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	$	928,000		$	267,000		$	409,000		$	252,000
Variable manufacturing and selling expenses		474,000			117,000			203,000			154,000
Contribution margin		454,000			150,000			206,000			98,000
Fixed expenses:
Advertising, traceable		69,500			8,700			40,500			20,300
Depreciation of special equipment		43,300			20,200			7,200			15,900
Salaries of product-line managers		114,900			40,000			38,100			36,800
Allocated common fixed expenses*		185,600			53,400			81,800			50,400
Total fixed expenses		413,300			122,300			167,600			123,400
Net operating income (loss)	$	40,700		$	27,700		$	38,400		$	(25,400)

*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		Current Total	Total if racing bikes are dropped	Difference: Net operating income increase or (decrease)
	Sales	$       9,28,000	$       6,76,000	$     -2,52,000
	Variable manufacturing and selling expenses	$       4,74,000	$       3,20,000	$       1,54,000
	Contribution margin (loss)	$       4,54,000	$       3,56,000	$         -98,000
	Fixed expenses:
	Advertising, traceable	$           69,500	$           49,200	$           20,300
	Depreciation on special equipment	$           43,300	$           43,300	$                    -
	Salaries of product managers	$       1,14,900	$           78,100	$           36,800
	Allocated common expense	$       1,85,600	$       1,85,600	$                    -
	Total fixed expenses	$       4,13,300	$       3,56,200	$           57,100
	Net operating income (loss)	$           40,700	$               -200	$         -40,900
2	No
	Discontinuation of Production and sale of racing bikes will incur more loss than existing loss from the unit
3		Total	Dirt Bikes	Mountain Bikes	Racing Bikes
	Sales	$       9,28,000	$       2,67,000	$       4,09,000	$       2,52,000
	Variable manufacturing and selling expenses	$       4,74,000	$       1,17,000	$       2,03,000	$       1,54,000
	Contribution margin (loss)	$       4,54,000	$       1,50,000	$       2,06,000	$           98,000
	Traceable Fixed expenses:
	Advertising, traceable	$           69,500	$             8,700	$           40,500	$           20,300
	Depreciation on special equipment	$           43,300	$           20,200	$             7,200	$           15,900
	Salaries of product managers	$       1,14,900	$           40,000	$           38,100	$           36,800
	Total traceable fixed expenses	$       2,27,700	$           68,900	$           85,800	$           73,000
	Product line segment margin (loss)	$       2,26,300	$           81,100	$       1,20,200	$           25,000
	Allocated common fixed expense	$       1,85,600
	Net operating income (loss)	$           40,700