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	$	928,000	$	267,000	$	405,000	$	256,000
Variable manufacturing and selling expenses		469,000		117,000		199,000		153,000
Contribution margin		459,000		150,000		206,000		103,000
Fixed expenses:
Advertising, traceable		69,700		8,400		40,600		20,700
Depreciation of special equipment		43,200		20,100		7,400		15,700
Salaries of product-line managers		115,900		40,900		38,400		36,600
Allocated common fixed expenses*		185,600		53,400		81,000		51,200
Total fixed expenses		414,400		122,800		167,400		124,200
Net operating income (loss)	$	44,600	$	27,200	$	38,600	$	(21,200)

*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:

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

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

= 20,700+36,600-103,000

= $(45,700)

Depreciation is sunk cost and allocated fixed expenses are not relevant

2.No, since it will reduce net income

3.

	Totals	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	928,000	267,000	405,000	256,000
Less: Variable Costs	469,000	117,000	199,000	153,000
Contribution Margin (loss)	459,000	150,000	206,000	103,000
Traceable Fixed Expenses:
Advertising	69,700	8,400	40,600	20,700
Depreciation	43,200	20,100	7,400	15,700
Salaries	115,900	40,900	38,400	36,600
Total traceable fixed expenses	228,800	69,400	86,400	73,000
Product line segment margin (loss)	230,200	80,600	119,600	30,000
Common Fixed Expenses	185,600
Net Operating income (loss)	44,600

Yes, more useful