Question

Exercise 12-2 Dropping or Retaining a Segment [LO12-2]

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	$	300,000		$	90,000		$	150,000		$	60,000
Variable manufacturing and selling expenses		120,000			27,000			60,000			33,000
Contribution margin		180,000			63,000			90,000			27,000
Fixed expenses:
Advertising, traceable		30,000			10,000			14,000			6,000
Depreciation of special equipment		23,000			6,000			9,000			8,000
Salaries of product-line managers		35,000			12,000			13,000			10,000
Allocated common fixed expenses*		60,000			18,000			30,000			12,000
Total fixed expenses		148,000			46,000			66,000			36,000
Net operating income (loss)	$	32,000		$	17,000		$	24,000		$	(9,000	)

*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

Part-1
	Total	Discontinue	Net Increase/(Decrease)
	AMOUNT $	AMOUNT $	AMOUNT $
Sales Revenue	$300,000	$240,000	-$60,000
Less: Variable cost	$120,000	$87,000	-$33,000
Contribution margin	$180,000	$153,000	-$27,000
Less: Fixed cost
Advertisement	$30,000	$24,000	-$6,000
Depreciation	$23,000	$23,000	$0
Salary of product line manager	$35,000	$25,000	-$10,000
Common Fixed cost	$60,000	$60,000	$0
SEGMENT MARGIN	$32,000	$21,000	-$11,000
Hence Financial Disadvantage of $11000 per quarter , in case of discontinuing th Racing Bikes

Part-2 No, Racing Rike Division Shall not be Discontinued

Part-3 SEGMENT-WISE INCOME STATEMENT
	Total	Dirt	Mountain	Racing
	AMOUNT $	AMOUNT $	AMOUNT $	AMOUNT $
Sales Revenue	$300,000	$90,000	$150,000	$60,000
Less: Variable cost	$120,000	$27,000	$60,000	$33,000
Contribution margin	$180,000	$63,000	$90,000	$27,000
Less: Traceable Expense
Advertisement	$30,000	$10,000	$14,000	$6,000
Depreciation	$23,000	$6,000	$9,000	$8,000
Salary of product line manager	$35,000	$12,000	$13,000	$10,000
Total Traecable expense	$88,000	$28,000	$36,000	$24,000
SEGMENT MARGIN	$92,000	$35,000	$54,000	$3,000
Less: Common Fixed expesne	$60,000
Net Operating Income	$32,000