See Also:
Segmenting Customers for Profit
Net Profit Margin Analysis
Operating Profit Margin Ratio
Margin vs Markup
Profitability Index MethodWhat is Segment Margin?What is segment margin? Segment margin is a measure of profitability that applies to individual product lines. Segment margin is calculated as segment revenues minus
variable costs minus avoidable
fixed costs. Segment margin is used to measure the profitability of a segment or product line when making the decision of whether to continue or discontinue that segment or product line.
Segment Margin CalculationSegment Margin = Segment Revenues – Variable Costs – Avoidable Fixed Costs Segment Margin and Decision-MakingSegment margin separates relevant costs from irrelevant costs when analyzing a product line. For instance, if management is deciding whether to continue or discontinue a product line, the appropriate calculation for measuring the relevant revenues and relevant expenses for the decision would be the segment margin calculation.
The difference between segment margin and other measures of profitability, such as contribution margin, is that segment margin divides fixed costs into three categories. One of the categories of fixed costs is considered relevant when making decisions about the segment in question; the other two categories of fixed costs are irrelevant.
Segment Margin and Fixed CostsThe three categories are avoidable fixed costs, unavoidable fixed costs, and common expenses. Avoidable fixed costs are relevant in the decision-making process of whether to continue or discontinue a product line. Unavoidable fixed costs and common expenses are irrelevant for decisions regarding a particular product line.
Avoidable fixed costs are those fixed costs that would not be incurred if the segment or product line were to be eliminated. Unavoidable fixed costs are fixed costs that are necessary for the continuation of the segment or product line, but that would continue to be incurred if that segment or product line were to be discontinued. Eliminating the segment in question would merely cause these unavoidable fixed costs to be allocated to another segment. Common expenses refer to expenses incurred by the company as a whole that are allocated to various segments or product lines.
Source:Barfield, Jesse T., Michael R. Kinney, Cecily A. Raiborn. “Cost Accounting Traditions and Innovations,” West Publishing Company, St. Paul, MN, 1994.