Segment margin and segment reporting

Checked for updates, April 2022. Accountingverse.com

Introduction

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, these 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.

Key Takeaways

In segment reporting, only the direct costs are taken into account when calculating segment margin. Common costs are not included.

Also, when evaluating a segment manager's performance, the only fixed costs to include are fixed costs that the manager can control.

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