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: Total Dirt Bikes Mountain Bikes Racing Bikes Sales $ 935,000 $ 268,000 $ 409,000 $ 258,000 Variable manufacturing and selling expenses 460,000 117,000 191,000 152,000 Contribution margin 475,000 151,000 218,000 106,000 Fixed expenses: Advertising, traceable 69,600 8,800 40,100 20,700 Depreciation of special equipment 44,300 21,000 7,300 16,000 Salaries of product-line managers 114,300 40,900 38,300 35,100 Allocated common fixed expenses* 187,000 53,600 81,800 51,600 Total fixed expenses 415,200 124,300 167,500 123,400 Net operating income (loss) $ 59,800 $ 26,700 $ 50,500 $ (17,400) *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: 1a. What is the impact on net operating income by discontinuing racing bikes? (Decreases should be indicated by a minus sign.)

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

Explanation / Answer

1a. For racing bikes, the net loss is $ 17,400, which will be reduced. Against this, the depreciation of the special equipment for racing bikes will continue. Hence, the net operating income will increase by $ 17,400 - $ 16,000 = $ 1,400 if special bikes are discountinued. 1b. As the net operating income of the Company goes up by $ 1,400, hence production and sale of racing bikes should definitely be discontinued. 2a. The Regal Cycle Company All Amounts in $ Segment Income Statement Dirt Bikes Mountain Racing Total Bikes Bikes Sales 268000 409000 258000 935000 Variable Manufacturing and Selling Expenses 117000 191000 152000 460000 Contribution Margin 151000 218000 106000 475000 Fixed Expenses Traceable Advertising 8800 40100 20700 69600 Depreciation of Special Equipment 21000 7300 16000 44300 Salaries of Product-Line Managers 40900 38300 35100 114300 Allocated Fixed Expenses 53600 81800 51600 187000 Total Fixed Expenses 124300 167500 123400 415200 Net Operating Income 26700 50500 -17400 59800 2b. Yes. Since the profitability can be assessed segment wise, giving inputs to the Company about which segment is specifically into losses and needs to be shut down, the segmented income statement would be more usable to management in assessing the long-run profitability of the various product lines.

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