Harvard Business School

Teaching Case

Polysar Ltd.

AGENDA

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

AGENDA

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

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 G RO UP
NASA
S A R N IA 1 P L A N T
H a lo b u t y l

S A R N IA 2 P L A N T
B u ty l

ERO W
AN TW ERP PLAN T
B u t y l & H a lo b u t y l

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 Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(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

Budget
(000's)

Deviation
(000's)

65,872
160
66,032
- 2,793
63,239

61,050
210
61,260
- 2,600
58,660

4,822
50
4,722
- 193
4,579

-22,589
54
241
-22,294

-21,450
-21,450

- 1,139
54
241
- 844

40,945

37,210

3,735

-25,060
168
498
-11,375
-35,769
5,176

-23,100
80
- 6,125
-29,145
8,065

-1,960
88
498
-5,250
-6,624
-2,889

- 4,163
222
208
- 4,177

- 4,000
210
50
- 4,160

999
-1,875
- 876

3,905
-1,900
2,005

163
12
158
17

-2,906
25
- 2,881

Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(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

Budget
(000's)

Deviation
(000's)

65,872
160
66,032
- 2,793
63,239

61,050
210
61,260
- 2,600
58,660

4,822
50
4,722
- 193
4,579

-22,589
54
241
-22,294

-21,450
-21,450

- 1,139
54
241
- 844

40,945

37,210

3,735

-25,060
168
498
-11,375
-35,769
5,176

-23,100
80
- 6,125
-29,145
8,065

-1,960
88
498
-5,250
-6,624
-2,889

- 4,163
222
208
- 4,177

- 4,000
210
50
- 4,160

999
-1,875
- 876

3,905
-1,900
2,005

163
12
158
17

-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 Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(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

Budget
(000's)

Deviation
(000's)

65,872
160
66,032
- 2,793
63,239

61,050
210
61,260
- 2,600
58,660

4,822
50
4,722
- 193
4,579

-22,589
54
241
-22,294

-21,450
-21,450

- 1,139
54
241
- 844

40,945

37,210

3,735

-25,060
168
498
-11,375
-35,769
5,176

-23,100
80
- 6,125
-29,145
8,065

-1,960
88
498
-5,250
-6,624
-2,889

- 4,163
222
208
- 4,177

- 4,000
210
50
- 4,160

999
-1,875
- 876

3,905
-1,900
2,005

163
12
158
17

-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 Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(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

Budget
(000's)

Deviation
(000's)

65,872
160
66,032
- 2,793
63,239

61,050
210
61,260
- 2,600
58,660

4,822
50
4,722
- 193
4,579

-22,589
54
241
-22,294

-21,450
-21,450

- 1,139
54
241
- 844

40,945

37,210

3,735

-25,060
168
498
-11,375
-35,769
5,176

-23,100
80
- 6,125
-29,145
8,065

-1,960
88
498
-5,250
-6,624
-2,889

- 4,163
222
208
- 4,177

- 4,000
210
50
- 4,160

999
-1,875
- 876

3,905
-1,900
2,005

163
12
158
17

-2,906
25
- 2,881

Exhibit 1
NASA RUBBER DIVISION
Regular Butyl Rubber
Statistics and Analyses
September 1986
9 Months ended September 30, 1986
Vo lume - Tonnes

Actual
(000's)

Budget
(000's)

Deviation
(000's)

Sales

35.8

33.0

2.8

Production

47.5

55.0

-7.5

Transfers
to EROW
from EROW

12.2
2.1

19.5
1.0

-7.3
1.1

Production Costs
Fixed Cost - Direct
- Allocated Cash
- Allocated Non-Cash
Fixed Cost to Production
Transfers to/from FG Inventory
Transfers to EROW
Transfers from EROW
Fixed Cost of Sales

($ 000's)

($ 000's)

($ 000's)

-21,466
- 7,036
-15,625
-44,127

-21,900
- 7,125
-15,600
-44,625

1,120
8,540
-1,302

2,450
13,650
-620

-1,330
-5,110
- 682

-35,769

-29,145

-6,624

434
89
25
498

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 Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(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

Budget
(000's)

Deviation
(000's)

65,872
160
66,032
- 2,793
63,239

61,050
210
61,260
- 2,600
58,660

4,822
50
4,722
- 193
4,579

-22,589
54
241
-22,294

-21,450
-21,450

- 1,139
54
241
- 844

40,945

37,210

3,735

-25,060
168
498
-11,375
-35,769
5,176

-23,100
80
- 6,125
-29,145
8,065

-1,960
88
498
-5,250
-6,624
-2,889

- 4,163
222
208
- 4,177

- 4,000
210
50
- 4,160

999
-1,875
- 876

3,905
-1,900
2,005

163
12
158
17

-2,906
25
- 2,881

Exhibit 2
NASA RUBBER DIVISION
Regular Butyl Rubber
Statement of Net Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(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

Budget
(000's)

Deviation
(000's)

65,872
160
66,032
- 2,793
63,239

61,050
210
61,260
- 2,600
58,660

4,822
50
4,722
- 193
4,579

-22,589
54
241
-22,294

-21,450
-21,450

- 1,139
54
241
- 844

40,945

37,210

3,735

-25,060
168
498
-11,375
-35,769
5,176

-23,100
80
- 6,125
-29,145
8,065

-1,960
88
498
-5,250
-6,624
-2,889

- 4,163
222
208
- 4,177

- 4,000
210
50
- 4,160

999
-1,875
- 876

3,905
-1,900
2,005

163
12
158
17

-2,906
25
- 2,881

Price and Efficiency Variances for

Feedstocks, Chemicals and Energy

S.P.

$54K FAVORABLE
COST ADJUSTMENT

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

$241K
FAV.
A.Q.*

EFFICIENCY
VARIANCE

The outer box represents the flexible

budget amount of $22,589.

S.Q.*

Exhibit 1
NASA RUBBER DIVISION
Regular Butyl Rubber
Statistics and Analyses
September 1986
9 Months ended September 30, 1986
Vo lume - Tonnes

Actual
(000's)

Budget
(000's)

Deviation
(000's)

Sales

35.8

33.0

2.8

Production

47.5

55.0

-7.5

Transfers
to EROW
from EROW

12.2
2.1

19.5
1.0

-7.3
1.1

Production Costs
Fixed Cost - Direct
- Allocated Cash
- Allocated Non-Cash
Fixed Cost to Production
Transfers to/from FG Inventory
Transfers to EROW
Transfers from EROW
Fixed Cost of Sales

($ 000's)

($ 000's)

($ 000's)

-21,466
- 7,036
-15,625
-44,127

-21,900
- 7,125
-15,600
-44,625

1,120
8,540
-1,302

2,450
13,650
-620

-1,330
-5,110
- 682

-35,769

-29,145

-6,624

434
89
25
498

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 Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(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

Budget
(000's)

Deviation
(000's)

65,872
160
66,032
- 2,793
63,239

61,050
210
61,260
- 2,600
58,660

4,822
50
4,722
- 193
4,579

-22,589
54
241
-22,294

-21,450
-21,450

- 1,139
54
241
- 844

40,945

37,210

3,735

-25,060
168
498
-11,375
-35,769
5,176

-23,100
80
- 6,125
-29,145
8,065

-1,960
88
498
-5,250
-6,624
-2,889

- 4,163
222
208
- 4,177

- 4,000
210
50
- 4,160

999
-1,875
- 876

3,905
-1,900
2,005

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 Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(000's)
Sales Revenue - Third Party
- Diversified Product Group
- Total
Delivery Cost
Net Sales Revenue

Variable Costs
Standard
Cost Adjustments
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

Budget
(000's)

Deviation
(000's)

65,872
160
66,032
- 2,793
63,239

61,050
210
61,260
- 2,600
58,660

4,822
50
4,722
- 193
4,579

-22,589
54
241
-22,294

-21,450
-21,450

- 1,139
54
241
- 844

40,945

37,210

3,735

-25,060
168
498
-11,375
-35,769
5,176

-23,100
80
- 6,125
-29,145
8,065

-1,960
88
498
-5,250
-6,624
-2,889

- 4,163
222
208
- 4,177

- 4,000
210
50
- 4,160

999

3,905

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
implemented 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.

b)

Where a p lant has never been required to run full out, demonstrated
capacity could be reasonably considered as name plate capacity after
adjusting 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

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

47,850
($000's)
94,504
- 4,584
89,920

Variable Costs
Standard
Purchase Price Variance
Inventory Revaluation
Efficiency Variance
Total

- 28,662
203
46
32
- 28,473
61,447

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:

- 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 halobutyl 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

Schedule of Regular Butyl Shipments from NASA to EROW

Actual
To nnes

Budget
Tonnes

1985

21,710

23,500

1984

12,831

13,700

1983

1,432

4,000

1982

792

600

1981

1,069

700

PRODUCT COSTING AND TRANSFER PRICES A purchase price variance (were input prices above or below standard
prices?) and an efficiency variance (did production require more or less inputs than
standard?) were calculated for variab le costs each accounting period.
F ixed costs comprised three categories of cost. Direct costs included d irect
labor, maintenance, chemicals required to keep the plant bubbling, and fixed
utilities. Allocated cash costs included p lant management, purchasing department
costs, engineering, planning, and accounting. Allocated non-cash costs represented
primarily depreciation.
F ixed costs were allocated to production based on a p lants demonstrated
capacity using the following formula,
Standard Fixed
Costs per Tonne

Estimated Annual Total Fixed Costs

Annual Demonstrated P lant Capacity

To apply the formula, production estimates were estab lished 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 fixed cost to be allocated to each
tonne of output was calculated 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 calculated as the simple difference between actual
total fixed costs and estimated 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 accounting 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 Contribution
September 1986
9 Months ended Sept. 30, 1986
Actual
(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

Budget
(000's)

Deviation
(000's)

65,872
160
66,032
- 2,793
63,239

61,050
210
61,260
- 2,600
58,660

4,822
50
4,722
- 193
4,579

-22,589
54
241
-22,294

-21,450
-21,450

- 1,139
54
241
- 844

40,945

37,210

3,735

-25,060
168
498
-11,375
-35,769
5,176

-23,100
80
- 6,125
-29,145
8,065

-1,960
88
498
-5,250
-6,624
-2,889

- 4,163
222
208
- 4,177

- 4,000
210
50
- 4,160

999
-1,875
- 876

3,905
-1,900
2,005

163
12
158
17

-2,906
25
- 2,881

Exhibit 1
NASA RUBBER DIVISION
Regular Butyl Rubber
Statistics and Analyses
September 1986
9 Months ended September 30, 1986
Vo lume - Tonnes

Actual
(000's)

Budget
(000's)

Deviation
(000's)

Sales

35.8

33.0

2.8

Production

47.5

55.0

-7.5

Transfers
to EROW
from EROW

12.2
2.1

19.5
1.0

-7.3
1.1

Production Costs
Fixed Cost - Direct
- Allocated Cash
- Allocated Non-Cash
Fixed Cost to Production
Transfers to/from FG Inventory
Transfers to EROW
Transfers from EROW
Fixed Cost of Sales

($ 000's)

($ 000's)

($ 000's)

-21,466
- 7,036
-15,625
-44,127

-21,900
- 7,125
-15,600
-44,625

1,120
8,540
-1,302

2,450
13,650
-620

-1,330
-5,110
- 682

-35,769

-29,145

-6,624

434
89
25
498

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.