ACC222 Chapter 6

Omission of costs

Companies using absorption costing for reporting purposes omit upstream and downstream costs, thus the product is under-costed and the company might maintain products that would result in losses in the long run

Common Mistakes in Segmented Income Statement

1. Omission of costs 2. Inappropriate methods in assigning traceable costs among segments 3. Arbitrarily assigning common costs among segments

Traceable fixed cost

A traceable fixed cost of a segment is incurred because of the existence of the segment. If the segment had never existed, the fixed cost never would have occurred. If the segment were eliminated the fixed cost would disappear.

Arbitrarily assigning common costs among segments

Might result in making an otherwise profitable segment appear to be unprofitable

Dollar sales for company to break-even

= (Traceable fixed expenses + common fixed expenses) / Overall CM ratio *Assumes a constant sales mix (one segment will remain a certain percentage of total sales and so will the other segment)

Common Fixed Cost

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

Implications of allocating common costs

Any allocation of common costs to segments reduces the value of the segment margin as a measure of long-run segment profitability and segment performance.

Importance of Contribution Margin

Especially useful in decisions involving temporary uses of capacity such as special orders

Inappropriate methods in assigning traceable costs among segments

First, some companies do not trace costs directly to a specific segment Second, some companies use inappropriate allocation bases to allocate costs to segments

Segment Margin

Obtained by deducting the traceable fixed costs of a segment from the segment's contribution margin Represents the margin available after a segment has covered all of its own costs. The segment margin is the beset gauge of the long-run profitability of a segment because it includes only those costs that are caused by the segment

Breakeven for Segments

Segment Traceable Fixed Costs/Segment CM ratio

Dollar Sales for a segment to break even

Segment traceable fixed expenses/ segment CM ratio If both segments just break even the company would still incur a loss due to common fixed costs