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	$	929,000			$	268,000			$	403,000			$	258,000
Variable manufacturing and selling expenses		456,000				110,000				195,000				151,000
Contribution margin		473,000				158,000				208,000				107,000
Fixed expenses:
Advertising, traceable		69,900				8,600				40,600				20,700
Depreciation of special equipment		43,500				20,100				7,700				15,700
Salaries of product-line managers		115,800				40,500				38,800				36,500
Allocated common fixed expenses*		185,800				53,600				80,600				51,600
Total fixed expenses		415,000				122,800				167,700				124,500
Net operating income (loss)	$	58,000			$	35,200			$	40,300			$	(17,500)

*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:

Part 1a. What is the impact on net operating income by discontinuing racing bikes?

In this type of decision, fixed cost which is relevant to the product line is important. If the particular product line is discontinued, the traceable fixed cost or the fixed cost directly related to the product line will not incur and it will be a cost saving to the company.

Incremental Analysis for Discontinuation Decision of Racing Bikes	$$
Contribution Margin lost if Racing Bikes is discontinued	$107,000
Less: Fixed cost savings if Racing BIke discontinued (Advertising $20,700 + Salaries of product line managers $36,500)	-$57,200
Operating Loss	$49,800

Note – Allocated Common Fixed Expenses does not consider since it is not directly related to this product line.

-- Depreciation is a non cash item hence it will not be considered in analysis of cost saving.

From the Above analysis it is clear if the Racing Bike Product Line is discontinued the companies Net Operating Income will be decreased by $49,800

Part 1b -- Should production and sale of the racing bikes be discontinued --- NO

Part 2a – Segmented income statement

Regal Cycle Company
Contribution Format Segmented Income Statement
	Total Company	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	$929,000	$268,000	$403,000	$258,000
Variable manufacturing and selling expenses	$456,000	$110,000	$195,000	$151,000
Contribution Margin	$473,000	$158,000	$208,000	$107,000
Traceable fixed expenses:
Advertising, traceable	$69,900	$8,600	$40,600	$20,700
Salaries of product-line managers	$115,800	$40,500	$38,800	$36,500
Depreciation of special equipment	$43,500	$20,100	$7,700	$15,700
Total Traceable fixed expenses	$229,200	$69,200	$87,100	$72,900
Segment Margin (loss)	$243,800	$88,800	$120,900	$34,100
Non traceable Fixed Expenses (Allocated common fixed expenses)	$185,800
Net operating income (loss)	$58,000

Part 2b --- Would a segmented income statement format be more usable to management in assessing the long-run profitability of the various product lines--- YES

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