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	$	937,000		$	270,000		$	409,000		$	258,000
Variable manufacturing and selling expenses		463,000			111,000			194,000			158,000
Contribution margin		474,000			159,000			215,000			100,000
Fixed expenses:
Advertising, traceable		70,200			8,600			40,800			20,800
Depreciation of special equipment		43,700			20,400			7,800			15,500
Salaries of product-line managers		115,800			40,600			38,900			36,300
Allocated common fixed expenses*		187,400			54,000			81,800			51,600
Total fixed expenses		417,100			123,600			169,300			124,200
Net operating income (loss)	$	56,900		$	35,400		$	45,700		$	(24,200)

*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:

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

Regal Cycle Company 1. What is the financial advantage (disadvantage) per quarter of discontinuing the Racing Bikes? Total If Difference: Net Racing Bikes Operating Income Current Total Are Dropped Increaseor (Decrease) Sales 937000 679000 -258000 Variable manufacturing and selling expenses 463000 305000 158000 Contribution margin (loss) 474000 374000 - 100000 Fixed expenses: Advertising, traceable 70200 49400 20800 Depreciation on special equipment 43700 43700 0 Salaries of product managers 115800 79500 36300 Common allocated costs 187400 187400 Total fixed expenses 417100 360000 57100 Net operating income (loss) 56900 14000 -42900 0 2. Should the production and sale of racing bikes be discontinued? No, production and sale of the racing bikes should not be discontinued. If the racing bikes were discontinued, then the net operating income for the company as a whole would decrease by $(42,900) each quarter: The depreciation of the special equipment is a sunk cost and is not relevant to the decision. The common costs are allocated and will continue regardless of whether or not the racing bikes are discontinued; thus, they are not relevant to the decision. 3. Prepare a properly formatted segmented income statement Totals 937000 463000 Mountain Bikes 409000 Dirt Bikes 270000 111000 159000 Racing Bikes 258000 158000 194000 474000 215000 100000 70200 40800 Sales Variable manufacturing and selling expenses Contribution margin (loss) Traceable fixed expenses: Advertising, traceable Depreciation on special equipment Salaries of product managers Total traceable fixed expenses Product line segment margin Common fixed expenses Net operating income (loss) 8600 20400 40600 20800 15500 7800 38900 36300 69600 81800 72600 43700 115800 229700 244300 187400 56900 89400 133200 27400