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	$	927,000		$	269,000		$	406,000		$	252,000
Variable manufacturing and selling expenses		471,000			115,000			197,000			159,000
Contribution margin		456,000			154,000			209,000			93,000
Fixed expenses:
Advertising, traceable		70,300			8,700			41,000			20,600
Depreciation of special equipment		43,900			20,900			7,500			15,500
Salaries of product-line managers		115,900			40,400			38,700			36,800
Allocated common fixed expenses*		185,400			53,800			81,200			50,400
Total fixed expenses		415,500			123,800			168,400			123,300
Net operating income (loss)	$	40,500		$	30,200		$	40,600		$	(30,300)

*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

Product segments are arise when a company produce same product's different versions. Expenses are allocated to each segments and profit is ascertained.

1.

Current Total 927,000 471,000 456,000 Total if racing bikes Financial Advantagel discontinued Disadvantage 675,000 252,000 Disadvantage 312,000 159,000 Disadvantage 363,000 93,000 Disadvantage Sales Variable manufacturing and selling expenses Contribution margin Fixed expenses: Advertising, traceable Depreciation of special equipment Salaries of product-line managers Allocated common fixed expenses* Total fixed expenses Net operating income (loss) 70,300 43,900 115,900 185,400 415,500 40,500 49,700 43,900 79,100 185,400 358,100 4,900 20,600 Advantage 0 36,800 Advantage 0 57,400 Advantage 35,600 Disadvantage

If the racing bikes are discontinuing, therr will be a financial disadvantage of $35,600 per quarter.

Working notes:

It is given that the special equipment used to produce racing bikes has no resale value and does not wear out. Hence, depreciation will be charged on the equipment, even after dropping the racing bike.

Common fixed expense will be incurred even after dropping the racing bike.

Advertising and salaries to product line managers are traceable. Hence, the cost incurred for racing bikes is reduced.

2. No. The production and sale of racing bikes should not be discontinued as it will cause a financial disadvantage of $35,600 per quarter.

3.

Segmented Income Statement Dirt Mountain Racing Total Bikes Bikes Bikes Sales 927,000|| 269,000 406,000 252,000 Variable manufacturing and selling expenses 471,000 115,000 197,000 159,000 Contribution margin 456,000 154,000 209,000 93,000 Fixed expenses: Advertising, traceable 70,300 8,700 41,000 20,600 Depreciation of special equipment 43,900 20,900 7,500 15,500 Salaries of product-line managers 115,900 40,400 38,700 36,800 Total traceable fixed expenses 230,100 70,000 87,200 72,900 Product line segment margin 225,900 84,000 121,800 20,100 Common fixed expenses 185,400 Net operating income 40,500