Question

Exercise 11-2 Dropping or Retaining a Segment [LO11-2] 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 $ 923,000 $ 264,000 $ 403,000 $ 256,000 Variable manufacturing and selling expenses 477,000 117,000 204,000 156,000 Contribution margin 446,000 147,000 199,000 100,000 Fixed expenses: Advertising, traceable 69,200 8,800 40,200 20,200 Depreciation of special equipment 43,500 20,300 7,300 15,900 Salaries of product-line managers 115,900 40,700 38,600 36,600 Allocated common fixed expenses* 184,600 52,800 80,600 51,200 Total fixed expenses 413,200 122,600 166,700 123,900 Net operating income (loss) $ 32,800 $ 24,400 $ 32,300 $ (23,900) *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

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Amount in $

1) Financial Advantage/Disadvantage per quarter of discountinuing the Race Bike Sales Variable Cost Contribution Margin Total Dirt Bike Mountain Bike 667,000 264,000 403,000 321,000 117,000 204,000 346,000 147,000 199,000 Fixed Expense Advertising Depreciation Salary Common Fixed Expense Total Fixed Expenses Net Operating Income/Loss 49,000 27,600 79,300 184,600 340,500 5,500 8,800| 20,300 40,700 73,065 142,865 4,135 40,200 7,300 38,600 111,535 WN-1 197,635 1,365(Contribution Margin minus Total Fixed Expense) Total Operating Income when Race bike is continued Total Operating Income when Race bike is discountinued Financial disadvantage (32,800 - 5500) 32,800 5,500 27,300 2) Should the production and Sale of Racing bike be discontinued No, because the net operating income falls to 5500 from 32800 it's recommended to discontinue Racing Bike Segment. The reason behind such a drop in Net Operating Income is because of the Race Bike Segment's higher contribution towards common fixed expense

3) Segmented Income Statement Sales Less: Variable Manufacturing & Selling Expense Less: Segment Specific Advertising Expense Less: Segment Specific Depreciation Less: Segment Specific Salary Segment's Contribution Margin Less: Allocated Fixed Cost Based on Sale Net Operating Income/Loss Segments Moutain Total Dirt Bike Racing Bike Bike 923,000 264,000 403,000 256,000 477,000 117,000 204,000 156,000 69,200 8,800 40,200 20,200 43,500 20,300 7,300 15,900 115,900 40,700 38,600 36,600 217,400 77,200 112,900 27,300 184,600 52,800 80,600 51,200 32,800 24,400 32,300 -23,900 29% 28% 11% Contribution Margin % (Sales/Segment's Contribution Margin) WN-1 Common Fixed Cost can't be avoided when Racing Bike Production and Sale is discontinued. It needs to be allocated to remaining segments based on their sales numbers Total Common Fixed Cost Total Sales from Dirt & Mountain bikes Fixed Cost to Sales 184,600 667,000 27.68% By Multiplying this rate to Segment's Sales we can allocate the Total Fixed Cost