1. Chapter Eight Segment and Interim Reporting McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Rationale for Segment and Interim Reporting Increased diversification through corporate mergers made financial statement analysis difficult Demand built for “disaggregated” information, according to natural business “segments” Because of seasonality and the increasing appetite for current information, demand built for interim disclosure 8-2

3. Opposition to Additional Disclosure Cost to generate data Additional reporting burden Fear of disclosing information to competitors Pressure on short-term results based on interim information 8-3

4. Industry Segments Domestic & Foreign Ops Export Sales Major Customers FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise (December 1976) 8-4

5. SFAS 14, Industry Segment Disclosures For each reportable segment, a company was required to disclose: Revenues. Operating profit or loss. Identifiable assets. Aggregate amount of depreciation, depletion and amortization expense. Capital expenditures. Equity in the net income from an investment in the net assets of equity investees. For each reportable segment, a company was required to disclose: Revenues. Operating profit or loss. Identifiable assets. Aggregate amount of depreciation, depletion and amortization expense. Capital expenditures. Equity in the net income from an investment in the net assets of equity investees. 8-5

6. Advantages of basing segments on internal organization structure Reflects the risks and opportunities that management believes to be important Seeing the company from the perspective of management improves analysts’ ability to predict management actions which might significantly impact future cash flows Minimal incremental cost of producing segment information Less subjective segmentation 8-6

7. Evidence of Segment Information Usefulness Improved analytical accuracy in predicting consolidated sales and earnings Greater consensus in analysts’ forecasts of sales and earnings Segment revenue data appear to be more useful than segment earnings data in forecasting Geographic data used to assess the risk of foreign operations This increased the analysts’ appetite for MORE segment disclosure! 8-7

8. FASB Statement No. 14 Domestic & Foreign Operations Disclosures For domestic operations and operations in each significant foreign geographic area, disclosure was required for: Revenues Operating profit or loss Identifiable assets For domestic operations and operations in each significant foreign geographic area, disclosure was required for: Revenues Operating profit or loss Identifiable assets 8-8

9. SFAS 14, Disclosures Related to Export Sales and Major Customers Export Sales: A company was required to disclose for domestic operations the amount of revenue from exporting products to unaffiliated customers in foreign countries. Major Customers: A company was required to disclose the amount of revenue derived from sales to each major customer (but not the identity of these customers!) Export Sales: A company was required to disclose for domestic operations the amount of revenue from exporting products to unaffiliated customers in foreign countries. Major Customers: A company was required to disclose the amount of revenue derived from sales to each major customer (but not the identity of these customers!) 8-9

10. FASB Statement No. 131... 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. 8-10

11. 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 8-11

12. FASB Statement No. 131 The objective of segment reporting is to help financial statement users:  Better understand the enterprise’s performance  Better assess prospects for future net cash flows  Make more informed judgements about the enterprise as a whole 8-12

13. Changes to required segment disclosures. Changes how segments are determined. FASB Statement No. 131 Disclosures about Segments of an Enterprise and Related Information 8-13

14. FASB Statement No. 131 Uses the “Management Approach” to determine segments. Reportable segments must be operating segments of the company. Looks 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 8-14

15. FASB Statement No. 131 An “operating segment” is a component of an enterprise:  That engages in business activities from which it earns revenues and incurs expenses  Whose operating results are regularly reviewed by the chief operating decision maker to assess performance and make resource allocation decisions  For which discrete financial information is available 8-15

16. FASB Statement No. 131 Five similarites 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. Disclosures about Segments of an Enterprise and Related Information 8-16

17. Operating Segment Tests There are three quantitative tests for identifying a Reportable Industry Segment:  Revenue Test  Profit or Loss Test  Asset Test Only one of the three has to be satisfied for a segment to be reportable. There are three quantitative tests for identifying a Reportable Industry Segment:  Revenue Test  Profit or Loss Test  Asset Test Only one of the three has to be satisfied for a segment to be reportable. 8-17

18. 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 intersegment sales.) 8-18

19. 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 reported profit of all profitable segments OR... the absolute value of the combined reported loss of all segments that incurred a loss? 8-19

20. Operating Segment Tests Identifiable Assets Test Do a segment’s identifiable assets equal or exceed 10% of the combined identifiable assets of all operating segments of the company? 8-20

21. Operating Segment Tests Other Guidelines The combined sales revenues of the disclosed segments must equal or exceed 75% of total company sales. (Intersegment sales are excluded from the total.) Segments must be added until the 75% test is met, even if the additional segments do not meet the reportable segment criteria. (Firms are advised not to disclose more than 10 segments) The combined sales revenues of the disclosed segments must equal or exceed 75% of total company sales. (Intersegment sales are excluded from the total.) Segments must be added until the 75% test is met, even if the additional segments do not meet the reportable segment criteria. (Firms are advised not to disclose more than 10 segments) ¾ 8-21

22. 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 8-22

23. Operating Segments - Example Examine the information for Vitesse, Inc. Test each division to determine whether it must be disclosed as a reportable segment. 8-23

24. Operating Segments - Example 8-24

25. Operating Segments - Example Vitesse, Inc. Division Information, 12/31/08 Business Segments (in thousands of $) Retail Parts Delivery Car Clothing 120 150 265 955 140 (17) 4 15 5 (40) Net sales (including intersegment sales) Net income (loss) 8-25

26. Operating Segments - Example Enter the revenue for each segment (including intersegment sales) 8-26

27. Operating Segments Example 8-27

28. Operating Segments Example Enter the absolute value of the profit or loss for each segment. 8-28

29. Operating Segments - Example 8-29

30. Operating Segments - Example 8-30

31. Operating Segments - Example Enter total assets for each segment. 8-31

32. Operating Segments - Example 8-32

33. Operating Segments - Example 8-33

34. Operating Segments - Example 8-34

35. Operating Segments - Example 8-35

36. The Parts Division did not meet any of the three tests, so it is not reportable. Operating Segments - Example 8-36

37. In addition, the 75% test must be met. Total revenues, excluding intersegment revenues, are $1,265,000. 75% of $1,265,000 is $948,750. Combined sales, excluding intersegment sales, for the Retail, Delivery, Car, and Clothing 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 intersegment revenues, are $1,265,000. 75% of $1,265,000 is $948,750. Combined sales, excluding intersegment sales, for the Retail, Delivery, Car, and Clothing segments is $1,195,000. $1,195,000 > $948,750 Therefore, no other segments must be reported. Operating Segments - Example 8-37

38. Other Enterprise Disclosures Products & Services Geographi c Areas Major Customers The company must also disclose additional information regarding... 8-38

39. Disclosures about... Products and Services 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. 8-39

40. Disclosures about... Geographic Areas Revenues from external customers and 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 revenues is derived or assets are held. Revenues from external customers and 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 revenues is derived or assets are held. 8-40

41. Disclosures about... Major Customers In 2006, Briggs & Stratton reported significant sales to three “major engine customers...” Whenever 10% or more of a company’s revenues is derived from a single customer...... The company must disclose that it has a “major” customer. The IDENTITY of the “major” customer need not be disclosed. Whenever 10% or more of a company’s revenues is derived from a single customer...... The company must disclose that it has a “major” customer. The IDENTITY of the “major” customer need not be disclosed. BRIGGS & STRATTON 8-41

42. Interim Reporting To provide more timely information The SEC requires quarterly statements from publicly traded companies in the U.S. Two possible approaches:  Discrete  Integral APB Opinion No. 28 (issued in 1973) provides a primarily integral approach 8-42

43. Interim Reporting APB Opinion 28 Integral approach means that information is presented as a portion of the longer period. Expenses, such as bonuses, must be predicted early in the year and allocated to each of the interim reporting periods. Provides for less volatility of information Integral approach means that information is presented as a portion of the longer period. Expenses, such as bonuses, must be predicted early in the year and allocated to each of the interim reporting periods. Provides for less volatility of information 8-43

44. Interim Reporting Revenues Revenues are recognized in the interim periods in which they are earned. Revenues from long-term contracts should be recognized in the interim periods in the same way as on the annual basis. Losses from long-term contracts should be recognized fully in the interim period in which they become apparent. 8-44

45. Interim Reporting 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. 8-45

46. Interim Reporting – Other Items Expenses not directly matched with revenues should be charged to income in the interim period in which they occur (unless they can be identified with activities or benefits of other periods, in which case they should be reasonably allocated.) Extraordinary Items should be reported separately and in full in the interim period in which they occur. 8-46

47. Interim Reporting - Other Items Cumulative effects of a change in accounting principles should be reported as if they occurred in the first interim period. (This may required restatement) Income Taxes for each interim period should be computed based on an estimated annual effective tax rate. 8-47

48. Interim Reporting Minimum Disclosures EPS Seasonal Revenues & Expenses Significant changes in estimates Disposal of a segment Changes in accounting principles Contingent items 8-48

49. Interim Reporting – Segment Disclosures SFAS 131 requires the following interim disclosure for each operating segment:  Revenues from external customers  Intersegment revenues  Segment profit or loss  Total assets (if there has been a material change from the last annual report) SFAS 131 does NOT require interim disclosure about major customers or geographic areas 8-49

50. Summary Disaggregated information allows users to “pierce the camouflage” of consolidated statements Currently, FASB advocates a “management approach” to disclosing segment information Three quantitative tests are applied to identify reportable segments With interim reporting, an integral approach is adopted 8-50

51. Possible Criticisms Some critics argue that increased globalization eliminates the need for separate disclosure of foreign operations While the FASB requires the disclosure of major customers, it does not require their identity to be disclosed Some critics argue that a discrete approach to interim reporting would be more appropriate WHAT DO YOU THINK ????? 8-51