SEGMENT REPORTING

The process of delegating the decision-making authority of top management throughout an

organization is called decentralization.

A centralized approach to decision making helps top management to retain control over key
business functions, ensuring a desired level of performance – by maximizing the top
management’s expertise.

However, top management may not be able to manage operations in detailed levels, probably
because of the lack of local knowledge, which can be timely obtained by lower-level managers
in their respective segments or divisions in directly responding to customers.

Suboptimization occurs when there is lack of harmony or congruence among the overall
organization goals, the subunit or segment or divisional goals, and the individual or responsible
manager’s / supervisor’s goals. This is because division managers may focus only on his unit’s
success rather than the organization as a whole.

Goal congruence is the consistency or agreement of individual goals, unit or divisional goals
with the overall company goals. The people in all levels of the organization share the same goal.

Some managers, however, may regard themselves as competing with other managers from other
units or divisions within the organization as if they were external rivals.

What is a segment and segment reporting?

A segment is any profit-making entity within an organization in which managers seek cost,
revenue and profit data.

Direct fixed expenses are fixed expenses that are directly traceable to a segment. These are
sometimes called avoidable fixed expenses because when the segment in which these costs are
associated where eliminated, such costs are avoided. Direct fixed expenses existed only because
of the segment, so if the segment had never existed, such fixed costs would not have been
incurred.

Common fixed expenses are fixed expenses jointly caused by two or more segments but are not
directly traceable in whole or in part to any one segment. These expenses will continue even if
one or more of the segments is eliminated.

Segment margin is contribution margin less traceable fixed costs. It represents the margin
available after a segment has covered all of its own traceable costs.

Contribution margin Pxx

Less: Controllable (Traceable) Direct Fixed Costs xx
Controllable margin xx
Less: Non-controllable (Traceable) Direct Fixed Costs xx
Segment margin Pxx

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 Less: Common or allocated Fixed Costs xx
Net operating income (loss) Pxx

Deducting the traceable (direct) fixed costs from the contribution margin (whether controllable
or not by the division or responsible manager) would yield to segment margin, which is a
contribution available to indirect or common or allocated costs. Stated in another way, a segment
margin represents the margin available after a segment has covered all of its own identifiable or
direct costs.

Deducting the allocated or common fixed costs from the segment margin would result to the net
operating income or loss of the segment.

The purpose of segment reporting is to provide information needed by the manager to

determine profitability of product lines, divisions, sales territories, and other segments of a
company. It emphasizes performance of a profit or investment center rather than the performance
of the company as a whole.

Illustrative Problem
Tea Company produces blenders and coffee makers. During the past year, 100,000 blenders and
25,000 coffee makers were produced and sold. Fixed costs for Tea Company totaled P250,000,
of which P90,000 can be avoided if blenders are not produced and P45,000 can be avoided if the
coffee makers are not produced. Revenue and variable cost information are provided below:
Blenders
Selling price per unit P22
Variable cost per unit 20
Coffee Makers
Selling price per unit P45
Variable cost per unit 43

Required:
a. Prepare a segmented income statement by product line.
b. What would the effect be if Tea Company dropped the Blender line? the Coffee Maker
line?
c. What would be the effect on Tea Company’s net income if an additional 10,000 Blenders
are produced and sold for P20.50 on a special-order basis?

Answer: (a)
Blenders Coffee Makers Total
Revenue P2,200,000 P1,125,000 P3,325,000
Less: Variable Costs 2,000,000 1,075,000 3,075,000
Contribution Margin P 200,000 P 50,000 P 250,000
Less: Direct Fixed Costs (90,000) (45,000) (135,000)
Segment Margin P 110,000 P 5,000 P 115,000
Less: Common Fixed Costs (115,000)*
Net Income P -0-
*common fixed cost is computed as P250,000 – P90,000 – P45,000 = P115,000.

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Answer: (b)
If the Blender line is dropped the overall profit will decrease by P110,000 which is equal to the
segment’s margin.

If the Coffee Maker line is dropped the overall profit will decease by P5,000 which is equal to
the segment’s margin.

To prove:
If the Blender line is dropped, the income statement will show a loss of P110,000:
Revenue from the Coffee Makers only P1,125,000
Variable costs from the Coffee Makers only 1,075,000
Contribution margin from the Coffee Makers only P 50,000
Less: Direct Fixed Costs 45,000
Segment Margin P 5,000
Less: Common Fixed Costs 115,000*
Net Loss P (110,000)

If the Coffee Maker line is dropped, the income statement will show a loss of P5,000:
Revenue from the Blenders only P2,200,000
Variable costs from the Blenders only 2,000,000
Contribution margin from the Coffee Makers only P 200,000
Less: Direct Fixed Costs 90,000
Segment Margin P 110,000
Less: Common Fixed Costs 115,000*
Net Loss P (5,000)

Answer: (c)
If additional 10,000 Blenders are produced and sold (assuming it is within the capacity of Tea
Company’s production and that the regular sales will not be affected by this special order), then
Selling Price of Blender P20.50
Less: Variable cost per unit 20.00
Contribution margin per unit P 0.50
Multiplied by 10,000 units
Additional Segment Margin P5,000
The overall profit of Tea Company will increase by P5,000.

TAKE NOTE: Drop only a segment if the segment margin is NEGATIVE.

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