Question

Exercise 11-2 Dropping or Retaining a Segment [LO11-2]

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	$	922,000		$	265,000		$	406,000		$	251,000
Variable manufacturing and selling expenses		479,000			113,000			208,000			158,000
Contribution margin		443,000			152,000			198,000			93,000
Fixed expenses:
Advertising, traceable		70,200			8,700			40,800			20,700
Depreciation of special equipment		44,100			20,900			7,700			15,500
Salaries of product-line managers		114,800			40,300			38,500			36,000
Allocated common fixed expenses*		184,400			53,000			81,200			50,200
Total fixed expenses		413,500			122,900			168,200			122,400
Net operating income (loss)	$	29,500		$	29,100		$	29,800		$	(29,400)

*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

1
	Current Total	Total If Racing Bikes Are Dropped	Difference: Net Operating Income
Sales	922000	671000	-251000
Variable manufacturing and selling expenses	479000	321000	158000
Contribution margin (loss)	443000	350000	-93000
Fixed expenses:
Advertising, traceable	70200	49500	20700
Depreciation on special equipment	44100	44100	0
Salaries of product manager	114800	78800	36000
Common allocated costs	184400	184600	-200
Total fixed expenses	413500	357000	56500
Net operating income (loss)	29500	-7000	-36500
Financial (disadvantage) $(36500)
2
No, production and sale of racing bikes should not be discontinued
3
	Total	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	922000	265000	406000	251000
Variable manufacturing and selling expenses	479000	113000	208000	158000
Contribution margin (loss)	443000	152000	198000	93000
Traceable fixed expenses:
Advertising, traceable	70200	8700	40800	20700
Depreciation on special equipment	44100	20900	7700	15500
Salaries of product manager	114800	40300	38500	36000
Total traceable fixed expenses	229100	69900	87000	72200
Product line segment margin	213900	82100	111000	20800
Common fixed expenses	184400
Net operating income (loss)	29500