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Case Analysis
As of May 18, 2010
Team Awesome
Consulting Group #10
heather lyons
jennifer to
ryan shephard
keeyoun dolan
BACKGROUND
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:
2
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.
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.
3
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.
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
4
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.