Chapter 14 Segment and Interim Financial Reporting by

Chapter 14: Segment and Interim Financial Reporting by Jeanne M. David, Ph. D. , Univ. of Detroit Mercy to accompany Advanced Accounting, 10 th edition by Floyd A. Beams, Robin P. Clement, Joseph H. Anthony, and Suzanne Lowensohn © Pearson Education, Inc. publishing as Prentice Hall 14 -1

Segment and Interim Reporting: Objectives 1. Understand how the management approach is used to identify potentially reportable operating segments. 2. Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating profit test. 3. Apply the 75% external revenue test to determine whether additional segments must be reported. 4. Understand the types of information that may be disclosed for segments and the reasons that the levels of disclosure may vary across companies. © Pearson Education, Inc. publishing as Prentice Hall 14 -2

Objectives (cont. ) 5. Understand what segment disclosures are reconciled to the consolidated amounts. 6. Know the types of enterprise-wide disclosures related to products and services, geographic areas of operation, and major customers that are required to be disclosed. 7. Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. 8. Compute interim-period income tax expense. © Pearson Education, Inc. publishing as Prentice Hall 14 -3

Segment and Interim Financial Reporting 1: Reportable Operating Segments © Pearson Education, Inc. publishing as Prentice Hall 14 -4

Operating Segments • FASB Statement No. 131 governs segment reporting • Firm's internal reporting and evaluation system: – If it is geographically based • External segment reporting is geographically based – If it is product-line or industry based • External reporting is product-line or industry based © Pearson Education, Inc. publishing as Prentice Hall 14 -5

Operating Segment (def. ) • A component of a business enterprise 1. Engages in business activities • Revenues and expenses • Includes intercompany amounts 2. Operating results are reviewed by chief operating decision maker 3. Discrete financial information is available Excludes pension and post-retirement plans, general corporate headquarters © Pearson Education, Inc. publishing as Prentice Hall 14 -6

Combining Segments • Similar economic characteristics – Products and services – Production processes – Classes of customers – Distribution systems – Regulatory environment, if applicable © Pearson Education, Inc. publishing as Prentice Hall 14 -7

Tests of Segments • Three tests to see if a segment exists: 1. 10% Revenue test 2. 10% Profit or loss test 3. 10% Asset test • One test to see if sufficient segments have been identified 1. 75% External revenue test © Pearson Education, Inc. publishing as Prentice Hall 14 -8

Segment and Interim Financial Reporting 2: Threshold Tests © Pearson Education, Inc. publishing as Prentice Hall 14 -9

Reportable Segments • Operating segments are reportable and material if any one of the threshold tests are met 1. Revenue test 2. Asset test 3. Profit or loss test • Segments not meeting any of the three tests are combined into one "all other" category © Pearson Education, Inc. publishing as Prentice Hall 14 -10

10% Revenue Test Segment reported revenue, including intersegment revenues, is 10% or more of the combined revenue of all operating segments. – Combined includes "all other" category – Intersegment revenues are not eliminated so that combined revenue may be > consolidated revenue © Pearson Education, Inc. publishing as Prentice Hall 14 -11

Example: 10% Revenue Test Operating Total segment Intersegment Reportrevenue able? Transportation $360 $0 $360 Yes Oil refining 405 480 885 Yes Insurance 95 20 115 No Financing 140 0 140 No Total $1, 000 $500 $1, 500 A segment is reportable if its total revenue ≥ 10% of combined segment revenue. Threshold = 10%(1, 500) = $150 Transportation ($360) and Oil refining ($885) are reportable segments. © Pearson Education, Inc. publishing as Prentice Hall 14 -12

10% Asset Test Segment assets are 10% or more of combined assets of all operating segments. – Combined includes "all other" – Use the segment's identifiable assets – General corporate assets • May be excluded or included • Consider organization of assets for decision making purposes – Combined assets of segments may be less than total corporate assets © Pearson Education, Inc. publishing as Prentice Hall 14 -13

Example: 10% Asset Test Operating segment's identifiable assets Reportable? Transportation $700 Yes Oil refining 950 Yes Insurance 180 No Financing 1, 170 Yes Total $3, 000 A segment is reportable if its identifiable assets ≥ 10% of combined segment assets. Threshold = 10%(3, 000) = $300 Transportation, Oil refining, and Financing are reportable segments. © Pearson Education, Inc. publishing as Prentice Hall 14 -14

10% Profit or Loss Test The absolute value of the segment's reportable profit loss is 10% or more of the greater of: 1. The combined reported profit of all segments reporting profits, or 2. The absolute value of the combined reported losses of all segments reporting losses. – Operating segment profit or loss • Not defined by GAAP • Management decision making – May include or exclude common revenues and costs © Pearson Education, Inc. publishing as Prentice Hall 14 -15

Example: 10% Profit or Loss Test Separate profitable and unprofitable segments. Segment operating profit operating loss Reportable? Transportation (100) Yes Oil refining 200 Yes Insurance 20 No Financing 50 Yes Total 270 (100) A reportable segment's |profit or loss| ≥ 10% of the greater of |combined profits or combined losses|. $270 is greater than $100. Threshold = 10%(270) = $27. Transportation, Oil refining and Finance are reportable segments. © Pearson Education, Inc. publishing as Prentice Hall 14 -16

Segment and Interim Financial Reporting 3: Test for Additional Segments © Pearson Education, Inc. publishing as Prentice Hall 14 -17

75% External Revenue Test • FASB Statement No. 131 requires that the external revenue of reportable segments must be at least 75% of the total consolidated revenue. – Exclude intersegment revenues – If reportable segment external revenues do not sufficient • Add other segments until the 75% test is met © Pearson Education, Inc. publishing as Prentice Hall 14 -18

Preliminary Segment Test Results Based on the 10% revenues, 10% assets, 10% profit and loss tests: – Three reportable segments • Transportation • Oil refining • Financing – One non-reportable segment which becomes "all other" • Insurance Now, check to see if the three are enough! © Pearson Education, Inc. publishing as Prentice Hall 14 -19

Example: 75% External Revenue Operating Total segment Intersegment Reportrevenue able? Transportation $360 $0 $360 Yes Oil refining 405 480 885 Yes Insurance 95 20 115 No Financing 140 0 140 No Total $1, 000 $500 $1, 500 Re-examining the schedule for the 10% segment revenue test, we now look at the operating segment revenue without intersegment sales data. Sufficient segments have been identified if reportable segment revenues ≥ 75% consolidated revenues. Threshold = 75%(1, 000) = $750 $360 + 405 + 140 > $750 … Yes! © Pearson Education, Inc. publishing as Prentice Hall 14 -20

Segment and Interim Financial Reporting 4: Disclosures © Pearson Education, Inc. publishing as Prentice Hall 14 -21

Disclose for Each Reportable Segment Profit or loss Total assets Revenues from • External customers • Other segments • Interest • Income from equity method investments Expenses items • Interest • Depreciation, depletion and amortization Other income statement items • Unusual items • Extraordinary items Significant noncash items other than depreciation… © Pearson Education, Inc. publishing as Prentice Hall 14 -22

Segment and Interim Financial Reporting 5: Reconciling Segments to Consolidated Amounts © Pearson Education, Inc. publishing as Prentice Hall 14 -23

Reconciliations Reconciliation schedules should be provided to explain the difference between segment amounts and consolidated totals 1. Reportable segment revenue to consolidated revenue • Intersegment revenues 2. Reportable segment profit and loss to consolidated income before taxes • Intersegment revenues, expenses, and common or allocated costs © Pearson Education, Inc. publishing as Prentice Hall 14 -24

Reconciliations (cont. ) 3. Reportable segment assets to consolidated assets • Corporate assets 4. If other significant information is disclosed, reconcile the segment amounts with consolidated amounts for each item © Pearson Education, Inc. publishing as Prentice Hall 14 -25

Segment and Interim Financial Reporting 6: Enterprise-wide Disclosures © Pearson Education, Inc. publishing as Prentice Hall 14 -26

Additional Disclosures Additional enterprise-wide disclosures – Needed if not already reported with segment information 1. Products and services • Revenues by product/product line, service 2. Geographic information • Revenues and fixed assets • Domestic and foreign • Specific country if > 10% © Pearson Education, Inc. publishing as Prentice Hall 14 -27

Additional Disclosures (cont. ) 3. Major customers • Customer revenues > 10% • Revenues • Segment which has those revenues • Not required: customer identity © Pearson Education, Inc. publishing as Prentice Hall 14 -28

Segment and Interim Financial Reporting 7: Interim versus Annual Reporting © Pearson Education, Inc. publishing as Prentice Hall 14 -29

Accounting for Interim Periods Question about interim periods In terms of quarterly reports: Is each quarterly report separate from the other three quarters of the year, or is each quarterly report one of four integral parts of the annual report? APB Opinion No. 28 says it is an integral part of the annual report © Pearson Education, Inc. publishing as Prentice Hall 14 -30

An Integral Part • As an integral part of the annual report – Basically follow annual reporting procedures – May make some modifications to allow more frequent reporting • Integral to the annual report – Quarterly taxes are a portion of the annual taxes, probably use average effective rate • Separate reports – Each quarter bears its own taxes, probably use marginal tax rate © Pearson Education, Inc. publishing as Prentice Hall 14 -31

Product Cost Modifications • Use gross profit method to estimate inventory and cost of sales • For LIFO inventories, may assume that liquidation of layers are temporary, with replacement of layers before year end • Lower of cost or market for inventories may consider expected year end outcomes • Standard costing variances may be deferred if expected to be absorbed by year end © Pearson Education, Inc. publishing as Prentice Hall 14 -32

Other Expense Modifications • Annual expenses may be allocated • Advertising expenses may be deferred to later interim periods if clearly applies – Only in the same fiscal year • Income taxes from continuing operations – Use an estimated effective annual tax rate • Income taxes on unusual, infrequent and other items – Calculate separately and include in the interim period containing that item © Pearson Education, Inc. publishing as Prentice Hall 14 -33

Segment and Interim Financial Reporting 8: Interim-Period Income Taxes © Pearson Education, Inc. publishing as Prentice Hall 14 -34

Tax Rates Interim taxes on operations are based on estimated effective annual tax rate If expected annual taxable income = $120, 000 Taxes = $22, 250 +. 39(120, 000 – 100, 000) = $30, 050 Effective tax rate = 30, 050 / 120, 000 = 25. 042% The 25. 042% rate is used for all four quarters. © Pearson Education, Inc. publishing as Prentice Hall 14 -35

Interim Period Disclosures Sales or gross revenues Provision for taxes Extraordinary items, net of tax Cumulative effect of accounting changes Net income © Pearson Education, Inc. publishing as Prentice Hall Additional items: 1. Basic, diluted EPS 2. Seasonal revenues, costs and expenses 3. Significant change in estimated taxes 4. Disposals, extraordinary, unusual, infrequent items 5. Contingent items 6. Changes in accounting principles or estimates 7. Significant change in financial position 14 -36

Other Interim Disclosures • Segment information disclosures are reduced for interim reporting • SEC requires – Q 1, Q 2, Q 3 and annual reports – Quarterly requirements similar to annual – Comparative information • Current quarter vs. last year's • Quarterly and year-to-date © Pearson Education, Inc. publishing as Prentice Hall 14 -37

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