Accounting chapter 6

variable and absorption costing

The two general costing approaches used by manufacturing companies to prepare income statements. They account for fixed overhead differently

Absorption Costing

are generally used for external reports. required by GAAP and IFRS

segment contribution margin

segment sales - segment variable expenses

Dollar sales for a segment to break even

segment traceable fixed expenses / segment CM ratio

segment margin

segment's contribution margin - traceable fixed costs of a segment. useful for major capacity decision

Costs that can be traced directly to a segment

should not be allocated to other segments

Discontinuing a profitable segment results in

the loss of the segment's revenues a reduction in the overall profits of the company

variable costing

which rely on the contribution format, for internal decision making purposes.

dollar break even

(Traceable fixed expenses + Common fixed expenses) ÷ Overall CM ratio

Dollar sales for a company to break even

(traceable fixed expenses + common fixed expenses) / overall CM ratio

common mistakes made in preparing segmented income statements

1. Arbitrarily dividing common costs among segments 2.Omitting costs that should be included 3.Using inappropriate allocation bases

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 segments.

segment

A part or activity of an organization about which managers seek cost, revenue or profit data. company's operations can be divided by product lines, geographical area, manufacturing plants, service centers or sales territories

traceable fixed cost

a fixed cost that is incurred because of the existence of the segment. Disappears over time if the segment itself disappeared. Can become common

A segment should probably be dropped when

it cannot cover its own costs it has a contribution margin that cannot cover traceable fixed costs

Contribution Margin

most useful for short-term sales volume decisions

When a segment is eliminated

traceable fixed cost will disappear common fixed cost will remain unchanged