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