Rubber Group is the largest of the three operating units of Polysar Limited. The primary users of its products, such as butyl and halobutyl, are manufacturers of automobile tires; other users are from various industries. In 1986, Rubber group contributed 0.8 billion which is 46 percent of the company annual sale. The operation of the group is divided into four divisions, NASA (North America and South America) and EROW (Europe and rest of the world), Research department and Global Marketing department. NASA and EROW operate as profit centers each produce butyl and halobutyl dedicated to regional customers. Both of the centers have relatively flexible producing schedule to satisfy the increasing demand of halobutyl. After establishing the second plant in Sarnia, NASA is able to have each plant producing halobutyl and regular butyl. EROW, which has been running near capacity since 1980, solely focus on the production of halobutyl. Any idle capacity is utilized in manufacturing butyl. FINANCIAL PERFORMANCE ANALYSIS
In 1986, Rubber NASA achieved a sale of approx. 66million which was 4.8million higher than the budget. However, when came down to bottom line (net contribution), the division ended up a loss of 876thousand. This was 2.8million lower than expected. Comparatively, EROW did well in all aspects with a sale of 89million and a net profit of 22.6million. Why did the two divisions with same products have such a difference? After further exam, management concluded the large fixed cost absorbed sale figure. First it is important to understand the standard costing system implemented in Rubber group. Standard costing assigns quantity and price standards to each component of variable and fixed costs in calculating the total cost. In the case of NASA, the system uses standard purchasing price (input cost) and standard inputs usage in place for variable costs, and standard spending price (input cost) and standard production (demonstrated capacity) for fixed costs. In each accounting period, a purchase price variance and an efficiency variance will be calculated to find the change in price and usage of the variable inputs (see Appendix I). In 1986, NASA incurred more variable cost than expected by844thousand. However, the nature of variable cost is that it accumulates for each additional unit used in the production. Because of the sale growth, more inputs were applied into production. Again, the incremental cost was about 4% of the standard; hence the budgeting on variable cost was fairly accurate. Fixed Cost
Management wanted to focus on the fixed cost as it turned a favourable gross margin (pre-fixed cost) to an underperformed gross profit (after-fixed cost). Fixed costs were composed by direct costs, allocated cash costs and allocated non-cash costs, including direct labour, maintenance, plant management, and depreciation etc. Management finds two things after evaluation. First, the management noticed that fixed cost took a large portion of the total cost as it included many mandatory costs in daily operating and maintaining for a manufacturer. Additionally, direct labour cost was also calculated into fixed cost because the staff number had always been stable through the years. Second, fixed cost is sunk cost that doesn’t change with amount of production within capacity. In EROW, fixed cost was allocated to the production of butyl and halobutyl because two lines shared one capacity. This was different from NASA who dedicated each plant on each product (Sarnia2 on butyl). As that being said, management realized that NASA would naturally incur more fixed cost on regular butyl than their counterpart which only used 50% capacity on butyl. Moreover, EROW required 12.2thousand butyl from NASA as its production couldn't meet the demand in Europe. The revenue were then recorded into EROW’s when the transfers were sold. If one incurred full cost while the other incurred half of the...