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	$	921,000		$	262,000		$	402,000		$	257,000
Variable manufacturing and selling expenses		485,000			119,000			208,000			158,000
Contribution margin		436,000			143,000			194,000			99,000
Fixed expenses:
Advertising, traceable		69,500			8,400			40,200			20,900
Depreciation of special equipment		44,400			20,900			7,600			15,900
Salaries of product-line managers		114,300			40,500			38,100			35,700
Allocated common fixed expenses*		184,200			52,400			80,400			51,400
Total fixed expenses		412,400			122,200			166,300			123,900
Net operating income (loss)	$	23,600		$	20,800		$	27,700		$	(24,900)

*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	Financial disadvantage	=	$         -42,400
	Workings:
1		Current Total	Total if racing bikes are dropped	Difference: Net operating income increase or (decrease)
	Sales	$       9,21,000	$       6,64,000	$     -2,57,000
	Variable manufacturing and selling expenses	$       4,85,000	$       3,27,000	$       1,58,000
	Contribution margin (loss)	$       4,36,000	$       3,37,000	$         -99,000
	Fixed expenses:
	Advertising, traceable	$           69,500	$           48,600	$           20,900
	Depreciation on special equipment	$           44,400	$           44,400	$                    -
	Salaries of product managers	$       1,14,300	$           78,600	$           35,700
	Allocated common expense	$       1,84,200	$       1,84,200	$                    -
	Total fixed expenses	$       4,12,400	$       3,55,800	$           56,600
	Net operating income (loss)	$           23,600	$         -18,800	$         -42,400

2	No
	Discontinuation of Production and sale of racing bikes will incur more loss than existing loss from the unit

3		Total	Dirt Bikes	Mountain Bikes	Racing Bikes
	Sales	$       9,21,000	$       2,62,000	$       4,02,000	$             2,57,000
	Variable manufacturing and selling expenses	$       4,85,000	$       1,19,000	$       2,08,000	$             1,58,000
	Contribution margin (loss)	$       4,36,000	$       1,43,000	$       1,94,000	$                99,000
	Traceable Fixed expenses:
	Advertising, traceable	$           69,500	$             8,400	$           40,200	$                20,900
	Depreciation on special equipment	$           44,400	$           20,900	$             7,600	$                15,900
	Salaries of product managers	$       1,14,300	$           40,500	$           38,100	$                35,700
	Total traceable fixed expenses	$       2,28,200	$           69,800	$           85,900	$                72,500
	Product line segment margin (loss)	$       2,07,800	$           73,200	$       1,08,100	$                26,500
	Allocated common fixed expense	$       1,84,200
	Net operating income (loss)	$           23,600

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