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	$	932,000		$	263,000		$	409,000		$	260,000
Variable manufacturing and selling expenses		470,000			117,000			198,000			155,000
Contribution margin		462,000			146,000			211,000			105,000
Fixed expenses:
Advertising, traceable		70,000			8,700			40,700			20,600
Depreciation of special equipment		44,200			20,400			7,800			16,000
Salaries of product-line managers		115,200			40,300			38,500			36,400
Allocated common fixed expenses*		186,400			52,600			81,800			52,000
Total fixed expenses		415,800			122,000			168,800			125,000
Net operating income (loss)	$	46,200		$	24,000		$	42,200		$	(20,000)

*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	Difference: Net Operating income increase (decrease)
Sales	$9,32,000.00	$6,72,000.00	-$2,60,000.00
Variable manufacturing and selling expenses	$4,70,000.00	$3,15,000.00	-$1,55,000.00
Contribution margin	$4,62,000.00	$3,57,000.00	-$1,05,000.00
Fixed expenses:
Advertising traceable	$70,000.00	$49,400.00	-$20,600.00
Depreciation of special equipment	$44,200.00	$44,200.00	$0.00
Salaries of product manager	$1,15,200.00	$78,800.00	-$36,400.00
Common allocated costs	$1,86,400.00	$1,86,400.00	$0.00
Total fixed expenses	$4,15,800.00	$3,58,800.00	-$57,000.00
Net Operating income (loss)	$46,200.00	-$1,800.00	-$48,000.00

Financial Disadvantage = $48,000

Solution 2:

No, production and sale of racing bikes should not be discontinued as there is financial disadvantage of $48,000 if discontinued.

Solution 3:

Segmanted Income Statement
Particulars	Total	Dirt Bikes	Mountaing Bikes	Racing Bikes
Sales	$9,32,000.00	$2,63,000.00	$4,09,000.00	$2,60,000.00
Variable manufacturing and selling expenses	$4,70,000.00	$1,17,000.00	$1,98,000.00	$1,55,000.00
Contribution margin	$4,62,000.00	$1,46,000.00	$2,11,000.00	$1,05,000.00
Fixed expenses:
Advertising traceable	$70,000.00	$8,700.00	$40,700.00	$20,600.00
Depreciation of special equipment	$44,200.00	$20,400.00	$7,800.00	$16,000.00
Salaries of product manager	$1,15,200.00	$40,300.00	$38,500.00	$36,400.00
Total traceable fixed expenses	$2,29,400.00	$69,400.00	$87,000.00	$73,000.00
Segmant income	$2,32,600.00	$76,600.00	$1,24,000.00	$32,000.00
Common fixed expenses	$1,86,400.00
Net Operating income (Loss)	$46,200.00