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		476,000			116,000			200,000			160,000
Contribution margin		451,000			153,000			207,000			91,000
Fixed expenses:
Advertising, traceable		69,300			8,500			40,700			20,100
Depreciation of special equipment		42,700			20,200			7,300			15,200
Salaries of product-line managers		115,300			40,500			38,600			36,200
Allocated common fixed expenses*		185,400			53,800			81,400			50,200
Total fixed expenses		412,700			123,000			168,000			121,700
Net operating income (loss)	$	38,300		$	30,000		$	39,000		$	(30,700)

*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.

	Totals	Dirt Bikes	Mountain Bikes	Racing Bikes
Contribution Margin (Loss)
Traceable Fixed Expenses:
Total Traceable Fixed Expenses
Product line segment margin (loss)
Net operating income (loss)

Answer 1

1.

Contribution margin of Racing Bikes = $91,000

Traceable fixed costs of Racing bikes = Advertising + Depreciation of special equipment + Salaries of product line managers

= 20,100 + 15,200 + 36,200

= $71,500

Hence, segment margin of Racing bikes = Contribution margin - Traceable fixed costs

= 91,000 - 71,500

= $19,500

Hence, financial disadvantage if Racing bikes is discontinued = $19,500

2.

If Racing bikes is discontinued, there will be loss of margin of $19,500 provided by the Racing bikes. Hence Racing bikes should not be discontinued.

3.

Segmented income statement

	Totals	Dirt bikes	Mountain bikes	Racing bikes
Sales (i)	927,000	269,000	407,000	251,000
Variable manufacturing and selling expenses (ii)	476,000	116,000	200,000	160,000
Contribution margin (i) - (ii) = (iii)	451,000	153,000	207,000	91,000
Traceable fixed costs:
Advertising	69,300	8,500	40,700	20,100
Depreciation of special equipment	42,700	20,200	7,300	15,200
Salaries of product line managers	115,300	40,500	38,600	36,200
Total traceable fixed expenses (iv)	227,300	69,200	86,600	71,500
Product line segment margin (iii)- (iv) = (v)	223,700	83,800	120,400	19,500
Allocated common fixed expenses (vi)	185,400	53,800	81,400	50,200
Net operating profit (loss) (v) - (vi)	38,300	30,000	39,000	(30,700)

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