Polysar Ltd.

Topics: Variable cost, Costs, Total cost Pages: 9 (2845 words) Published: April 20, 2009
Polysar Limited is Canada’s largest chemical company. It is structured into 3 groups, namely, basic petrochemicals, rubber, and diversified products. 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. EROW’s demand exceeds its manufacturing capacity, so EROW “buys” butyl from NASA. FINANCIAL PERFORMANCE ANALYSIS

In 1986, Rubber NASA enjoyed sales worth $65.872 million which exceeded the estimated sales by $4.822 million. However, when it came to the net contribution, the division ended up with a loss of $876,000. This was $2.8 million less than the expected contribution. Comparatively, EROW did well in all aspects with sales worth $89 million and a net profit worth $22.6 million. After further exam, management concluded that the large fixed cost absorbed the sale figure, due to which the two divisions with same products have such a difference. 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. Variable Cost

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 (exhibit 2). These variable inputs include costs of feedstock, chemicals and energy. In 1986, NASA incurred more variable cost than expected by $844,000. However, the nature of variable cost is that it accumulates for each additional unit used in the production. Because of the growth in sales, more inputs were used for production. Again, the incremental cost was approx. 4% of the standard cost; hence the budgeting on variable cost was fairly accurate. Fixed Cost

Management wanted to focus on the fixed cost as it turned a favorable 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 labor, maintenance, plant management, and depreciation etc. Management finds two things after evaluation. 1.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 labor cost was also calculated into fixed cost because the staff number had always been stable through the years.

2.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 (Sarnia 2 on regular butyl). With that being said, management realized that NASA would naturally incur more fixed cost...
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