accounting

Module 1 - Segmented Income StatementsIn addition to classification as fixed and variable, costs may be either directly or indirectly related to a particular cost object. A cost object is a segment, product, or other item for which costs may be accumulated. In other words, a cost is not direct or indirect in and of itself. It is only direct or indirect in relation to a given cost object. A direct cost (expense) is specifically traceable to a given cost object. An indirect cost (expense) is not traceable to a given cost object but has been allocated to it. Accountants can designate a particular cost (expense) as direct or indirect by reference to a given cost object. Thus, a cost that is direct to one cost object may be indirect to another. For instance, the salary of a segment manager may be a direct cost of a given manufacturing segment but an indirect cost of one of the products manufactured by that segment. In this example, the segment and the product are two distinct cost objects. Because a direct cost is traceable to a cost object, the cost is likely to be eliminated if the cost object is eliminated. For instance, if the plastics segment of a business closes down, the salary of the manager of that segment probably is eliminated. Sometimes a direct cost would remain even if the cost object was eliminated, but this is the exception rather than the rule. An indirect cost is not traceable to a particular cost object; therefore, it only becomes an expense of the cost object through an allocation process. For example, consider the depreciation expense on the company headquarters building that is allocated to each segment of the company. The depreciation expense is a direct cost for the company headquarters, but it is an indirect cost to each segment. If a segment of the company is eliminated, the indirect cost for depreciation assigned to that segment does not disappear; the cost is simply allocated among the remaining segments. In a given situation, it may be possible to identify an indirect cost that would be eliminated if the cost object were eliminated, but this would be the exception to the general rule. Because the direct costs of a segment are clearly identified with that segment, these costs are often controllable by the segment manager. In contrast, indirect costs become segment costs only through allocation; therefore, most indirect costs are non-controllable by the segment manager. Be careful, however, not to equate direct costs with controllable costs. For example, the salary of a segment manager may be direct to that segment and yet is non-controllable by that manager because managers cannot specify their own salaries. When preparing internal reports on the performance of segments of a company, management often finds it is important to classify expenses as fixed or variable and as direct or indirect to the segment. These classifications may be more useful to management than the traditional classifications of cost of goods sold, operating expenses, and non-operating expenses that are used for external reporting in the company’s financial statements. As a result, many companies prepare an income statement for internal use with the format shown below. https://youtu.be/q39AzZhpoNQ