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 • 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)

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. • EROW’s 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 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.

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.

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.

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. 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.

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 NASA’s performance relative to budget for sales price and volume.

25. 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)

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

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

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.

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

36. POLYSAR 2. Calculate NASA’s 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 EROW’s 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. 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.

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