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	$	920,000		$	265,000		$	405,000		$	250,000
Variable manufacturing and selling expenses		472,000			111,000			204,000			157,000
Contribution margin		448,000			154,000			201,000			93,000
Fixed expenses:
Advertising, traceable		70,000			8,700			40,400			20,900
Depreciation of special equipment		43,700			20,900			7,600			15,200
Salaries of product-line managers		115,600			40,300			38,600			36,700
Allocated common fixed expenses*		184,000			53,000			81,000			50,000
Total fixed expenses		413,300			122,900			167,600			122,800
Net operating income (loss)	$	34,700		$	31,100		$	33,400		$	(29,800)

*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
	Current Total			Total if			Difference
				Racing Bikes are dropped
Sales	$	920,000		$	670,000		$	250,000
Variable manufacturing and selling expenses		472,000			315,000			157,000
Contribution margin		448,000			355,000			93,000
Fixed expenses:								0
Advertising, traceable		70,000			49,100			20,900
Depreciation of special equipment		43,700			28,500			15,200
Salaries of product-line managers		115,600			78,900			36,700
Allocated common fixed expenses		184,000			184,000			0
Total fixed expenses		413,300			290,500			122,800
Net operating income (loss)	$	34,700		$	14,500		$	20200
The general administrative overhead is allocated and none of it would be avoided if the program were dropped; thus it is not relevant to the decision.
Financial disadvantage
3			Total			Dirt			Mountain Bikes			Racing
						Bikes						Bikes
		Sales	$	920,000		$	265,000		$	405,000		$	250,000
		Variable manufacturing and selling expenses		472,000			111,000			204,000			157,000
		Contribution margin		448,000			154,000			201,000			93,000
		Traceable Fixed expenses:
		Advertising, traceable		70,000			8,700			40,400			20,900
		Depreciation of special equipment		43,700			20,900			7,600			15,200
		Salaries of product-line managers		115,600			40,300			38,600			36,700
		Totaltraceable fixed expenses		229,300			69,900			86,600			72,800
		Product line segment margin		218,700			84,100			114,400			20,200
		common fixed expenses		184,000
		Net operating income (loss)	$	34,700

2.	No, the housekeeping program should not be discontinued. It is actually
	generating a positive program segment margin and is, of course, providing a
	valuable service to seniors.