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)

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.

POLYSAR
RUBBER GROUP

NASA

EROW

SARNIA 1 PLANT Halobutyl

SARNIA 2 PLANT Butyl

ANTWERP PLANT Butyl & Halobutyl

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 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.

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
NASA RUBBER DIVISION Regular Butyl Rubber Statement of Net Contri buti on September 1986
9 Months ended Sept. 30, 1986 A ctual (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 Budget (000's) 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 Deviation (000's) 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

Exhibit 2
NASA RUBBER DIVISION Regular Butyl Rubber Statement of Net Contri buti on September 1986
9 Months ended Sept. 30, 1986 A ctual (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 Budget (000's) 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 Deviation (000's) 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

-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

-2,906 25 - 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
NASA RUBBER DIVISION Regular Butyl Rubber Statement of Net Contri buti on September 1986
9 Months ended Sept. 30, 1986 A ctual (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 Budget (000's) 61,050 210 61,260 - 2,600 58,660 Deviation (000's) 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

-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

-2,906 25 - 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 NASAs performance relative to budget for sales price and volume.

Exhibit 2
NASA RUBBER DIVISION Regular Butyl Rubber Statement of Net Contri buti on September 1986
9 Months ended Sept. 30, 1986 A ctual (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 Budget (000's) 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 Deviation (000's) 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

Exhibit 1
NASA RUBBER DIVISION Regular Butyl Rubber Stati cs and Analyses sti September 1986 9 Months ended September 30, 1986 Vo lume - Tonnes Sales Producti on Transfers to EROW from EROW Producti on Costs Fixed Cost - Direct - All ocated Cash - All ocated Non-Cash Fixed Cost to Production Transfers to/from FG Inventory Transfers to EROW Transfers from EROW Fixed Cost of Sales Actual (000's) 35.8 47.5 12.2 2.1 ($ 000's) -21,466 - 7,036 -15,625 -44,127 1,120 8,540 -1,302 -35,769 Budget (000's) 33.0 55.0 19.5 1.0 ($ 000's) -21,900 - 7,125 -15,600 -44,625 2,450 13,650 -620 -29,145 Deviation (000's) 2.8 -7.5 -7.3 1.1 ($ 000's) 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.

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)

POLYSAR
1e) Evaluate NASAs performance relative to budget for plant efficiency, raw materials prices, fixed manufacturing expenses, and non-manufacturing expenses.

Exhibit 2
NASA RUBBER DIVISION Regular Butyl Rubber Statement of Net Contri buti on September 1986
9 Months ended Sept. 30, 1986 A ctual (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 Budget (000's) 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 Deviation (000's) 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

- 4,163 222 208 - 4,177 999 -1,875 - 876

163 12 158 17

-2,906 25 - 2,881

Exhibit 2
NASA RUBBER DIVISION Regular Butyl Rubber Statement of Net Contri buti on September 1986
9 Months ended Sept. 30, 1986 A ctual (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 Budget (000's) 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 Deviation (000's) 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

- 4,163 222 208 - 4,177 999 -1,875 - 876

163 12 158 17

-2,906 25 - 2,881

Price and Efficiency Variances for Feedstocks, Chemicals and Energy

The outer box represents the flexible budget amount of $22,589.
S.P.

A.P. $22,294K ACTUAL COST *For actual output $241K FAV. A.Q.*

S.Q.*

EFFICIENCY VARIANCE

$54K FAVORABLE COST ADJUSTMENT

Exhibit 1
NASA RUBBER DIVISION Regular Butyl Rubber Stati cs and Analyses sti September 1986 9 Months ended September 30, 1986 Vo lume - Tonnes Sales Producti on Transfers to EROW from EROW Producti on Costs Fixed Cost - Direct - All ocated Cash - All ocated Non-Cash Fixed Cost to Production Transfers to/from FG Inventory Transfers to EROW Transfers from EROW Fixed Cost of Sales Actual (000's) 35.8 47.5 12.2 2.1 ($ 000's) -21,466 - 7,036 -15,625 -44,127 1,120 8,540 -1,302 -35,769 Budget (000's) 33.0 55.0 19.5 1.0 ($ 000's) -21,900 - 7,125 -15,600 -44,625 2,450 13,650 -620 -29,145 Deviati on (000's) 2.8 -7.5 -7.3 1.1 ($ 000's) 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.

Exhibit 2
NASA RUBBER DIVISION Regular Butyl Rubber Statement of Net Contri buti on September 1986
9 Months ended Sept. 30, 1986 A ctual (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 T otal 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 Budget (000's) 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 Deviation (000's) 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

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.

Exhibit 2
NASA RUBBER DIVISION Regular Butyl Rubber Statement of Net Contri buti on September 1986
9 Months ended Sept. 30, 1986 A ctual (000's) Sales Revenue - Third Party - Diversified Product Group - Total Delivery Cost Net Sales Revenue 65,872 160 66,032 - 2,793 63,239 Budget (000's) 61,050 210 61,260 - 2,600 58,660 Deviation (000's) 4,822 50 4,722 - 193 4,579 -

Variable Costs Standard Cost Adjustm nts e Efficie ncy 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

-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

-21,450 -21,450
37,210 -23,100 80 - 6,125 -29,145 8,065 - 4,000 210 50 - 4,160 3,905

- 1,139 54 241 - 844

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

-2,906

AGENDA
Polysar Ltd.
Introduction to Polysar Standard Costing Variance Analysis for Variable Costs Fixed Overhead Volume Variance Transfer Pricing

POLYSAR
2. Calculate NASAs 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 EROWs 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. 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.

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 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.

Exhibit 5

POLYSAR LIMITED CONTROLLERS GUIDE

DEFINITIONS Demonstrated capacity is the actual annualized production of a p lant which was required to run full out within the last fiscal year for a sufficiently long period to assess production capab ility after ad justing for abnormally low or high unscheduled shutdowns, scheduled shutdowns, and unusual or annualized items which impacted either favourab ly or unfavourab ly on the periods production. The resulting ad justed historical base should be further modified for changes planned to be i mplemented within the current fiscal year. a) Where a p lant has not been required to run full out within the last fiscal year, production data may be used for a past period afer ad justing for changes (debottleneckings/inefficiencies) s ince that time affecting production. Where a p lant has never been required to run full out, demonstrated capacity could be reasonably considered as name plate capacity after adjusti ng for i) ii) iii) known invalid assumptions in arriving at name p late changes to original design affecting name plate a reasonable negative allowance for error

b)

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 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.

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 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.

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 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 Notes: 47,850 ($000's) 94,504 - 4,584 89,920 - 28,662 2 03 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

Fixed costs are allocated between regular butyl production (above) and h alobutyl production (reported separately).

POLYSAR
EROWs variable cost per ton is approximately $595.

NASAs 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 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.

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?

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 EROWs 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

Exhibit 6

S chedule of Regular Butyl Shipments from NASA to EROW

Actual To nnes 1985 1984 1983 1982 1981 21,710 12,831 1,432 792 1,069

Budget Tonnes 23,500 13,700 4,000 600 700

PRODUCT COSTING AND TRANSFER PRICES A purchase pri ce variance (were i nput pri ces above or below standard pri ces?) and an efficiency variance (did production requi more or less inputs than re standard?) were cal culated for variab le costs each accounting period. Fixed costs compri sed three categories of cost. Di rect costs included d irect l abor, mai ntenance, chemical required to keep the plant bubbling, and fixed s utilities. All ocated cash costs included p lant management, purchasing department costs, engineering, planning, and accounti ng. All ocated non-cash costs represented primarily depreciation. Fixed costs were all ocated to producti on based on a p lants demonstrated capacity using the foll owing formula, Standard Fixed Costs per Tonne = Estimated Annual Total Fi xed Costs Annual Demonstrated P lant Capacity

To apply the formula, production estimates were estab li shed each fall for the upcoming year. Then, the amount of total fixed costs applicab le to this level of production was estimated. The amount of total fi xed cost to be allocated to each tonne of output was cal culated by dividing total fixed cost by the p lants demonstrated capacity. Exhibit 5 reproduces a section of the Controllers Guide that defines demonstrated capacity. Each accounting period, two variances were calculated for fixed costs. The first was a spending variance cal culated as the simple difference between actual total fixed costs and esti mated total fixed costs. The second variance was a volume variance calculated using the formula: Vo lume Variance = x Standard Fixed Cost per Tonne (Actual Tonnes Produced - Demonstrated Capacity)

Product transfers between divisions for performance accounti ng purposes were made at standard full cost, representing, for each tonne, the sum of standard variab le cost and standard fixed cost.

Exhibit 2
NASA RUBBER DIVISION Regular Butyl Rubber Statement of Net Contri buti on September 1986
9 Months ended Sept. 30, 1986 A ctual (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 Budget (000's) 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 Deviation (000's) 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

Exhibit 1
NASA RUBBER DIVISION Regular Butyl Rubber Stati cs and Analyses sti September 1986 9 Months ended September 30, 1986 Vo lume - Tonnes Sales Producti on Transfers to EROW from EROW Producti on Costs Fixed Cost - Direct - All ocated Cash - All ocated Non-Cash Fixed Cost to Production Transfers to/from FG Inventory Transfers to EROW Transfers from EROW Fixed Cost of Sales Actual (000's) 35.8 47.5 12.2 2.1 ($ 000's) -21,466 - 7,036 -15,625 -44,127 1,120 8,540 -1,302 -35,769 Budget (000's) 33.0 55.0 19.5 1.0 ($ 000's) -21,900 - 7,125 -15,600 -44,625 2,450 13,650 -620 -29,145 Deviation (000's) 2.8 -7.5 -7.3 1.1 ($ 000's) 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.