Accounting for Managers: Interpreting accounting information for decision-making

116 ACCOUNTING FOR MANAGERS

Market segmentsmay be defined geographically, by customer or by customer
groups, by product/service or by product/service groups, or by different distri-
bution channels. In any of these cases, decisions may be made about expanding
or contracting in different segments based on the relative profitability of those
segments. These are important decisions, but the methods by which costs are allo-
cated over each segment must be understood before informed decision-making
can take place.
As we will see in Chapter 11, major assumptions are involved in how costs are
allocated within a business. However, for the purposes of the present chapter,
we will separate fixed costs into unavoidable business-wide costs and avoidable
segment-specific costs.Unavoidable costsare allocated by an often arbitrary
method to each business unit or market segment, although these costs are only
able to be influenced at the corporate level. Avoidable costs are identifiable with
and are able to be influenced by decisions made at the business unit level.
As this chapter has already shown, provided that the selling price exceeds
variable costs, there is a contribution from the sales of products/services towards
covering fixed costs and towards profitability. This position is confused when
financial reports include an allocation of unavoidable business-wide costs and
those reports need to be analysed more carefully.
An example is an accounting practice that prepares tax returns on behalf of
clients. The clients are grouped into three market segments: business (where the
practice also carries out accounting services); business (where the practice only
completes the tax return); and personal returns. The practice thinks that personal
returns may be unprofitable and a partner has produced the data in Table 8.3.
As the example in Table 8.3 shows, despite the loss made by the personal tax
returns market segment, these clients contribute £7,000 in the period towards the
unavoidable overhead. If this segment were discontinued, the profit of the practice
would fall by £7,000 to £18,000. This is because, even though the fixed costs for
administrative support would be saved if the segment were discontinued, the
whole of the unavoidable costs of £50,000 would continue.
The following case study illustrates segmental profitability.

Table 8.3 Profitability of business segmentsfor an accounting practice

Business

(accounting

services)

Business

(tax only)

Personal Total

Revenue 120,000 50,000 30,000 200,000
Variable costs 50,000 22,000 18,000 90,000
Contribution 70,000 28,000 12,000 110,000
Avoidable fixed costs for
administrative support

20,000 10,000 5,000 35,000

Contribution to overhead 50,000 18,000 7,000 75,000
Unavoidable fixed business
expenses (rent, partner salaries etc.)
allocated as a percentage of revenue

30,000

60%

12,500

25%

7,500

15%

50,000

Profit 20,000 5,500 (500) 25,000