N
RegularB utylRubber
StatementofN etContribution

Septem
ber1986
9MonthsendedSept. 30,1986
A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
SalesR evenue-T hirdParty 65,872 61,050 4,822
-D iversifiedProduct Group 160 210 - 50
-Total 66,032 61,260 4,722
DeliveryC ost -2,793 -2,600 - 193
Net SalesR evenue 63,239 58,660 4,579

VariableC osts
Standard -22,589 -21,450 -1,139
C ost Adjustm ents 54 - 54
EfficiencyV ariance 241 - 241
Total -22,294 -21,450 - 844

GrossMargin -$ 40,945 37,210 3,735

FixedC osts
Standard -25,060 -23,100 -1,960
C ost Adjustm ents 168 80 88
SpendingV ariance 498 - 498
V olum eV ariance -11,375 -6,125 -5,250
Total -35,769 -29,145 -6,624
G rossProfit - $ 5,176 8,065 -2,889

PeriodC osts
A dm inistration, Selling, Distribution -4,163 -4,000 - 163
Technical Service - 222 - 210 - 12
O therIncom e/Expense 208 50 158
Total -4,177 -4,160 - 17

B usinessC ontribution 999 3,905 -2,906


Interest onW orkingC apital -1,875 -1,900 25
N et Contribution -876 2,005 -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
NA SARU BB ERD IVISIO N
RegularB utylRubber
StatementofN etContribution

Septem
ber1986
9MonthsendedSept. 30,1986
A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
SalesR evenue-T hirdP arty 65,872 61,050 4,822
-DiversifiedProduct Group 160 210 - 50
-Total 66,032 61,260 4,722
DeliveryC ost -2,793 -2,600 - 193
NetSalesR evenue 63,239 58,660 4,579

VariableC osts
Standard -22,589 -21,450 -1,139
C ost Adjustm ents 54 - 54
EfficiencyV ariance 241 - 241
Total -22,294 -21,450 - 844

GrossMargin -$ 40,945 37,210 3,735

FixedC osts
Standard -25,060 -23,100 -1,960
C ost Adjustm ents 168 80 88
SpendingV ariance 498 - 498
V olum eV ariance -11,375 -6,125 -5,250
Total -35,769 -29,145 -6,624
G rossProfit - $ 5,176 8,065 -2,889

PeriodC osts
A dm inistration, Selling, Distribution -4,163 -4,000 - 163
Technical Service - 222 - 210 - 12
O therIncom e/Expense 208 50 158
Total -4,177 -4,160 - 17

B usinessC ontribution 999 3,905 -2,906


Interest onW orkingC apital -1,875 -1,900 25
N et Contribution -876 2,005 -2,881
Exhibit1

NASAR U B BE RD IVISIO N
RegularB utylRubber
StatisticsandA nalyses

Septem
ber1986

9MonthsendedSeptem
ber30,1986
Volume-Tonnes A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
Sales 35.8 33.0 2.8

Production 47.5 55.0 -7.5

Transfers
to E ROW 12.2 19.5 -7.3
from EROW 2.1 1.0 1.1
ProductionCosts ($‘000's) ($‘000's) ($‘000's)
FixedCost-D irect -21,466 -21,900 434
-AllocatedCash - 7,036 - 7,125 89
-AllocatedNon-Cash -15,625 -15,600 - 25
FixedCosttoProduction -44,127 -44,625 498

Transfersto/fromFGInventory 1,120 2,450 -1,330


Transfersto ERO W 8,540 13,650 -5,110
Transfersfrom E ROW -1,302 -620 - 682

FixedCostofSales -35,769 -29,145 -6,624

Note: asindicatedonp. 1ofthecase, financial datahavebeendisguised


anddonot representthetruefinancial resultsofthecom pany.
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
NA SARU BB ERD IVISIO N
RegularB utylRubber
StatementofN etContribution

Septem
ber1986
9MonthsendedSept. 30,1986
A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
SalesR evenue-T hirdParty 65,872 61,050 4,822
-D iversifiedProduct Group 160 210 - 50
-Total 66,032 61,260 4,722
DeliveryC ost -2,793 -2,600 - 193
Net SalesR evenue 63,239 58,660 4,579

VariableC osts
Standard -22,589 -21,450 -1,139
C ost A djustments 54 - 54
E fficiencyV ariance 241 - 241
Total -22,294 -21,450 - 844

GrossMargin -$ 40,945 37,210 3,735

FixedC osts
Standard -25,060 -23,100 -1,960
C ost Adjustm ents 168 80 88
SpendingV ariance 498 - 498
V olum eV ariance -11,375 -6,125 -5,250
Total -35,769 -29,145 -6,624
G rossProfit - $ 5,176 8,065 -2,889

PeriodC osts
A dm inistration, Selling, Distribution -4,163 -4,000 - 163
Technical Service - 222 - 210 - 12
O therIncom e/Expense 208 50 158
Total -4,177 -4,160 - 17

B usinessC ontribution 999 3,905 -2,906


Interest onW orkingC apital -1,875 -1,900 25
N et Contribution -876 2,005 -2,881
Exhibit 2
NA SARU BB ERD IVISIO N
RegularB utylRubber
StatementofN etContribution

Septem
ber1986
9MonthsendedSept. 30,1986
A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
SalesR evenue-T hirdParty 65,872 61,050 4,822
-D iversifiedProduct Group 160 210 - 50
-Total 66,032 61,260 4,722
DeliveryC ost -2,793 -2,600 - 193
Net SalesR evenue 63,239 58,660 4,579

VariableC osts
Standard -22,589 -21,450 -1,139
C ostA djustm ents 54 - 54
EfficiencyV ariance 241 - 241
Total -22,294 -21,450 - 844

GrossMargin -$ 40,945 37,210 3,735

FixedC osts
Standard -25,060 -23,100 -1,960
C ost Adjustm ents 168 80 88
SpendingV ariance 498 - 498
V olum eV ariance -11,375 -6,125 -5,250
Total -35,769 -29,145 -6,624
G rossProfit - $ 5,176 8,065 -2,889

PeriodC osts
A dm inistration, Selling, Distribution -4,163 -4,000 - 163
Technical Service - 222 - 210 - 12
O therIncom e/Expense 208 50 158
Total -4,177 -4,160 - 17

B usinessC ontribution 999 3,905 -2,906


Interest onW orkingC apital -1,875 -1,900 25
N et Contribution -876 2,005 -2,881
Price and Efficiency Variances for
Feedstocks, Chemicals and Energy
The outer box represents the flexible
budget amount of $22,589.

S.P.
$54K FAVORABLE
“COST ADJUSTMENT”

EFFICIENCY
VARIANCE
A.P.
$22,294K $241K
ACTUAL COST FAV.

*For actual output A.Q.* S.Q.*


Exhibit1

NASAR U B BE RD IVISIO N
R egularB utylRubber
StatisticsandA nalyses

September1986

9MonthsendedSeptem
ber30,1986
Volume-Tonnes A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
Sales 35.8 33.0 2.8

Production 47.5 55.0 -7.5

Transfers
to E ROW 12.2 19.5 -7.3
from EROW 2.1 1.0 1.1
ProductionCosts ($‘000's) ($‘000's) ($‘000's)
FixedCost-Direct -21,466 -21,900 434
-AllocatedCash - 7,036 - 7,125 89
-AllocatedNon-Cash -15,625 -15,600 - 25
FixedCosttoProduction -44,127 -44,625 498

Transfersto/fromFGInventory 1,120 2,450 -1,330


Transfersto ER OW 8,540 13,650 -5,110
Transfersfrom E ROW -1,302 -620 - 682

FixedCostofSales -35,769 -29,145 -6,624

N ote: asindicatedonp. 1ofthecase, financial datahavebeendisguised


anddonot representthetruefinancial resultsofthecom pany.
Exhibit 2
NA SARU BB ERD IVISIO N
RegularB utylRubber
StatementofN etContribution

Septem
ber1986
9MonthsendedSept. 30,1986
A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
SalesR evenue-ThirdParty 65,872 61,050 4,822
-D iversifiedProduct Group 160 210 - 50
-Total 66,032 61,260 4,722
DeliveryC ost -2,793 -2,600 - 193
Net SalesR evenue 63,239 58,660 4,579

VariableC osts
Standard -22,589 -21,450 -1,139
C ost Adjustm ents 54 - 54
EfficiencyV ariance 241 - 241
Total -22,294 -21,450 - 844

GrossMargin -$ 40,945 37,210 3,735

FixedC osts
Standard -25,060 -23,100 -1,960
C ost Adjustm ents 168 80 88
SpendingV ariance 498 - 498
V olum eV ariance -11,375 -6,125 -5,250
Total -35,769 -29,145 -6,624
G rossProfit - $ 5,176 8,065 -2,889

PeriodC osts
A dm inistration, Selling, Distribution -4,163 -4,000 - 163
Technical Service - 222 - 210 - 12
O therIncom e/Expense 208 50 158
Total -4,177 -4,160 - 17

B usinessC ontribution 999 3,905 -2,906


Interest onW orkingC apital -1,875 -1,900 25
N et Contribution -876 2,005 -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.
Exhibit2
NA SARU BB ERD IVISIO N
RegularB utylRubber
StatementofN etContribution

Septem
ber1986
9MonthsendedSept. 30,1986
A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
SalesR evenue-T hirdParty 65,872 61,050 4,822
-D iversifiedProduct Group 160 210 - 50
-T otal 66,032 61,260 4,722
DeliveryC ost -2,793 -2,600 - 193
Net SalesR evenue 63,239 58,660 4,579

VariableC osts
Standard -22,589 -21,450 -1,139
C ostA djustments 54 - 54
E fficiencyV arian
ce 241 - 241
T otal -22,294 -21,450 - 844

GrossMargin -$ 40,945 37,210 3,735

FixedC osts
Standard -25,060 -23,100 -1,960
C ost Adjustm ents 168 80 88
SpendingV ariance 498 - 498
V olum eV ariance -11,375 -6,125 -5,250
Total -35,769 -29,145 -6,624
G rossProfit - $ 5,176 8,065 -2,889

PeriodC osts
A dm inistration, Selling, Distribution -4,163 -4,000 - 163
Technical Service - 222 - 210 - 12
O therIncom e/Expense 208 50 158
Total -4,177 -4,160 - 17

BusinessContribution 999 3,905 -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’SGUIDE

DEFINITIONS

Demonstratedcapacity istheactualannualizedproductionofaplantwhichwas
requiredtorunfull out withinthelastfiscalyearforasufficientlylongperiodto
assessproductioncapabilityafteradjustingforabnorm allyloworhighunscheduled
shutdowns,scheduledshutdowns,andunusualorannualizeditem swhichim pacted
either favourably or unfavourably ontheperiod’sproduction. Theresulting
adjustedhistoricalbaseshouldbefurthermodifiedforchangesplannedtobe
im plementedwithinthecurrentfiscalyear.

a) W hereaplanthasnotbeenrequiredtorunfullout withinthelast fiscal


year,productiondatam aybeusedforapastperiodaferadjustingfor
changes( debottleneckings /inefficiencies)sincethat timeaffecting
production.

b) W hereaplanthasneverbeenrequiredtorunfull out,demonstrated
capacitycouldbereasonablyconsideredas“nameplate”capacityafter
adjustingfor

i) knowninvalidassum ptionsinarrivingat“nam eplate”


ii) changestooriginaldesignaffecting“nameplate”
iii) areasonablenegative allowanceforerror
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 RUBBERD IV ISION
RegularButyl Rubber
CondensedStatement ofNet Contribution

September1986
9MonthsEndedSeptember30, 1986
SalesVolume --Tonnes 47,850
($’000's)
SalesRevenue 94,504
DeliveryCost - 4,584
Net SalesRevenue 89,920

VariableCosts
Standard -28,662
PurchasePriceVariance 203
InventoryRevaluation - 46
EfficiencyVariance 32
Total -28,473

GrossMargin - $ 61,447

FixedCost toProduction
Depreciation - 4,900
Other -16,390
-21,290
Transfersto/fromF.G.Inventory - 775
Transfersto/fromN ASA - 7,238
-29,303
GrossProfit - $ 32,144

PeriodCosts - 7,560
BusinessContribution 24,584
Interest onW orkingCapital - 1,923
Net Contribution 22,661

Notes: Fixedcostsareallocatedbetweenregularbutyl production(above)


and halobutyl production(reportedseparately).
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 …”
Exhibit6

S
cheduleofRegularButylShipmentsfromNASAto EROW

Actual Budget
Tonnes Tonnes

1985 21,710 23,500

1984 12,831 13,700

1983 1,432 4,000

1982 792 600

1981 1,069 700


PRODUCTCOSTINGANDTRANSFERPRICES-
Apurchasepricevariance(w ereinputpricesaboveorbelowstandard
prices?)andanefficiencyvariance(didproductionrequiremoreorlessinputsthan
standard?)werecalculatedforvariablecostseachaccountingperiod.

Fixedcostscom prisedthreecategoriesofcost. D irectcostsincludeddirect


labor,m aintenance,chem icalsrequiredtokeeptheplantbubbling,andfixed
utilities. A llocatedcashcostsincludedplantm anagem ent,purchasingdepartm ent
costs,engineering,planning,andaccounting. A llocatednon-cashcostsrepresented
prim arilydepreciation.

Fixedcostsw ereallocatedtoproductionbasedonaplant’s“dem
onstrated
capacity”usingthefollowingform ula,

StandardFixed = EstimatedA nnualTotalFixedCosts


CostsperTonne AnnualDemonstratedPlantC apacity

Toapplytheform ula,productionestim ateswereestablishedeachfallforthe


upcom ingyear. Then,theam ountoftotalfixedcostsapplicabletothislevelof
productionw asestim ated. Theam ountoftotal fixedcosttobeallocatedtoeach
tonneofoutputw ascalculatedbydividingtotalfixedcostbytheplant’s
dem onstratedcapacity. E xhibit5reproducesasectionoftheC ontroller’sGuide
thatdefinesdem onstratedcapacity.

Eachaccountingperiod,tw ovariancesw erecalculatedforfixedcosts. The


firstw asaspendingvariancecalculatedasthesim pledifferencebetweenactual
totalfixedcostsandestimatedtotalfixedcosts. Thesecondvariancew asavolum e
variancecalculatedusingtheform ula:

VolumeVariance = StandardFixedCostperTonne
x (ActualTonnesProduced -DemonstratedCapacity)

Producttransfersbetw eendivisionsforperformanceaccountingpurposes
w erem adeatstandardfullcost,representing,foreachtonne,thesumofstandard
variablecostandstandardfixedcost.
Exhibit 2
NA SARU BB ERD IVISIO N
RegularB utylRubber
StatementofN etContribution

Septem
ber1986
9MonthsendedSept. 30,1986
A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
SalesR evenue-T hirdParty 65,872 61,050 4,822
-D iversifiedProduct Group 160 210 - 50
-Total 66,032 61,260 4,722
DeliveryC ost -2,793 -2,600 - 193
Net SalesR evenue 63,239 58,660 4,579

VariableC osts
Standard -22,589 -21,450 -1,139
C ost Adjustm ents 54 - 54
EfficiencyV ariance 241 - 241
Total -22,294 -21,450 - 844

GrossMargin -$ 40,945 37,210 3,735

FixedC osts
Standard -25,060 -23,100 -1,960
C ost Adjustm ents 168 80 88
SpendingV ariance 498 - 498
V olum eV ariance -11,375 -6,125 -5,250
Total -35,769 -29,145 -6,624
G rossProfit - $ 5,176 8,065 -2,889

PeriodC osts
A dm inistration, Selling, Distribution -4,163 -4,000 - 163
Technical Service - 222 - 210 - 12
O therIncom e/Expense 208 50 158
Total -4,177 -4,160 - 17

B usinessC ontribution 999 3,905 -2,906


Interest onW orkingC apital -1,875 -1,900 25
N et Contribution -876 2,005 -2,881
Exhibit1

NASAR U B BE RD IVISIO N
RegularB utylRubber
StatisticsandA nalyses

Septem
ber1986

9MonthsendedSeptem
ber30,1986
Volume-Tonnes A ctual B udget Deviation
(‘000's) (‘000's) (‘000's)
Sales 35.8 33.0 2.8

Production 47.5 55.0 -7.5

Transfers
to E ROW 12.2 19.5 -7.3
from EROW 2.1 1.0 1.1
ProductionCosts ($‘000's) ($‘000's) ($‘000's)
FixedCost-D irect -21,466 -21,900 434
-AllocatedCash - 7,036 - 7,125 89
-AllocatedNon-Cash -15,625 -15,600 - 25
FixedCosttoProduction -44,127 -44,625 498

Transfersto/fromFGInventory 1,120 2,450 -1,330


Transfersto ERO W 8,540 13,650 -5,110
Transfersfrom E ROW -1,302 -620 - 682

FixedCostofSales -35,769 -29,145 -6,624

Note: asindicatedonp. 1ofthecase, financial datahavebeendisguised


anddonot representthetruefinancial resultsofthecom pany.