LaTonya Washington, plant manager for Ultratech, Inc., was sitting at her desk, glumly re¬

garding the latest financial statements relating to the manufacture of silicon chips. Ultrat¬

ech was purchased under a leveraged buy-out two years ago, and top management insisted on minimum gross margin of 25% for every product—no exceptions.

The chips are manufactured in a process which requires: (1) the growing of silicon cylinders, (2) slicing the cylinders into thin circular wafers and dicing these into square wafers, and (3) photolithographing the chips and baking them at high temperatures. For each batch of 2,000 raw silicon wafers started into production in Department 3, the out¬

put is:

375 high-density memory chips 1,125 low-density memory chips 500 defective memory chips High-density memory chips sell for $14 and low-density memory chips sell for $8. Defec¬

tive chips are thrown away. Joint costs of $8,000 are incurred through production in De¬

partment 3 and are allocated according to the units-produced method.

LaTonya's neighbor. Harmony Schultz, runs a gift shop located in the Silicon Valley.

Technically-oriented memorabilia and whatnots are in high demand. Harmony has offered to purchase the defective chips for $0.05 each to embed in key chains and related items. As Harmony points out, customers won't care if the chips work as long as the key chain does.

At first, LaTonya was delighted with the plan. Then she saw a profit-loss statement orga¬

nized by product line.

Required:

1. Calculate the gross margin and gross margin percentage by product for the high-den¬

sity and low-density chips before Harmony's offer to buy defective chips was made.

2. Assume that Harmony's offer has been accepted and that Ultratech's accountant treated the defective chips as a main product. Calculate the gross margin and gross margin per¬

centage by product. Explain why LaTonya is distressed by the results.

3. Can you suggest an alternative accounting method for the defective chips which will please LaTonya and Ultratech's management? Recalculate the gross margin and gross margin percentage by product using your method.