- Define and explain traceable and common fixed costs or expenses.
- What is the difference between traceable and common fixed costs?
The most puzzling aspect of segmented income statements is probably the treatment of fixed costs. While preparing segmented income statements the fixed cost is divided into two parts one is traceable fixed cost and other is common fixed cost. Only traceable fixed costs are assigned to the segment. If a cost is not traceable then it is not assigned to segments. Following paragraphs define explain these two types of fixed costs.
Traceable fixed cost:
A traceable fixed cost is a fixed cost that is incurred because of the existence of a segment. If the segment had never existed, the fixed cost would have not been incurred; and if the segment were eliminated, the fixed cost would disappear.
Examples of traceable fixed costs include the following:
- The salary of the Fritos product manager at Pepsi CO. is traceable fixed cost of the Fritos business segment of Pepsi Co.
- The liability insurance at Disney World is a traceable fixed cost of the Disney World business segment of the Disney Corporation
Common fixed cost:
Common Cost Definition:
A common fixed cost is a fixed common cost that supports the operations of more than one segment, but is not traceable in whole or in part to any one segment. Even if a segment were entirely eliminated, there would be no change in true common fixed cost.
Examples of Common fixed cost:
Example of common fixed cost include the following:
- The salary of general manager who controls all the segments. The salary of CEO at general motors is also an example of common fixed cost. No single segment can be regarded as the sole reason of this cost.
- The salary of receptionist at an office shared by a number of doctors is a common fixed cost of the doctors. The cost is traceable to the office, but not to any one of the doctors individually.
Identifying traceable and common fixed costs is crucial in segment reporting, since the traceable fixed costs are charged to the segments and common fixed costs are not charged to segments. In actual situations, it is some times hard to determine whether a cost should be classified as traceable or common. The general guideline is to treat as traceable costs only those costs that would disappear over time if the segment itself disappeared.
Traceable cost can become common cost:
Fixed cost that is traceable to one segment can become a common cost for another segment. For example, an air line might want a segmented income statement that shows the segment margin for a particular flight from Loss Angeles to Paris further broken down into first class, business class and economy class segment margins. The airline must pay a landing fee Charles DeGaulle air port in Paris. This fixed landing fee is a trace able fixed cost of the flight, but it is a common fixed cost of first class, business class and economy class segments. Even the first class cabinet is empty the entire landing fee must be paid. So the landing fee is not a traceable cost of the first class segment. But on the other hand paying the landing fee is necessary in order to have any first, business and economy class passengers. So the landing fee is common cost for these three class of passengers and is a traceable cost for the flight as a whole.
You may also be interested in other articles from “decentralization, segment reporting and transfer pricing” chapter:
- Decentralization in organizations
- Traceable and common fixed costs
- Segment reporting and profitability analysis-segmented income statements
- Hindrances/Problems to Proper Cost Assignment in Segmented Reporting
- Segmented Financial Information on External Reports
- Return on Investment (ROI) for Measuring Managerial Performance
- Controlling and Improving Rate of Return on Investment
- Return on Investment (ROI) and Balanced Scorecard
- Criticism, Disadvantages or Limitations of Return on Investment (ROI)
- Residual Income-Another Method to Measure Managerial Performance
- Limitations, Criticism or Disadvantage of Residual Income Method
- Allow the managers involved in the transfer to negotiate their own transfer price (negotiated transfer pricing).
- Set transfer prices at cost using variable or full (absorption) cost
- Set transfer prices at the market price
- Divisional Autonomy and Sub optimization
- International Aspects of Transfer Pricing
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