CH 07 Segmented Income Statements - YouTube

Segmented income statements are used by managers to make decisions. Managers

are going to need more than just the company-wide income statement. They're

going to need income statements that focus on the various parts of the

company. So Target Corporation might want to have an income statement for Target

Corporation but also one for the College Station store, or they might even want to

drill down further and look at the clothing department in the College

Station store. So a segment is any part of the organization that managers want

cost and revenue data on. Examples could be a product line. Adidas makes various

shoes, they might want to look at the profitability of the basketball shoe

line. A department could be the cosmetics department at Macy's. Again, it could be

anything that managers want this information collected on. It is worth

noting that GAAP does require some segmented information to be in the

annual report for publicly traded companies. However, we're going to look at

the management use of these segmented income statements. So to do this, these

statements can be prepared at various levels within the organization.

Sales and variable costs are generally traceable to the segment, and its really

fixed costs that are our problem. In other words, we can easily identify the

sales of Target Corporation but we can also eat easily identify the sales that

come from the College Station store and the cost of goods sold in other variable

expenses of running the College Station store. But some of the fixed expenses are

not directly traceable to the College Station store, like the president's

salary. So we need to revisit direct and common fixed costs. Remember that this

is looked at from the perspective of a particular segment. Direct fixed

cost exist because the segment exists. That is, they're traceable to the segment.

An example might be the production department manager's salary to the

production department. Common fixed cost exists because of multiple departments.

These costs are allocated. Maybe the president's salary is divided equally

among all of the divisions. But these allocations are really not very useful

when you're evaluating the profitability of those segments. An example would be

the vice-president of production salary to one of four production departments. So

this manager oversees all four departments and even if you divided that

salary by four, it is not going to be very useful for evaluating this segment.

Now if you think about why, what would happen if we went down to three

production departments? Would the managers total salary decrease by one fourth? And

the answer, of course, is no. What would happen is that manager salary would now

be divided three ways instead of four. Okay, so that is the problem with

allocations of these fixed costs.

Companies often make mistakes in believing that the way they've divided

up the cost is useful. And so what we need to do is look at a new income

statement format. And you may be thinking, another new income statement format? Well

it's true, but if you take a look you can see that it's really very much like the

contribution margin income statement. You'll start with sales less variable

cost to get contribution margin. Fixed costs will be divided up between direct

and common. So first, you'll subtract the direct fixed cost to get segment

margin. Then you allocate the common fixed costs and subtract those out and

you have division income. Now this segment margin, this is the most useful

item for evaluating segments. So this is a new term that you will need to

understand. But if you look at this it's really sales minus direct costs, whether

they're variable or fixed. Let's look at an example of segmented income

statements. Now what I've given you is two segmented income statements that I

prepared for Mary's Market. And I prepared those based on this information.

Mary's Market generated total sales of $1,500,000 and operates two main segments.

The meat department whose sales were $900,000 and

variable costs for $460,000. And the produce department who sales were

$600,000 and variable costs were$350,000.

The company expects to incur a total of $640,000

in fixed costs. Of this amount, $230,000 is

traceable to the meat department and $170,000 is traceable to

the produce department. So another word for traceable to meat department, that

$230,000 is a direct fixed cost. The two segmented income

statements below show the following. The segmented income statement for the two

main segments of Mary's Market, meat department, and produce department. And

then second, a further segmenting of the produce department into two main product

lines (fresh produce and packaged produce). Of the $600,000 of

sales related to produce, fresh produce generated sales of $400,000

and packaged produce generated sales of $200,000. Variable cost incurred

totaled $200,000 for fresh produce and

$150,000 for packaged produce. Traceable fixed costs were $40,000

and $60,000, respectively. So if you look below you see that I have

created two segmented income statements. The first one being the two main

segments (meat and produce), and then I took the produce department who had

sales of $600,000 and I further segmented that into two product

lines (fresh produce and packaged produce). So think in terms of fresh produce is

where you pick the apples that you would like to buy individually, whereas

packaged produce you pick up a bag of apples and you get what you get. All

right, with that let's look at each of these individually. Now it is important

with this much information that you sort of identify what is relevant to

each of those income statements. And you'll note that the first part of the

information relates to the initial segmenting into meat and produce, and the

latter part relates to the further segmenting of the produce department.

Let's look at each of these in turn.

All right, so here we have the first segmenting. And you can see that I've

highlighted the sales in yellow, the variable cost in green, and the traceable

fixed cost in an aqua blue. All of these amounts are given. So all I did with that

information is found the totals, and determined the

contribution margin, and the segment margin. All of that information is given

or just computed within the income statement. But then we have to find the

common fixed costs. And that $240,000 of total

common fixed cost was computed based on the fact that we were told total fixed

costs will be $640,000. And we know that $400,000 was direct

fixed cost, so $240,000 must be the total common fixed cost. Now we do need

to allocate that among the segment's in order to get net operating income. And

here we see that for this segmenting, this allocation is based on sales

dollars. And if you look at the mix of sales, we have $1.5 million of total sales

with meat being $900,000 of that, that's 60% of sales. So that

means that 60% of $240,000 will be allocated to the meat department.

Likewise, 40% will be allocated to the produce

department because $600,000 dollars divided by $1.5 million dollars

says that produce comprises 40% of sales. Now looking at this segmented

income statement, you can see that the company does have earnings of

$15,000 but the reason they may be concerned about the produce

department is that it is showing a loss of $16,000. Notice

though that produce is covering its own costs. It is covering all of its variable

expenses and it's direct fixed costs, and showing a positive segment margin of

$80,000. It just cannot cover all of the common cost that is

allocated to it. So let's look further at produce and break it into its two main

segments. Once again I've color-coded sales that were given, the variable cost

that were given, and the direct fixed cost that we're given in the initial

information.

Now we can see that the packaged produce is really the problem here because it is

not even covering its own direct costs. But let's go ahead and look at how the

other calculations were made. The

$70,000 is divided equally among the segments. Now I computed the

$70,000 because that is if you take the $170,000 of total fixed

cost for the produce department that was direct to that department and

$100,000 is traceable to the two segments, that leaves $70,000 that is

common to the two segments. Then it says that they allocated those equally

among the segments. So once again it does appear that the packaged product line is

really the problem in our produce department. So what we could do is

further segment this into packaged apples, packaged oranges, packaged

potatoes, packaged onions. We can figure out which one of them is really causing

a problem or how several of them may be. All right, now you'll get some

practice with actually making calculations with one segmented income

statement. In the interest of time, you will not actually be doing the

segmenting, and then the further segmenting, and further segmenting but it

is important to realize that this is how you can drill down and identify what is

working well, what changes need to be made,

etc.