Advanced Accounting, Fifth Edition 14 Reporting for Segments and for Interim Financial Periods Advanced Accounting, Fifth Edition

Learning Objectives Understand the need for disaggregated financial data. Describe the basic requirements of public companies in reporting segmental data. Determine an operating segment. Define a reportable segment. Identify the information to be presented for each reportable segment.

Learning Objectives Explain when and what types of geographic data must be reported. Explain when information about major customers must be reported. Compare the international accounting standards for segmental reporting with the U.S. requirements. Describe current requirements for companies to report interim information. Indicate some problems with interim reporting and the authoritative position on the issue.

Need for Disaggregated Financial Data Users need information to determine conditions, trends, and ratios that assist in predicting cash flows of firms. Different industries or geographic areas have different rates of profitability, opportunities for growth, and types of risk. Disaggregated information is useful to assist in analyzing uncertainties surrounding expected cash flows. LO 1 The need for disaggregated financial data.

Standards of Financial Accounting and Reporting FASB ASC topic 280 (Segment Reporting): Segmental disclosures have limitations as well as strengths. Primary benefit - unveiling information. Arguments against segmental disclosures include: May be misleading due to accounting problems, lack of user knowledge, different measurement techniques. Disclosures to competing firms, labor unions, etc. Adds to already excessive amount of disclosures. LO 2 Basic disclosure requirements. LO 1 The need for disaggregated financial data.

Standards of Financial Accounting and Reporting Basic Disclosure Requirements (Management Approach): Objective is to facilitate consistency between internal and external reporting. Segmented by Product or service, Geographic area, Customer type, or Legal entity. Reporting Requirement Segmental profit or loss, Certain items of revenue and expense, Segmental assets, and Other items. LO 2 Basic disclosure requirements.

Standards of Financial Accounting and Reporting Common Cost Allocation Common costs should be allocated to a segment (external reporting purposes only) if they are included in the segment’s profit or loss calculations that are used internally by the chief operating decision maker. Two of the most difficult tasks in applying the segment disclosure requirements are those of determining An appropriate basis for the allocation of common costs and Appropriate operating segments LO 2 Basic disclosure requirements.

Standards of Financial Accounting and Reporting Question A component of an enterprise that may earn revenues and incur expenses, and about which management evaluates separate financial information in deciding how to allocate resources and assess performance is a(n) identifiable segment. operating segment. reportable segment. industry segment.

Standards of Financial Accounting and Reporting Operating Segment - Component of an enterprise that May earn revenues and incur expenses. Chief operating decision maker regularly reviews the component’s operating results. Discrete financial information is available. Reportable Segment Significant to an enterprise’s operations. Has passed one of three 10% tests or Determined to be reportable by other criteria. LO 3 Operating segment. LO 4 Reportable segment.

Standards of Financial Accounting and Reporting Determining Operating Segments Modified Management Approach Aggregation Criteria Quantitative Thresholds LO 3 Determine an operating segment.

Standards of Financial Accounting and Reporting Question An entity is permitted to aggregate operating segments if the segments are similar regarding the nature of the production processes. types or class of customers. methods used to distribute products or provide services. all of these. LO 3 Determine an operating segment.

Standards of Financial Accounting and Reporting Determining Operating Segments Aggregation Criteria - entity is permitted to aggregate operating segments that have similar economic characteristics and are similar in ALL the following: Nature of their products or services. Nature of the production processes. Types or class of customers. Methods used to distribute products or provide services. Nature of the regulatory environment. LO 3 Determine an operating segment.

Standards of Financial Accounting and Reporting Determining Operating Segments Quantitative Thresholds - Segment is reportable if it meets one or more of the following: Combined (external and internal) revenue is 10% or more of combined revenue of all reportable segments. Profit or loss is 10% or more of the greater absolute amount of: Combined profit of all segments not reporting a loss. Combined loss of all segments that reported a loss. Assets are 10% or more of the combined assets of all segments. LO 3 Determine an operating segment.

Standards of Financial Accounting and Reporting Problem 14-1: Significance Tests—Segmental Reporting Bacon Industries operates in seven different segments. Information concerning the operations of these segments for the most recent fiscal period follows:

Standards of Financial Accounting and Reporting Problem 14-1: Determine which of the segments must be treated as reportable segments. Revenue Test

Standards of Financial Accounting and Reporting Problem 14-1: Determine which of the segments must be treated as reportable segments. Operating Profit Test

Standards of Financial Accounting and Reporting Problem 14-1: Determine which of the segments must be treated as reportable segments. Identifiable Assets Test Summary: Segments 3, 4, 5, 6, and 7 are reportable segments.

Standards of Financial Accounting and Reporting Seventy-Five Percent Combined Revenue Test The combined revenue from sales to unaffiliated customers of all reportable segments must constitute at least 75% of the combined revenue from sales to unaffiliated customers of all operating segments. LO 4 Determine a operating segment. LO 3 Determine an operating segment.

Standards of Financial Accounting and Reporting Review Question To determine whether a substantial portion of a firm's operations are explained by its segment information, the combined revenue from sales to unaffiliated customers of all reportable segments must constitute at least 10% of the combined revenue of all operating segments. 75% of the combined revenue of all operating segments. 10% of the combined revenue from sales to unaffiliated customers of all operating segments. 75% of the combined revenue from sales to unaffiliated customers of all operating segments.

Standards of Financial Accounting and Reporting Problem 14-1 Data: 75% Test Nonaffiliated Revenue from reportable segments $176,100 Nonaffiliated revenue (reportable segments) $176,100 Total nonaffiliated revenue $184,300 = 95.6%

Standards of Financial Accounting and Reporting Information to be Presented For each reportable segments and in the aggregate for the segments not separately reported. General information. Operating profit or loss. Assets. Bases for measurement. Interim disclosures. Reconciliation of segment amounts and consolidated amounts for revenue, profit or loss, assets, and other significant items. Enterprise wide disclosures. Product or service. Geographic area. Major customer (10%). LO 5 Reportable segment information to be presented.

Standards of Financial Accounting and Reporting Geographic Areas Where operations in foreign countries are grouped into geographic areas, the groupings should consider proximity, economic affinity, similarities of business environments, and the nature, scale, and degree of interrelationship of the operations in the various countries. LO 6 Reporting on geographical areas.

Standards of Financial Accounting and Reporting Information about Major Customers If 10% or more of the revenue of a firm is derived from sales to any single customer, or If 10% or more of the revenue is derived from sales to the federal government, a state government, a local government, or a foreign government, that fact and the amount of revenue must be disclosed. LO 7 Reporting on major customers.

Standards of Financial Accounting and Reporting Review Question Which of the following is not a consideration in segment reporting for diversified companies? Consolidation policy. Defining the segments. Transfer pricing. Allocation of joint costs.

Interim Financial Reporting Interim financial statements are presented to provide information concerning financial status and progress for time periods of less than one year. Normal time period is a quarter of a year. Prepared for most recent interim period, as well as on a cumulative or year-to-date basis. May consists of statements of financial position, income, and cash flows. SEC requires public companies to file Form 10-Q. LO 9 Current interim reporting requirements.

Interim Financial Reporting Problems in Interim Reporting Seasonal nature of operations in many industries can cause wide fluctuations in revenues and expenses. Short time period to determine interim results. Some accountants hold that each interim period should stand alone (discrete view) as a basic accounting period. Other accountants view each interim period as essentially an integral part of the annual period. In response to SEC complaints and general pressure, the APB issued APB Opinion No. 28 in May 1973 (now included in FASB ASC topic 270, Interim Reporting). LO 10 Problems in interim reporting.

Interim Financial Reporting The Board concluded that “each interim period should be viewed as an integral part of an annual period”. Financial statements for each interim period should be based on accounting practices used for annual statements. Revenue should be recognized on same basis as used for the full year. Costs Associated with Revenue should be similarly treated for interim purposes. LO 10 Problems in interim reporting.

Interim Financial Reporting Acceptable alternatives for inventory costing: COGS can be estimated using gross profit rates. Liquidated LIFO base should be charged at replacement cost if expected to be replaced by year end. Inventory loss from market declines expected to recover before year end need not be recognized. Standard cost for determining inventory and product cost should be based on the procedures used for the fiscal year. LO 10 Problems in interim reporting.

Interim Financial Reporting Review Question Which of the following methods of inventory valuation is allowable at interim dates but not at year-end? Estimated gross profit rates. Retail method. Specific identification. Weighted average.

Interim Financial Reporting All Other Costs and Expenses (other than product costs) Charged to income as incurred or allocated based on an estimate of time expired, benefit received or activity associated with the periods. If not readily identified with activities or benefits should be charged when incurred. Arbitrary assignment of costs should not be made. Gains and losses that would not be deferred at year-end should not be deferred at interim periods. LO 10 Problems in interim reporting.

Interim Financial Reporting Review Question In considering interim financial reporting, how did the Accounting Principles Board conclude that such reporting should be viewed? As useful only if activity is evenly spread throughout the year so that estimates are unnecessary. As a “special” type of reporting that need not follow generally accepted accounting principles. As reporting of an integral part of an annual period. As reporting of a basic accounting period.

Interim Financial Reporting Provision for Income Taxes The basic technique for computing income tax provisions for interim financial statements is described in FASB ASC subtopic 740-270 (Income Taxes – Interim Reporting). At the end of each interim period the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The effective rate should reflect anticipated tax credits, foreign tax rates, percentage depletion, and other available tax planning alternatives. LO 10 Problems in interim reporting.

Interim Financial Reporting – Income Taxes Exercise 14-8: Spur Company’s actual earnings for the first two quarters of 2008 and its estimate during each quarter of its annual earnings are: Actual first-quarter earnings $ 400,000 Actual second-quarter earnings 510,000 First-quarter estimate of annual earnings 1,350,000 Second-quarter estimate of annual earnings 1,420,000 Spur Company estimated its permanent differences between accounting income and taxable income for 2008 as: Environmental violation penalties $ 25,000 Dividend income exclusion 180,000 The combined state and federal tax rate for 2008 is 42%.

Interim Financial Reporting – Income Taxes Exercise 14-8: Prepare journal entries to record Spur Company’s provisions for income taxes for the first two quarters of 2008. First Quarter x * ($1,195,000 x 42%) ** ($501,900 / $1,350,000)

Interim Financial Reporting – Income Taxes Exercise 14-8: Prepare journal entries to record Spur Company’s provisions for income taxes for the first two quarters of 2008. First Quarter Journal Entry Income Tax Expense 148,800 Income Tax Payable 148,800

Interim Financial Reporting – Income Taxes Exercise 14-8: Prepare journal entries to record Spur Company’s provisions for income taxes for the first two quarters of 2008. Second Quarter x * ($1,265,000 x 42%) ** ($531,300 / $1,420,000)

Interim Financial Reporting – Income Taxes Exercise 14-8: Prepare journal entries to record Spur Company’s provisions for income taxes for the first two quarters of 2008. Second Quarter Journal Entry Income Tax Expense 191,540 Income Tax Payable 191,540 1st 2nd 3rd 4th 1st Quarter tax provision = $148,800 2nd Quarter tax provision = $191,540 * Year-to-Date tax provision = $340,340 * $340,340 - $148,800

Interim Financial Reporting Accounting Changes in Interim Periods Changes in Estimate Accounted for in interim period when change is made. No restatement of previous interim reports. Effect on earnings disclosed for current and subsequent interim periods. Current GAAP requires retrospective application to financial statements of prior periods where practical. LO 10 Problems in interim reporting.

Interim Financial Reporting Minimum Disclosures in Interim Reports Gross revenues, provision for income taxes, extraordinary items (including related income tax effects), and net income. Basic and diluted earnings-per-share data. Seasonal revenue, costs, or expenses. Significant changes in estimates or provisions for income taxes. Disposal of a segment of a business and extraordinary, unusual, or infrequently occurring items. Contingent items. Changes in accounting principles or estimates. Significant changes in financial position. LO 10 Problems in interim reporting.

International Issues in Interim Reporting IAS 34, “Interim Financial Reporting”, does not state which entities should prepare and publish interim financial statements. The standard determines the minimum content of the interim reports if the entity elects or is required to prepare interim financial statements. IAS 34 generally requires that the interim period be a discrete reporting period. IAS 34 applies when an entity publishes an interim financial report in accordance with International Financial Reporting Standards (IFRS).

Differences between IFRS and US GAAP The view of an interim period is conceptually quite different under U.S. GAAP and under IFRS. Under IFRS, the interim period is defined as a discrete reporting period, with certain exceptions. Under U.S. GAAP, an interim period is an integral part of the full year (again, with certain exceptions).

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