Question

When an income statement shows data for segments of the organization, and data for each segment are added together to get totals for the whole organization, what should be done?

1) All expenses should be allocated to the segments.
2) Common fixed expenses should be allocated to the segments.
3) Only direct revenues and direct expenses should be assigned to segments.
4) Direct fixed expenses should be subtracted as one amount in the 'total' column.

Answer 1

Only direct revenues and direct expenses should be assigned to each segment in an income statement, with common fixed expenses included in the 'total' column without specific allocation to segments.

Step-by-step explanation:

When an income statement displays data for segments of the organization, and these data are aggregated to represent the whole organization, only direct revenues and direct expenses should ideally be assigned to each segment.

This approach ensures that the profitability of each part of the business can be accurately assessed. Segment reporting often excludes common fixed expenses, as these are not directly attributable to any single segment.

Common fixed expenses, such as the rent of a factory or the cost of equipment, remain consistent regardless of the level of production.

Therefore, unless there is a rational basis for allocation, these should not be arbitrarily divided among segments but rather be included in the 'total' column without specific allocation. Accurate representation of fixed costs and variable costs is crucial, especially when evaluating the performance of various parts of the business.

For instance, using the example of 'The Clip Joint' barber shop, the fixed costs, including the space and equipment, are $160 per day and do not change with the level of production, while variable costs, like wages for additional barbers at $80 per barber, increase with the level of production. These costs are combined to calculate the total costs for the business, and proper segment reporting would reflect this.