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of Segmented Reporting

Tarif-Ul-Haque

8/30/2015

Cost Behavior Analysis and Justifications of Segmented Reporting

Course Title: Managerial Accounting

Submitted To

Lecturer

Department of Finance

Faculty of Business Studies

University of Dhaka

Submitted By

Tarif-Ul-Haque

Department Of Finance (19th Batch)

University of Dhaka

Date of Submission

2

Table of Contents

Introduction ............................................................................................................................................. 5

Executive Summary ............................................................................................................................ 5

Acknowledgement .............................................................................................................................. 6

Background of the Report ................................................................................................................... 7

Objectives of the Study ....................................................................................................................... 7

Methodology ....................................................................................................................................... 7

Limitations of the Study...................................................................................................................... 7

Study on Cost Behavior .......................................................................................................................... 8

Variable Cost ...................................................................................................................................... 8

Fixed Costs ......................................................................................................................................... 8

Committed and Discretionary Fixed Costs ......................................................................................... 9

The Linearity Assumption and the Relevant Range ......................................................................... 10

Step Variable and Step Fixed Cost ................................................................................................... 11

Mixed Costs ...................................................................................................................................... 12

Analyzing Mixed Cost with different Methods ............................................................................ 13

Least-squares regression ............................................................................................................... 15

Application of Least-Squares Regression ..................................................................................... 16

Study on Segmented Reporting ............................................................................................................ 19

Segmented Financial Information in External Reports ..................................................................... 19

Case on Segment Reporting .............................................................................................................. 19

Solution of the Case .......................................................................................................................... 22

Requirement: 1 (Segmented Income Statements) ......................................................................... 22

Requirement 2 (Justification of the Segmentation):...................................................................... 23

Findings and Policy Implication ........................................................................................................... 25

Fixed costs are not fixed for ever ...................................................................................................... 25

Average Variable cost may change over time................................................................................... 25

Mixed Costs are hardly ever linear ................................................................................................... 25

Allocation of traceable cost is a very crucial decision for successful segmented reporting ............. 25

Conclusion ............................................................................................................................................ 26

3

Letter of Transmittal

Lecturer

Department of Finance

University of Dhaka

Subject: Submission of the report on “Cost Behavior Analysis and Justifications of Segmented

Reporting”

Dear Madam,

I am glad to state that the report on ―Cost Behavior Analysis and Justifications of Segmented

Reporting‖ is completed and ready for your viewing. I am privileged to submit it as part of

completion of the requirements for our Managerial Accounting (F-302) course instructed by you. It

is an opportunity and great pleasure for me to use different method to analyze cost behavior and study

deeper into the segmented reporting theories and practices.

It was an experience of applying our theoretical knowledge practically in analyzing the managerial

accounting decisions. The gathered and acquired knowledge will help me in my career.

I have tried my best to put up a good report with as much information as I could gather during the

time span allotted for writing this report.

Thank you for your kind support and help throughout the course. I hope you will appreciate this

sincere effort.

Best Regards

Tarif-Ul-Haque

ID: 17-260

Section: A

Department of Finance

University of Dhaka

4

Introduction

Executive Summary

This study has two parts, (1) Cost Behavior Analysis, and (2) Justifications of Segmented Reporting.

In the Cost Behavior Analysis part I tried to focus on the different types of fixed, variable, and mixed

cost behaviors. I tried to dig deeper into the analysis of mixed costs. I tried to demonstrate the use of

scatter-plot, high-low, and finally least squares regression methods to analyze the mixed cost

behavior. I demonstrated use of the software Microsoft© Excel to do least squares regression with the

relevant formulas.

In the Justifications of Segmented Reporting part of the study I gave an introduction to what

segmented reporting is and why it me be required. After that, I tried to solve a hypothetical case on

segmented reporting adapted from the CMA (Certified Management Accountant) Examinations. The

case contains preparing segmented contribution type income statements of an organization and the

justification of the allocation of traceable costs.

The study was instructed by our honorable course teacher, MS. Shakila Halim, Lecturer, Department

of Finance, University of Dhaka. It was requested on 23 August 2015 and the due date of submission

is 30 August 2015. The investigation was done by Tarif-Ul-Haque.

The main findings were that (1) Fixed costs are not fixed for ever, (2) Average Variable cost may

change over time, (3) Mixed costs are hardly ever liner, and (4) allocation of traceable cost is a very

crucial decision for successful segmented reporting.

It was concluded that we have to look cost behavior and nature very carefully for managerial

accounting. If we make wrong assumptions on those two, our analysis may become meaningless.

The recommendations are that mixed cost should be analyzed with a scatter-plot first, if there is an

observable liner relationship, we have to do least square regression analysis to come up with a mixed

cost formula. As least square regression analysis can be done very easily with software like

Microsoft© Excel the high-low method should be avoided. High-low method uses only two extreme

points to come up with a mixed cost formula which may be questionable. The second

recommendations is that managers should understand the distinction between common and traceable

cost before attempting to do segmented reporting unless the segmented report may results those will

make no sense.

5

Acknowledgement

First of all I want to thank the Almighty. I want to give thanks to every person helped me completing

the report. I would like to express our gratitude to our honorable course teacher Ms. Shakila Halim,

Lecturer, Department of Finance, University of Dhaka for providing me with such opportunity to

work on this type of topic. This report is an outcome of our effort, but its successful completion would

have been impossible without the sincere effort and helping attitude of our course teacher. Without

her vast support, advice, encouragement and guidance it would have not been possible for me to

prepare this report.

I also get a lot of help from Internet and our course book Managerial Accounting (2014) by Garrison,

Ray H.; Noreen, Eric W.; Brewer, C. Petter.

I would also like to thank my fellow students of BBA 19th Batch, Department of Finance, University

of Dhaka. Without their advice and supports at different levels it would have been extremely though

for me to complete the report.

6

Background of the Report

This report is generated under the academic supervision of our course teacher MS. Shakila Halim,

Lecturer, Department of Finance, University of Dhaka. This report is prepared as with the requirement

of Managerial Accounting (F-302) course. This really provides me the opportunity to explore and

confront the reality about real-life managerial accounting situations.

To be able to use theoretical knowledge into practice

To know more about Cost Behavior, Segmented Reporting

Methodology

All the data used in this report have been gathered from the cases from different books

and internet.

I study different chapters of the course book and try to connect the ideas in real life

situations relevant to my topic of study.

We faced some problems while preparing the report such as-

Lack of Experience

Limitation of Knowledge

Non-availability of information for more relevant analysis

7

Cost Behavior

It is often necessary to predict how a certain cost will behave in response to a change in activity. Cost

behavior refers to how a cost reacts to changes in the level of activity. As the activity level rises and

falls, a particular cost may rise and fall as well or it may remain constant. For planning purposes, a

manager must be able to anticipate which of these will happen; and if a cost can be expected to

change, the manager must be able to estimate how much it will change. To help make such

distinctions, costs are often categorized as variable, fixed, or mixed. The relative proportion of each

type of cost in an organization is known as its cost structure. For example, an organization might have

many fixed costs but few variable or mixed costs. Alternatively, it might have many variable costs but

few fixed or mixed costs.

Variable Cost

A variable cost varies, in total, in direct proportion to changes in the level of activity. Common

examples of variable costs include cost of goods sold for a merchandising company, direct materials,

direct labor, variable elements of manufacturing overhead, such as indirect materials, supplies, and

power, and variable elements of selling and administrative expenses, such as commissions and

shipping costs.

For a cost to be variable, it must be variable with respect to something. That ―some- thing‖ is its

activity base. An activity base is a measure of whatever causes the incurrence of a variable cost. An

activity base is sometimes referred to as a cost driver. Some of the most common activity bases are

direct labor-hours, machine-hours, units produced, and units sold. Other examples of activity bases

(cost drivers) include the number of miles driven by salespersons, the number of pounds of laundry

cleaned by a hotel, the number of calls handled by technical support staff at a software company, and

the number of beds occupied in a hospital.

Fixed Costs

A fixed cost is a cost that remains constant, in total, regardless of changes in the level of activity.

Examples of fixed costs include straight-line depreciation, insurance, property taxes, rent, supervisory

salaries, administrative salaries, and advertising.

Unlike variable costs, fixed costs are not affected by changes in activity. Consequently, as the activity

level rises and falls, total fixed costs remain constant unless influenced by some outside force.

8

Cost Behavior

For planning purposes, fixed costs can be viewed as either committed or discretionary. Committed

fixed costs represent organizational investments with a multiyear planning horizon that can’t be

significantly reduced even for short periods of time without making fundamental changes. Examples

include investments in facilities and equipment, as well as real estate taxes, insurance expenses, and

salaries of top management. Even if operations are interrupted or cut back, committed fixed costs

remain largely unchanged in the short term because the costs of restoring them later are likely to be

far greater than any short-run savings that might be realized. Discretionary fixed costs (often referred

to as managed fixed costs) usually arise from annual decisions by management to spend on certain

fixed cost items. Examples of discretionary fixed costs include advertising, research, public relations,

management development programs, and internships for students. Discretionary fixed costs can be cut

for short periods of time with minimal damage to the long-run goals of the organization.

9

Cost Behavior

Management accountants ordinarily assume that costs are strictly linear; that is, the relation between

cost on the one hand and activity on the other can be represented by a straight line. Economists point

out that many costs are actually curvilinear; that is, the relation between cost and activity is a curve.

Nevertheless, even if a cost is not strictly linear, it can be approximated within a narrow band of

activity known as the relevant range by a straight line as illustrated in Figure 3. The relevant range is

the range of activity within which the assumption that cost behavior is strictly linear is reasonably

valid. Outside of the relevant range, a fixed cost may no longer be strictly fixed or a variable cost may

not be strictly variable. Managers should always keep in mind that assumptions made about cost

behavior may be invalid if activity falls outside of the relevant range. The concept of the relevant

range is important in understanding fixed costs.

10

Cost Behavior

Cost behavior patterns such as salaried employees are often called step-variable costs. Step-variable

costs can often be adjusted quickly as conditions change. Furthermore, the width of the steps for step-

variable costs is generally so narrow that these costs can be treated essentially as variable costs for

most purposes. The width of the steps for fixed costs, on the other hand, is so wide that these costs

should be treated as entirely fixed within the relevant range.

11

Cost Behavior

Mixed Costs

A mixed cost contains both variable and fixed cost elements. Mixed costs are also known as semi -

variable costs. Figure 5 depicts the behavior of this mixed cost.

Because the mixed cost in Figure 5 is represented by a straight line, the following equation for a

straight line can be used to express the relationship between a mixed cost and the level of activity:

In this equation,

Y = a + bX

b = the variable cost per unit of activity (the slope of the line)

12

Cost Behavior

Managers can use a variety of methods to estimate the fixed and variable components of a mixed cost

such as account analysis, the engineering approach, the high-low method, and least-squares regression

analysis. In account analysis, an account is classified as either variable or fixed based on the analyst’s

prior knowledge of how the cost in the account behaves. For example, direct materials would be

classified as variable and a building lease cost would be classified as fixed because of the nature of

those costs. The engineering approach to cost analysis involves a detailed analysis of what cost

behavior should be, based on an industrial engineer’s evaluation of the production methods to be used,

the materials specifications, labor requirements, equipment usage, production efficiency, power

consumption, and so on. The high-low and least-squares regression methods estimate the fixed and

variable elements of a mixed cost by analyzing past records of cost and activity data.

Importance of Scatter-plot

Plotting the data on a scatter-graph is an essential diagnostic step that should be performed before

performing the high-low method or least-squares regression calculations. If the scatter-graph plot reveals

linear cost behavior, then it makes sense to perform the high-low or least-squares regression calculations to

separate the mixed cost into its variable and fixed components. If the scatter-graph plot does not depict

linear cost behavior, then it makes no sense to proceed any further in analyzing the data.

Assuming that the scatter-graph plot indicates a linear relation between cost and activity, the fixed and

variable cost elements of a mixed cost can be estimated using the high-low method or the least-

squares regression method. The high-low method is based on the rise-over-run formula for the slope

of a straight line. To analyze mixed costs with the high-low method, begin by identifying the period

with the lowest level of activity and the period with the highest level of activity. The period with the

lowest activity is selected as the first point in the above formula and the period with the highest

activity is selected as the second point. Consequently, the formula becomes:

13

Cost Behavior

Sometimes the high and low levels of activity don’t coincide with the high and low amounts of cost.

For example, the period that has the highest level of activity may not have the highest amount of cost.

Nevertheless, the costs at the highest and lowest levels of activity are always used to analyze a mixed

cost under the high-low method. The reason is that the analyst would like to use data that reflect the

greatest possible variation in activity.

The high-low method is very simple to apply, but it suffers from a major (and some- times critical)

defect—it utilizes only two data points. Generally, two data points are not enough to produce accurate

results. Additionally, the periods with the highest and lowest activity tend to be unusual. A cost

formula that is estimated solely using data from these unusual periods may misrepresent the true cost

behavior during normal periods. Such a distortion is evident in Figure 6. The straight line should

probably be shifted down somewhat so that it is closer to more of the data points. For these reasons,

least-squares regression will generally be more accurate than the high-low method.

14

Cost Behavior

Least-squares regression

The least-squares regression method, unlike the high-low method, uses all of the data to separate a

mixed cost into its fixed and variable components. A regression line of the form Y = a + bX is fitted

to the data, where a represents the total fixed cost and b represents the variable cost per unit of

activity. The basic idea underlying the least- squares regression method is illustrated in Figure 7 using

hypothetical data points. Notice from the figure that the deviations from the plotted points to the

regression line are measured vertically on the graph. These vertical deviations are called the

regression errors. There is nothing mysterious about the least-squares regression method. It simply

computes the regression line that minimizes the sum of these squared errors. The formulas that

accomplish this are fairly complex and involve numerous calculations, but the principle is simple.

15

Cost Behavior

The least-squares regression method for estimating a linear relationship is based on the equation for a

straight line:

Y = a + bX

As explained in the chapter, least-squares regression selects the values for the intercept a and the

slope b that minimize the sum of the squared errors. The following formulas, which are derived in

statistics and calculus texts, accomplish that objective:

Manually performing the calculations required by the formulas is tedious at best. Fortunately,

statistical software packages are widely available that perform the calculations automatically.

Spreadsheet software, such as Microsoft® Excel, can also be used to do least-squares regression—

although it requires a little more work than using a specialized statistical application.

In addition to estimates of the intercept (fixed cost) and slope (variable cost per unit), Excel also

provides a statistic called the R2, which is a measure of ―goodness of fit.‖ The R2 tells us the

percentage of the variation in the dependent variable (cost) that is explained by variation in the

independent variable (activity). The R2 varies from 0% to 100%, and the higher the percentage, the

better. We should always plot the data in a scatter-graph, but it is particularly important to check the

data visually when the R2 is low.

16

Cost Behavior

A quick look at the scatter-graph can reveal that there is little relation between the cost and the

activity or that the relation is something other than a simple straight line. In such cases, additional

analysis would be required.

To illustrate how Excel can be used to calculate the intercept a, the slope b, and the R2, we will use a

hypothetical data of Brentline Hospital data for maintenance costs. The worksheet in Figure 8

contains the data and the calculations.

Y

$12,000.00

$10,000.00

$8,000.00

$6,000.00

Y

$4,000.00

$2,000.00

$0.00

0 2,000 4,000 6,000 8,000 10,000

17

Cost Behavior

As we can see, the X values (the independent variable) have been entered in cells B4 through B10.

The Y values (the dependent variable) have been entered in cells C4 through C10. The slope,

intercept, and R2 are computed using the Excel functions INTERCEPT, SLOPE, and RSQ. We must

specify the range of cells for the Y values and for the X values.

In Exhibit 2A–1, cell B12 contains the formula =INTERCEPT(C4:C10,B4:B10); cell B13 contains

the formula =SLOPE(C4:C10,B4:B10); and cell B14 contains the formula = RSQ(C4:C10,B4:B10).

According to the calculations carried out by Excel, the fixed maintenance cost (the intercept) is

$3,431 per month and the variable cost (the slope) is $0.76 per patient-day. Therefore, the cost

formula for maintenance cost is:

Y = a + bX

Y = $3,431 + $0.76X

Note that the R2 (i.e., RSQ) is 0.90, which is quite good and indicates that 90% of the variation in

maintenance costs is explained by the variation in patient-days.

18

Segmented Reporting

Segmented income statements provide information for evaluating the profitability and performance of

divisions, product lines, sales territories, and other segments of a company. Under the contribution

approach variable costs and fixed costs are clearly distinguished from each other and only those costs

that are traceable to a segment are assigned to the segment. A cost is considered traceable to a

segment only if the cost is caused by the segment and could be avoided by eliminating the segment.

Fixed Common costs are not allocated to segments. The segment margin consists of revenues, less

variable expenses, less traceable fixed expenses of the segment. (Garrison, Noreen, & Brewer, 2014)

It is very important to distinguish traceable and common fixed cost because any misallocation of

common costs to segments reduces the value of the segment margin as a measure of long-run segment

profitability and segment performance.`

The Financial Accounting Standards Board (FASB) now requires that companies in the United States

include segmented financial and other data in their annual reports and that the segmented reports

prepared for external users must use the same methods and definitions that the companies use in

internal segmented reports that are prepared in aid in making operating decisions.

Now we are going to discuss a hypothetical case (adapted from Certificate in Management

Accounting (CMA) examination.

Music Teachers, Inc. is an educational association for music teachers that have 20,000 members. The

association operates from a central headquarters but has local membership chapters throughout the

United States. Monthly meetings are held by the local chapters to discuss recent developments on

topics of interest to music teachers. The association’s journal, Teachers’ Forum, is issued monthly

with features about recent developments in the field. The association publishes books and reports and

also sponsors professional courses that qualify for continuing professional education credit. The

association’s statement of revenues and expenses for the current year is presented below.

19

Segmented Reporting

Revenues $3,275,000.00

Expenses:

Salaries $920,000.00

Personnel Costs $230,000.00

Occupancy Costs $280,000.00

Reimbursement of costs to local chapters $600,000.00

Other membership services $500,000.00

Printing and Papers $320,000.00

Postage and shipping $176,000.00

Instructors' Fees $80,000.00

General and administrative $38,000.00

Total Expense $3,144,000.00

Excess of revenues over expenses $131,000.00

The board of directors of Music Teachers, Inc., has requested that a segmented income statement be

prepared showing the contribution of each profit center to the association. The association has four

profit centers: Membership Division, Magazine Subscriptions Division, Books and Reports Division,

and Continuing Education Division. Mike Doyle has been assigned responsibility for preparing the

segmented income statement, and he has gathered the following data prior to its preparation.

a) Membership dues are $100 per year, of which $20 is considered to cover and one-year

subscription to the association’s journal. Other benefits include membership in the association

and chapter affiliation. The portion of the dues covering the magazine subscription ($20)

should be assigned to Magazine Subscription Division.

b) One-year subscriptions to Teachers’ Forum (magazine) were sold to nonmembers and

libraries at $30 per subscription. A total of 2,500 of these subscriptions were sold last year. In

addition to subscriptions, the magazine generated $100,000 in advertising revenues. The costs

per magazine subscription were $7 for printing and paper and $4 for postage and shipping.

c) A total of 28,000 technical reports and professional texts were sold by the Books and Reports

Division at an average unit selling price of $25. Average costs per publication were $4 for

printing and paper and $2 for postage and shipping.

d) The association offers a variety of continuing education courses to both members and non-

members. The one-day courses had a tuition cost of $75 each and were attended by 2,400

students. A total of 1,760 students took two-day courses at a tuition cost of $125 for each

student. Outside instructors were paid to teach some courses.

20

Segmented Reporting

Membership $210,000 2,000

Magazine Subscriptions 150,000 2,000

Books and Reports 300,000 3,000

Continuing Education 180,000 2,000

Corporate staff 80,000 1,000

Total $920,000 10,000

Personnel costs are 25% of salaries in the separate divisions as well as for corporate staff. The

$280,000 in occupancy costs includes $50,000 in rental cost for a warehouse used by the Books and

Reports Division for storage purposes.

f) Printing and paper costs other than for magazine subscriptions and for books and reports

relate to the Continuing Education Division.

g) General and administrative expenses include costs relating to overall administration of the

association as a whole. The company’s corporate staff does some mailing of materials for

general administrative purposes.

The expenses that can be traced or assigned to the corporate staff, as well as any other

expenses that are not traceable to the profit centers, will be treated as common costs. It is not

necessary to distinguish between variable and fixed costs.

Required:

1. Prepare a contribution format segmented income statement for Music Teachers, Inc. This

statement should show the segment margin for each division as well as results for association

as a whole.

2. Give justification to the traceable costs segmentations

21

Segmented Reporting

Requirement: 1 (Segmented Income Statements)

Segmented Income Statements

For the Year Ended November 30

Division

Association

Magazine Books & Continuing

Total

Revenues: Membership Subscription Reports Education

Sales $2,000,000.00 $1,600,000.00 $400,000.00

Non-member Magazine

subscription $75,000.00 $75,000.00

Advertising $100,000.00 $100,000.00

Reports and Texts $700,000.00 $700,000.00

Continuing Education

Courses $400,000.00 $400,000.00

Total Revenues $3,275,000.00 $1,600,000.00 $575,000.00 $700,000.00 $400,000.00

Expenses traceable to

segments:

Salaries $840,000.00 $210,000.00 $150,000.00 $300,000.00 $180,000.00

Personnel Costs $210,000.00 $52,500.00 $37,500.00 $75,000.00 $45,000.00

Occupancy Costs $257,000.00 $46,000.00 $46,000.00 $119,000.00 $46,000.00

Reimbursement of member

costs to local chapters $600,000.00 $600,000.00

Other membership services $500,000.00 $500,000.00

Printing and Paper $320,000.00 $157,500.00 $112,000.00 $50,500.00

Postage and Shipping $146,000.00 $90,000.00 $56,000.00

Instructors' Fees $80,000.00 $80,000.00

Total traceable expenses $2,953,000.00 $1,408,500.00 $481,000.00 $662,000.00 $401,500.00

Division Segment Margin $322,000.00 $191,500.00 $94,000.00 $38,000.00 ($1,500.00)

Common Expenses not

traceable to divisions:

Salaries-Corporate staff $80,000.00

Personnel Cost $20,000.00

Occupancy Costs $23,000.00

Postage and Shipping $30,000.00

General and administrative $38,000.00

Total common expenses $191,000.00

Excess of revenues over

expenses $131,000.00

22

Segmented Reporting

Breakdown of revenues:

Units Values Amount in Dollar

Sales:

Membership dues (20,000 x $100) 20,000 $100 $2,000,000.00

Assigned to Magazine Division (20,000 x $20) 20,000 $20 $400,000.00

Assigned to Membership Division $1,600,000.00

Non-Member Magazine Subscription (2,500 x 30) 2,500 $30 $75,000.00

Advertising Revenues $100,000.00

Report and Texts (28,000 x $25) 28,000 $25 $700,000.00

Continuing education courses:

One-day (2,400 x $75) 2,400 $75 $180,000.00

Two-day (1,760 x $125) 1,760 $125 $220,000.00

Total revenue $3,275,000.00

Personnel Costs

Salaries (25% of Salaries)

Membership Division $210,000.00 $52,500.00

Magazine Subscriptions Division $150,000.00 $37,500.00

Books & Reports Division $300,000.00 $75,000.00

Continuing Education Division $180,000.00 $45,000.00

Total assigned to Division $840,000.00 $210,000.00

Corporate Staff $80,000.00 $20,000.00

Total $920,000.00 $230,000.00

Some may argue that, except for the $50,000 in rental cost directly attributed to the Books and

Reports Divisions, occupancy costs are common costs that should not be allocated. The correct

treatment of the occupancy costs depends on whether they could be avoided in part by eliminating

a division. In the solution below, we have assumed they could be avoided.

Assumed

Division Percentage Direct Allocation Amount

Membership Division 20% $ 46,000.00

Magazine Division 20% $ 46,000.00

Continuing Education Division 20% $ 46,000.00

Books and Report Division 30% $ 50,000.00 $ 119,000.00

Corporate Staff 10% $ 23,000.00

Total 100% $ 280,000.00

23

Segmented Reporting

Total Printing and paper costs = $320,000

Magazine Division 22,500 $7.00 $157,500.00

Books and Reports Division 28,000 $4.00 $112,000.00

Total Magazine and Books divisions $269,500.00

Remainder-Continuing Education Division $50,500.00

Postage and shipping costs = $176,000

Magazine Division 22,500 $4 $90,000

Books Division 28,000 $2 $56,000

Total Magazine and Books Division $146,000

Remainder- Corporate Staff $30,000

24

Conclusion

As I have completed the study I come up with the following findings about Cost Behavior:

The term fixed cost is a misnomer. Fixed cost is not fixed forever. They are just not strictly

proportional to the activity level. But vast increase of activity may result in change in fixed cost.

Average variable cost per unit is assumed to be constant by managers. But variable cost may change,

for instance, rate of direct labor may vary for different reasons.

Managers assume linear equations for mixed cost. But mixed costs are hardy ever linear in reality. We

have to take the linear approximation with a grain of salt. Scatter-plot can give us a good insight of

ours costs.

segmented reporting

Success of Segmented Reporting is a function of appropriate allocation of traceable costs. If managers

don’t get the point of distinction between common and traceable costs the whole Segmented

Reporting will be meaningless.

25

Conclusion

Conclusion

We have to look cost behavior and nature very carefully for managerial purposes. Wrong assumptions

on those two can make our analysis meaningless.

The mixed cost should be analyzed with a scatter-plot first, if there is an observable liner relationship,

we have to do least square regression analysis to come up with a mixed cost formula. As least square

regression analysis can be done very easily with software like Microsoft © Excel, the high-low method

should be avoided. High-low method uses only two extreme points to come up with a mixed cost

formula which may not be reliable.

On the other hand, if scatter-plot shows no linear relationship at all, we should not attempt to get a

linear cost equation.

And managers should understand the distinction between common and traceable cost before

attempting to do segmented reporting. Wrong allocation of costs may result in incorrect segment

margin that may lead to fatal decision of closure of profitable business segments wile operating the

unprofitable ones.

26

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