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Polysar Limited

Case Analysis
As of May 18, 2010

Team Awesome
Consulting Group #10

heather lyons
jennifer to
ryan shephard
keeyoun dolan

BBUS 373: Managerial Accounting


Dr. Hardin


BACKGROUND

Polysar Limited is a Canadian chemical company, established in 1942 in response to


a need for a synthetic rubber due to World War II’s interception of natural rubber to the
Allied forces. Polysar remained open after the war and was owned by Canada until 1972
when the Canada Development Corporation bought the company in order to encourage
Canadian business development. Between 1982 and 1985, the majority of shares were sold
to the Canadian public and it has remained a publicly traded company. Currently Polysar
has 20 manufacturing plants worldwide with productions focused on basic petrochemicals,
rubber and diversified products. The majority of Polysar’s production is the rubber
division, with their biggest customers being tire manufacturers who are buying halobutyl
and butyl. The rubber group is broken down into two main sections, North and South
America (NASA) and Europe and the rest of the world (EROW).

ISSUES

 Due to projected demand increases, Polysar built a new facility in Canada to produce
butyl. However, demand has not picked up as fast as expected, so the facility (NASA)
now has excess capacity.
 Polysar’s European plant, EROW, is operating at full capacity and often calls on NASA
for extra shipments in order to meet demand. NASA and EROW transfer shipments
to one another on the basis of full standard cost, but this is convoluting NASA’s
performance.

ANALYSIS

The following Figure 1 is a comprehensive table of calculations for the fixed overhead
allocation rate, overhead variances, materials variances, and other key calculations:

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Polysar currently breaks up the variances so it can clearly and easily see where the costs
are coming from. For example, the spending variance is the difference between actual fixed
overhead rate incurred and fixed overhead budgeted. It indicates that either the price or
quantity of variable overhead was different from expected.

Volume variance is the amount of under-applied or over-applied fixed factory overhead. In


other words, the difference between the fixed budgeted factory overhead and the amount
applied based on a predetermined rate and the standard input allowed for actual output. It
measures the utilization of the facilities rather than the specific cost outlays.

Looking at Exhibit 2 of the case, we did not know what the line item “cost adjustments”
was. However, by taking the actual quantity of transfers from EROW and multiplying it by
the difference between NASA’s transfer price and EROW’s transfer price, we get the
$168,000 amount. This amount includes the “discount” that NASA gets from EROW when
transferring the goods since EROW’s production costs are much lower and thus the transfer
rate is smaller.

Other calculations such as the standard fixed costs was calculated by taking the fixed cost to
production, both actual and budgeted, and then dividing it by the demonstrated capacity.
Demonstrated capacity was 85,000 but since there was only 9 months into the year, it was
actually 63,750. After doing so, we get the standard fixed cost allocation rate of $700.

Transfers to and from finished goods inventory are shown below:

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These amounts represent the “net flows” of inventory, including productions and shipments
in from EROW less sales and shipments out to EROW. Thus, if EROW did not request the
budgeted amount of transfers from NASA, the total effect on FG inventory would be an
increase, resulting in increased holding and storage costs.

Transfers to EROW are shown below in further detail:

Again, this highlights the great variability of fixed cost allocation as a function of the
transfers needed by EROW, even though EROW’s costs are much lower (so EROW will only
order from NASA when it no longer has capacity left to fulfill demand).

Another important point is that “business contribution” is the total of gross profit less
period costs; it is essentially the “operating income of the segment.” On the other hand, net
contribution is similar to net income of the segment, as interest on working capital has
been deducted as a non-operating expense. Net contribution is usually low in the industrial
sector because it is capital-intensive.

RECOMMENDATIONS

 Polysar’s budgeting needs to be examined as their budgeted variances are seriously


understated and convoluted.
 A realistic budget is essential because the amount of butyl EROW purchases directly
affects NASA’s ending inventory. As they are operating now, if EROW purchases less
butyl from NASA, NASA cuts back on their production and their volume variance
increases, which in turn lowers their contribution income. However, if Polysar
produces at budgeted demand and EROW does not purchase what was budgeted for,
NASA’s ending inventory will be higher since it will not affect NASA’s net

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contribution and the fixed cost will be transferred to ending inventory. This is
unsustainable as the cost of carrying inventory is high. Polysar therefore needs to
ensure that its accounting methods (i.e. the application of fixed costs and the
recognition of intra-company transfers) do not confound its own performance.

 If Polysar were to allocate fixed overhead based on budgeted activity as follows, its
estimates would be more accurate.

 Polysar needs to allocate production of butyl and halobutyl to NASA and EROW with
the goal of reducing production and shipping costs, but continue to produce enough
in order to meet customer demand. If Polysar is successful in doing this, the
company will be able to ignore fixed costs, as they are now sunk cost, however it
should only produce butyl if the sales price is higher than variable costs and
production and distribution costs.