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	$	915,000		$	262,000		$	402,000		$	251,000
Variable manufacturing and selling expenses		469,000			120,000			198,000			151,000
Contribution margin		446,000			142,000			204,000			100,000
Fixed expenses:
Advertising, traceable		69,700			8,800			40,200			20,700
Depreciation of special equipment		44,000			20,400			7,800			15,800
Salaries of product-line managers		115,000			40,000			38,700			36,300
Allocated common fixed expenses*		183,000			52,400			80,400			50,200
Total fixed expenses		411,700			121,600			167,100			123,000
Net operating income (loss)	$	34,300		$	20,400		$	36,900		$	(23,000)

*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

Solution 1:

Impact on net income on discontinuing racing bike
Particulars	Current Total	Total if racing bikes are dropped	Financial advantage (disadvantage) of discontinuing racing bikes
Sales	$915,000.00	$664,000.00	-$251,000.00
Variable manufacturing and selling expenses	$469,000.00	$318,000.00	-$151,000.00
Contribution margin	$446,000.00	$346,000.00	-$100,000.00
Fixed expenses:
Advertising traceable	$69,700.00	$49,000.00	-$20,700.00
Depreciation of special equipment	$44,000.00	$44,000.00	$0.00
Salaries of product manager	$115,000.00	$78,700.00	-$36,300.00
Common allocated costs	$183,000.00	$183,000.00	$0.00
Total fixed expenses	$411,700.00	$354,700.00	-$57,000.00
Net Operating income (loss)	$34,300.00	-$8,700.00	-$43,000.00

Solution 2:

As there is net financial disadvantage, therefore production and sale of racing bike should not be discontinued.

Solution 3:

Segmanted Income Statement
Particulars	Total	Dirt Bikes	Mountaing Bikes	Racing Bikes
Sales	$915,000.00	$262,000.00	$402,000.00	$251,000.00
Variable manufacturing and selling expenses	$469,000.00	$120,000.00	$198,000.00	$151,000.00
Contribution margin	$446,000.00	$142,000.00	$204,000.00	$100,000.00
Fixed expenses:
Advertising traceable	$69,700.00	$8,800.00	$40,200.00	$20,700.00
Depreciation of special equipment	$44,000.00	$20,400.00	$7,800.00	$15,800.00
Salaries of product manager	$115,000.00	$40,000.00	$38,700.00	$36,300.00
Total traceable fixed expenses	$228,700.00	$69,200.00	$86,700.00	$72,800.00
Segmant income	$217,300.00	$72,800.00	$117,300.00	$27,200.00
Common fixed expenses	$183,000.00
Net Operating income (Loss)	$34,300.00