Advanced financial accounting by baker chapter 13

Segment Reporting Accounting Issues • International Financial Reporting Standards for operating segments – IFRS 8 specifies segment reporting – This standard requires disclosure of info

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Segment and

Interim Reporting

13

Segment Reporting Accounting Issues

• FASB 131 - A management approach to the definition of segments

– Focus on financial information that an

enterprise’s financial decision makers use to evaluate the entity’s operating segments

Segment Reporting Accounting Issues

• FASB 131 defines an operating segment as having

three characteristics:

1 The component unit’s business activities generate

revenue and incur expenses, including any revenue or expenses in transactions with other business units of the company

2 The component unit’s operating results are regularly

reviewed by the entity’s chief operating decision maker, who then determines the resources to be assigned to the segment and evaluates it

3 Separate financial information is available for the

component unit

Segment Reporting Accounting Issues

• Issues

– Generally, the corporate headquarters is not a

separate operating segment– The company may choose to aggregate

several individual operating segments that have very similar economic characteristics – Management belief that aggregation will

provide more meaningful information to users– Allocation of costs to specific segments

Segment Reporting Accounting Issues

• International Financial Reporting Standards for operating

segments

– IFRS 8 specifies segment reporting

– This standard requires disclosure of

information about an entity’s reportable operating segments both in its annual and its interim financial statements

– International standards are similar to those of

U.S GAAP although there are several differences

Information about Operating Segments

• 10 percent quantitative thresholds:

• Separate disclosures required for segments meeting at least one

of the following tests:

1 10 percent revenue test

2 10 percent profit (loss) test

3 10 percent assets test

Information about Operating Segments

• 10 percent revenue test

– Applied to each operating segment’s total

revenue as a percentage of the combined revenue of all segments before elimination of intersegment transfers and sales

– If an operating segment’s total revenue is 10

percent or more of the combined revenue of all segments, then the segment is separately reportable and supplementary disclosures must be provided for it in the annual report

Information about Operating Segments

• 10 percent profit (loss) test

– Determine whether a segment’s profit or loss

is equal to or greater than 10 percent of the absolute value of either the combined

operating profits or the combined operating losses of the segments, whichever is greater

Information about Operating Segments

• 10 percent assets test

– Determine if the segment’s assets are 10

percent or more of the total assets of all operating segments

– Items composing each segment’s assets are

defined by management, as used for internal decision-making purposes

Information about Operating Segments

• Comprehensive disclosure test

– 75 percent consolidated revenue test

– Applied after determining which segments are

reportable under any of the 10 percent tests– The total revenue from external sources by all

separately reportable operating segments must equal at least 75 percent of the total consolidated revenue

Information about Operating Segments

• Other considerations

– An upper limit of about 10 segments is used

– Above this, a company should consider

aggregating the closely related segments

Information about Operating Segments

• Other considerations

– Exercising judgement in determining segments

• Companies should separately report segments that have

been reported in prior years but fail the current period’s significance tests because of abnormal occurrences

• Companies need not separately report a segment that has

met a 10 percent test on a one-time basis only

• If a segment becomes reportable in the current period but

has not been reported separately in earlier periods, the prior years’ comparative segment disclosures, which are included in the current year’s annual report, should be restated

Information about Operating Segments

• Information to be disclosed for a segment determined to be

separately reportable:

– General information

– Amounts for each separately reportable

segment– Measures of segment profit or loss

– Segment assets

– Reconciliations to consolidated totals

Enterprisewide Disclosures

• FASB 131 established enterprisewide disclosure standards to

provide users more information about the risks of the company

– Typically made in a footnote to the financial

statements

Enterprisewide Disclosures

• Information about products and services

– A company is required to report the revenues

from external customers for each major product and service, or each group of similar products and services, unless it is

impracticable for it to do so– The reason for this requirement is that the

company may have organized its operating segments on a basis different from its product lines

Enterprisewide Disclosures

• Information about geographic areas

• If practical to do, the company must report:

– Revenues from external customers attributed

to the company’s home country of domicile and the revenue from external customers attributed to all foreign countries in which the enterprise generates revenues

an individual country are material, then the revenues for that country shall also be separately disclosed

Enterprisewide Disclosures

• Information about geographic areas

– Long-lived productive assets located in the

entity’s home country of domicile and the total assets located in all foreign countries in which the entity holds assets

material, then the amount of assets held in that specific country shall also be disclosed

separately– FASB 131 specified no materiality threshold

for specific country disclosures

Enterprisewide Disclosures

• Information about major customers

– Defining an individual customer

– An individual customer could be:

state government, a local government, or a foreign government

– Materiality is not defined, but the 10 percent

guideline has gained the support of practice

Interim Financial Reporting

• Interim reports cover a time period of less than one year

– Publicly held companies are required to

publish quarterly reports – The quarterly report is, in many ways, a

smaller version of the annual report

Interim Financial Reporting

• Form 10-Q is the SEC’s quarterly report

– This must be filed within 35 days after the end

of each of the first three quarters for publicly owned companies classified as “accelerated filers”

– Quarterly financial statements need not be

audited– Selected quarterly financial data must be

reported in a footnote in the annual financial report

The Format of the Quarterly Financial

Report

• Items in quarterly financial reports:

1 An income statement for the most recent

quarter of the current fiscal period and a comparative income statement for the same quarter for the prior fiscal year

2 Income statements for the cumulative

year-to-date time period and for the corresponding period of the prior fiscal year

3 A condensed balance sheet at the end of the

current quarter and a condensed balance

The Format of the Quarterly Financial

Report

• Items in quarterly financial reports (cont.):

4 A statement of cash flows as of the end of the

current cumulative year-to-date period and for the same time span for the prior year

5 Footnotes that update those in the last annual

report

6 A report by management analyzing and

discussing the results for the latest interim period

Accounting Issues

• Interim reporting presents several technical and conceptual

measurement issues

– Most of these center on the accounting

concept of periodicity and the division of the annual period into interim periods

Accounting Issues

• Discrete versus Integral view

– The discrete theory of interim reporting views

each interim period as a basic accounting period to be evaluated as if it were an annual accounting period

– Any end-of-period adjustments and deferrals

are determined using the same accounting principles used for the annual report

Accounting Issues

• Discrete versus Integral view

– The integral theory of interim reporting views

an interim period as an installment of an annual period

– Recognition and adjustment of certain income

or expense items may be affected by judgments about the expected results of the entire year’s operations

• The integral view was selected by APB as the primary theory for

interim reporting

Accounting Issues

• Accounting pronouncements on interim reporting

– APB 28 - Standardized the preparation and

reporting of interim income statements

– FASB 154 - Specifies that a change in an

accounting principle made in an interim period

is reported using the retrospective application

to the prechange interim periods for the direct effects of the change

Accounting Issues

• Accounting pronouncements on interim reporting

– FIN 18 - Tackles the problems of measuring

the tax provision for interim reports when the actual tax expense is based on annual income

– IAS 34 - International Financial Reporting

Standards for interim reporting; similar to those of U.S GAAP

Reporting Standards for Interim Income

Statements

Reporting Standards for Interim Income

Statements

• Revenue

– The measurement basis used in an interim

period should be the same as that used for the full fiscal year

– Revenue from seasonal businesses cannot be

manipulated to eliminate seasonal trends

Reporting Standards for Interim Income

Statements

• Cost of goods sold and inventory

– General rule: Interim cost of goods sold

should be computed with the direct and allocated cost elements on the same basis as used to compute the annual cost of goods

sold

– APB 28 does permit the following practical

modifications to this rule:

Reporting Standards for Interim Income

Statements

• All other costs and expenses

– General principle: Costs and expenses should

be charged to interim income in the interim period in which they are incurred

– Some costs and expenses however, are

allocated among the interim periods based on:

Reporting Standards for Interim Income

Statements

• Income taxes in interim periods

– The first step is to determine the effective

annual tax rate for use in computing the interim income tax provision

– The estimated rate includes all anticipated tax

credits, state income taxes, foreign income taxes, capital gains taxes, and other tax

planning efforts expected for the full fiscal– The estimate is updated each interim period

and the interim tax provision or benefit is then determined

Reporting Standards for Interim Income

Statements

Income taxes in interim periods

– Items such as unusual or infrequent events,

discontinued operations, and extraordinary items are not included in the estimate

– Differences between book and tax income

– Loss carryback and carryforward provisions

apply only to annual results, not to interim

Reporting Standards for Interim Income

Statements

• Disposal of a component or extraordinary, unusual, infrequently

occurring, and contingent items

– Measurement and reporting on the same

bases as used to prepare the annual report– Extraordinary items, discontinued operations,

and unusual and infrequently occurring items should be reported in the interim period in

which they occur – The materiality test for extraordinary items

should be based on the income estimate for the entire fiscal year

Reporting Standards for Interim Income

Statements

– The materiality test for discontinued

operations and unusual and infrequent transactions should be based on the operating income of the interim period in which the

discontinued operations are first reported– Contingencies that could affect the company

also must be disclosed on the same basis as that used in the annual report

Accounting Changes in Interim Periods

• Change in an accounting principle

– Requires retrospective application

– Only the direct effects of the change, including

any related tax effects, are included in the retrospective application

– A change from an accounting principle not

generally accepted to a generally accepted accounting principle is a correction of an error, requiring restatement of all prior financial

statements

Accounting Changes in Interim Periods

• Change in an accounting estimate

– The result of new information that becomes

available to the entity– These changes are reported on a current and

prospective basis only

Accounting Changes in Interim Periods

• Change in a reporting entity

– Requires retrospective application

– Primary examples of changes are:

statements rather than individual statements for the separate entities

the consolidated entity for which consolidated financials are presented

combined financial statements

Accounting Changes in Interim Periods

• International Financial Reporting Standards for accounting

changes

– IAS 8 provides the accounting treatment and

disclosures for changes in accounting policies, changes in accounting estimates, and

corrections of errors– The international standards for these changes

are very similar to U.S GAAP