Luotang Power Presentation and Questions

1.  Prepare a presentation for the HT Power Board of Directors to review the performance of the Luotang Project.  Pay particular attention to questions that may be raised concerning the accuracy and meaning of the volume variance and comparison with the standard cost metrics provided to you.  Focus your discussion on changes in the input variables which determine revenue and expenses in this industry.

Quantitative Variance Analysis

As what have been introduced before, Mr. Tan has to present the financial report to the Board of Director and he has obligation to illustrate why the plant had performed so badly relative to the previous year. To understand this, he required to use the variance analysis to find out what is the issues appear in his performance. But first he has to comprehend about the quantitative variance analysis. Variance analysis is the analysis of performance by means of variances.

Quantity Variance

A quantity variance is a part of standard costing concept where it is the budgeted cost and against which performance is monitored so that cost control is maintained. In this case, quantity variance can be found by using formula below:

= (Net generation MWh in current year - Net generation MWh in prior year) X Price per MWh in prior year

2010

QV= (3,937,377MWh-3,028,690MWh) X (RMB0.4200/kWh x 1000)

     = RMB 381,648,540 (F)

2011

      QV= (3,427,351MWh-3,937,377MWh) X (RMB0.4219/kWh x 1000)

           = (510,026MWh) X RMB421.90

     = (RMB 215,179,969.40) (U)

From the calculation above, there are huge difference between the quantity variance in 2010 and 2011 where it is based upon the quantity of electricity of Luotang Power sold to HPPC. It is shown that Luotang Power’s performance was unfavorable in year 2011 compared to prior year 2010. It means that Luotang Power produce less quantity of electricity sold to HPPC.

The production supervisor is normally in the best position to impact quantity variance of electricity. Experience supervisor and motivation of production employees coupled with careful use and managing of electricity, contribute to reduce waste.

Price variance

In this case, price variance is based upon the average price that electricity was sold to HPPC. We are using the formula below to find price variance:

= (Price per MWh in current year - Price per MWh in prior year) X Net generation in current year

2010

PV= (0.3817-0.4186) X 3,937,377MWh

     = (0.0369) X 3,937,377MWh

     = RMB (145,289.21) (U)

2011

PV= (0.3974-0.3817) X 3,427,351MWh

     =0.0157 X 3,427,351MWh

     =RMB 53,809.41 (F)

As in price variance calculation Luotang Power was favorable in year 2011 compared to year 2010 which was unfavorable. According standard price for all electricity sold increased in year 2011 from RMB0.3817 to RMB0.3974. But increase in regular price did not help in growing up the revenue in 2011.

Usually production supervisor is in the best position to influence cost variance of electricity. Thought skilful buying methods, an expert purchasing manager can obtain the best prices available for buying goods and services. To attain this goal, the purchasing manager will uses such methods as buying in quantity, comparing price among the vendors, negotiating purchase contracts, and global sourcing.

Based on Luotang Power Company situation, Luotang had contract of power purchase with HPPC’s that mentioned the minimum yearly purchase with certain price set, when HPPC’s needed more than the minimum annual purchase, Luotang will sell at approximately 65% of the regular price. In the meantime, HPPC’s the only entity legally allowed to buy electricity generated by the plant, this meant that HPPC’s would typically seek to renegotiated this price annually based upon its expected needs for electricity, this would affect the price sold and may vary with others. From the research by Claudio M. Ruibal, it is mention that suppliers are scattered and have less negotiating power, which impact Luotang’s power to set the price.

Fuel Efficiency Variance

This variance is based upon the quantity of coal used to generate each MWh of electricity sold to HPPC noting that some of the electricity generated at the plant was actually used internally and once generated, cannot be stored. This is defined by using this calculation:

= (Mass of coal used per net MWh sold this year-Mass of coal used per net MWh sold last year) X MWh sold this year X Price of coal last year

2010

FEV = [(347tonne/1000MWh)-(342tonne/1000MWh)] X 3,937,377MWh X [RMB269,         311,000/ (342tonne x1000MWh)]

= (0.347tonne-0.342tonne) X 3,937,377MWh X RMB787.46

=RMB15, 502,634.46(F)

2011

FEV=[(346tonne/1000MWh)-(347tonne/1000MWh)] X 3,427,351MWh X

        [RMB362, 062,000/ (347tonne x1000MWh)

=        (0.346tonne-0.347tonne) X 3,427,351MWh X RMB1,043.41

=(RMB3,576,132.31)(UF)

From variance above, we defined that fuel efficiency variance in Luotang Power is unfavorable in year 2011 whereas favorable in year 2010. The internal electricity used is more in 2011 with lesser gross electricity generated. What we can look is, in this variance, we are calculating how much efficiency of Luotang Power to produce electricity.

Fuel Cost Variance

Fuel cost variance is based on price of coal purchase but also take changes in market prices for coal and quality coal delivered into account. It is use to find how much different between price of coal purchase. We are using the formula below for calculation:

= (Price coal this year-Price coal last year) X Mass of coal used per net this year X MWh sold this year

2010

FCV= [(RMB362, 062,000/347,000MWh) - (RMB269, 311,000/342,000MWh)] X 0.347tonne X 3,937,377MWh

=(RMB1,043.41-RMB787.46) X 1,366,269.82MWh =RMB349,696,760.20 (F)