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	$	917,000		$	265,000		$	401,000		$	251,000
Variable manufacturing and selling expenses		470,000			112,000			201,000			157,000
Contribution margin		447,000			153,000			200,000			94,000
Fixed expenses:
Advertising, traceable		70,400			8,600			41,000			20,800
Depreciation of special equipment		43,900			20,800			7,200			15,900
Salaries of product-line managers		115,800			40,900			38,800			36,100
Allocated common fixed expenses*		183,400			53,000			80,200			50,200
Total fixed expenses		413,500			123,300			167,200			123,000
Net operating income (loss)	$	33,500		$	29,700		$	32,800		$	(29,000)

*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

1.

The depreciation of special equipment is sunk cost and not relevant to decision making. However, general or common costs would continue whether racing bikes are continued or not. They are not relevant to decision making of discontinuation.

Lost Contribution Margin (a)		$ 94,000
Fixed costs that can be avoided (b) :
Advertising, traceable	20,800
Salary of the product line manager	36,100	$ 56,900
Decrease in net operating income for company as whole (a-b)		$ (37,100)

The financial disadvantage of discontinuing the racing bikes would be $ 37,100. That means the company suffers a loss of additional $37,100 as a result of discontinuation of racing bikes.

2. No, the production of racing bikes shall not be discontinued. The discontinuation would result in loss of $ 37,100.

3.

The segmented report is prepared after elimination of common fixed expenses:

                                                Segmented Income Statement

	Total	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	$ 917,000	$ 265,000	$ 401,000	$ 251,000
Variable manufacturing and selling expense	470,000	112,000	201,000	157,000
Contribution margin	447,000	153,000	200,000	94,000
Traceable fixed expenses
Advertising	70,400	8,600	41,000	20,800
Depreciation of special equipment	43,900	20,800	7,200	15,900
Salaries of product line managers	115,800	40,900	38,800	36,100
Total traceable fixed expenses	230,100	70,300	87,000	72,800
Allocated common fixed expenses	183,400
Net operating income (loss)	$ 33,500

Segmented income statement is more useful to management in assessing long run profitability of various product lines as it eliminates common fixed expenses and reports them on whole basis before arriving at the net operating income.

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