Wize University Managerial Accounting Textbook > Incremental Analysis
Keep or Eliminate Segment
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Keep or Eliminate an Unprofitable Segment
A segment is a division of a company that operates independently of other segments. When a segment is not profitable, the company must determine whether it should eliminate it or keep it operating.
Direct Fixed Costs vs Allocated Fixed Costs
- A direct fixed cost is a cost that is directly cause by a particular segment. These costs are eliminated if the segment is discontinued.
- Allocated fixed costs are costs that are incurred by the overall company and allocated to the segments. These costs are not eliminated if the segment is discontinued, the costs are instead reallocated to the remaining segments.
Wize Tip
If Direct Fixed Costs > Contribution Margin: Eliminate Segment
If Direct Fixed Costs < Contribution Margin: Keep Segment
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Example: Keep or Eliminate Segment
ABC Corp. has been having issues with one of its segments in recent years. Segment C has been operating at a loss and now management is considering eliminating it.
If Segment C is discontinued, $30,000 of its fixed costs would be eliminated, what should ABC Corp do?
Practice: Keep or Eliminate Segment
XYZ Inc. is considering shutting down one of its segment because it has been operating at a loss for the past few years. The company operates two segments, A & B, below is the income reported by the segment and the overall company last year, income is expected to not change in a significant way this year.
In segment B, 30% of cost of goods sold are variable and 45% of selling and administrative expenses are fixed. The manager of segment B would be let go if the segment is discontinued, her annual income is $60,000. The remaining fixed costs consist mainly of rent and depreciation and will not be avoided.
Segment B should be: