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	$	266,000	$	406,000	$	253,000
Variable manufacturing and selling expenses		476,000		114,000		209,000		153,000
Contribution margin		449,000		152,000		197,000		100,000
Fixed expenses:
Advertising, traceable		69,000		8,300		40,300		20,400
Depreciation of special equipment		43,800		20,800		7,600		15,400
Salaries of product-line managers		114,200		40,100		38,500		35,600
Allocated common fixed expenses*		185,000		53,200		81,200		50,600
Total fixed expenses		412,000		122,400		167,600		122,000
Net operating income (loss)	$	37,000	$	29,600	$	29,400	$	(22,000)

*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:

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

Solution:
1a.	The impact on net operating income by discontinuing racing bikes	-44000
Working Notes:
		a	b	c=b-c
		Current Total	Total If Racing Bikes Are Dropped	Difference: Net Operating Income Increase or (Decrease)
	Sales	925,000	672,000	-253,000
Less:	Variable manufacturing and selling expenses	$476,000	323,000	153,000
	Contribution margin (loss)	$449,000	349,000	-100,000
	Fixed expenses:
	Advertising, traceable	69,000	48600	20,400
	Depreciation on special equipment	43,800	43800	0
	Salaries of product managers	114,200	78600	35,600
	Common allocated costs	185,000	185000	0
	Total fixed expenses	$412,000	356000	56,000
	Net operating income (loss)	$37,000	($7,000)	-44,000
Notes:	Total If Racing Bikes Are Dropped is calculated by subtracting Racing Bikes cost & revenue ,contribution margin from Current total column.
1b.	No
Working Notes:
	Since, operating income is decrease by $44,000 if Racing Bikes division will be discontinued but if we continue Racing Bikes , the overall operating income will be positive $37,000
2a.	Segmented income statement.
		Totals	Dirt Bikes	Mountain Bikes	Racing Bikes
a	Sales	925000	266000	406,000	253,000
b	Variable manufacturing and selling expenses	476000	114000	209,000	153,000
c=a-b	Contribution margin	449000	152000	197000	100,000
	Fixed expenses:
d	Advertising, traceable	69000	8300	40,300	20,400
e	Depreciation of special equipment	43800	20800	7,600	15400
f	Salaries of product-line managers	114200	40100	38,500	35,600
g=d+e+f	Total traceable fixed expenses	227000	69200	86,400	71,400
h=c-g	Product line segment margin	222000	82800	110,600	28,600
i	Common fixed expenses	185,000
j=h-i	Net operating income (loss)	37,000
2b.	Yes
Working Notes:	Yes, a segmented income statement format be more usable to management in assessing the long-run profitability of the various product lines. As in segmented income statement each segment traceable expenses and income and their impact on the company can be easily identify that will be helpful in analysis of long-run profitability of the various product lines, correct steps to arrest the real problem in segment can be done and operating income can also be improved.
Please feel free to ask if anything about above solution in comment section of the question.