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	$	919,000		$	261,000		$	404,000		$	254,000
Variable manufacturing and selling expenses		468,000			119,000			198,000			151,000
Contribution margin		451,000			142,000			206,000			103,000
Fixed expenses:
Advertising, traceable		69,500			8,200			40,700			20,600
Depreciation of special equipment		43,400			20,300			7,300			15,800
Salaries of product-line managers		115,100			40,400			38,700			36,000
Allocated common fixed expenses*		183,800			52,200			80,800			50,800
Total fixed expenses		411,800			121,100			167,500			123,200
Net operating income (loss)	$	39,200		$	20,900		$	38,500		$	(20,200)

*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) The impact of discontinuing the racing bikes can be seen as under:

	Total	If Racing Bikes are dropped	Net Operating Income Increase or Decrease
Sales	$ 9,19,000	$ 6,65,000	$ -2,54,000
Variable Manufacturing and Selling Expenses	$ 4,68,000	$ 3,17,000	$ 1,51,000
Contribution Margin	$ 4,51,000	$ 3,48,000	$ -1,03,000
Fixed Expenses
Advertising, Traceable	$    69,500	$ 48,900	$ 20,600
Depreciation of Special Equipment	$    43,400	$ 43,400	$ -
Salaries of Product Line Managers	$ 1,15,100	$ 79,100	$ 36,000
Allocated Common Fixed Expenses	$ 1,83,800	$ 1,83,800	$ -
Total Fixed Expenses	$ 4,11,800	$ 3,55,200	$ 56,600
Net Operating Income	$    39,200	$ -7,200	$ -46,400

Depreciation is a sunk cost, hence it would not make any impact on decision. Further the common fixed expenses will continue regardless of sale or discontinuation of racing bikes. The financial disadvantage of discontinuing the bikes is that the company was earning quarterly profit of $39200 will have a net loss of $7200.

2) Since the discontinuation of racing bikes would lead to loss of Company, the production and sale of racing bikes should not be discontinued.

3) The segmented income statement has been provided below:

	Total	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	$ 9,19,000	$ 2,61,000	$          4,04,000	$    2,54,000
Variable Manufacturing and Selling Expenses	$ 4,68,000	$ 1,19,000	$          1,98,000	$    1,51,000
Contribution Margin	$ 4,51,000	$ 1,42,000	$          2,06,000	$    1,03,000
Fixed Expenses
Advertising, Traceable	$    69,500	$      8,200	$             40,700	$       20,600
Depreciation of Special Equipment	$    43,400	$    20,300	$                7,300	$       15,800
Salaries of Product Line Managers	$ 1,15,100	$    40,400	$             38,700	$       36,000
Total Fixed Expenses	$ 2,28,000	$    68,900	$             86,700	$       72,400
Product Line Segment Margin	$ 2,23,000	$    73,100	$          1,19,300	$       30,600
Allocated Common Fixed Expenses	$ 1,83,800
Net Operating Income	$    39,200

Since each bikes earns profit before allocation of common fixed expenses, it is more useful for the company in assessing long run profitability.