Common Mistakes in reation to segmented income statements

Companies often make mistakes when assigning cost to segments. they omit some costs, inappropriately assign traceable fixed costs, and arbitrarily allocate common fixed costs.

Companies do not correctly handle traceable fixed expenses on segmented income statements.
------1) They do not trace fixed expenses to segments even when it is feasible to do so.
------2) They use inappropriate allocation bases to allocate traceable fixed expenses to segments.

Failure to trace Cost Directly - Cost that can be traced directly to a specific segment should be charged directly to that segment and should not be allocated to other segments.

Inappropriate Allocation base - Some Companies us arbitrary allocation bases to allocate costs to segments. Example: Some companies allocate selling and administrative expenses on the of sales revenues. Thus, if a segment generates 20% of total company sales, it would be allocated 20% of the company's selling and administrative expenses as it " fair share".

Arbitrarily Dividing common costs among segments - The 3rd business practice that leads to distorted segment costs is the practice of assigning non-traceable costs to segments. example: Some companies allocate the common costs of the corporate headquarters building to products on segment reports

Segmented Income Statements

In the segmented income statements are statements that allow a company to makes decisions and evaluate managerial performance by creating a contribution format income statements segmented by the company's divisions, product lines, and sales channels.

To prepare a segmented income statement, variable expenses are deducted from sales to yield the contribution margin for the segment. the contribution margin tells us what happens to profits as volume changes the two components of contribution margin.

Difference between variable and absorption expense

The difference between Variable Costing and Absorption costing is that variable costing the fixed manufacturing overhead is treated as a period cost and like selling and administrative expenses, it is expensed in its entirety each period. Where Absorption costing treats all manufacturing costs as product costs, regardless of whether they are variable or fixed.

Omission of cost

The costs assigned to a segment should include all costs attributable to that segment from the company's entire value chain.

To avoid having to maintain two costing systems and provide consistency between internal and external reports, many companies also use absorption costing for their internal reports such as segmented income statements.

Chapter 6 Glossary

Absorption Costing - A costing method that includes all manufacturing cost in unit product cost. This will include direct materials, direct labor and both variable and fixed manufacturing overhead.

Common Fixed Cost - A fixed cost that supports more than one business segment, but is not traceable in whole or in part to any one of the business segment. Even if that segment were entirely eliminated, there would be no change in a true common fixed cost.

Segment - Any part or activity of an organization about which managers seek  cost, revenue, or profit data.

Segment Margin - A segment contribution margin less its traceable fixed cost. it represents the margin available after a segment has covered all of its own traceable costs. The segment margin is the best gauge of the long run profitability of a segment because it includes only those costs that are caused by the segment. If a segment can't cover its own costs, then that segment probably should be dropped.

Traceable fixed cost - a fixed cost that is incurred because of the existence of a particular business  segment and that would be eliminated.

Variable costing - A costing method that includes only variable manufacturing costs ( direct materials, direct labor and both variable manufacturing overhead ) in product costs.

Common fixed cost

A common fixed cost that supports the operations of more than one segment, but is not traceable in whole or part to any one segment.

Traceable fixed cost

A traceable fixed cost of a segment is fix cost that is incurred because of the existence of the segment - if the segment had never existed, the fixed cost would not have been incurred; and if the segment were eliminated, the fixed cost would disappear.