 Hello and welcome to the session. This is Professor Farhad in which we would look at segmented income statement and specifically we're going to be dealing with traceable fixed cost and common fixed cost. I'm pretty sure that if you study financial reporting you might you might have heard about segmented reporting. Yes segmented reporting is for financial reporting and if you did study this we discuss the three 10 percent test plus the 75 percent test. That's for financial reporting. This section is about managerial reporting perspective. So we're going to look at the segmented income statement from a managerial perspective. Some prerequisite knowledge is what is fixed cost, what is variable cost. Fixed cost is a cost that does not change with production. It stays the same within a variable range within the relevant range. Variable cost is a cost that changes with production or sales. It varies. Now the assumption is you know what fixed cost is, you know what variable cost is. In this session we're going to be focusing more about traceable fixed cost and common fixed cost and obviously we need to know what variable cost is. So what is a segment first? Because we're looking at a segment. Segment is a part of the company. It's a part or activity for which the manager collects cost revenue or profit data. Profit means sales minus revenues. So any part of the company, it could be a service center. It could be a specific territory. For example, territory could be a country, could be a continent, could be a city, could be the east coast versus the west coast. Or we can break down the segment of the company by product. So we can break down the company by various segments. So we need to be familiar with specifically three terms. The first one is traceable fixed cost. Again, fixed cost is cost that does not change with production within the relevant range. It's a fixed cost that's now related specifically to that segment. So that fixed cost exists, comes with that segment. In contrast, so in contrast to what? In contrast to something called common fixed cost. Common fixed cost, it's a cost that exists because of the overall operation of the company and would not go away if that segment is eliminated. So a traceable fixed cost means if a segment is gone, the traceable cost is gone. Common fixed cost, if the segment is gone, if that division is gone, that fixed cost will remain, will exist. So we need to differentiate between, we should separate common fixed cost to enable, the reason we need to do this, to enable something called segment margin. Remember, we are dealing with segmented income statement. So what is segment margin? Segment margin is taking the sales of that segment, whatever that segment is, that territory, that product, minus the variable cost for that specific, specific segment, minus the traceable fixed cost for that specific segment. So notice now we are breaking down the operation by specific segment. Again, traceable fixed cost exists for a particular segment and would appear if that segment disappeared. For example, if you eliminated a division and you have a manager in that division, the salary of that manager will be gone. So that's a traceable fixed cost. It means when you compute the profit of that division, well, the cost of the manager is a traceable cost, because if that division is gone, the manager salary will need to be eliminated, assuming that manager is not transferred to another division. So that's what we mean. Common fixed cost, let's assume we discontinue that division. The CEO of the company would stay, because the CEO is a common fixed cost for all divisions of the company. So that's why we need to differentiate between the two. And the segment margin is the best indicator of the long-term profitability of a segment. So if you really want to know how well a segment is doing, well, compute the segment margin, sales minus the variable cost for that segment, minus the fixed traceable fixed cost for that segment. Only the traceable fixed cost is used. We don't count common cost when we are computing segment, segment margin. Now we have to keep in mind that traceable cost can become a common cost. So traceable fixed cost for one segment could be a common cost for another segment. How? Let's think about an airline company. An airline company might have to pay a lending fee in Heathrow, in London Heathrow, or in New York. Well, guess what? That lending fee is a traceable to that particular flight, flight A414, okay? American AA414, American airline 414. Well, if they pay a fee at Heathrow or in New York to lend their plane, that cost is traceable to that particular segment. Now, if you want to compute the profit of that flight by first class, business class, economy class, well, that cost becomes a common cost if you're going to break down the profitability of the flight for American airlines versus looking at the flight itself. It's a traceable cost. If you want to break down, because you can break down the profitability, you can break down the segment by first class versus business class versus economy. It becomes a common cost. Now, the best way to look to understand this is to look at actual numbers, just to see how all this fits together. Now, before we look at an actual number, actual example, most likely you are an accounting student or a CPA candidate and welcome. You have arrived. Go a step further to farhatlectures.com, where I provide you additional resources that's going to help you do better in your accounting courses and preparing for the CPA exam. My resources consist of lectures, multiple choice through false, many questions and exercises that's going to help you do better. Connect with me on social media, LinkedIn, YouTube, Twitter, Instagram, and Reddit. To illustrate the point, we're going to be working with Adam Company and Adam Company sells copiers. So just for the sake of this to keep this example simple. And this is the contribution margin format, the income statement for Adam Company sales a million variable cost of goods sold other variable cost total variable cost sales minus variable cost equal to the contribution margin minus the total fixed cost the company overall is making a quarter of a million in profit. Now, what are we going to do? We're going to take this income statement and break it down. So this is this is the total if you're not copy the numbers now, if you're not a subscriber to farhat lectures, and we're going to break it down by business division and the consumer division. So Adam sells to business and sells to consumers. So let's break down by business and consumer. It looks like the business is 60%. The consumer is 60%. Therefore, we break down the variable cost by 60%. We compute the contribution margin for the business division. We compute the contribution margin for the consumer division. Now, the total traceable cost for both division is 145. Remember, the total fixed cost when we looked at it here, it was 270. Well, that fixed cost not all of it traceable. Some of it is directly traceable. Some of it is not directly traceable to a particular division. Therefore, we allocate 100 not we allocate 100,000 is the business division fixed cost traceable to the fixed cost and 45 is for the consumer division. Now you're saying hold on a second. So what about the 125? You mean what if both divisions gone? Yes, if both divisions are gone, the 125 is gone, but we cannot allocate the 125 randomly or haphazardly to those divisions. So we're still going to count it. So the division margin is 375. The common fixed cost is 125. Just we don't allocate it to the one we compute the segment. Therefore, the net operating income is still 250. So notice how we break down the fixed cost. So we have the fixed cost. We say some of it is traceable and some of it is common. Now, what I'm going to do is this. I'm going to go a step further because you can break this into various components. We're going to take the business division. I'm going to look at the business division and I'm going to break the business division now into remember we're selling copier. We're going to we sell two types of copier. We sell regular copiers and deluxe copiers. Again, this is only the business division. And I'm going to break down again the sales by by product. Again, we'll do the same thing. Although the total fixed cost is 100,000. Notice it was specifically notice here the 100,000 was totally traceable. Now when we break it by division, here the 100,000, some of it is common. Some of it is fixed. It means even if we eliminated the copiers, 20,000 would still somehow exist. Okay. So now what we do is we we do that. And now we understand what the regular copier profit is the division profit and the deluxe profit. Again, what we can do we can break this further. For example, we can take a look at let me see what did I break down. I broke down the deluxe. We can take the deluxe sales the deluxe division and quote and break it down by sales channel. And this is the deluxe. These are the deluxe numbers and we're going to break down by sales that we do online through online marketing and online sales and sales that we do in the physical stores. Now what we see is in the online we if we break it down by online with we're making a profit the physical stores as we are incurring a loss. And this is how segmented income statement might help us from a managerial perspective. Now what does that mean? Should we eliminate the physical stores or not? This is what we'll discuss in another session down the road about about whether to add or drop a division so on and so forth. But the point of this session just I want you to understand the difference what is operating segment sales minus variable cost of that segment minus traceable fixed cost and obviously you need to know what is a traceable fixed cost and what's a common fixed cost what you should do now go to far hat lectures subscribe work multiple choice questions invest in yourself invest in your career invest in your education good luck study hard and of course stay safe