© The McGraw-Hill Companies, Inc., 2004 Slide 8-1 McGraw-Hill/Irwin Chapter Eight Segment and Interim Reporting

© The McGraw-Hill Companies, Inc., 2004 Slide 8-2 McGraw-Hill/Irwin FASB Statement No Any single segment made up 90% of a company’s revenues, profit or loss, and identifiable assets. SFAS No. 14 provided that a company could avoid industry segment disclosures if... In 1996, McDonald’s reported having a dominant industry segment and avoided industry segment disclosure.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-3 McGraw-Hill/Irwin FASB Statement No. 131 The special AICPA Committee on Financial Reporting acknowledged that companies reporting a dominant segment were common... In 1997, the Committee’s work resulted in the issuance of SFAS No. 131 to address the shortcomings of SFAS no. 14 Continue

© The McGraw-Hill Companies, Inc., 2004 Slide 8-4 McGraw-Hill/Irwin Changes to required segment disclosures. Changes how segments are determined. FASB Statement No. 131 Disclosures about Segments of an Enterprise and Related Information

© The McGraw-Hill Companies, Inc., 2004 Slide 8-5 McGraw-Hill/Irwin FASB Statement No. 131 Uses the Management Approach to determine segments. Reportable segments must be operating segments of the company. Look at the internal reporting system for guidance. Segment information must be reported for each operating segment that meets one of three tests. Similar operating segments may be combined. Disclosures about Segments of an Enterprise and Related Information

© The McGraw-Hill Companies, Inc., 2004 Slide 8-6 McGraw-Hill/Irwin FASB Statement No. 131 How Management disaggregates the enterprise for decision- making purposes will determine which operating segments exists However, a segment is a component of a company:  That engages in business activities from which it earns revenues and incurs expenses  Whose operating results are regularly reviewed by management to assess performance and allocate resources  From which discrete financial information is available. Additionally (applicable in mixed structures): 1. an operating segment has a segment manager 2. If a matrix reporting structure exists e.g. by product and by geographical region, then the product segment is used What is an operating segment?

© The McGraw-Hill Companies, Inc., 2004 Slide 8-7 McGraw-Hill/Irwin FASB Statement No. 131 Five similarities must exist before combining segments: Nature of the products/services provided by each operating segment. Nature of the production process. Type or class of customer. Distribution methods. Nature of the regulatory environment. (if applicable) Disclosures about Segments of an Enterprise and Related Information See Comprehensive example for application of this

© The McGraw-Hill Companies, Inc., 2004 Slide 8-8 McGraw-Hill/Irwin Operating Segment Tests There are three tests for identifying a Reportable Industry Segment. 1.Revenue Test 2.Operating Profit/Loss Test 3.Identifiable Assets Test Only one test has to be satisfied for a segment to be reportable. There are three tests for identifying a Reportable Industry Segment. 1.Revenue Test 2.Operating Profit/Loss Test 3.Identifiable Assets Test Only one test has to be satisfied for a segment to be reportable.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-9 McGraw-Hill/Irwin Operating Segment Tests Revenue Test Does a segment’s total revenue equal or exceed 10% of the combined revenue of all the industry segments of the company? Note: Total revenue includes inter- segment sales.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-10 McGraw-Hill/Irwin Operating Segment Tests Profit or Loss Test Does the absolute amount of operating profit or loss for each segment equal or exceed 10% of the larger of the absolute value of the combined operating profit of all industry segments that did not incur an operating loss OR... the absolute value of the combined operating loss of all industry segments that incurred an operating loss? Note - If common costs (expenses) are not normally allocated among segments for internal reporting then they can be excluded when determining the segment profit/loss applicable for this test

© The McGraw-Hill Companies, Inc., 2004 Slide 8-11 McGraw-Hill/Irwin Operating Segment Tests Identifiable Assets Test Does a subunit’s identifiable assets equal or exceed 10% of the combined identifiable assets of all operating segments of the company?

© The McGraw-Hill Companies, Inc., 2004 Slide 8-12 McGraw-Hill/Irwin Operating Segment Tests Other Guidelines The combined external sales revenues of the disclosed segments must equal or exceed 75% of the total company external sales. (i.e. Inter-segment sales are excluded from this test) Segments must be added until the 75% test is met, even if the additional segments do not meet the reportable segment criteria. Do not disclose more than 10 segments. The combined external sales revenues of the disclosed segments must equal or exceed 75% of the total company external sales. (i.e. Inter-segment sales are excluded from this test) Segments must be added until the 75% test is met, even if the additional segments do not meet the reportable segment criteria. Do not disclose more than 10 segments. ¾

© The McGraw-Hill Companies, Inc., 2004 Slide 8-13 McGraw-Hill/Irwin Operating Segment Tests Reportable Segment information is reported in the Notes to the Financial Statements. Required information includes:  Segment Revenue  Segment Operating Income (or Loss)  Identifiable Segment Assets  Other related disclosures Reportable Segment information is reported in the Notes to the Financial Statements. Required information includes:  Segment Revenue  Segment Operating Income (or Loss)  Identifiable Segment Assets  Other related disclosures

© The McGraw-Hill Companies, Inc., 2004 Slide 8-14 McGraw-Hill/Irwin Operating Segments Example Examine the information for Rapid Send, Inc. Test each product line to determine whether it must be disclosed as a reportable segment.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-15 McGraw-Hill/Irwin Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-16 McGraw-Hill/Irwin Operating Segments Example Enter the revenue for each segment.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-17 McGraw-Hill/Irwin Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-18 McGraw-Hill/Irwin Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-19 McGraw-Hill/Irwin Operating Segments Example Enter the absolute value of the profit or loss for each segment.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-20 McGraw-Hill/Irwin Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-21 McGraw-Hill/Irwin Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-22 McGraw-Hill/Irwin Operating Segments Example Enter total assets for each segment.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-23 McGraw-Hill/Irwin Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-24 McGraw-Hill/Irwin Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-25 McGraw-Hill/Irwin Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-26 McGraw-Hill/Irwin Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-27 McGraw-Hill/Irwin The Parts segment did not meet any of the three tests and so it is not reportable. Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-28 McGraw-Hill/Irwin In addition, the 75% test must be met. Total revenues, excluding inter-segment revenues, are $1,265, % of $1,265,000 is $948,750. Combined sales, excluding inter-segment sales, for the Clothing, Home, Car, and Food segments is $1,195,000. $1,195,000 > $948,750 Therefore, no other segments must be reported. In addition, the 75% test must be met. Total revenues, excluding inter-segment revenues, are $1,265, % of $1,265,000 is $948,750. Combined sales, excluding inter-segment sales, for the Clothing, Home, Car, and Food segments is $1,195,000. $1,195,000 > $948,750 Therefore, no other segments must be reported. Operating Segments Example

© The McGraw-Hill Companies, Inc., 2004 Slide 8-29 McGraw-Hill/Irwin Reconciliation of Segment Information The company must prepare a reconciliation between the reportable segment’s 1.Revenues and consolidated revenues 2.Profit or loss and the Company’s income before tax as a whole 3.Assets and the Company’s total assets Adjustments and eliminations must be identified The company must prepare a reconciliation between the reportable segment’s 1.Revenues and consolidated revenues 2.Profit or loss and the Company’s income before tax as a whole 3.Assets and the Company’s total assets Adjustments and eliminations must be identified

© The McGraw-Hill Companies, Inc., 2004 Slide 8-30 McGraw-Hill/Irwin Other Enterprise Disclosures 1. Products & Services 2. Geographic Areas 3. Major Customers The company must also disclose additional information regarding...

© The McGraw-Hill Companies, Inc., 2004 Slide 8-31 McGraw-Hill/Irwin Disclosures about Products and Services In 2001, Lowes made product disclosures even though they reported one dominant segment. SFAS No. 131 requires disclosure of revenues derived from transactions with external customers from each product or service if operating segments have not been determined based on differences in products and services.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-32 McGraw-Hill/Irwin Disclosures about Geographic Areas (1) Revenues from external customers and (2) long-lived assets must be disclosed for … 1.The domestic country. 2.All foreign countries in which the enterprise derives revenues or holds assets. 3.Each foreign country in which a material amount of consolidated (i.e. external) revenues is derived or assets are held. (1) Revenues from external customers and (2) long-lived assets must be disclosed for … 1.The domestic country. 2.All foreign countries in which the enterprise derives revenues or holds assets. 3.Each foreign country in which a material amount of consolidated (i.e. external) revenues is derived or assets are held. In 1998, IBM reported that 44% of their revenues came from the U.S. and 10% came from Japan. Profit/ loss is no longer required as was the case with SFAS14

© The McGraw-Hill Companies, Inc., 2004 Slide 8-33 McGraw-Hill/Irwin Disclosures about... 3.Major Customers In 2001, Briggs & Stratton reported significant sales to three “major engine customers...” Whenever 10% or more of a company’s consolidated revenues is derived from a single customer The company must disclose that it has a “major” customer. The IDENTITY of the “major” customer does not have to be disclosed. Whenever 10% or more of a company’s consolidated revenues is derived from a single customer The company must disclose that it has a “major” customer. The IDENTITY of the “major” customer does not have to be disclosed. BRIGGS & STRATTON

© The McGraw-Hill Companies, Inc., 2004 Slide 8-34 McGraw-Hill/Irwin Interim Reporting - APB Opinion 28 Mandatory for SEC Companies: Interim = Quarterly Requires that interim periods be treated as “integral” parts of the fiscal period. Expenses, such as bonuses, must be predicted early in the year and allocated to each of the interim reporting periods. Mandatory for SEC Companies: Interim = Quarterly Requires that interim periods be treated as “integral” parts of the fiscal period. Expenses, such as bonuses, must be predicted early in the year and allocated to each of the interim reporting periods.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-35 McGraw-Hill/Irwin Interim Reporting: 1-Revenues Revenues are recognized in the interim periods in which they are earned. Revenue from long-term contracts should be recognized on the % of completion basis. Losses from long-term contracts should be recognized fully in the interim period in which they become apparent.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-36 McGraw-Hill/Irwin Interim Reporting: 2-Inventory and Cost of Goods Sold LIFO Liquidations Interim period gross profit should not reflect gains resulting from “temporary” LIFO liquidations. LIFO Liquidations Interim period gross profit should not reflect gains resulting from “temporary” LIFO liquidations. Standard Costing Variances that are expected to be absorbed by year-end should not be recognized in the interim period. Lower -of-Cost-or-Market Inventory write-downs should be reflected in interim period numbers if the market value is not expected to recover by year- end. Lower -of-Cost-or-Market Inventory write-downs should be reflected in interim period numbers if the market value is not expected to recover by year- end.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-37 McGraw-Hill/Irwin Interim Reporting: 3-Other Issues Extraordinary Items If material (when compared to expected income for the year), disclose separately. Extraordinary Items If material (when compared to expected income for the year), disclose separately. Income Taxes Interim tax should be computed at an estimated annual effective tax rate. Income Taxes Interim tax should be computed at an estimated annual effective tax rate. Cumulative Effect of an Accounting Change Accounting changes occurring at any time during the year should be retroactively reported in the 1st interim period. Cumulative Effect of an Accounting Change Accounting changes occurring at any time during the year should be retroactively reported in the 1st interim period. Hey, pal! You getting’ this down? To the extent possible, annual costs should be accrued at interim periods

© The McGraw-Hill Companies, Inc., 2004 Slide 8-38 McGraw-Hill/Irwin Interim Reporting Other Items Expenses not directly matched with revenues should be charged to income in the interim period in which they occur. Income Taxes for each interim period should be computed based on an estimated annual effective tax rate. Extraordinary Items should be reported separately and in full in the interim period in which they occur.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-39 McGraw-Hill/Irwin Interim Reporting SFAS No. 3 Cumulative Effect of Accounting Changes Reported in full in the FIRST interim period of the fiscal year. Even if the change occurs in a later interim period, the FIRST period must be restated to include the cumulative effect of the accounting change.

© The McGraw-Hill Companies, Inc., 2004 Slide 8-40 McGraw-Hill/Irwin Interim Reporting: Minimum Disclosures EPS Seasonal Revenues & Expenses Significant changes in estimates Disposal of a segment Changes in accounting principles Contingent items Sales, income taxes, extraordinary items, cum effect of change in accounting principles and net income

© The McGraw-Hill Companies, Inc., 2004 Slide 8-41 McGraw-Hill/Irwin THE END 1.The following segment information is required for interim reports: External revenues Inter-segment revenues Segment profit or loss Total assets 2.A reconciliation to the company totals (where applicable) is still required 3.Segment information is not required until the second year that a company applies SFAS131