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	$	915,000	$	262,000	$	400,000	$	253,000
Variable manufacturing and selling expenses		471,000		111,000		201,000		159,000
Contribution margin		444,000		151,000		199,000		94,000
Fixed expenses:
Advertising, traceable		70,300		8,900		40,500		20,900
Depreciation of special equipment		43,600		20,800		7,600		15,200
Salaries of product-line managers		115,200		40,300		38,200		36,700
Allocated common fixed expenses*		183,000		52,400		80,000		50,600
Total fixed expenses		412,100		122,400		166,300		123,400
Net operating income (loss)	$	31,900	$	28,600	$	32,700	$	(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:

1a.	What is the impact on net operating income by discontinuing racing bikes? (Decreases should be indicated by a minus sign.)

       

1b.	Should production and sale of the racing bikes be discontinued?
	Yes No

  

2a.	Prepare a segmented income statement.

        

2b.	Would a segmented income statement format be more usable to management in assessing the long-run profitability of the various product lines.
	Yes No

Answer 1

1-a. Impact on income on discontinuing racing bikes will be as follows:

Sales	$253,000
Variable manufacturing and selling expenses	159,000
Contribution margin	94,000
Avoidable Fixed Expenses:
Advertising, traceable	20,900
Salaries of product-line managers	36,700
Total avoidable fixed expenses	57,600
Net Operating Income/(Loss)	36,400

Net operating income will reduce by $36,400 on discontinuing racing bikes

i.e. Net Impact = -$36,400

Note: Depreciation is a sunk cost and hence irrelevant

1b. No, since decrease in income

2-a Segmented Income Statement:

	Dirt Bikes	Mountain Bikes	Racing Bikes	Total
Sales	262,000	400,000	253,000	915,000
Variable manufacturing and selling expenses	111,000	201,000	159,000	471,000
Contribution margin	151,000	199,000	94,000	444,000
Avoidable Fixed Expenses:
Advertising, traceable	8,900	40,500	20,900	70,300
Depreciation	20,800	7,600	15,200	43,600
Salaries of product-line managers	40,300	38,200	36,700	115,200
Net Operating Income/(Loss)	81,000	112,700	21,200	214,900
Common Fixed Expenses				183,000
Net Profit				31,900

2b Yes, since it reflects true position