Question

Check m Dirt Racing Mountain Bikes Bikes Bikes Total $ 924,000 $268,000 $ 404,000 $ 252,000 Sales Variable manufacturing and selling 465,000 110,000 196,000 159,000 expenses Contribution margin 459,000 158,000 208,000 93,000 Fixed expenses: Advertising, traceable Depreciation of special equipment Salaries of product-line managers Allocated common fixed expenses* Total fixed expenses 70,600 43,600 114,400 8,900 20,700 40,700 40,900 7,300 38,300 80,800 20,800 15,600 35,400 50,400 122,200 184,800 413,400 53,600 123,900 167,300 $45,600 $ 34,100 $ 40,700 $ (29,200) Net operating income (loss) *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

1.

There is financial disadvantage if R.B is discontinued.

Allocated fixed expenses ($50,400) should not be considered, since this is unavoidable, therefore, irrelevant in decision making.

Depreciation of equipment ($15,600) should not be considered, since there is no wear-out, therefore, charging depreciation is irrelevant.

If these two amounts are withdrawn, the net operating income of R.B would be as below:

Net operating income = (Allocated fixed expenses + Depreciation of equipment) – Net operating loss

                                    = (50,400 + 15,600) – 29,200

                                    = 66,000 – 29,200

                                    = $36,800

Answer: the financial disadvantage is net operating income, which is $36,800.

2.

Answer: No

The segment (R.B) should not be discontinued, since by doing so there would be a financial disadvantage of $36,800 through net operating income --- the income will be gone.

3.

In the long-run all factors of production become variable; therefore, there will be no fixed costs. The income statement would be based on sales and variable expenses only.

Income statement

(In the long-run)

	Total	D.B	M.B	R.B
Sales	$ 924,000	$ 268,000	$ 404,000	$ 252,000
Variable expenses	(465,000)	(110,000)	(196,000)	(159,000)
Net operating income	459,000	158,000	208,000	93,000

Note: Contribution margin becomes net operating income in the long-run.