The Regal Cycle Company manufactures three types of bicycles—a dirt bike, a moun

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:

*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.

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.

Total Dirt
Bikes Mountain Bikes Racing
Bikes Sales $ 926,000 $ 265,000 $ 408,000 $ 253,000 Variable manufacturing and selling expenses 466,000 116,000 194,000 156,000 Contribution margin 460,000 149,000 214,000 97,000 Fixed expenses: Advertising, traceable 69,400 8,400 40,400 20,600 Depreciation of special equipment 43,300 20,900 7,300 15,100 Salaries of product-line managers 114,500 40,300 38,100 36,100 Allocated common fixed expenses* 185,200 53,000 81,600 50,600 Total fixed expenses 412,400 122,600 167,400 122,400 Net operating income (loss) $ 47,600 $ 26,400 $ 46,600 $ (25,400)

Explanation / Answer

1) From the given fixed expenses, only traceable advertising and salaries of product line managers are relevant cost and considers in decision making, other fixed expenses are irrelevant for the decision. If the production of Racing bikes is discontinued then the contribution margin of $97,000 will be lost but there is a saving in advertising and salaries. Financial disadvantage of discontinuing the Racing Bikes is calculated as follows:-

Financial Disadvantage = Contribution Margin - Saving in Advertising - Saving in Salaries

= $97,000 - $20,600 - $36,100 = $40,300

2) No, the production and sale of racing bikes should not be discontinued because there is a net financial disadvantage of discontinuing the Racing Bikes of $40,300.

3) Segmented Income Statement (Amounts in $)

Particulars Totals Dirt Bikes Mountain Bikes Racing Bikes Sales 926,000 265,000 408,000 253,000 Variable manufacturing and selling expenses 466,000 116,000 194,000 156,000 Contribution margin (loss) (A) 460,000 149,000 214,000 97,000 Traceable fixed expenses: Advertising, traceable 69,400 8,400 40,400 20,600 Depreciation of special equipment 43,300 20,900 7,300 15,100 Salaries of product-line managers 114,500 40,300 38,100 36,100 Total traceable fixed expenses (B) 227,200 69,600 85,800 71,800 Product line segment margin (A-B) 232,800 79,400 128,200 25,200 Less: Common Fixed expenses (185,200) Net Operating Income (loss) 47,600

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