Question

What is segment margin? How is it different from contribution margin? What is the difference between traceable fixed costs and common fixed costs?

Choose a company. Break that company into two separate segments. What are three common fixed costs of the company? What are three traceable fixed costs to each segment?

Answer 1

Segment margin is the amount of net profit or net loss generated by a portion of a business. It is useful to track segment margins (especially on a trend line) in order to learn which parts of a total business are performing better or worse than average.

The difference between segment margin and other measures of profitability, such as contribution margin, is that it divides fixed costs into three categories. Consider one of the categories of fixed costs relevant when making decisions about the segment in question; the other two categories of fixed costs are irrelevant.

Segment Margin and Fixed Costs

The three categories include the following: avoidable fixed costs, unavoidable fixed costs, and common expenses. Avoidable fixed costs are relevant in the decision-making process of whether to continue or discontinue a product line. Unavoidable fixed costs and common expenses are irrelevant for decisions regarding a particular product line.

Avoidable fixed costs are those fixed costs that would not be incurred if you eliminated the segment or product line. Unavoidable fixed costs are fixed costs that are necessary for the continuation of the segment or product line. But those fixed costs would continue to be incurred if you discontinued that segment or product line. Eliminating the segment in question would merely cause the allocation of these unavoidable fixed costs to another segment. Refer to common expenses as expenses incurred by the company as a whole that are allocated to various segments or product lines.

A traceable fixed cost is a fixed cost that is incurred because of the existence of a segment. If the segment had never existed, the fixed cost would have not been incurred; and if the segment were eliminated, the fixed cost would disappear.

A common fixed cost is a fixed common 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 true common fixed cost.