In August 2010, Wentao Chen, manager of Danshui Plant No. 2 in southern China, was anxious. The plant was in the third month of a 12-month contract to assemble the Apple iPhone 4. The contract called for Danshui to assemble 2.4 million iPhones in the period between June 1, 2010, and May 31, 2011, but now in the third month of the contract, production was only 180,000 units per month. Chen called Jianye Ma, the plant controller, to request a summary of monthly operations for August as soon after the end of the month as possible. Danshui was a contract manufacturer that assembled electronic products for companies wishing to save labor costs by locating in southern China where semiskilled labor was available for less than one dollar an hour. Manufacturers like Danshui assembled parts in large plants using assembly line techniques according to specifications of the international companies that contracted with them for assembly and final testing. The largest contract manufacturer in China was Foxconn, a division of the Hon Hai Group of Taiwan, with more than 800,000 workers in China alone and contracts to supply Apple, Dell, and Hewlett Packard among others. In expectation of high demand for the iPhone 4, Apple had contracted with Danshui to assemble iPhones in Plant No. 2, which had been assembling computer hard drives on a contract that was fulfilled at the end of May 2010. Although the assembly of hard drives was different than assembly of iPhones, Danshui was confident that its workers would adapt to the new assembly tasks and that it could hire and train the additional workers as needed. Chen's job was to get Plant No. 2 up to speed to fulfill the Apple contract and earn a profit for Danshui's parent company, located in Hong Kong, China. Danshui Plant No. 2 was a profit center that was credited for each iPhone produced and shipped, and charged for parts, labor, overhead, and shipping. Because the contract was for a year, an annual budget was established soon after the iPhone contract was signed. This budget was divided by 12 to establish equal monthly budgets to which actual revenues and expenses could be compared. All budgeting and monthly reporting was done in U.S. dollars. As the plant manager, Wentao Chen was responsible for control of all costs in his plant. Materials, labor, and overhead were his responsibility. This was done to provide incentive to control all costs whether caused by use waste, damage, theft, or inefficiencies. The Apple iPhone 4 The iPhone 4 contained more than 100 components manufactured in plants located in Europe, Asia, and the United States. For examples, Samsung supplied flash memories and application processors, and Infineon (a German chip maker) supplied chips that send and receive phone calls and data. A gyroscope, new to the iPhone 4, came from STMicroelectronics, based in Geneva, and a touch-screen module came from Taiwan. Contract manufacturers assembled these parts in assembly line plants that required each worker to focus on one or more tasks in a short period of time as each phone moved along an assembly line toward completion. Estimates of the material cost of each iPhone were around $180, assembly labor around 7% of total cost, and Apple's profit margins about 60% of the selling price to customers. (See Exhibits 1 and 2 for estimated standard costs and overhead budgets for the Danshui Plant No. 2.) The assembly process at Danshui Plant No. 2 was almost entirely based on handwork by workers. There were about 140 steps in the assembly process for an iPhone 4, and each phone was handled by 325 individuals during the five days required for assembly. Apple released the iPhone 4 on June 24, 2010 and more than 1.7 million units were sold in the first three days it was available. It was the most successful product launch in Apple history. Apple fanatics around the world waited in long lines to get their hands on the new phone. The August Report On September 2, Chen arrived at his office and found a report on August operations. (See Exhibit 3). The controller, Jianye Ma, had attached a note which Chen read with interest. To: Wentao Chen From: Jianye Ma and Bingqian Li Date: September 1, 2010 Per your request we have compiled a preliminary report on August operations. At first glance, revenue was below budget, material usage seems good, and labor costs were above budget. In terms of plant profit, our budget was $100,000, but we actually had a loss of $672,000. The main reason for the shortfall may be that we have been unable to produce 200,000 iPhone 4 units in any of the three months we have been working on this contract Our major obstacle is hiring enough qualified labor to get production up to 200,000 units per month. We cannot find people to hire, even though we have raised our factory wages by almost 30% since July. (A friend at Foxconn in Shenzhen told Li that they raised their starting pay by 35% since March, and they are building new plants elsewhere where unemployment is high.) In addition, we continue to have trouble with the Samsung flash memory installation. Unless these are handled very carefully, they can be damaged by heat during installation. One thousand flash memories were damaged in August and had to be replaced after inspection. Samsung is aware of this problem and has begun to install a shield to prevent some of the damage; however, as a result, Samsung raised the price of each unit $2.00 starting in mid June. Fortunately, Apple raised our revenue recovery by an equal amount, so this should be neutral. We apparently had a favorable variance on flash memories and other parts. Li is uncomfortable with this report. She feels we should prepare a new budget showing what we would have spent using standard costs and a production volume of 180,000 units. She says that the current report (Exhibit 3) distorts how we did, and that until we prepare a "flexible budget" to compare our actual performance to that budget we run the risk of misinterpreting our performance. It will take Li a couple of days to prepare and evaluate a flexible budget because she is working on a tax report that is due September 7. I will talk with you next week once we receive the flexible budget from Li. Exhibit 1 Standard Variable Costs for iPhone 4 (U.S. Dollars) Bill of materials (per unit) Purchased chips: Flash memory (Samsung) Application processor (Samsung) Chip for phone calls (Infinion) Gryoscope (STMicroelectronics) 8 other purchased chips Variable supplies and tools Labor: Assembly and packaging (per unit) Shipping (per unit) $27.00 10.75 14.05 2.60 70.95 $125.35 62.54 187.89 13.11 1.06 Source: Casewriters and David Barboza, "Supply Chain for iPhone Highlights Costs in China," New York Times, July 6, 2010, p. Bl. Exhibit 2 Budgeted Fixed Overhead per Month Factory rent Machine depreciation Utility fee and local taxes Supervision Monthly fixed costs $400,000 150,000 52,000 127.000 $729,000 Exhibit 3 August 2010 Preliminary Report on the Results of Operations (Thousands of U.S. Dollars) Monthly Actual Budget (200,000 units) (180,000 units) $41,240 $37,476 Variance (20,000 units) $3,764 U 5,400 2,150 2,810 520 14,190 12,507 37,577 5,249 1,935 2,529 468 12,643 11,305 34,129 151 F 215 F 281 F 52 F 1,547 F 1,202 F 3,448F Revenue (transfer from Shenzhen) Variable costs Materials Flash memory Application process Chips-phone Gyroscope 8 other chips Variable supplies and tools Subtotal Labor Assembly and packaging Shipping Total variable costs Fixed Costs: Factory rent Machine depreciation Utility fee and taxes Supervision Total fixed costs Total costs 2,622 212 40,411 3,092 191 37,412 470 U 215 2,999 F 400 150 52 127 729 41140 400 150 52 134 736 38.148 ZU 7U 2.992E Net income $ 100 $ (672) $ 772 U Treasure Trophy Case Questions 1. Allocate manufacturing overhead to departments. Specific overhead items should be allocated on an individual basis when there is a logical basis for doing so. 2. Develop overhead application rates for the three departments on the basis of direct labor cost. 3. Complete the job cost sheet shown in case Exhibit 2 in order to get the total cost for the job based on the full costing method. 4. Calculate the cost of each of the two jobs using the direct costing method. 5. As Bob Morden, what factors would you consider before setting a firm quote for these two orders? 6. What price should Treasure Trophy Company be willing to quote for the Royal Golf Club