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	$	917,000		$	264,000		$	401,000		$	252,000
Variable manufacturing and selling expenses		466,000			110,000			202,000			154,000
Contribution margin		451,000			154,000			199,000			98,000
Fixed expenses:
Advertising, traceable		69,600			8,400			41,000			20,200
Depreciation of special equipment		43,900			20,600			7,900			15,400
Salaries of product-line managers		116,200			40,800			38,900			36,500
Allocated common fixed expenses*		183,400			52,800			80,200			50,400
Total fixed expenses		413,100			122,600			168,000			122,500
Net operating income (loss)	$	37,900		$	31,400		$	31,000		$	(24,500)

*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:

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

Relevant fixed expenses will be considered for the purpose of this decision and allocated costs will be irrelevant since these costs will not change as a result of this decision

1.Financial Advantage/(Disadvantage)of discontinuing the racing bikes = Fixed costs saved – Contribution Margin lost

= 56,700-98,000

= $(41,300)

Depreciation is sunk cost and allocation fixed expenses are not relevant

2.No, since it will reduce net income

3.

	Totals	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	917,000	264,000	401,000	252,000
Less: Variable Costs	466,000	110,000	202,000	154,000
Contribution Margin (loss)	451,000	154,000	199,000	98,000
Traceable Fixed Expenses:
Advertising	69,600	8,400	41,000	20,200
Depreciation	43,900	20,600	7,900	15,400
Salaries	116,200	40,800	38,900	36,500
Total traceable fixed expenses	229,700	69,800	87,800	72,100
Product line segment margin (loss)	221,300	84,200	111,200	25,900
Common Fixed Expenses	183,400
Net Operating income (loss)	37,900