[PPT]ROI and Residual Income - Oregon State Universityclasses.bus.oregonstate.edu/ba528/Slide show week 9 topic... · Web viewHarvard Business School Teaching Case Polysar Ltd. POLYSAR

Harvard Business School Harvard Business School Teaching CaseTeaching Case

Polysar Ltd.Polysar Ltd.

AGENDAAGENDAPolysar Ltd.Polysar Ltd.

• Introduction to Polysar• Standard Costing• Variance Analysis for Variable

Costs• Fixed Overhead Volume Variance• Transfer Pricing




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)

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.

POLYSAR

S A R N IA 1 P L A N TH alob u tyl

S A R N IA 2 P L A N TB u tyl

N A S A

A N TW E R P P L A N TB u tyl & H a lob u tyl

E R O W

R U B B E R G R O U P




POLYSAR1a) 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.

POLYSAR1d) 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.

POLYSAR1a) 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.

POLYSAR1b) Interpret the amount $22,589 on

Exhibit 2, for variable costs.

Exhibit 2NASA RUBBER DIVISION

Regular Butyl RubberStatement of Net Contribution

September 19869 Months ended Sept. 30, 1986

Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)

Sales Revenue - Third Party - Diversified Product Group - TotalDelivery CostNet Sales Revenue

Variable Costs Standard Cost Adjustments Efficiency Variance Total

Gross Margin - $

Fixed Costs Standard Cost Adjustments Spending Variance Volume Variance TotalGross Profit - $

Period Costs Administration, Selling, Distribution Technical Service Other Income/Expense Total

Business ContributionInterest on Working CapitalNet Contribution

65,872160

66,032- 2,79363,239

-22,58954

241-22,294

40,945

-25,060168498

-11,375-35,769

5,176

- 4,163- 222

208- 4,177

999-1,875- 876

61,050210

61,260- 2,60058,660

-21,450- -

-21,450

37,210

-23,10080-

- 6,125-29,145

8,065

- 4,000- 210

50- 4,160

3,905-1,9002,005

4,822- 504,722

- 1934,579

- 1,13954

241- 844

3,735

-1,96088

498-5,250-6,624-2,889

- 163- 12

158- 17

-2,90625

- 2,881




Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)



Gross Margin - $




65,872160

66,032- 2,79363,239

-22,58954

241-22,294

40,945

-25,060168498

-11,375-35,769

5,176

- 4,163- 222

208- 4,177

999-1,875- 876

61,050210

61,260- 2,60058,660

-21,450- -

-21,450

37,210

-23,10080-

- 6,125-29,145

8,065

- 4,000- 210

50- 4,160

3,905-1,9002,005

4,822- 504,722

- 1934,579

- 1,13954

241- 844

3,735

-1,96088

498-5,250-6,624-2,889

- 163- 12

158- 17

-2,90625

- 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)?

POLYSAR1c) Interpret the amount $21,450 on

Exhibit 2, for variable costs.




Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)



Gross Margin - $




65,872160

66,032- 2,79363,239

-22,58954

241-22,294

40,945

-25,060168498

-11,375-35,769

5,176

- 4,163- 222

208- 4,177

999-1,875- 876

61,050210

61,260- 2,60058,660

-21,450- -

-21,450

37,210

-23,10080-

- 6,125-29,145

8,065

- 4,000- 210

50- 4,160

3,905-1,9002,005

4,822- 504,722

- 1934,579

- 1,13954

241- 844

3,735

-1,96088

498-5,250-6,624-2,889

- 163- 12

158- 17

-2,90625

- 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).

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

POLYSARProduct 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.




POLYSAR1d) Evaluate NASA’s performance

relative to budget for sales price and volume.




Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)



Gross Margin - $




65,872160

66,032- 2,79363,239

-22,58954

241-22,294

40,945

-25,060168498

-11,375-35,769

5,176

- 4,163- 222

208- 4,177

999-1,875- 876

61,050210

61,260- 2,60058,660

-21,450- -

-21,450

37,210

-23,10080-

- 6,125-29,145

8,065

- 4,000- 210

50- 4,160

3,905-1,9002,005

4,822- 504,722

- 1934,579

- 1,13954

241- 844

3,735

-1,96088

498-5,250-6,624-2,889

- 163- 12

158- 17

-2,90625

- 2,881

Exhibit 1

NASA RUBBER DIVISIONRegular Butyl RubberStatistics and Analyses

September 1986

9 Months ended September 30, 1986

Volume - Tonnes Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)

Sales

Production

Transfers to EROW from EROW

35.8

47.5

12.22.1

33.0

55.0

19.51.0

2.8

-7.5

-7.31.1

Production Costs ($ ‘000's) ($ ‘000's) ($ ‘000's)

Fixed Cost - Direct - Allocated Cash - Allocated Non-CashFixed Cost to Production

Transfers to/from FG InventoryTransfers to EROWTransfers from EROW

Fixed Cost of Sales

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

1,1208,540

-1,302

-35,769

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

2,45013,650

-620

-29,145

43489

- 25498

-1,330-5,110- 682

-6,624

Note: as indicated on p. 1 of the case, financial data have been disguisedand do not represent the true financial results of the company.

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)

POLYSAR1e) Evaluate NASA’s performance

relative to budget for plant efficiency, raw materials prices, fixed manufacturing expenses, and non-manufacturing expenses.




Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)



Gross Margin - $




65,872160

66,032- 2,79363,239

-22,58954

241-22,294

40,945

-25,060168498

-11,375-35,769

5,176

- 4,163- 222

208- 4,177

999-1,875- 876

61,050210

61,260- 2,60058,660

-21,450- -

-21,450

37,210

-23,10080-

- 6,125-29,145

8,065

- 4,000- 210

50- 4,160

3,905-1,9002,005

4,822- 504,722

- 1934,579

- 1,13954

241- 844

3,735

-1,96088

498-5,250-6,624-2,889

- 163- 12

158- 17

-2,90625

- 2,881




Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)



Gross Margin - $




65,872160

66,032- 2,79363,239

-22,58954

241-22,294

40,945

-25,060168498

-11,375-35,769

5,176

- 4,163- 222

208- 4,177

999-1,875- 876

61,050210

61,260- 2,60058,660

-21,450- -

-21,450

37,210

-23,10080-

- 6,125-29,145

8,065

- 4,000- 210

50- 4,160

3,905-1,9002,005

4,822- 504,722

- 1934,579

- 1,13954

241- 844

3,735

-1,96088

498-5,250-6,624-2,889

- 163- 12

158- 17

-2,90625

- 2,881

Price and Efficiency Variances for Feedstocks, Chemicals and Energy

S.P.

A.P.

A.Q.* S.Q.*

$22,294KACTUAL COST

$241KFAV.

$54K FAVORABLE“COST ADJUSTMENT”

EFFI

CIEN

CY V

ARIA

NCE

*For actual output

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

Exhibit 1


September 1986



Budget(‘000's)

Deviation(‘000's)

Sales

Production


35.8

47.5

12.22.1

33.0

55.0

19.51.0

2.8

-7.5

-7.31.1




Fixed Cost of Sales

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

1,1208,540

-1,302

-35,769

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

2,45013,650

-620

-29,145

43489

- 25498

-1,330-5,110- 682

-6,624





Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)



Gross Margin - $




65,872160

66,032- 2,79363,239

-22,58954

241-22,294

40,945

-25,060168498

-11,375-35,769

5,176

- 4,163- 222

208- 4,177

999-1,875- 876

61,050210

61,260- 2,60058,660

-21,450- -

-21,450

37,210

-23,10080-

- 6,125-29,145

8,065

- 4,000- 210

50- 4,160

3,905-1,9002,005

4,822- 504,722

- 1934,579

- 1,13954

241- 844

3,735

-1,96088

498-5,250-6,624-2,889

- 163- 12

158- 17

-2,90625

- 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.




Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)



Gross Margin - $



Business Contribution

65,872160

66,032- 2,79363,239

-22,58954

241-22,294

40,945

-25,060168498

-11,375-35,769

5,176

- 4,163- 222

208- 4,177

999

61,050210

61,260- 2,60058,660

-21,450- -

-21,450

37,210

-23,10080-

- 6,125-29,145

8,065

- 4,000- 210

50- 4,160

3,905

4,822- 504,722

- 1934,579

- 1,13954

241- 844

3,735

-1,96088

498-5,250-6,624-2,889

- 163- 12

158- 17

-2,906




POLYSAR

2. Calculate NASA’s rate for allocating manufacturing overhead costs to Butyl.

POLYSARFixed Manufacturing Overhead Demonstrated Capacity= $44,625K .85,000 tons per year x 9/12=$700 per ton

POLYSAR3. 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

POLYSARFixed Costs of Sales on Exhibit 2

Actual:$700/tonne x 35.8K tonnes = $25,060K

Budgeted:$700/tonne x 33.0K tonnes = $23,100K

POLYSARTransfers 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

POLYSARTransfers to EROW on Exhibit 1

Actual:$700/tonne x 12.2K tonnes = $8,540K

Budget:$700/tonne x 19.5K tonnes = $13,650K

POLYSAR4. Does Polysar close out variances

to Cost of Goods Sold, or allocate variances between Cost of Goods Sold and Inventory?

POLYSARIn 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.”

POLYSAR5. 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?

POLYSARFrom 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.

POLYSAR6. What do the budgeted and

actual volume variances of $6,125 and $11,375 represent?

POLYSARBudgetCapacity for 9 mo.s of 63,750 tonsBudgeted production of 55,000 (63,750 - 55,000) x $700 = $6,125KActualCapacity for 9 months of 63,750 tonsActual production of 47,500 (63,750 - 47,500) x $700 = 16,250 x $700 = $11,375K

POLYSAR7. 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.

POLYSARFixed Manufacturing Overhead Budgeted Production=$44,625K .55,000 tons

= $811 per ton

POLYSARUsing 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




POLYSAR8a) 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?

POLYSAR8a. 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.

POLYSARInterview 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.

POLYSAR8b. What is the transfer price for

butyl?

Product Costing and Transfer Prices –… Fixed costs were allocated to production based on a plant’s “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 – CONTROLLER’S GUIDE

DEFINITIONS

Demonstrated capacity is the actual annualized production of a plant which wasrequired to run full out within the last fiscal year for a sufficiently long period toassess production capability after adjusting for abnormally low or high unscheduledshutdowns, scheduled shutdowns, and unusual or annualized items which impactedeither favourably or unfavourably on the period’s production. The resultingadjusted historical base should be further modified for changes planned to beimplemented within the current fiscal year.

a) Where a plant has not been required to run full out within the last fiscalyear, production data may be used for a past period afer adjusting forchanges (debottleneckings/inefficiencies) since that time affectingproduction.

b) Where a plant has never been required to run full out, demonstratedcapacity could be reasonably considered as “name plate” capacity afteradjusting for

i) known invalid assumptions in arriving at “name plate”ii) changes to original design affecting “name plate”iii) 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

POLYSAR8c. 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 NASA’s fixed costs with each ton “purchased” from NASA.

When EROW takes less butyl than planned, and NASA cuts back on production accordingly, NASA’s 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 NASA’s net contribution. The $700 per ton in fixed costs that NASA thought would be covered by EROW, will now be capitalized in ending inventory.

POLYSAR8c. What is the best butyl sourcing

strategy for Polysar?

POLYSARPolysar 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 7EROW RUBBER DIVISION

Regular Butyl RubberCondensed Statement of Net Contribution

September 1986

9 Months Ended September 30, 1986

Sales Volume -- Tonnes

Sales RevenueDelivery CostNet 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 CostsBusiness ContributionInterest on Working CapitalNet Contribution

47,850($’000's)

94,504- 4,584

89,920

- 28,662203

- 4632

- 28,473

61,447

- 4,900- 16,390- 21,290- 775- 7,238- 29,303

32,144

- 7,560 24,584

- 1,92322,661

Notes: Fixed costs are allocated between regular butyl production (above)and halobutyl production (reported separately).

POLYSAR

EROW’s variable cost per ton is approximately $595.

NASA’s variable cost per ton is approximately $623.

POLYSAR8f. What is the best butyl sourcing

strategy for EROW, given the current accounting treatment, and the bonus scheme?

POLYSAR From EROW’s 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 NASA’s variable costs, plus shipping, plus $699, will they want to?

In the above situation, will the company want EROW to make the sale?

POLYSARCompensationManagement –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.

POLYSARProduct SchedulingAlthough 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. …

POLYSARProduct 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 EROW’s incentives in the

budgeting process?

What happens if EROW estimates greater demand for butyl than EROW actually needs?

POLYSARInterview 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 BudgetTonnes 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 standardprices?) and an efficiency variance (did production require more or less inputs thanstandard?) were calculated for variable costs each accounting period.

Fixed costs comprised three categories of cost. Direct costs included directlabor, maintenance, chemicals required to keep the plant bubbling, and fixedutilities. Allocated cash costs included plant management, purchasing departmentcosts, engineering, planning, and accounting. Allocated non-cash costs representedprimarily depreciation.

Fixed costs were allocated to production based on a plant’s “demonstratedcapacity” using the following formula,

Standard Fixed = Estimated Annual Total Fixed CostsCosts per Tonne Annual Demonstrated Plant Capacity

To apply the formula, production estimates were established each fall for theupcoming year. Then, the amount of total fixed costs applicable to this level ofproduction was estimated. The amount of total fixed cost to be allocated to eachtonne of output was calculated by dividing total fixed cost by the plant’sdemonstrated capacity. Exhibit 5 reproduces a section of the Controller’s Guidethat defines demonstrated capacity.

Each accounting period, two variances were calculated for fixed costs. Thefirst was a spending variance calculated as the simple difference between actualtotal fixed costs and estimated total fixed costs. The second variance was a volumevariance calculated using the formula:

Volume Variance = Standard Fixed Cost per Tonne x (Actual Tonnes Produced - Demonstrated Capacity)

Product transfers between divisions for performance accounting purposeswere made at standard full cost, representing, for each tonne, the sum of standardvariable cost and standard fixed cost.




Actual(‘000's)

Budget(‘000's)

Deviation(‘000's)



Gross Margin - $




65,872160

66,032- 2,79363,239

-22,58954

241-22,294

40,945

-25,060168498

-11,375-35,769

5,176

- 4,163- 222

208- 4,177

999-1,875- 876

61,050210

61,260- 2,60058,660

-21,450- -

-21,450

37,210

-23,10080-

- 6,125-29,145

8,065

- 4,000- 210

50- 4,160

3,905-1,9002,005

4,822- 504,722

- 1934,579

- 1,13954

241- 844

3,735

-1,96088

498-5,250-6,624-2,889

- 163- 12

158- 17

-2,90625

- 2,881

Exhibit 1


September 1986



Budget(‘000's)

Deviation(‘000's)

Sales

Production


35.8

47.5

12.22.1

33.0

55.0

19.51.0

2.8

-7.5

-7.31.1




Fixed Cost of Sales

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

1,1208,540

-1,302

-35,769

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

2,45013,650

-620

-29,145

43489

- 25498

-1,330-5,110- 682

-6,624


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