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: Dirt Mountain Racing Total Bikes Bikes Bikes $ 921,000 $261,000 $ 400,000 $ 260,000 470,000 117,000 203,000 150,000 451,000 144,000 197,000 110,000 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) 69,200 8,300 40,200 20,700 44,100 20,500 7,700 15,900 116,100 40,200 38,900 37,000 184,200 52,200 80,000 52,000 413,600 121,200 166,800 125,600 $ 37,400 $ 22,800 $ 30,200 $(15,600) *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

Answer to Question 1 and 2:

$ (110,000) Question 1 Contribution Margin lost Fixed costs that can be avoided Advertising, traceable Salary of the product line manager Decrease in net operating income $ 20,700 $ 37,000 $ (52,300) Financial disadvantage of discontinuing Racing Bikes = $52,300 Note: The depreciation on special equipment is a sunk cost, and is irrelevant for the decision to be made. Also, the common fixed cost that has been allocated is also irrelevant for decision making, as it will be incurred irrespective of whether the racing bikes continue or not. Question 2 No, the racing bikes should not be discontinued, because if it is discontinued, it will result in a decrease in net operating income of $52,300

Answer to Question 3:

Question 3 Dirt Mountain Racing Total Bikes Bikes Bikes Sales $ 921,000 $ 261,000 $ 400,000 $ 260,000 Variable manufacturing expenses 470,000 $ 117,000 $ 203,000 $ 150,000 Contribution Margin 451,000 $ 144,000 $ 197,000 $ 110,000 Traceable fixed expenses Advertising $ 69,200 $ 8,300 $ 40,200 $ 20,700 Depreciation of special equipment 44,100 $ 20,500 $ 7,700 $ 15,900 Salaries of product line manager 116,100 $ 40,200 $ 38,900 $ 37,000 Total traceable fixed expenses $ 229,400 $ 69,000 $ 86,800 $ 73,600 (69,200 + 44,100 (8,300 + 20,500 + (40,200 + 7,700 + (20,700 + 15,900 + 116,100) 40,200) 38,900) + 37,000) Product line segment margin $ 221,600 $ 75,000 $ 110,200 $ 36,400 (144,000 - Calculation 69,000) (197,000 - 86,800)| (110,000 - 73,600) Less: Common fixed expenses $ 184,200 Net operating income $ 37,400 (221,600 - Calculation 184,200)