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	$	924,000		$	265,000		$	406,000		$	253,000
Variable manufacturing and selling expenses		477,000			117,000			209,000			151,000
Contribution margin		447,000			148,000			197,000			102,000
Fixed expenses:
Advertising, traceable		69,600			8,400			41,000			20,200
Depreciation of special equipment		43,000			20,400			7,400			15,200
Salaries of product-line managers		113,600			40,000			38,500			35,100
Allocated common fixed expenses*		184,800			53,000			81,200			50,600
Total fixed expenses		411,000			121,800			168,100			121,100
Net operating income (loss)	$	36,000		$	26,200		$	28,900		$	(19,100)

*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:

1. What is the financial advantage (disadvantage) per quarter of discontinuing the Racing Bikes?

2. Should the production and sale of racing bikes be discontinued?

3. Prepare a properly formatted segmented income statement that would be more useful to management in assessing the long-run profitability of the various product lines.

Answer 1

• All working forms part of the answer
• The Point that should be noted is that IF Racing Bikes got discontinued, ALL sales and variable cost will be foregone. Also, all the fixed expenses, EXCEPT for Common Allocated fixed expense will also be NOT incurred.
• Requirement 1

	Total before Discontinuation of racing Bikes	Racing Bikes Discontinuation Effect	Total IF Racing Bikes got discontinued
Sales	$         924,000.00	$      (253,000.00)	$        671,000.00
Variable manufacturing and selling expenses	$         477,000.00	$      (151,000.00)	$        326,000.00
Contribution margin	$         447,000.00	$      (102,000.00)	$        345,000.00
Fixed expenses:
Advertising, traceable	$           69,600.00	$        (20,200.00)	$          49,400.00
Depreciation of special equipment	$           43,000.00	$        (15,200.00)	$          27,800.00
Salaries of product-line managers	$         113,600.00	$        (35,100.00)	$          78,500.00
Allocated common fixed expenses*	$         184,800.00		$        184,800.00
Total fixed expenses	$         411,000.00	$        (70,500.00)	$        340,500.00
Net Operating Income (loss)	$           36,000.00		$             4,500.00

Since, Net Operating Income is decreasing to $ 4500 from $ 36000, there will be Financial DISADVATGE of $ (31,500) per quarter if Racing Bikes got discontinued. [ 36000 – 4500]

• Requirement 2

NO, the production and sales of Racing Bikes should not be discontinued because if it got discontinued there will be financial disadvantages (as mentioned in Requirement 1). This is because the contribution margin provided by the division will be lost.

• Requirement 3

Segment Income Segment with similar format as provided below can be more useful to management:

	Dirt Bikes	Mountain Bikes	Racing Bikes	Total
Sales	$      265,000.00	$      406,000.00	$               253,000.00	$             924,000.00
Variable manufacturing and selling expenses	$      117,000.00	$      209,000.00	$               151,000.00	$             477,000.00
Contribution margin	$      148,000.00	$      197,000.00	$               102,000.00	$             447,000.00
Traceable Fixed Expenses:
Advertising, traceable	$          8,400.00	$        41,000.00	$                 20,200.00	$               69,600.00
Depreciation of special equipment	$        20,400.00	$           7,400.00	$                 15,200.00	$               43,000.00
Salaries of product-line managers	$        40,000.00	$        38,500.00	$                 35,100.00	$             113,600.00
Total traceable fixed expenses	$        68,800.00	$        86,900.00	$                 70,500.00	$             226,200.00
Segment Margin	$        79,200.00	$      110,100.00	$                 31,500.00	$             220,800.00
Common Fixed Expenses				$             184,800.00
Net Operating Income				$               36,000.00