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	$	926,000		$	263,000		$	406,000		$	257,000
Variable manufacturing and selling expenses		485,000			117,000			209,000			159,000
Contribution margin		441,000			146,000			197,000			98,000
Fixed expenses:
Advertising, traceable		69,600			8,500			40,200			20,900
Depreciation of special equipment		43,200			20,500			7,200			15,500
Salaries of product-line managers		115,300			40,600			39,000			35,700
Allocated common fixed expenses*		185,200			52,600			81,200			51,400
Total fixed expenses		413,300			122,200			167,600			123,500
Net operating income (loss)	$	27,700		$	23,800		$	29,400		$	(25,500)

*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

Relevant fixed expenses will be considered for the purpose of this decision and allocated costs will be irrelevant since these costs will not change as a result of this decision

1.Financial Advantage/(Disadvantage)of discontinuing the racing bikes = Fixed costs saved – Contribution Margin lost

= 20,900+35,700-98,000

= $(41,400)

Depreciation is sunk cost and allocated fixed expenses are not relevant

2.No, since it will reduce net income

	Totals	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	926,000	263,000	406,000	257,000
Less: Variable Costs	485,000	117,000	209,000	159,000
Contribution Margin (loss)	441,000	146,000	197,000	98,000
Traceable Fixed Expenses:
Advertising	69,600	8,500	40,200	20,900
Depreciation	43,200	20,500	7,200	15,500
Salaries	115,300	40,600	39,000	35,700
Total traceable fixed expenses	228,100	69,600	86,400	72,100
Product line segment margin (loss)	212,900	76,400	110,600	25,900
Common Fixed Expenses	185,200
Net Operating income (loss)	27,700