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	$	922,000		$	268,000		$	404,000		$	250,000
Variable manufacturing and selling expenses		473,000			114,000			203,000			156,000
Contribution margin		449,000			154,000			201,000			94,000
Fixed expenses:
Advertising, traceable		69,800			8,600			40,700			20,500
Depreciation of special equipment		43,500			20,300			7,900			15,300
Salaries of product-line managers		115,100			40,600			39,000			35,500
Allocated common fixed expenses*		184,400			53,600			80,800			50,000
Total fixed expenses		412,800			123,100			168,400			121,300
Net operating income (loss)	$	36,200		$	30,900		$	32,600		$	(27,300)

*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

Requirement 1 | Financial Advantage / (Disadvantage) If we discontinue the Racing Bikes, the Regal Cycle company will not have any sales revenue and also will not incur any variable expenses, which means the company will lose Contribution Margin from Racing Bikes Line. Discontinuing Racing bikes line also have some savings in Fixed Expenses, like Advertising and Salaries of product-line managers. Depreciation of Special Equipment will not be saved as it is a sunk cost and Common Expenses will remain the same even if the line is discontinued, so, there will be savings towards depreciation and common expenses. Particulars Amount ($) Cost : Loss in Contribution $ (94,000) Benefit : Savings in Advertising Expenses $ 20,500 Savings in Salaries of Product-line Managers $ 35,500 Financial Disadvantage from Discontinuing the line $ (38,000) Requirement 2 | Decision If we continue the Line, there will be loss of $ 27,300. But if we discontinue the line, there will be a loss of $ 38,000. So, Racing Bikes Line shall not be discontinued. Total Dirt Bikes Mountain Bikes Racing Bikes 922,000 $ 268,000 $ 404,000 $ 250,000 473,000 $ 114,000 $ 203,000 $ 156,000 449,000 $ 154,000 $ 201,000 $ 94,000 $ Requirement 3 | Formatted Income Statement Particulars Sales $ Less : Variable manufacturing and selling expenses $ Contribution Margin Less : Fixed Expenses Advertising, traceable Depreciation of Special Equipment Salaries of Product-Line Managers Segment Margin / (Loss) Less : Common Fixed Expenses Net Operating Income / (Loss) $$$$$$ 69,800 $ 43,500 $ 115,100 $ 220,600 $ 184,400 36,200 8,600 $ 20,300 $ 40,600 $ 84,500 $ 40,700 $ 7,900 $ 39,000 $ 113,400 $ 20,500 15,300 35,500 22,700