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:

1a. What is the impact on net operating income by discontinuing racing bikes? (Decreases should be indicated by a minus sign.)

1b. Should production and sale of the racing bikes be discontinued?

2a. Prepare a segmented income statement.

2b. Would a segmented income statement format be more usable to management in assessing the long-run profitability of the various product lines.

Total Dirt
Bikes Mountain Bikes Racing
Bikes Sales $ 929,000 $ 268,000 $ 403,000 $ 258,000 Variable manufacturing and selling expenses 456,000 110,000 195,000 151,000 Contribution margin 473,000 158,000 208,000 107,000 Fixed expenses: Advertising, traceable 69,900 8,600 40,600 20,700 Depreciation of special equipment 43,500 20,100 7,700 15,700 Salaries of product-line managers 115,800 40,500 38,800 36,500 Allocated common fixed expenses* 185,800 53,600 80,600 51,600 Total fixed expenses 415,000 122,800 167,700 124,500 Net operating income (loss) $ 58,000 $ 35,200 $ 40,300 $ (17,500)

Explanation / Answer

Solution:

Part 1a. What is the impact on net operating income by discontinuing racing bikes?

In this type of decision, fixed cost which is relevant to the product line is important. If the particular product line is discontinued, the traceable fixed cost or the fixed cost directly related to the product line will not incur and it will be a cost saving to the company.

Incremental Analysis for Discontinuation Decision of Racing Bikes

$$

Contribution Margin lost if Racing Bikes is discontinued

$107,000

Less: Fixed cost savings if Racing BIke discontinued (Advertising $20,700 + Salaries of product line managers $36,500)

-$57,200

Operating Loss

$49,800

Note – Allocated Common Fixed Expenses does not consider since it is not directly related to this product line.

-- Depreciation is a non cash item hence it will not be considered in analysis of cost saving.

From the Above analysis it is clear if the Racing Bike Product Line is discontinued the companies Net Operating Income will be decreased by $49,800

Part 1b -- Should production and sale of the racing bikes be discontinued --- NO

Part 2a – Segmented income statement

Regal Cycle Company

Contribution Format Segmented Income Statement

Total Company

Dirt Bikes

Mountain Bikes

Racing Bikes

Sales

$929,000

$268,000

$403,000

$258,000

Variable manufacturing and selling expenses

$456,000

$110,000

$195,000

$151,000

Contribution Margin

$473,000

$158,000

$208,000

$107,000

Traceable fixed expenses:

Advertising, traceable

$69,900

$8,600

$40,600

$20,700

Salaries of product-line managers

$115,800

$40,500

$38,800

$36,500

Depreciation of special equipment

$43,500

$20,100

$7,700

$15,700

Total Traceable fixed expenses

$229,200

$69,200

$87,100

$72,900

Segment Margin (loss)

$243,800

$88,800

$120,900

$34,100

Non traceable Fixed Expenses

(Allocated common fixed expenses)

$185,800

Net operating income (loss)

$58,000

Part 2b --- Would a segmented income statement format be more usable to management in assessing the long-run profitability of the various product lines--- YES

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you

Incremental Analysis for Discontinuation Decision of Racing Bikes

$$

Contribution Margin lost if Racing Bikes is discontinued

$107,000

Less: Fixed cost savings if Racing BIke discontinued (Advertising $20,700 + Salaries of product line managers $36,500)

-$57,200

Operating Loss

$49,800

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