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© 2009 The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Segment and Interim

Reporting

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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

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• 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

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• 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

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• 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

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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

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• 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

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• 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

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• 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

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• 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

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• Other considerations– An upper limit of about 10 segments is used

– Above this, a company should consider aggregating the closely related segments

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• 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

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• 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

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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

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• 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

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• 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• If revenues from external customers generated in

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

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• 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• If assets in an individual foreign country are

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

– The 10 percent has gained acceptance

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• Information about major customers– Defining an individual customer

– An individual customer could be:• Any single customer, the federal government, a

state government, a local government, or a foreign government

– Materiality is not defined, but the 10 percent guideline has gained the support of practice

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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

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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

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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 sheet at the end of the prior fiscal year

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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

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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

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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

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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

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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

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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

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Reporting Standards for Interim Income Statements

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• 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

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• 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:• Use estimated gross profit rates• LIFO temporary liquidations• Lower-of-cost-or-market valuations• Standard cost systems

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• 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: • An estimate of time used• An estimate of benefit received, or• Activity level of the interim period

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• 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

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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• “Permanent” or nontemporary differences• “Temporary” differences

– Loss carryback and carryforward provisions apply only to annual results, not to interim results

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• 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

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– 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

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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

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• 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

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• Change in a reporting entity – Requires retrospective application

– Primary examples of changes are: • Presenting consolidated or combined financial

statements rather than individual statements for the separate entities

• Changing the specific subsidiaries that comprise the consolidated entity for which consolidated financials are presented

• Changing the entities that are included in combined financial statements

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• 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

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Documents

condensed

quarterly

combined financial

external customers

prior fiscal

requires retrospective

quarterly

interim income