Segment Reporting Basics & Tools

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  • 0:02 Segment Reporting
  • 1:45 Segmented Income Statement
  • 4:02 Additional Considerations
  • 5:08 Lesson Summary
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Lesson Transcript
Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology.

Segment reporting allows management to assess the profitability of divisions or product lines. In this lesson, you will learn how to prepare a segmented income statement and use the information to make decisions.

Segment Reporting

The Timeless Book Den has three departments: mystery, classics and comics. Its owner, Mr. Reed, knows his business is profitable overall, but he would like better information on the profitability of each of his segments. Let's examine how we can help Mr. Reed with his objective.

Businesses are required to produce financial information that reports the profitability of the overall business on a regular basis. While this information is useful, it doesn't provide management with information to assess the profitability of individual divisions or departments. Segment reporting provides management with information on a division or department's revenue and expenses (both variable and fixed) and profitability. This information allows management to make decisions about discontinuing a product or department or making changes to improve profitability.

Revenue represents the amount of money earned by a company by selling its goods and services. Variable costs are expenses that vary with the level of activity. Examples include hydropower costs and the cost of labor used to manufacture a product. Fixed costs are those costs that remain the same despite the level of activity. An example would be rent that a company pays on its production facility.

Fixed costs can be classified as either traceable or common. Traceable fixed costs are those that can be traced directly to a particular segment or division. An example of a traceable fixed cost would be the salary of a supervisor in a particular department. Common fixed costs are those costs that would be incurred whether the segment or division operates or not. An example would be rent, as it would still need to be paid if there were two divisions or three divisions.

Segmented Income Statement

An income statement is a financial statement that shows a company's revenues, expenses and net income, which is the difference between revenues and expenses. A segmented income statement separates the revenues and expenses by department so that the profitability of each area can be determined. In order to determine the profitability of a particular department or segment, it is useful to prepare an income statement that includes the contribution margin. The contribution margin is the difference between sales and variable costs, and it represents the mark-up or profit earned before fixed costs are deducted. A department should have a positive contribution margin if it is to continue operating.

Let's examine the contribution margin income statement for the Timeless Book Den.

Timeless Book Den: segmented income statement
income statement

The segmented income statement shows that while the Timeless Book Den has a net income of $3,100 overall, the classics department lost $500 during the month. Even though it lost money overall, the classics department has a positive contribution margin:

Contribution margin = sales - variable costs

This means the classics department is still contributing to fixed costs and overall profitability. Just using the net loss information might lead Mr. Reed to conclude that he should close the classics department and leave the other two departments open; however, he needs to look more closely at his fixed costs before making this decision.

The traceable costs of $1,200 might disappear if the classics department were to close. Here, we're assuming that they are all avoidable, which means they won't be incurred if the department closes. However, the common fixed costs of $800 would need to be allocated to the two remaining departments: mystery and comics. The segmented income statement in this situation would look like this:

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