Question

Explain how segment margin is different from contribution margin.

How is it possible for a cost that is traceable to a segment become a common cost if the segment is divided into further segments?

Answer 1

Difference between Segment Margin and Contribution Margin

• The contribution margin is the portion of sales revenue remaining after deducting variable expenses.

The segment margin is the margin remaining after deducting traceable fixed expenses from the contribution margin.

• The contribution margin is useful as a planning tool for many decisions, including those in which fixed costs don’t change.

The segment margin is useful in assessing the overall profitability of a segment.

• From a decision-making point of view, the segment margin is most useful in major decisions that affect capacity such as dropping a segment.

By contrast, the contribution margin is most useful in decisions involving short-run changes in volume, such as pricing special orders that involve temporary use of existing capacity.

Ans 2:

There are often limits to how far down an organization a cost can be traced. Therefore, costs that are traceable to a segment may become common as that segment is divided into smaller segment units. For example, advertising might be traceable to product line, but be a common cost of the sales territories in which that product line is sold.

Another example, an airline might want a segmented income statement that shows the segment margin for a particular flight from London to Edinburg further broken down into first class, business class and economy-class segment margins. The airline must pay a substantial allocating common costs to segments does not ensure that this will happen. In fact, adding a share of common costs to the real costs of a segment may make an otherwise profitable segment appear to be unprofitable. If a manager eliminates the apparently unprofitable segment, the real traceable costs of the segment will be saved, but its revenues will be lost. And what happens to the common fixed costs that were allocated to the segment? They don't disappear; they are reallocated to the remaining segments of the company. That makes all of the remaining segments appear to be less profitable - possibly resulting in dropping other segments. The net effect will be to reduce the overall profits of the company and make it even more difficult to "cover the common costs"