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	$	918,000		$	264,000		$	404,000		$	250,000
Variable manufacturing and selling expenses		474,000			117,000			202,000			155,000
Contribution margin		444,000			147,000			202,000			95,000
Fixed expenses:
Advertising, traceable		70,300			8,900			40,800			20,600
Depreciation of special equipment		44,100			20,900			7,800			15,400
Salaries of product-line managers		115,200			40,800			38,300			36,100
Allocated common fixed expenses*		183,600			52,800			80,800			50,000
Total fixed expenses		413,200			123,400			167,700			122,100
Net operating income (loss)	$	30,800		$	23,600		$	34,300		$	(27,100)

*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

Solution 1:

Impact on net income on discontinuing racing bike
Particulars	Current Total	Total if racing bikes are dropped	Financial advantage (disadvantage) of discontinuing racing bikes
Sales	$918,000.00	$668,000.00	-$250,000.00
Variable manufacturing and selling expenses	$474,000.00	$319,000.00	-$155,000.00
Contribution margin	$444,000.00	$349,000.00	-$95,000.00
Fixed expenses:
Advertising traceable	$70,300.00	$49,700.00	-$20,600.00
Depreciation of special equipment	$44,100.00	$44,100.00	$0.00
Salaries of product manager	$115,200.00	$79,100.00	-$36,100.00
Common allocated costs	$183,600.00	$183,600.00	$0.00
Total fixed expenses	$413,200.00	$356,500.00	-$56,700.00
Net Operating income (loss)	$30,800.00	-$7,500.00	-$38,300.00

Solution 2:

As there is net financial disadvantage, therefore production and sale of racing bikes should not be discontinued.

Solution 3:

Segmanted Income Statement
Particulars	Total	Dirt Bikes	Mountaing Bikes	Racing Bikes
Sales	$918,000.00	$264,000.00	$404,000.00	$250,000.00
Variable manufacturing and selling expenses	$474,000.00	$117,000.00	$202,000.00	$155,000.00
Contribution margin	$444,000.00	$147,000.00	$202,000.00	$95,000.00
Fixed expenses:
Advertising traceable	$70,300.00	$8,900.00	$40,800.00	$20,600.00
Depreciation of special equipment	$44,100.00	$20,900.00	$7,800.00	$15,400.00
Salaries of product manager	$115,200.00	$40,800.00	$38,300.00	$36,100.00
Total traceable fixed expenses	$229,600.00	$70,600.00	$86,900.00	$72,100.00
Segmant income	$214,400.00	$76,400.00	$115,100.00	$22,900.00
Common fixed expenses	$183,600.00
Net Operating income (Loss)	$30,800.00