Question

Exercise 12-2 Dropping or Retaining a Segment [LO12-2]

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		$	269,000		$	401,000		$	256,000
Variable manufacturing and selling expenses		462,000			117,000			195,000			150,000
Contribution margin		464,000			152,000			206,000			106,000
Fixed expenses:
Advertising, traceable		69,800			8,500			40,800			20,500
Depreciation of special equipment		43,800			20,500			7,300			16,000
Salaries of product-line managers		115,100			40,900			38,500			35,700
Allocated common fixed expenses*		185,200			53,800			80,200			51,200
Total fixed expenses		413,900			123,700			166,800			123,400
Net operating income (loss)	$	50,100		$	28,300		$	39,200		$	(17,400)

*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.

Answer 1

1)
	Currrent Total	Total If Racing Bikes Are Dropped	Difference: Net Operating Income Increase or (Decrease)
Sales	926,000	670,000	-256,000
Variable manufacturing and selling expenses	462,000	312,000	150,000
Contribution margin	464,000	358,000	-106,000
Fixed expenses:
Advertising, traceable	69,800	49,300	20,500
Depreciation of special equipment	43,800	43,800	0
Salaries of product-line managers	115,100	79,400	35,700
Allocated common fixed expenses*	185,200	185,200	0
Total fixed expenses	413,900	357,700	56,200
Net operating income (loss)	50,100	300.00	49,800
2)
No, production and sale of the racing bikes should not  be discontinued/
3)
	Total	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	926,000	269,000	401,000	256,000
Variable manufacturing and selling expenses	462,000	117,000	195,000	150,000
Contribution margin	464,000	152,000	206,000	106,000
Traceable fixed expenses:
Advertising, traceable	69,800	8,500	40,800	20,500
Depreciation of special equipment	43,800	20,500	7,300	16,000
Salaries of product-line managers	115,100	40,900	38,500	35,700
Total traceable fixed expenses	113,600	29,000	48,100	36,500
Product line segment margin	350,400	123,000	157,900	69,500
Common fixed expenses	185,200
Net operating Income	165,200