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	$	933,000		$	265,000		$	408,000		$	260,000
Variable manufacturing and selling expenses		464,000			115,000			190,000			159,000
Contribution margin		469,000			150,000			218,000			101,000
Fixed expenses:
Advertising, traceable		69,700			8,500			40,600			20,600
Depreciation of special equipment		43,300			20,600			7,300			15,400
Salaries of product-line managers		115,400			40,600			38,600			36,200
Allocated common fixed expenses*		186,600			53,000			81,600			52,000
Total fixed expenses		415,000			122,700			168,100			124,200
Net operating income (loss)	$	54,000		$	27,300		$	49,900		$	(23,200)

*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.calulation of financial advantage (disadvantage) per quarter of discontinuing the racing bikes:

Sales	260,000
Variable manufacturing and selling expenses	159,000
Contribution margin	101,000
Avoidable Fixed expenses:
Advertising, traceable	20,600
Salaries of product-line managers	36,200
Total Avoidable Fixed Expenses	56,800
Net Operating Income	$44,200

Hence, discontinuing Racing bikes will reduce operating income by $44,200

Hence, disadvantage of $44,200

Note: Depreciation is a sunk cost, not relevant for decision making

Allocated fixed costs are unavoidable and hence not relevant for decision making.

2. the production and sale of racing bikes SHPOULD NOT be discontinued

3.More Useful Statement:

	Total	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	933,000	265,000	408,000	260,000
Variable manufacturing and selling expenses	464,000	115,000	190,000	159,000
Contribution margin	469,000	150,000	218,000	101,000
Specific Fixed Expenses:
Advertising, traceable	69,700	8,500	40,600	20,600
Depreciation of special equipment	43,300	20,600	7,300	15,400
Salaries of product-line managers	115,400	40,600	38,600	36,200
Total Specific Fixed Expenses	228,400	69,700	86,500	72,200
Operating income/(loss)	240,600	80,300	131,500	28,800
Common Fixed Costs	186,600
Net Operating income (Loss)	54,000