Harvard Business School Teaching Case Polysar Ltd.

1. Harvard Business School Teaching CasePolysar Ltd.

2. AGENDAPolysar Ltd. • Introduction to Polysar • Flexible Budgeting & Standard Costing • Variance Analysis for Variable Costs • Fixed Overhead Volume Variance • Transfer Pricing

3. AGENDAPolysar Ltd. • Introduction to Polysar • Flexible Budgeting & 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

11. AGENDAPolysar Ltd. • Introduction to Polysar • Flexible Budgeting & Standard Costing • Variance Analysis for Variable Costs • Fixed Overhead Volume Variance • Transfer Pricing

12. Flexible Budgeting Budgets are based on some measure of output; such as units sold or produced. The static budget is based on the original, projected level of activity. The flexible budget adjusts budgeted costs for the actual level of activity.

13. Flexible Budgeting Building a flexible budget involves the following steps: Obtain the flexible budget for fixed costs directly from the static budget. Use the static budget to calculate the variable cost per unit of activity. Multiply the variable cost per unit by the actual number of units

14. Flexible Budgeting Pro forma statements, for hypothetical levels of output, also use the same “flexible budgeting” technique.

15. The Spring Valley Bicycle Company planned to produce and sell 6,000 units of its sole product in 2007. The product is a mountain bike. The company planned to earn revenues during the year of $5,160,000. The budget calls for direct materials of $250 per bike, and direct labor of $114 per bike. Total fixed manufacturing overhead was budgeted at $1,100,000. Total variable overhead was budgeted at $402,000. The company budgeted a sales commission of $70 per unit. In addition to the sales commission, which is a variable cost, there are fixed S.G. & A. expenditures budgeted at $85 per unit when 6,000 units are produced and sold. Required: Complete the following table. Be sure to indicate if variances are favorable or unfavorable.

16. The Spring Valley Bicycle Company planned to produce and sell 6,000units of its sole product in 2007. The company planned to earn revenues during the year of $5,160,000. The budget calls for direct materials of $250 and direct labor of $114 per bike. Fixed mfg overhead was budgeted at $1,100,000. Total variable overhead was budgeted at $402,000. The company budgeted a sales commission of $70 per unit. In addition, there are fixed S.G. & A. expenditures budgeted at $85 per unit when 6,000 units are produced and sold.

17. The Spring Valley Bicycle Company planned to produce and sell 6,000units of its sole product in 2007. The company planned to earn revenues during the year of $5,160,000. The budget calls for direct materials of $250 and direct labor of $114 per bike. Fixed mfg overhead was budgeted at $1,100,000. Total variable overhead was budgeted at $402,000. The company budgeted a sales commission of $70 per unit. In addition, there are fixed S.G. & A. expenditures budgeted at $85 per unit when 6,000 units are produced and sold.

18. Two meanings of “standard” • A “standard” is one type of a budgeted number • Noted for its precision • Often involves engineering estimates • Budgeted amounts need not be standard amounts (e.g., might be historical data) • “Standard” is a type of costing system • prevalent among manufacturing firms • other costing systems include actual costing and normal costing systems

19. What is a Standard? BUDGET STANDARD

20. Choice of Cost Accounting Systems

21. Actual versus Budgeted Amounts • Actual or budgeted rates for overhead. • Actual or budgeted prices/rates of direct inputs. • Actual quantities of direct inputs, or standard quantities based on actual production. • Actual quantity of overhead, or standard quantity based on actual production.

22. Three Costing Systems

23. Three Costing Systems Standardquantity of the allocation base allowed for actual outputs = budgeted (standard) inputs per output x actual outputs

24. AGENDAPolysar Ltd. • Introduction to Polysar • Flexible Budgeting & Standard Costing • Variance Analysis for Variable Costs • Fixed Overhead Volume Variance • Transfer Pricing

25. The derivation of the price and efficiency variances AP = actual price per unit of input (e.g., price per yard). Q = quantity of inputs for total output (e.g., yards). AP ACTUAL COST AQ

26. The flexible budget SP = budgeted price per unit of input (e.g., price per yard). SQ = budgeted quantity of inputs required for total output achieved (e.g., total yards of fabric that should have been needed for actual production). SP FLEXIBLE BUDGET SQ

27. The variable cost flexible budget variance (in green) P = price per unit of input. Q = quantity of inputs for total output. Actual Price Standard Price FLEXIBLE BUDGET Standard Actual Quantity Quantity

28. The price variance AP = actual price per unit of input. SP = budgeted price per unit of input. Q = quantity of inputs for total output. Actual Price Standard Price PRICE VARIANCE FLEXIBLE BUDGET Standard Actual Quantity Quantity S.Q. = standard quantity for actual outputs

29. The efficiency (or quantity) variance AP = actual price per unit of input. SP = budgeted price per unit of input. Q = quantity of inputs for total output. Actual Price Standard Price FLEXIBLE BUDGET QUANTITY VARIANCE Standard Actual Quantity Quantity S.Q. = standard quantity for actual outputs

30. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance AP = actual price per unit of input. SP = budgeted price. Q = quantity of inputs for total output. Actual Price Standard Price PRICE VARIANCE FLEXIBLE BUDGET QUANTITY VARIANCE Standard Actual Quantity Quantity S.Q. = standard quantity for actual outputs

31. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance AP = actual price per unit of input. SP = budgeted price. Q = quantity of inputs for total output (e.g., yards). Actual Price Standard Price why price? PRICE VARIANCE FLEXIBLE BUDGET QUANTITY VARIANCE Standard Actual Quantity Quantity S.Q. = standard quantity for actual outputs

32. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance Abbreviations: Price or Wage Rate or Spending Variance = PV Quantity or Usage or Efficiency Variance = QV Actual quantity of inputs = AQ Standard quantity of inputs = SQ Actual price per input unit = AP Standard price per input unit = SP

33. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance These variances apply to direct materials, direct labor, and variable overhead. Formulas: PV = AQ x (AP - SP) QV = SP x (AQ - SQ) For direct materials, AQ sometimes refers to materials purchased, instead of materials used. In this case, the price variance and the efficiency variance will not sum to the flexible budget variance, due to the timing difference.

34. The McBean Company makes stars. The budgeted cost for each star is as follows: Materials:2 pounds of “star stuff” at $4 per lb. = $8 per star Labor:1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25 per lb. Of this amount, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 1. What is the direct material price variance, assuming that the company recognizes the price variance at the time the materials are purchased? 2. What is the direct material usage (quantity) variance? 3. What is the direct labor rate (price) variance? 4. What is the direct labor efficiency variance?

35. Formulas: PV = AQ x (AP - SP) QV = SP x (AQ - SQ) PV = Price Variance QV = Quantity Variance AQ (SQ) = Actual (Standard) quantity of inputs AP (SP) = Actual (Standard) price per input Standards for Direct materials: 2 lbs of “star stuff” at $4 per lb. = $8 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” was purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. What is the direct material price variance, assuming that the company recognizes the price variance at the time materials are purchased?

36. Standards for Direct materials: 2 lbs. of “star stuff” at $4 per lb. = $8 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. What is the direct material price variance, assuming that the company recognizes the price variance at the time materials are purchased? PV = AQ x (AP - SP) = 2,600 lbs. x ($4.25 per lb. - $4.00 per lb.) = 2,600 lb. x $0.25 per lb. = $650 Unfavorable

37. Formulas: PV = AQ x (AP - SP) QV = SP x (AQ - SQ) PV = Price Variance QV = Quantity Variance AQ (SQ) = Actual (Standard) quantity of inputs AP (SP) = Actual (Standard) price per input Standards for Direct materials: 2 lbs. of “star stuff” at $4 per lb. = $8 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. 2. What is the direct material usage (quantity) variance?

38. Standards for Direct materials: 2 lbs. of “star stuff” at $4 per lb. = $8 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. 2. What is the direct material usage (quantity) variance? QV = SP x (AQ - SQ) = $4 per lb. x (2,300 lbs. - 2,400 lbs.*) = $4 per lb. x 100 lbs. = $400 favorable * 2 lbs. per star x 1,200 stars

39. Formulas: PV = AQ x (AP - SP) QV = SP x (AQ - SQ) PV = Price Variance QV = Quantity Variance AQ (SQ) = Actual (Standard) quantity of inputs AP (SP) = Actual (Standard) price per input Standards for Direct labor: 1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 3. What is the direct labor rate (price) variance?

40. Standards for Direct labor: 1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 3. What is the direct labor rate (price) variance? PV = AQ x (AP - SP) = 1,820 hr.s x (11.50 per hr* - $12 per hr) = 1,820 hr.s x $0.50 per hr = $910 favorable * $20,930 ÷ 1,820 hours = $11.50 per hr.

41. Formulas: PV = AQ x (SP - AP) QV = SP x (AQ - SQ) PV = Price Variance QV = Quantity Variance AQ (SQ) = Actual (Standard) quantity of inputs AP (SP) = Actual (Standard) price per input Standards for Direct labor: 1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 4. What is the direct labor efficiency variance?

42. Standards for Direct labor: 1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 4. What is the direct labor efficiency variance? QV = SP x (AQ - SQ) = $12 per hour x (1,820 hrs - 1,800 hrs*) = $12 per hour x 20 hrs. = $240 Unfav. * 1,200 stars x 1.5 hours per star = 1,800 hr.s

43. 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.

44. 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.

46. AGENDAPolysar Ltd. • Introduction to Polysar • Flexible Budgeting & Standard Costing • Variance Analysis for Variable Costs • Fixed Overhead Volume Variance • Transfer Pricing

47. Cost Variances for Fixed and Variable Overhead • Variances for Variable Overhead • Variances for Fixed Overhead

48. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance Abbreviations: Price or Wage Rate or Spending Variance = PV Quantity or Usage or Efficiency Variance = QV Actual quantity of inputs = AQ Standard quantity of inputs = SQ Actual price per input unit = AP Standard price per input unit = SP

49. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance These variances apply to direct materials, direct labor, and variable overhead. Formulas: PV = AQ x (AP - SP) QV = SP x (AQ - SQ) For Variable Overhead, the Q’s are the quantity of the allocation base. AQ is the actual quantity of the allocation base used. SQ is the standard quantity of the allocation base. The P’s are the Overhead Rate. AP is the Actual Overhead Rate. SP is the Budgeted Overhead Rate.

50. Spending Variance = Actual quantity of allocation base incurred x (Actual O/H rate – Budgeted O/H rate) Efficiency Variance = Budgeted O/H rate x (Actual quantity of allocation base incurred – Standard quantity of allocation base based on actual output) The variable overhead variances