Segment and Interim Financial Reporting Chapter 15 Segment and Interim Financial Reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 1

Segment and Interim Financial Reporting: Objectives Understand how the management approach is used to identify potentially reportable operating segments. Apply the threshold tests to identify reportable operating segments: the revenue test, the asset test, and the operating profit test. Apply the 75% external revenue test to determine whether additional segments must be reported. Understand the types of information that may be disclosed for segments and the reasons that the levels of disclosure may vary across companies. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Segment and Interim Financial Reporting: Objectives (cont.) Understand what segment disclosures are reconciled to the consolidated amounts. 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. Understand the similarities and differences in the reporting of operations in an interim versus an annual reporting period. Compute interim-period income tax expense. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Segment and Interim Financial Reporting 1: reportable operating segments Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Operating Segments According to GAAP, companies that have publicly traded debt or equity instruments must report on their business segments. Reporting is based on the structure used by management to make decisions or evaluate performance. For example, if the company’s internal reporting and evaluation system is geographically based, the segment reporting is geographically based. if the internal reporting and evaluation system is product-line based, the segment reporting is product-line based. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Operating Segment (def.) A component of a business enterprise Engages in business activities Revenues and expenses tracked Intercompany amounts included Operating results are reviewed by chief operating decision maker Discrete financial information is available Excludes pension and post-retirement plans, and general corporate headquarters Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Combining Segments Segments with similar economic characteristics may be combined. Products and services Production processes Classes of customers Distribution systems Regulatory environment, if applicable Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Segment and Interim Financial Reporting 2: Threshold tests Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Reportable Segments Operating segments are reportable and material if any one of the three threshold tests are met 10% Revenue test 10% Asset test 10% Profit or loss test Segments not meeting any of the three tests are combined into one "all other" category. One additional test to see if a sufficient number of segments have been identified 75% External revenue test Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Example: 10% Revenue Test   Operating segment revenue Intersegment revenue Total segment revenue Report-able? Transportation $360 $0 Yes Oil refining 405 480 885 Insurance 95 20 115 No Financing 140 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Transportation, Oil refining, and Financing are reportable segments. Example: 10% Asset Test   Operating segment's identifiable assets Reportable? Transportation $ 700 Yes Oil refining 950 Insurance 180 No Financing 1,170 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 10% Profit or Loss Test The absolute value of the segment's reportable profit or loss is 10% or more of the greater of: The combined reported profit of all segments reporting profits, or The absolute value of the combined reported losses of all segments reporting losses. Operating segment profit or loss Is not defined by GAAP Is based on the calculation used by management for decision making May include or exclude common revenues and costs Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Example: 10% Profit or Loss Test Separate profitable and unprofitable segments. 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.   Segment operating profit Segment operating loss Reportable? Transportation (100) Yes Oil refining 200 Insurance 20 No Financing 50 Total 270 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

3: TEST FOR ADDITIONAL SEGMENTS Segment and Interim Financial Reporting 3: TEST FOR ADDITIONAL SEGMENTS Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

75% External Revenue Test GAAP does not specify the number of segments that must be reported; however, the external revenue of reportable segments must be at least 75% of the total consolidated revenue. Exclude intersegment revenues Add other segments until the 75% test is met Segments are typically aggregated so that there are not more than ten separate segments reported. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Preliminary Segment Test Results: Example (cont.) 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! Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

75% External Revenue: Example Now we examine the operating segment revenue without intersegment sales data. Have sufficient segments been identified? Threshold = 75%(1,000) = $750 $360 + 405 + 140 > $750 … Yes!   Operating segment revenue Intersegment revenue Total segment revenue Report-able? Transportation $ 360 $ 0 $ 360 Yes Oil refining 405 480 885 Insurance 95 20 115 No Financing 140 Total $1,000 $500 $1,500 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Segment and Interim Financial Reporting 4: segment disclosures Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Reportable Segment Disclosures Profit or loss Total assets Revenue from external customers Revenue from other operating segments Interest income and expense Depreciation and amortization expense Unusual items Income from equity method investments Income tax expense or benefit Extraordinary items Significant noncash items other than depreciation Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Reportable Segment Disclosures (cont.) Remember: GAAP is depending on the company’s chief operating decision maker to determine the most useful information. Whatever data is required internally will also be used for external disclosures. However, the company allocating expenses among the operating segments should be continued for external segment disclosure purposes. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

5: reconciling segments to consolidated amounts Segment and Interim Financial Reporting 5: reconciling segments to consolidated amounts Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Reconciliations Reconciliation schedules should be provided to explain the difference between segment amounts and consolidated totals for: Reportable segment revenue to consolidated revenue Intersegment revenues Reportable segment profit and loss to consolidated income before taxes Intersegment revenues, expenses, and common or allocated costs Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Reconciliations (cont.) Reportable segment assets to consolidated assets Corporate assets If other significant information is disclosed, reconcile the segment amounts with consolidated amounts for each item Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

6: Enterprise-wide disclosures Segment and Interim Financial Reporting 6: Enterprise-wide disclosures Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Additional Disclosures Additional enterprise-wide disclosures are required if not already reported with segment information Products and services Revenues by product/product line, service Geographic information Revenues and fixed assets Domestic and foreign And if >10%, the specific country must be disclosed Major customers Customer revenues > 10% Total Revenues Segment which has those revenues Not required: customer identity Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

7: interim financial reporting Segment and Interim Financial Reporting 7: interim financial reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Accounting for Interim Periods Are interim reports “stand-alone” periods, or an integral part of the annual period? GAAP has concluded that an interim period is an integral part of the whole, and should be based on the same accounting principles and practices used in the annual financial statements. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Product Cost Modifications Companies that determine Cost of Goods Sold via a physical inventory may use the Gross Profit method for interim periods. LIFO inventory layers that are liquidated in an interim period may be expensed at current cost if the layer will be replaced by year end. Inventory market declines are not required to be recorded if the decline is temporary. Variances under a standard cost system that are expected to be absorbed by year end may be deferred at the interim date. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Other Interim Modifications Annual expenses may be allocated, such as property taxes or major annual repairs. Advertising expenses may be deferred to later interim periods if the benefits clearly apply. Income taxes from continuing operations use an estimated effective annual tax rate. Income taxes on unusual, infrequent, and other items are calculated separately and included in the interim period containing that item. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

8: interim-period income taxes Segment and Interim Financial Reporting 8: interim-period income taxes Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Estimated Annual Effective 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Interim Period Disclosures Sales or gross revenues Provision for taxes Extraordinary items, net of tax Net income and Comprehensive income Basic and Diluted EPS Seasonal revenues, costs, or expenses Significant changes in estimated taxes Disposals, extraordinary, unusual, or infrequent items Contingent items Changes in accounting principles or estimates Significant change in financial position Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Other Interim Disclosures Segment information disclosures are reduced for interim reporting Certain information about defined benefit pension plans Certain information about the use of fair value measurements, derivatives, and other financial instruments Information about impairments Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

SEC Interim Financial Disclosures SEC requires Q1, Q2, Q3 and annual reports Quarterly requirements similar to annual Comparative information Current quarter vs. prior year quarter Quarterly and year-to-date for current and prior year Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall