Solution manual advanced accounting 4e jeter ch14

An operating segment is a significant segment if it meets one or more of the following tests: a Its combined external and internal revenue is 10% or more of the combined external and in

CHAPTER 14

ANSWERS TO QUESTIONS

1 Segmented financial reports would have the most significance for a highly diversified company because the industries in which the company operates may have widely different rates of profitability, degrees of risk, and opportunities for growth Thus, investors need information about these operating segments in order to make informed decisions

2 Financial statement users need information about segments of a firm to aid in evaluating prospective investments Different industries may have different rates of profitability, opportunities for growth, and types of risk Segmented financial data aid the investor in determining the uncertainties surrounding the timing and amount of expected future cash flows and, therefore, aid in assessing the related risk of an investment

3 Operating segment A component of an enterprise that may earn revenues and incur expenses,

about which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance

Reportable segment A segment considered to be significant to an enterprise’s operations;

specifically, one that has passed one of three 10% tests or has been identified as being reportable through other criteria (aggregation, for example)

4 A segment is an operating segment if it possesses the following characteristics It engages in

business activities that may earn revenues and incur expenses (including transactions with other components of the entity) The entity’s chief operating decision maker (may be one individual or a group of executives) regularly reviews the component’s operating results to assess its performance and make decisions about resources to be allocated to it Discrete financial information is available

An operating segment is a significant segment if it meets one or more of the following tests:

a) Its combined external and internal revenue is 10% or more of the combined external and

internal revenue of all reportable segments

b)The absolute amount of its reported profit or loss is 10% or more of the greater absolute amount

of:

- the combined reported profit of all operating segments not reporting a loss

- the combined reported loss of all operating segments that reported a loss

c) Its assets are 10% or more of the combined assets of all operating segments

5 (a) Product or service disclosures: revenues from external customers for each product or service

or group of products or services, on the same basis as the general-purpose financial statements This disclosure is not required if the reportable segments are structured around products or services

(b) Geographic area disclosures: revenues from external customers and long-lived assets for the

firm’s country of domicile and for all other countries in total, also on the same basis as the general

purpose financial statements; and revenues from external customers and long-lived assets for each

foreign country or group of foreign countries, if material, along with the basis for allocating

revenues (location of customer, where shipped, etc.) These disclosures are generally not required if

the company’s reportable segments have been organized around geographic area

(c) Major customer disclosures: information about major customers for each customer

representing 10% or more of total enterprise revenues, including the amount of revenues and the

segment(s) to which the revenue is traceable A group of customers under common control is treated as a single customer, as are the various agencies of a government

6 SFAS No 131 requires that segmental disclosures be included in interim reports The extent of the

disclosures depends upon whether the firm presents a complete set of financial statements for the interim period, or condensed financial statements If the firm presents a complete set of statements, the interim disclosures are the same as presented above for reportable segments If condensed statements are presented for interim periods, they should include the following for each reportable segment: revenues, including intersegment sales; profit or loss; disclosures of any changes in measurement bases for segmentation or components of profit or loss since the most recent annual report; any material changes in assets since the most recent annual report; and a reconciliation of income from continuing operations for the consolidated entity and for the total of the reportable segments

7 Although the normal segment information disclosures need not be made, the financial statements should identify the industry in which the major portion of the firm’s operations takes place

8 The following items are disclosed only if they are included in the measures reviewed by the chief

operating decision maker: revenues from external customers, revenues from other segments, interest revenue and expense, depreciation, depletion, and amortization expense, income tax expense, equity income from investments, extraordinary items, other unusual items, and other significant noncash items

9 Information about the reportable segments of a firm may be included in its financial statements in any of the following ways:

a Within the body of the financial statements, with appropriate explanatory disclosures in the footnotes to the financial statements

b Entirely in the footnotes to the financial statements

c In a separate schedule that is included as an integral part of the financial statements

10 The types of information that must be disclosed for each foreign country or geographic area (and for domestic operations) are:

a Revenue, with separate disclosure of sales to nonaffliliates and intracompany sales or transfers, along with the basis of accounting for intracompany sales and transfers and the nature and effect

of any change in method

b Operating profit or loss, or some other measure of profitability A common measure of profitability must be used for all countries and/or geographic areas presented

c Identifiable assets, using the same procedures for presenting operating segment information

11 Foreign operations are defined as those located outside the United States (or other “home country”) that produce revenue from sales to unaffiliated customers or from intra-enterprise sales or transfers

between countries or geographic areas Foreign operations do not, however, include unconsolidated

subsidiaries and investees If operations are conducted in two or more foreign countries or geographic areas, information must be presented separately for each significant foreign country or geographic area and in the aggregate for all other foreign operations Where the operations of some foreign countries are grouped into geographic areas, the groupings should be made on the basis of a consideration of (1) proximity, (2) economic affinity, (3) similarities of business environments, and (4) the nature, scale, and degree of interrelationship of the operations in the various countries

12 Factors to be considered in grouping foreign operations into geographic areas are (1) proximity, (2) economic affinity, (3) similarities of business environments, and (4) the nature, scale, and degree of interrelationship of the operations in the various countries

13 To provide information about the potential effects of dependency on one or more major customers,

if 10% or more of the revenue of a firm is derived from sales to any single customer, that fact and

the amount of revenue from each such customer must be disclosed Also, 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 Disclosure should

include the amount of sales to each customer and the reportable segment making the sales Customer's names, however, need not be disclosed These disclosures are required even if the firm has only one reportable segment

14 Common costs Operating expenses incurred by the enterprise for the benefit of more than one

segment

General corporate expense An expense incurred for the benefit of the corporation as a whole,

which cannot be reasonably allocated to any segment

15 The purpose of interim financial reporting is to present timely information for use by external users

of financial statements Publicly owned companies prepare quarterly reports that must be filed with the stock exchanges on which their stock is listed, and with the Securities and Exchange Commission

16 Accountants who support the view that each interim period should stand alone as a basic accounting period believe that deferrals, accruals, and estimates at the end of each interim period should be determined by following essentially the same principles and judgments that apply to annual periods

Accountants who view interim periods as integral parts of annual periods believe that deferrals, accruals, and estimates at the end of each interim period should be affected by judgments made at the interim date as to results of operations for the balance of the annual period

17 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 rate determined should be used in providing for income taxes on a current year-to-date basis, giving effect to expected investment tax credit, foreign tax rates, percentage depletion, capital gain rates, and other available tax planning alternatives

18 Change in estimates should be accounted for in the interim period in which the change is made

19 Minimum disclosure requirements for interim reports are:

(a) Sales or gross revenues, provisions for income taxes, extraordinary items, cumulative effect of

a change in accounting principle, and net income;

(b) Basic and diluted earnings per share;

(c) Seasonal revenue, cost and expenses;

(d) Changes in estimates;

(e) Effect of a disposal of a segment;

(f) Contingencies;

(g) Changes in accounting principles;

(h) Significant changes in financial position

20.The general rule is that costs and expenses that are associated directly with or allocated to the

products sold or to the services rendered for annual reporting purposes should be treated in a similar manner for interim reports

BUSINESS ETHICS SOLUTIONS

Business ethics solutions are merely suggestions of points to address The objective is to raise the students' awareness of the topics, and to invite discussion In most cases, there is clear room for disagreement or conflicting viewpoints

1 Information to be presented for each of a firm’s reportable segments:

General information

Information about segment operating profit or loss

Information about segment assets

Information about the bases for measurement

Reconciliation (IAS 14 vs SFAS 131) of segment amounts and consolidated amounts for revenue, profit or loss, assets, and significant other items

Interim disclosures

Enterprise-wide disclosures

1 Product or service disclosures

2 Geographic area disclosures

3 Major customer disclosures

2 Since the management currently measures profit and losses and asset allocation by restaurant

concept, an abrupt change to presenting the segment information by geographical location only could be viewed as unethical However, this area is one where the standards clearly leave the door open for subjectivity in interpretation If management has a motivation for preferring to keep the information about the poorly performing restaurant private that is not counter to the objectives of the shareholders and other claim-holders (for example, prefers not to expose that information to competitors while a restructuring plan is implemented), then there could be ethical reasons for a

shift in disclosure choices According to SFAS No 131, firms should segment their disclosures

along the same lines that management uses in decision-making This does not appear to be the case here Thus, the CEO’s decision to present the segment information by geographical location seems

to be counter to the intent of segmental reporting, i.e., the unveiling of information that has been merged or buried in the consolidated data

ANALYZING FINANCIAL STATEMENTS SOLUTIONS

AFS 14-1

1 GE organizes the segment data based on the nature of markets and customers

2 and 3

Growth Rate

2003-2005 Infrastructure $41,803 $37,373 $36,569 $40,119 $36,419 14.3% Industrial 32,631 30,722 24,988 26,154 26,101 30.6% Healthcare 15,153 13,456 10,198 8,955 8,409 48.6% NBC Universal 14,689 12,886 6,871 7,149 5,769 113.8% Commercial Finance 20,646 19,524 16,927 15,688 14,610 22.0% Consumer Finance 19,416 15,734 12,845 10,266 9,508 51.2% Total segment revenues 144,338 129,695 108,398 108,331 100,816 33.2%

Infrastructure $7,769 $6,797 $7,362 $9,178 $7,869

Commercial Finance 4,290 3,570 2,907 2,170 1,784

Consumer Finance 3,050 2,520 2,161 1,799 1,602

Total segment profit 23,425 19,564 17,514 18,188 16,803

Segment Profit Margin 2005 2004 2003 2002 2001

Infrastructure 18.6% 18.2% 20.1% 22.9% 21.6%

Commercial Finance 20.8% 18.3% 17.2% 13.8% 12.2%

Consumer Finance 15.7% 16.0% 16.8% 17.5% 16.8%

Total segment profit margin 16.2% 15.1% 16.2% 16.8% 16.7%

Segment Asset Turnover 2005 2004 2003 2002 2001

Infrastructure 0.467 0.451 0.480 9.580 9.248

NBC Universal 0.471 0.377 0.591 25.996 4.852

Commercial Finance 0.108 0.106 0.098 2.891 3.195

Consumer Finance 0.122 0.104 0.121 54.317 43.816

Total Segment Asset Turnover 0.214 0.173 0.167 7.172 6.376

4

Segment Revenues to Total Revenues

2005 2004 2003 2002 2001 Infrastructure 29.0% 28.8% 33.7% 37.0% 36.1%

Industrial 22.6% 23.7% 23.1% 24.1% 25.9%

Healthcare 10.5% 10.4% 9.4% 8.3% 8.3%

NBC Universal 10.2% 9.9% 6.3% 6.6% 5.7%

Commercial Finance 14.3% 15.1% 15.6% 14.5% 14.5%

Consumer Finance 13.5% 12.1% 11.8% 9.5% 9.4%

Total segment

Revenues 100.0% 100.0% 100.0% 100.0% 100.0%

Segment Profit to Total Profit

2005 2004 2003 2002 2001 Infrastructure 33.2% 34.7% 42.0% 50.5% 46.8%

Industrial 10.9% 9.4% 7.9% 10.1% 15.7%

Healthcare 11.4% 11.7% 9.7% 8.5% 8.9%

NBC Universal 13.2% 13.1% 11.4% 9.1% 8.4%

Commercial Finance 18.3% 18.2% 16.6% 11.9% 10.6%

Consumer Finance 13.0% 12.9% 12.3% 9.9% 9.5%

Total segment profits 100.0% 100.0% 100.0% 100.0% 100.0%

The infrastructure segment generates the most revenue and profits to GE It has been growing

approximately 14% over the last three years However, the profit margin percentage has been slowly declining over time (with the exception of 2004 to 2005)

The industrial segment has grown 30% over the last three years While this segment has been

increasing the amount of sales relative to assets, the profit margin ratio has been very erratic (ranging from 5.5% to 10.1%) This segment also contributes the second most amount of revenue to GE

Healthcare’s revenues have been growing 48% over the last three years and the profit margin has been

very stable at around 17%

NBC Universal’s revenues grew at 114% over the last three years, but it is the smallest segment

measured by revenues Even though, this segment generates over a 20% profit margin

Commercial Finance’s revenues grew at 22% over the last three years The profit margin ratio has

been increasing every year for the last five years and is currently at 21% This segment contributes the second largest amount of operating profit (after Infrastructure)

Consumer Finance’s revenues grew at 51% but with declining profit margins However, because of

the growth in sales, this segment still has been contributing and increasingly larger amount of operating profit to GE

5

AFS 14-1 (Concluded)

In terms of both revenues and plant and equipment, the percentages from outside the US have been increasing steadily

ANSWERS TO EXERCISES

Exercise 14-1

Segments A, C, and D are reportable segments because the amount of each of their operating profit or loss is more than 10% of the greater in absolute amount of the combined operating profit of all segments that did not incur a loss ($1,000) or the combined operating loss of all segments that did incur

an operating loss($1,300) Thus, any segment with an operating profit or loss of $130 or more meets this test

Segment B is not a reportable segment because its operating profit is less than 10% of $1,300

Exercise 14-2

V

875 4

400 2

,

,

W

875 4

300

X

875 4

700

Y

875 4

100 1

,

,

Z

875 4

375

Exercise 14-3

Revenue Test

Industry segments A and B are reportable segments under this test because their total revenue is 10% or more of combined total revenue of $366,000 The other segments do not meet this test

Operating Profit Test

Industry segments A and B are reportable segments under this test because the absolute amounts of their operating profit or loss are each at least 10% of the greater of (1) the combined profit of all

operating segments that did not incur a loss ($12,000 + $1,500 = $13,500), or (2) the combined loss of all operating segments that incurred a loss ($17,400 + $600 = $18,000) Segments A and B both have operating profit or loss of more than $1,800 (10% $18,000) The other segments are not reportable segments under this test

Identifiable Assets Test

Operating segments A and B are reportable segments because their identifiable assets are at least 10%

of the combined assets of all segments The other segments are not reportable segments under this test

Exercise 14-3 (continued)

Final Test

Combined sales to nonaffiliated customers by segments A and B

Combined sales to nonaffiliated customers by all segments =

200 , 136

$

000 , 100

$

= 73%

Because the 75% test is not met, one of the segments that did not qualify as a reportable segment under the previous tests must be included as a reportable segment

Exercise 14-4

Ratio of each segment's payroll dollars to total payroll dollars of all segments:

000 53

800 34

,

,

Segment B: 0.34

000 , 53

200 , 18

Ratio of each segment's operating revenue to the total operating revenue of all segments

000 159

000 60

,

,

000 159

000 99

,

,

Ratio of each segment's assets to the total assets of all segments:

500 124

000 70

,

,

500 124

500 54

,

,

Formula Allocation of Joint Expenses

The arithmetic average of the three percentages above for each segment times the joint expenses:

3

56 0 38 0 66 0

.

.

; 0.533 $15,000 = $7,995

3

44 0 62 0 34 0

.

.

; 0.533 $15,000 = $7,005

Operating Profit (Loss) of each Segment

Segment A: $60,000 - $27,200 - $12,600 - $7,995 = $12,205

Segment B: $99,000 - $35,600 - $10,800 - $7,005 = $45,595

Exercise 14-5

Estimated income tax for the first three quarters: 0.38 ($70,000 + $50,000 + $40,600) $ 61,028 Actual tax provision for the first two quarters: 0.32 ($70,000 + $50,000) (38,400)

Exercise 14-6

B Major repairs 0 22,000 22,000 22,000

C Inventory loss 0 0 150,000 0

D Gain on sale of equipment 0 0 10,500 0

Exercise 14-7

Case A

Cost of Goods Sold

$3,000,000

Write down of ending inventory of 124,000 to market

4,892,000

Write down of ending inventory of 81,500 to market

6,153,000

Less write down recovery on ending inventory of 51,000

Verification

Add: Write down of ending inventory to the lower of cost or market (51,000 ($30 - $22)) 408,000

Case B

Cost of Goods Sold

Write down of ending inventory of 154,000 to market

$3,770,000

Less write down recovery on ending inventory of 124,000

Write down of ending inventory of 81,500 units to market

6,071,500

Less write down recovery on ending inventory of 51,000

Verification

Add: Write down of ending inventory to the lower of cost or market (51,000 ($30 - $27)) 153,000

Exercise 14-8

First Quarter

1,375,000

Estimated Annual Income Tax Payable ($1,195,000 0.42) 501,900 Estimated Effective Combined Annual Tax Rate (

000 , 350 , 1

900 , 501

$

Second Quarter

Less: Net Permanent Differences ($180,000 - $25,000) 155,000

Estimated Annual Income Tax Payable (1,265,000 0.42) 531,300 Estimated Effective Combined Annual Tax Rate (

000 , 420 , 1

300 , 531

$

Exercise 14-9

1 a

2 b

3 c

4 d

5 c

6 a

7 c