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	$	926,000		$	265,000		$	408,000		$	253,000
Variable manufacturing and selling expenses		466,000			116,000			194,000			156,000
Contribution margin		460,000			149,000			214,000			97,000
Fixed expenses:
Advertising, traceable		69,400			8,400			40,400			20,600
Depreciation of special equipment		43,300			20,900			7,300			15,100
Salaries of product-line managers		114,500			40,300			38,100			36,100
Allocated common fixed expenses*		185,200			53,000			81,600			50,600
Total fixed expenses		412,400			122,600			167,400			122,400
Net operating income (loss)	$	47,600		$	26,400		$	46,600		$	(25,400)

*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.

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?

	Yesradio button checked1 of 2 Noradio button unchecked2 of 2

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) 0 0 0 0 Traceable fixed expenses: Total traceable fixed expenses 0 0 0 0 0 $0 $0 $0 Net operating income (loss) $0

Answer 1

1) From the given fixed expenses, only traceable advertising and salaries of product line managers are relevant cost and considers in decision making, other fixed expenses are irrelevant for the decision. If the production of Racing bikes is discontinued then the contribution margin of $97,000 will be lost but there is a saving in advertising and salaries. Financial disadvantage of discontinuing the Racing Bikes is calculated as follows:-

Financial Disadvantage = Contribution Margin - Saving in Advertising - Saving in Salaries

= $97,000 - $20,600 - $36,100 = $40,300

2) No, the production and sale of racing bikes should not be discontinued because there is a net financial disadvantage of discontinuing the Racing Bikes of $40,300.

3) Segmented Income Statement (Amounts in $)

Particulars	Totals	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	926,000	265,000	408,000	253,000
Variable manufacturing and selling expenses	466,000	116,000	194,000	156,000
Contribution margin (loss) (A)	460,000	149,000	214,000	97,000
Traceable fixed expenses:
Advertising, traceable	69,400	8,400	40,400	20,600
Depreciation of special equipment	43,300	20,900	7,300	15,100
Salaries of product-line managers	114,500	40,300	38,100	36,100
Total traceable fixed expenses (B)	227,200	69,600	85,800	71,800
Product line segment margin (A-B)	232,800	79,400	128,200	25,200
Less: Common Fixed expenses	(185,200)
Net Operating Income (loss)	47,600