REPORTING SEGMENT AND RELATED INFORMATION CHAPTER 12 REPORTING SEGMENT AND RELATED INFORMATION

FOCUS OF CHAPTER 12 Objectives and Applicability of FAS 131 Reporting Operating Segment Information Reporting Enterprise-wide Information Products & services Geographic areas Major customers

Segment and Related Information Reporting: Objectives To provide information about a reporting entity’s different types of: Business activities. Economic environments.

Segment and Related Information Reporting: Objectives This information should help financial statement users: Better understand past performance. Better assess prospects for future net cash flows. Make more informed judgments about the entity as a whole.

Segment and Related Information Reporting: Overview & Applicability 05/04/97 Segment and Related Information Reporting: Overview & Applicability Segment and related information reporting under FAS 131 consists of disclosing the following 4 informational items: Operating segments. Products & services. Foreign operations/sales. Major customers. #1 FAS 131 #2 #3 #4 #2, #3, & #4 are “entity-wide disclosures.” They apply to ALL entities—even those having only l segment. 2

Segment and Related Information Reporting: Overview & Applicability 05/04/97 Segment and Related Information Reporting: Overview & Applicability Segment and related information reporting is: Needed because of the limitations of consolidated financial statements. Done in notes to the financial statements. Applicable to: Both ANNUAL & INTERIM statements. PUBLIC BUSINESS ENTERPRISES ONLY (excludes not-for-profit entities). 2

Segment and Related Information Reporting: Overview & Applicability Public business enterprises are entities that: Have issued debt or equity securities that are traded in a public market, Are required to file financial statements with the SEC, or Provide financial statements for the purpose of issuing any class of securities in the public market.

Segment and Related Information Reporting: Overview & Applicability Segment and related information reporting even applies to the following entities if they issue “separate company ” statements that are NOT in the same FINANCIAL REPORT as a set of consolidated statements: Parent enterprises. Subsidiaries. Joint ventures. Investees—if the equity method is used.

Segment Reporting: Basis of Segmentation Disaggregated financial information could be presented in several ways, for example: By products & services (rejected). By geographic area (rejected). By legal entity (rejected). By type of customer (rejected). By organization of the segments for reporting to management for decision-making (the “management” approach).

Segment Reporting: Basis of Segmentation FAS 131 requires : A SINGLE basis of segmentation. The MANAGEMENT approach basis of segmentation. In contrast, FAS 14 (which was superseded by FAS 131) required TWO bases of segmentation— by industry and by geographic areas.

Segment Reporting: Basis of Segmentation Merits of the “Management” Approach: Facilitates consistent descriptions in (1) annual reports and (2) various other published information. Entities need not develop a separate measure of profitability solely for segment reporting purposes. Thus: A non-GAAP method used internally is also used for segment reporting.

Segment Reporting: Basis of Segmentation The components that management establishes for reporting & decision-making are called OPERATING SEGMENTS. Such components: Engage in activities from which they may earn revenues and incur expenses. Such activities include revenues and expenses resulting from transactions with other segments (called intersegment transactions). #1

Segment Reporting: Basis of Segmentation Such components (continued): Have their operating results regularly reviewed by a chief operating decision maker. #2 Have discrete financial information available. #3

Segment Reporting: Basis of Segmentation What Could Be an Operating Segment: A start-up operation that has yet to report any revenues. A component of a vertically integrated operation—providing these operations are managed that way.

Segment Reporting: Basis of Segmentation What Could Not Be an Operating Segment: A corporate headquarters. Functional departments that earn either no revenues or only incidental revenues. What Is Definitely Not an Operating Segment: An entity’s pension plan. An entity’s postretirement benefit plan.

Segment Reporting: Disclosures Required An entity must disclose 4 types of information about its REPORTABLE OPERATING SEGMENTS: General information. Specified amounts. Reconciliations of specified amounts to consolidated amounts. Certain interim period information. TYPE 1 2 3 4

Segment Reporting: Disclosures Required—General Information TYPE 1—General Information Disclosures: Factors used to identify the entity’s reportable segments, including the basis of organization, such as based on: Products and services. Geographic areas. Regulatory environments. A combination of factors. Types of products & services from which each reportable segment derives its revenues.

Segment Reporting: Disclosures Required—Specified Amounts Information TYPE 2—Specified Amounts Disclosures: For each reportable segment, a measure of: Profit or loss. Total assets (but not liabilities). Certain account amounts (listed on next slide) if they are included in the measure of segment profit or loss.

Segment Reporting: Disclosures Required—Specified Amounts Information Certain Account Amounts That May Have to Be Disclosed: Revenues from external customers. Intersegment revenues. Interest revenue and interest expense. Depreciation & amortization expense and significant other NONCASH items. Unusual items & extraordinary items. Equity method income on investees. Income tax expense or benefit.

Segment Reporting: Disclosures Required—Specified Amounts Information 05/04/97 Segment Reporting: Disclosures Required—Specified Amounts Information Key Point #1—LACK OF UNIFORMITY: FAS 131 does NOT define segment operating profit or loss (as did FAS 14, its predecessor). Thus any measure of performance may be displayed—AS LONG AS THAT MEASURE OF PERFORMANCE IS REVIEWED BY THE CHIEF OPERATING DECISION MAKER. 3

Segment Reporting: Disclosures Required—Specified Amounts Information Key Point #2—Terminology: In dealing with segment reporting, the term “intercompany” is NOT RELEVANT. The RELEVANT terms are: Intersegment (sales between segments). Intrasegment (sales between components of a vertically integrated operation deemed to be a single operating segment).

Segment Reporting: Disclosures Required—Specified Amounts Information 05/04/97 Segment Reporting: Disclosures Required—Specified Amounts Information Key Point #3—Terminology: In presenting operating segment information: Intersegment sales must be disclosed separately ONLY IF they are included in the measure of profitability. Intrasegment sales need NOT be disclosed. 3

Segment Reporting: Disclosures Required—Specified Amounts Information Key Point #4—Transfer Pricing: FAS 131 did not establish a basis for setting prices for sales or transfers either between or within segments. Transfer pricing is more likely to be an issue within vertically integrated operations than between nonvertically integrated segments.

Segment Reporting: Disclosures Required—Specified Amounts Information 05/04/97 Segment Reporting: Disclosures Required—Specified Amounts Information Key Point #5—Allocations: A segment’s expenses (used in its measure of operations) may include BOTH: Directly traceable costs and Allocated common costs (costs that benefit two or more segments). Costs that are allocated must be allocated on a reasonable basis. #1 #2 6

Segment Reporting: Disclosures Required—Specified Amounts Information 05/04/97 Segment Reporting: Disclosures Required—Specified Amounts Information Key Point #6—Nonallocations: Common costs need not be allocated to or between segments. Costs accounted for on a consolidated basis need not be allocated to segments (e.g. pension costs). 6

Segment Reporting: Disclosures Required—Specified Amounts Information Key Point #7—Asymmetrical Allocations: Permitted in determining a segment’s: Measure of profitability and Total assets. Thus depreciation expense could be allocated to a segment but the related fixed assets could not.

Segment Reporting: Disclosures Required—Specified Amounts Information Key Point #8—R&D Costs: Disclosure of segment research & development costs is NOT required because: Doing so could result in competitive harm by providing competitors with early insight into strategic plans. R& D costs are often (1) incurred centrally and (2) NOT allocated to segments.

Segment Reporting: Disclosures Required—Specified Amounts Information Key Point #9—Liabilities: Disclosure of segment liabilities is NOT required: The value of information about segment liabilities in assessing segment performance was deemed limited, partly because in many cases liabilities are: Incurred centrally and NOT allocated to segments.

Segment Reporting: Disclosures Required—Specified Amounts Information Additional Asset-Related Disclosures for Reportable Segments—if the items are included in the determination of segment assets: The amount of investment in equity method investees. Total expenditures for additions to long-lived assets.

Segment Reporting: Disclosures Required—Specified Amounts Information MEASUREMENT—BASIC RULE: Each segment item amount reported must be the measure reported to the chief operating decision maker for assessing performance & allocating resources to the segment. Eliminations & Adjustments Made in Consolidation: Allocate to a segment ONLY IF they are included in the measure of profit and loss used by the chief operating decision maker.

Segment Reporting: Disclosures Required—Specified Amounts Information MEASUREMENT—MULTIPLE MEASURES: If more than one measure of a segment’s profit or loss and assets is used by the chief operating decision maker, the measure selected for segment reporting must be the measure most consistent with: Those used in measuring those items in the entity’s consolidated financial statements.

Segment Reporting: Disclosures Required—Specified Amounts Information MEASUREMENT—DISCLOSURES: For reportable segment’s profit or loss and assets, disclose as a minimum: The basis of accounting for intersegment transactions. The nature of differences reported on the specified reconciliations (for P/L and for assets), if not apparent thereon. #1 #2

Segment Reporting: Disclosures Required—Specified Amounts Information MEASUREMENT—DISCLOSURES (cont.): The nature and effect of any changes from prior periods in the measurement methods used to determine a reported segment P/L . The nature and effect of any asymmetrical allocations to segments. #3 #4

Segment Reporting: Disclosures Required—Reconciliations TYPE 3—Reconciliations of SPECIFIED Amounts to CONSOLIDATED Amounts: Reconcile the total of the reportable segments’: Revenues. Measure of profit or loss. Assets. Other significant items of information disclosed for reportable segments (e.g. liabilities, R&D expense).

Segment Reporting: Disclosures Required—Interim Period Information TYPE 4—Certain Interim Period Information: For each reportable segment, disclose: Revenues from external customers. Intersegment revenues. A measure of profit or loss. Total assets, if a material change from amount disclosed in last annual report. Changes in the segmentation basis or in basis of measurement of segment P/L. Reconciliations to consolidated amounts.

Segment Reporting: Disclosures Required—Cash Flow Information Reporting segment cash flows is NOT required. An indication of both an operating segment’s cash-generating ability and its cash requirements may be gathered from the required profitability and asset related disclosures.

Segment Reporting: Aggregation of Similar Segments Operating segments that have similar economic characteristics often have similar long-term financial performance. Thus two or more operating segments may be combined into a single operating segment if 3 criteria (on the next two slides) are met.

Segment Reporting: Aggregation Criteria The Three Aggregation Criteria: Aggregation must be consistent with the objectives & principles of FAS 131. The segments must have similar economic characteristics. The segments are similar in each of the following 5 areas: The nature of the products & services. #1 #2 #3

Segment Reporting: Aggregation Criteria Segments similar in 5 areas (Cont’d): The nature of the production processes. The type or class of customer for their products & services. The methods used to distribute their products or provide services. If applicable, the nature of the regulatory environment (e.g. banking, insurance, or public utilities).

Segment Reporting Quantitative Thresholds—Overview 05/04/97 Segment Reporting Quantitative Thresholds—Overview Not all operating segments are REPORTABLE operating segments. Three 10% tests are performed to determine if an operating segment is a reportable operating segment. ONLY ONE of the three 10% tests need be passed. The tests involve: REVENUES, PROFITABILITY, and ASSETS. 8

Segment Reporting: Quantitative Thresholds—The 10% Tests REVENUES: Are the segment’s reported revenues [includes both sales to external customers and intersegment sales or transfers] 10% or more of the combined revenue, internal and external, of ALL reported operating segments? #1

Segment Reporting: Quantitative Thresholds—The 10% Tests PROFITABILITY: Is the absolute amount of the segment’s reported profit or loss 10% or more of the greater, in absolute amount, of the combined reported: PROFIT of all operating profits that DID NOT report a loss or LOSS of all operating segments that DID report a loss? #2 Winners Losers

Segment Reporting: Quantitative Thresholds—The 10%Tests ASSETS: Are the segment’s assets 10% or more of the combined assets of ALL operating segments? Operating segments that do NOT meet any of the three 10% tests may be COMBINED with Other such operating segments to produce a reportable segment—ONLY IF they share a majority of the specified aggregation criteria (listed on slides #38 & #39). #3

Segment Reporting: Nonreportable Operating Segments Nonreportable operating segments and other business activities are: Combined and Disclosed in an “ALL OTHER” category. The Judgment Factor: A reportable segment in the preceding period that does NOT qualify as a reportable segment in the current period may be presented if management deems it to be of continuing significance.

Segment Reporting: The 75% Test Determining Reportable Operating Segments: Enough operating segments must be selected so that at least 75% of the total consolidated revenues (sales to external customers) is included in reportable operating segments. Describing Reportable Operating Segments: The product or service of each industry segment must be identified.

Enterprise-Wide Disclosures: The Three Categories of Information Three types of enterprise-wide disclosures are called for. Information about: Products and Services. Geographic Areas. Major Customers. #1 #2 #3

Enterprise-Wide Disclosures: Products and Services An entity must report REVENUES FROM EXTERNAL CUSTOMERS—unless it is impractical to do so—for: Each product and service, or Each group of similar products and services. If it is impractical to disclose this product and service information, disclose that fact.

Enterprise-Wide Disclosures: Geographic Areas—General 05/04/97 Enterprise-Wide Disclosures: Geographic Areas—General An entity must report geographic information—unless it is impractical to do so—for : REVENUES LONG-LIVED ASSETS If it is impractical to disclose this geographic information, disclose that fact. #1 #2 10

Enterprise-Wide Disclosures: Geographic Areas—Revenues 05/04/97 Enterprise-Wide Disclosures: Geographic Areas—Revenues REVENUES—Disclose: Revenues from external customers located: In the United States. Outside the United States, in total. Revenues attributed to an individual foreign country, if material. 10

Enterprise-Wide Disclosures: Geographic Areas—Long-Lived Assets LONG-LIVED ASSETS—Disclose: Long-lived assets located: In the United States. Outside the United States, in total. In an individual foreign country, if material.

Enterprise-Wide Disclosures: Geographic Areas—Long-Lived Assets Long-lived assets exclude: Financial instruments. Long-term customer relationships of a financial institution. Mortgage or other servicing rights. Deferred policy acquisition costs. Deferred tax assets.

Enterprise-Wide Disclosures: Major Customers 05/04/97 Enterprise-Wide Disclosures: Major Customers When an entity has revenues from any single customer in excess of 10% of total revenues, disclose: The fact of such revenues. The amount of revenues from each customer [but not the identity of each]. The industry segment(s) making the sales to each such customer. #1 #2 #3 13

Enterprise-Wide Disclosures: Major Customers Each is considered a SINGLE customer: A group of entities known to be under common control. The federal government. A state government. A local government. A foreign government.

Review Question #1 Revtex’s 5 operating segments have total revenues of: #1—$100,000, #2--$200,000, #3—$300,000 (includes intrasegment revenues of $30,000), #4—$400,000, and #5—$500,000 (includes intrasegment revenues of $50,000). The revenues test is based on revenues of: A. $1,420,000 B. $1,450,000 C. $1,470,000 D. $1,500,000

Review Question #1 With Answer Revtex’s 5 operating segments have total revenues of: #1—$100,000, #2--$200,000, #3—$300,000 (includes intrasegment revenues of $30,000), #4—$400,000, and #5—$500,000 (includes intrasegment revenues of $50,000). The revenues test is based on revenues of: A. $1,420,000 B. $1,450,000 ($1,500,000 - $50,000) C. $1,470,000 D. $1,500,000

Review Question #2 Optex’s 5 operating segments have operating profits and losses of: #1—$100,000, #2—$(200,000), #3—$300,000, #4—$400,000, and #5—$500,000. The operating profit or loss test is based on 10% of: A. $200,000 B. $1,100,000 C. $1,300,000 D. $1,500,000

Review Question #2 With Answer Optex’s 5 operating segments have operating profits and losses of: #1—$100,000, #2—$(200,000), #3—$300,000, #4—$400,000, and #5—$500,000. The operating profit or loss test is based on 10% of: A. $200,000 B. $1,100,000 C. $1,300,000 D. $1,500,000

End of Chapter 12 Time to Clear Things Up— Any Questions?