AIP 10.4 Allocating the Cost of Scrap LO 6 ITI Technology designs and manufactures solid-state computer chips. In one of its production departments, a 6-inch circular wafer is fabricated by laying down successive layers of silicon and then etching circuits into the layers. Each wafer contains 100 separate solid-state computer chips. After a wafer is manufactured, the 100 chips are cut out of the wafer, initially tested, mounted into protective covers and electrical leads attached. A final quality control test is then performed. The initial testing process consists of successive stages of heating and cooling the chips and testing how they work. If 99 percent of each chip's circuits work properly after the testing, it is classified as a high-density (HD) chip. If between 75 percent and 99 percent of a chip's circuits work properly, it is classified as a low-density (LD) chip. If fewer than 75 percent of the circuits work, it is discarded. Twenty wafers are manufactured 495 per batch. In each batch, 50 percent of the chips are HD, 20 percent are LD, and 30 percent are discarded. HD chips are sold to defense contractors and LD chips to consumer electronics firms. Chips sold to defense contractors require different types of mountings, packaging, and distribution channels than chips sold to consumer electronics firms do. HD chips sell for $30 each and LD chips sell for $16 each. Each batch of 20 wafers costs $29,100: $8,000 to produce, test, and sort; $21,100 for mounting, attaching leads, final inspection and distribution costs ($14,500 for HD chips and $6,600 for LD chips). The $29,100 total cost per batch consists of direct labor, direct materials, and variable overhead. The following report summarizes the operating data per batch: ITI Technology Operating Cost Summary for HD and LD Chips LD Chips Total HD Chips Scrap Percent of chips 100% 50% 20% 30% Total costs $29,100 $14,550 $5,820 $ 8,730 Revenue 36,400 29,100 30,000* 14,550 $15,450 6,400** Total costs 5,820 8,730 Profit per batch $ 7,300 $ 580 $(8,730) * $30,000 = 50% × 20 wafers × 100 chips per wafer x $30 per chip. ** $6,400 = 20% × 20 wafers × 100 chips per wafer x $16 per chip. The cost of scrap is charged to a plant-wide overhead account, which is then allocated directly to the lines of business based on profits in the line of business. a. Critically evaluate ITI's method of accounting for HD and LD chips. b. What suggestions would you offer ITI's management?