Harvard Business School Teaching Case Polysar Ltd'

1
Harvard Business School Teaching CasePolysar
Ltd.
2
AGENDAPolysar Ltd.

• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing

3
AGENDAPolysar Ltd.

• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing

4
POLYSAR

• Canadas largest chemical company.
• The Rubber Group accounts for 46 of Polysars
  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.
• EROWs demand exceeds its manufacturing capacity,
  so EROW buys butyl from NASA.

6
POLYSAR
7
AGENDAPolysar 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 NASAs performance relative to
  budget for sales price and volume.
• 1e) Evaluate NASAs performance relative to
  budget for plant efficiency, raw materials
  prices, fixed manufacturing expenses, and
  non-manufacturing expenses.

10
POLYSAR

• 1a) What evidence do we have that
  Polysar is on a standard costing
  system?

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
(No Transcript)
14
(No Transcript)
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
(No Transcript)
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.
POLYSAR
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
AGENDAPolysar Ltd.

• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing

22
POLYSAR

• 1d) Evaluate NASAs performance relative to
  budget for sales price and volume.

23
(No Transcript)
24
(No Transcript)
25
Evaluate NASAs 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 NASAs performance relative to
  budget for plant efficiency, raw materials
  prices, fixed manufacturing expenses, and
  non-manufacturing expenses.

27
(No Transcript)
28
(No Transcript)
29
Price and Efficiency Variances for Feedstocks,
Chemicals and Energy
The outer box represents the flexible budget
amount of 22,589.
S.P. A.P.
54K FAVORABLE
COST ADJUSTMENT
EFFICIENCY VARIANCE
241K FAV.
22,294K ACTUAL COST
A.Q. S.Q.
For actual output
30
(No Transcript)
31
(No Transcript)
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 income statements.

34
(No Transcript)
35
AGENDAPolysar Ltd.

• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing

36
POLYSAR

• 2. Calculate NASAs rate for allocating
  manufacturing overhead costs to Butyl.

37
POLYSAR
Fixed Manufacturing Overhead
Demonstrated Capacity
44,625K . 85,000 tons per year x
9/12 700 per ton
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
• Transfers to EROW on Exhibit 1

39
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
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 700/tonne x
19.5K tonnes 13,650K
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
  EROWs 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. EROWs fixed cost rate of
620 is lower than NASAs rate of 700, probably
because EROWs 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 16,250 x 700
11,375K
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 budgeted volume
  variances now be.

49
POLYSAR
Fixed Manufacturing Overhead
Budgeted Production 44,625K . 55,000
tons 811 per ton
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 811 x (55,000 - 47,500) 6,085
51
AGENDAPolysar Ltd.

• Introduction to Polysar
• Standard Costing
• Variance Analysis for Variable Costs
• Fixed Overhead Volume Variance
• Transfer Pricing

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).
• It does not include a mark-up.

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
plants 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
(No Transcript)
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. 44,625K/63,750
700 per ton
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 NASAs fixed costs with each ton purchased
  from NASA.

When EROW takes less butyl than planned, and NASA
cuts back on production accordingly, NASAs
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 NASAs
  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 production and distribution.
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
depreciation.
71
(No Transcript)
72
POLYSAR
EROWs variable cost per ton is approximately
595. NASAs 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 EROWs 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.
75
POLYSAR

• If EROW can sell one more ton of butyl, at a
  price equal to NASAs 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 EROWs 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
(No Transcript)
82
(No Transcript)
83
(No Transcript)
84
(No Transcript)