Respected members of Board of Directors:
In this report, I will discuss the performance of NASA Division for the past 9 months during the fiscal year with special attention to the meaning and accuracy of the volume variance. Then I will identify the issues of the best sales and production strategy for EROW Division, NASA Division and the Rubber Group as a whole. At last, my recommendations of changes that should be made in the management accounting performance system to improve the reporting and evaluation of the Rubber Group performance will be raised.
NASA Rubber Division’s performance:
As shown on the statement of net contribution September 1986, NASA Rubber Division’s actual net sales revenue exceeds the budget by yielding a favorable net sales variance of 4,579,000. NASA also generates a positive gross margin by accurately and reasonably budget the variable costs. NASA calculates standard variable cost per tonne of butyl by multiplying a standard utilization factor 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 is impossible to establish standard input prices that remained valid for extended periods. Therefore, the company reset feedstock standard costs each month to a price that reflected market prices. This constant adjustment makes sure the accuracy of the measurement of the variable costs. However, NASA’s actual gross profit is almost 50% below budget because the actual total fixed costs are much higher than the budget; and volume variance would be the key factor resulting in this discrepancy.
The unfavorable 5,250,000 volume variance is considered huge, which is about 50% of the actual volume variance cost. The big gap between the actual volume variance and the budget implies some potential problems of the measurement on the volume variance. The volume variance is calculated by multiply the standard fixed cost per tonne by the difference between actual tones produced and the demonstrated capacity. Therefore, two numbers are estimated when calculating volume variance, demonstrated capacity and standard fixed cost per tonne.
The demonstrated capacity is the actual annualized production of a plant within the last fiscal year after adjusting for abnormal items. The resulting adjusted historical base should be further modified for changes planned to be implemented within the current fiscal year. Therefore, for each plant of NASA, production level of previous year will be used to estimate the production capacity for current year. However, NASA’s regular butyl plant, Sarnia 2, may not have reliable historical data since it is newly built in late 1984 and begins operation for only one year around. Moreover, Sarnia 2 failed to achieve the annual nameplate production capacity with a shortage of 30,000 tonnes in 1985. These factors will all affect the accuracy of the demonstrated capacity estimate for 1986. In order to improve the accuracy on the estimate, I suggest Sarnia 2 could use Sarnia 1’s production data to forecast and budget the future performance since Sarnia 1 has longer operating history and its data is more stable and consistent.
The other number that affects the calculation of the volume variance is the standard fixed cost per tonne. This number is determined by dividing the estimated annual total fixed costs by annual demonstrated plant capacity. Besides the inaccuracy of the demonstrated capacity estimate discussed above, the determination of the annual total fixed costs is not accurate enough as well. The total fixed costs applicable to certain level of production can only be estimated after production estimates are established each fall for the upcoming year. However, the production estimates for Sarnia 2 are affected by the transfer to EROW. As shown in Statistics and Analyses in Exhibit 1 and schedule of shipment in...