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		$	265,000		$	403,000		$	257,000
Variable manufacturing and selling expenses		480,000			112,000			208,000			160,000
Contribution margin		445,000			153,000			195,000			97,000
Fixed expenses:
Advertising, traceable		69,600			8,300			41,000			20,300
Depreciation of special equipment		44,100			20,700			7,400			16,000
Salaries of product-line managers		114,700			40,200			38,600			35,900
Allocated common fixed expenses*		185,000			53,000			80,600			51,400
Total fixed expenses		413,400			122,200			167,600			123,600
Net operating income (loss)	$	31,600		$	30,800		$	27,400		$	(26,600)

*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) Before discontinuing the Racing Bikes, we need to do cost benefit analysis. So lets
do by bifurcating financial advantages and disadvantages :
Financial advantages and disadvantages of discontinuing
Racing Bikes for the quarter :
Advantages :
(i) Saving of advertising expenses	$ 20,300
(ii) No Depreciation as no use	$ 16,000
(iii)Saving of Salaries of product line manager	$ 35,900
Total financial advantages	$ 72,200
Disadvantages :
(i) Loss of contribution	$ 97,000
Net of Advantages/(Disadvantages)	$ 24,800
2) We can see that financial advantages is lower than disadvantages if discontinuing Racing bikes by
$ 24,800. It is also to be noted that allocated common fixed expenses is yet to be incurred whether
discontinued or not, that’s why it is not considered for cost benefit analysis. So production and sale
of racing bikes should not be discontinued .
3) Segmented Income Statement (Product wise) for the quarter if not discontinued
Particulars	Dirt Bikes	Mountain Bikes	Racing Bikes	Total
Sales	2,65,000	4,03,000	2,57,000	9,25,000
Variable Manufacturing & selling expenses	1,12,000	2,08,000	1,60,000	4,80,000
Contribution (Sales - Variable cost)	1,53,000	1,95,000	97,000	4,45,000
				-
Fixed Expenses :				-
Advertising	8,300	41,000	20,300	69,600
Depreciation	20,700	7,400	16,000	44,100
Salaries of Product line managers	40,200	38,600	35,900	1,14,700
Common fixed expenses	-	-	-	1,85,000
Total Fixed Expenses	69,200	87,000	72,200	4,13,400
Net Profit	83,800	1,08,000	24,800	31,600