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	$	927,000		$	269,000		$	407,000		$	251,000
Variable manufacturing and selling expenses		478,000			112,000			207,000			159,000
Contribution margin		449,000			157,000			200,000			92,000
Fixed expenses:
Advertising, traceable		68,900			8,600			40,100			20,200
Depreciation of special equipment		43,300			20,400			7,400			15,500
Salaries of product-line managers		114,200			40,700			38,200			35,300
Allocated common fixed expenses*		185,400			53,800			81,400			50,200
Total fixed expenses		411,800			123,500			167,100			121,200
Net operating income (loss)	$	37,200		$	33,500		$	32,900		$	(29,200)

*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) of discontinuing racing bikes

Particulars	Current Total	Total if racing bikes are dropped (Add dirt bikes and mountain bikes column)	Difference: Net operating income increase or (decrease)
Sales	$9,27,000	$6,76,000	-$2,51,000
Less: Variable manufacturing and selling expenses	$4,78,000	$3,19,000	-$1,59,000
Contribution margin (loss) (A)	$4,49,000	$3,57,000	-$92,000
Less: Fixed expenses:
Advertising, traceable	$68,900	$48,700	-$20,200
Depreciation on special equipment	$43,300	$43,300	$0
Salaries of product managers	$1,14,200	$78,900	-$35,300
Allocated common expense	$1,85,400	$1,85,400	$0
Total fixed expenses (B)	$4,11,800	$3,56,300	-$55,500
Net operating income (loss) (A-B)	$37,200	$700	-$36,500

Note:

i) Depreciation on special equipment is not avoidable even if racing bikes are discontinued

ii) Allocated common fixed expense is not avoidable even if racing bikes are discontinued

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

No.

If the racing bikes are net operating income will be reduced by $36500

3.Prepare Segmented Income Statement

Particulars	Total	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	$9,27,000	$2,69,000	$4,07,000	$2,51,000
Less:Variable manufacturing and selling expenses	$4,78,000	$1,12,000	$2,07,000	$1,59,000
Contribution margin (loss) (A)	$4,49,000	$1,57,000	$2,00,000	$92,000
Traceable fixed Expenses:
Advertising, traceable	$68,900	$8,600	$40,100	$20,200
Depreciation on special equipment	$43,300	$20,400	$7,400	$15,500
Salaries of product managers	$1,14,200	$40,700	$38,200	$35,300
Total traceable fixed Expense (B)	$2,26,400	$69,700	$85,700	$71,000
Product line segment margin(loss) (A-B)	$2,22,600	$87,300	$1,14,300	$21,000
common Fixed expense	$1,85,400
Net operating income (loss)	$37,200