In August 2010, Wentao Chen, manager of Danshui Plant No. 2 in southern China, w
ID: 2521802 • Letter: I
Question
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. Ma promised to prepare a report as quickly as he and his assistant, Bingqian Li, could do so in September.
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.
Required:
1. Using budget data, how many Apple iPhone 4’s would have to have been completed for
Danshui Plant No. 2 to break even?
2. Using budget data, what was the total expected cost per unit if all manufacturing and
shipping overhead (both variable and fixed) was allocated to planned production? What
was the actual cost per unit of production and shipping?
3. Prepare a flexible budget for 180,000 iPhone 4’s and calculate flexible budget variances using
actual costs for August.
4. Estimate material price and usage for flash memories, labor rate and usage (efficiency)
variances, and the overhead spending variance for August.
5. What are some strategies or decisions that Wentao Chen should consider in trying to solve
the problems with the Apple iPhone 4 contract in the next nine months? How would these
change the costs and profitability of Danshui Plant No. 2 and the iPhone 4 contract?
Tables below:
Exhibit 1
Standard Variable Costs for iPhone 4 (U.S. Dollars)
Bill of materials (per unit)
Purchased chips:
Flash memory (Samsung) $27.00
Application processor (Samsung) 10.75
Chip for phone calls (Infinion) 14.05
Gryoscope (STMicroelectronics) 2.60
8 other purchased chips 70.95
Variable supplies and tools $125.35
62.54
187.89
Labor:
Assembly and packaging (per unit) 13.11
Shipping (per unit) 1.06
Exhibit 2
Budgeted Fixed Overhead per Month
Factory rent $400,000
Machine depreciation 150,000
Utility fee and local taxes 52,000
Supervision 127,000
Monthly fixed costs $729,000
Exhibit 3
August 2010 Preliminary Report on the Results of Operations
(Thousands of U.S. Dollars)
Explanation / Answer
Requirement 1 Using the Budget data, Breakeven sales in units will be = Total fixed costs / Contribution per unit = 729000/4.145 175875 Contribution per unit = Sales per unit - variable cost per unit =(41240000/200000)-(40411000/200000) 4.145 Requirement 2 Total expected cost per unit, if all manufacturing and shipping overhed (both variable & Fixed) was allocated to planned production = Total costs / planned or budgeted production = =41140000/200000 205.7 The actual cost of unit of production and shipping = Total actual costs / actual production = =38148000/180000 211.93 Requirement 3 Flexible Budget for 180000 Apple iphone 4 and calculation of flexible budget variances using actual cost for August Budget Per unit Flexible Budget Actual Variances Units 200000 180000 180000 Revenue (Transfer from Shenzen) 41240000 206.2 37116000 37476000 360000 Favoruable Variable costs Materials Flash Memory 5400000 27 4860000 5249000 -389000 Unfavoruable Application process 2150000 10.75 1935000 1935000 0 None Chips Phone 2810000 14.05 2529000 2529000 0 None Gyroscope 520000 2.6 468000 468000 0 None 8 Other Chips 14190000 70.95 12771000 12643000 128000 Favourable Total 25070000 125.35 22563000 22824000 -261000 Unfavoruable Variable supplies & tools 12507000 62.535 11256300 11305000 -48700 Unfavoruable Labor 0 Assembly and Packing 2622000 13.11 2359800 3092000 -732200 Unfavoruable Shipping 212000 1.06 190800 191000 -200 Unfavoruable Total variable costs 40411000 202.055 36369900 37412000 -1042100 Unfavoruable Fixed costs 0 Factory rent 400000 2 400000 400000 0 None Machine Depreciation 150000 0.75 150000 150000 0 None Utility fees & taxes 52000 0.26 52000 52000 0 None Supervision 127000 0.635 127000 134000 -7000 Unfavoruable Total fixed costs 729000 3.645 729000 736000 -7000 Unfavoruable Net Income 100000 0.5 17100 -672000 -689100 Unfavoruable Requirement 4 Material price and Usage variance for flash memories Material price variance =Standard quanity*(standard price-actual price) = -389000 Unfavourable Material usage variance Standard price*(Standard quanity- actual quanity) In the absense of information about actual quanity of flash memory used in the plant we assume it to be 180000 So Material usage variance will be 0 Labor rate & usage variance labor rate variance (Assemby and packaging) = Standard Hours*(standard rate - actual rate) = -732200 Unfavourable labor rate variance (Assemby and packaging) = Standard Hours*(standard rate - actual rate) = -200 Unfavourable Labor usage variance In the absense of information, we assume that entire flexible budget variance is due to rate variance and quanity of labor hours remained the same So, Labor usage variance is 0 Overhead spending variance Variable supplies & tools variance -48700 Unfavourable Fixed overhead spending variance -7000 Unfavourable As per Chegg Policy, we are supposed to answer maximum of four sub-parts of a questions. If you have found the answer useful, please give feedback through rating. Thank you