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	$	930,000		$	270,000		$	407,000		$	253,000
Variable manufacturing and selling expenses		459,000			115,000			190,000			154,000
Contribution margin		471,000			155,000			217,000			99,000
Fixed expenses:
Advertising, traceable		69,800			8,500			40,900			20,400
Depreciation of special equipment		44,200			20,600			7,600			16,000
Salaries of product-line managers		114,600			40,600			38,100			35,900
Allocated common fixed expenses*		186,000			54,000			81,400			50,600
Total fixed expenses		414,600			123,700			168,000			122,900
Net operating income (loss)	$	56,400		$	31,300		$	49,000		$	(23,900)

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

Answer:

Lost contribution margin		-99,000
Fixed costs that can be avoided:
Advertising, traceable	20,400
Salary of the product-line manager	35,900	56,300
Financial (disadvantage) of discontinuing the Racing Bikes		-42,700

Calculation:

For calculating the  Financial (disadvantage) of discontinuing the Racing Bikes, first we need to tak e the contribution margin of racing bikes which would be lost if racing bikes is discontinued. Since it will be lost, we need to include as negative.

Then, we need to add the Fixed costs that can be avoided, which is advertising, traceable and salary of the product-line manager.

The depreciation here is a sunk cost so, not relevant to the decision. The common costs are allocated so will be there irrespective of discontinuation of racing bikes. So, they are not relevant to the decision.

Then, we get the Financial (disadvantage) of discontinuing the Racing Bikes.

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

Answer: No

Explanation:

No, production and sale of the racing bikes should not be discontinued as there will be Financial (disadvantage) of discontinuing the Racing Bikes of $42,700.

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:

	Total	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	930,000	270,000	407,000	253,000
Variable manufacturing and selling expenses	459,000	115,000	190,000	154,000
Contribution margin (loss)	471,000	155,000	217,000	99,000
Traceable Fixed expenses:
Advertising, traceable	69,800	8,500	40,900	20,400
Depreciation of special equipment	44,200	20,600	7,600	16,000
Salaries of product-line managers	114,600	40,600	38,100	35,900
Total traceable fixed expenses	228,600	69,700	86,600	72,300
Product line segment margin (loss)	242,400	85,300	130,400	26,700
Common fixed expenses	186,000
Net operating income (loss)	56,400

Calculation:

To prepare the properly formatted segmented income statement that would be more useful to management in assessing the long-run profitability of the various product lines, first we need to show the contribution margin as in the income statement provided.

Then, we need to include the Traceable Fixed expenses, which are Advertising, traceable, Depreciation of special equipment and Salaries of product-line managers. Then total it up and deduct from the contribution margin to get the Product line segment margin (loss). The common costs are allocated so will be there irrespective changes to any product line. So we are deducting that only from the total Product line segment margin. We arent considering invidual amounts. So, after deducting that, we get the net operating income.