Question

The Regal Cycle Company manufactures three types of bicycles—a dirt bike, a mountain bike, and a racing bike. Data on sales and expenses for the past quarter follow:

		Total		Dirt Bikes		Mountain Bikes		Racing Bikes
Sales	$	925,000	$	262,000	$	405,000	$	258,000
Variable manufacturing and selling expenses		463,000		113,000		196,000		154,000
Contribution margin		462,000		149,000		209,000		104,000
Fixed expenses:
Advertising, traceable		70,500		9,000		40,800		20,700
Depreciation of special equipment		44,200		20,900		7,800		15,500
Salaries of product-line managers		114,200		40,300		38,400		35,500
Allocated common fixed expenses*		185,000		52,400		81,000		51,600
Total fixed expenses		413,900		122,600		168,000		123,300
Net operating income (loss)	$	48,100	$	26,400	$	41,000	$	(19,300)

*Allocated on the basis of sales dollars.

Management is concerned about the continued losses shown by the racing bikes and wants a recommendation as to whether or not the line should be discontinued. The special equipment used to produce racing bikes has no resale value and does not wear out.

Required:

1a.	What is the impact on net operating income by discontinuing racing bikes? (Decreases should be indicated by a minus sign.)

       

1b.	Should production and sale of the racing bikes be discontinued?
	Yes No

  

2a.	Prepare a segmented income statement.

       

2b.	Would a segmented income statement format be more usable to management in assessing the long-run profitability of the various product lines.
	Yes No

Answer 1

Solution 1a:

Incremental Analysis - Regal Cycle - Racing Bikes
Particulars	Continue Racing Bikes (Alt 1)	Discontinue Racing Bikes (Alt2)	Impact on Net Income
Sales	$2,58,000	$0	-$2,58,000
Variable manufacturing and selling expenses	$1,54,000	$0	-$1,54,000
Contribution Margin	$1,04,000	$0	-$1,04,000
Fixed Expenses:
Advertising Traceable	$20,700	$0	-$20,700
Salaries of Product line manager	$35,500	$0	-$35,500
Net Income	$47,800	$0	-$47,800

Solution 1b:

No, production and sale of the racing bikes should not be discontinued as net income will decrease $47800.

Solution 2a:

Regal Cycle Company
Segmanted Income Statement
Particulars	Dirt bikes	Mountain bikes	Racing Bikes	Total
Sales	$2,62,000.00	$4,05,000.00	$2,58,000.00	$9,25,000.00
Variable Expenses	$1,13,000.00	$1,96,000.00	$1,54,000.00	$4,63,000.00
Contribution margin	$1,49,000.00	$2,09,000.00	$1,04,000.00	$4,62,000.00
Less: Direct Fixed Costs:
Advertising	$9,000.00	$40,800.00	$20,700.00	$70,500.00
Depreciation	$20,900.00	$7,800.00	$15,500.00	$44,200.00
Salaries of Product line managers	$40,300.00	$38,400.00	$35,500.00	$1,14,200.00
Segment Margin	$78,800.00	$1,22,000.00	$32,300.00	$2,33,100.00
Less: Common fixed expenses				$1,85,000.00
Operating Profit				$48,100.00

Solution 2b:

Yes, a segmented income statement format would be more usable to management in assessing the long-run profitability of the various product lines.