Segment Margin and Segment Reporting

Business segments such as divisions and product lines should be evaluated based on revenues and costs that are directly related to them.

Direct costs (or traceable costs) refer to costs that are directly associated with the existence of the business segment. Without the segment, the organization will not incur in such costs.

Direct costs may be controllable by the segment manager or controllable by other segments. In the computation of segment margin, both are deducted.

Common costs (non-traceable costs or indirect costs) are excluded in the computation of segment margin.

Segment Margin Formula

Segment margin is equal to revenues minus direct costs (controllable and non-controllable). In segment reporting, the computation is presented in several steps.

1. Sales - Variable costs = Contribution margin

2. Contribution margin - Direct fixed costs controllable by managers = Contribution controllable by segment managers (also known as short-run segment margin)

3. Contribution controllable by segment managers - Direct fixed costs controllable by others = Segment margin

For evaluation purposes in segment reporting, common costs are not allocated.

Segment Reporting Example

Here is a sample segmental report for a company with two segments. All figures are assumed.

 
Segment 1
 
Segment 2
 
Total
Sales
$90,000
 
$70,000
 
$160,000
Less: Variable Costs
42,000
 
25,000
 
67,000
Contribution Margin
$48,000
 
$45,000
 
$93,000
Less: Direct fixed costs controllable by managers
30,000
 
20,000
 
50,000
Contribution controllable by segment managers
$18,000
 
$25,000
 
$43,000
Less: Direct fixed costs controllable by others
16,000
 
10,000
 
26,000
Segment Margin
$ 2,000
 
$15,000
 
$17,000
Less: Unallocated common fixed costs        
8,000
Net Income        
$ 9,000

It would be unfair to include the common fixed costs in evaluating the segments since these costs are not traceable to the existence of any of the segments. If the common fixed costs of $8,000 were allocated, say at 50% to each segment, Segment 1 will report a loss. However, its segment margin shows a positive amount.

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