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	$	925,000		$	264,000		$	410,000		$	251,000
Variable manufacturing and selling expenses		481,000			116,000			207,000			158,000
Contribution margin		444,000			148,000			203,000			93,000
Fixed expenses:
Advertising, traceable		69,600			8,700			40,700			20,200
Depreciation of special equipment		43,100			20,800			7,100			15,200
Salaries of product-line managers		115,600			40,000			38,800			36,800
Allocated common fixed expenses*		185,000			52,800			82,000			50,200
Total fixed expenses		413,300			122,300			168,600			122,400
Net operating income (loss)	$	30,700		$	25,700		$	34,400		$	(29,400)

*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

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	$925,000.00	$674,000.00	-$251,000.00
Variable manufacturing and selling expenses	$481,000.00	$323,000.00	-$158,000.00
Contribution margin	$444,000.00	$351,000.00	-$93,000.00
Fixed expenses:
Advertising traceable	$69,600.00	$49,400.00	-$20,200.00
Depreciation of special equipment	$43,100.00	$43,100.00	$0.00
Salaries of product line manager	$115,600.00	$78,800.00	-$36,800.00
Common allocated costs	$185,000.00	$185,000.00	$0.00
Total fixed expenses	$413,300.00	$356,300.00	-$57,000.00
Net Operating income (loss)	$30,700.00	-$5,300.00	-$36,000.00

Solution 2:

As there is net financial disadvantage of $36,000, therefore racing bike should not be discontinued.

Solution 3:

Segmanted Income Statement
Particulars	Total	Dirt Bikes	Mountaing Bikes	Racing Bikes
Sales	$925,000.00	$264,000.00	$410,000.00	$251,000.00
Variable manufacturing and selling expenses	$481,000.00	$116,000.00	$207,000.00	$158,000.00
Contribution margin	$444,000.00	$148,000.00	$203,000.00	$93,000.00
Fixed expenses:
Advertising traceable	$69,600.00	$8,700.00	$40,700.00	$20,200.00
Depreciation of special equipment	$43,100.00	$20,800.00	$7,100.00	$15,200.00
Salaries of product manager	$115,600.00	$40,000.00	$38,800.00	$36,800.00
Total traceable fixed expenses	$228,300.00	$69,500.00	$86,600.00	$72,200.00
Segmant income	$215,700.00	$78,500.00	$116,400.00	$20,800.00
Common fixed expenses	$185,000.00
Net Operating income (Loss)	$30,700.00