|EXERCISE 13–2 |The Regal Cycle Company manufactures three types of bicycles—a dirt bike, a mountain bike, and a racing | |(30 minutes) |bike. Data on sales and expenses for the past quarter follow: LO2 | | | |[pic] | |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. |
1.No, production and sale of the racing bikes should not be discontinued. If the racing bikes were discontinued, then the net operating income for the company as a whole would decrease by $11,000 each quarter:
|Lost contribution margin | |$(27,000) | |Fixed costs that can be avoided: | | | |Advertising, traceable |$ 6,000 | | |Salary of the product line manager | 10,000 | 16,000 | |Decrease in net operating income for the company as a whole | |$(11,000) |
The depreciation of the special equipment is a sunk cost and is not relevant to the decision. The common costs are allocated and will continue regardless of whether or not the racing bikes are discontinued; thus, they are not relevant to the decision.
| |Current Total |Total If Racing Bikes|Difference: Net | | | |Are Dropped |Operating Income | | | | |Increase or (Decrease) | |Sales |$300,000 |$240,000 |$(60,000) | |Variable expenses | 120,000 | 87,000 | 33,000 | |Contribution margin | 180,000 | 153,000 | (27,000) | |Fixed expenses: | | | | |Advertising, traceable |30,000 |24,000 |6,000 | |Depreciation on special |23,000 |23,000 |0 | |equipment* | | | | |Salaries of product managers |35,000 |25,000 |10,000 | |Common allocated costs | 60,000 | 60,000 | 0 | |Total fixed expenses | 148,000 | 132,000 | 16,000 | |Net operating income |$ 32,000 |$ 21,000 |$ (11,000) |
*Includes pro-rated loss on the special equipment if it is disposed of. Exercise 13-2 (continued)
2.The segmented report can be improved by eliminating...