C121 Chapter 12 Interim Reporting & Disclosures About Segments of an Enterprise.

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Chapter 12

Interim Reporting & Disclosures About Segments of an Enterprise

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Interim Reporting

• Provides information on a timely basis

• Affects the decision making process

• Views each interim period as an integral part of the annual period

• Accounting principles employed for interim purposes are the same as those used for annual purposes with some modification

• Summarized interim data, rather than complete financial statements, may be presented

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Modification of Costs & Expenses

• Allows for interim data to be generated on a more timely basis

• There are exceptions from annual reporting principles

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Interim Modifications: Inventory

• Interim LIFO liquidations which are deemed to be temporary are given special treatment

• The gross profit method of determining cost of sales and ending inventory is acceptable

• Temporary declines in the market value of inventory under lower of cost may be ignored

• Interim price and volume variances which are planned and expected to be absorbed by year end should be deferred

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Interim Modifications: Other

• Items which are expensed for annual reporting purposes (e.g., research and development) and benefit more than one interim period should be allocated among the current year interim periods benefited

• If costs and expenses incurred in an interim period can not be readily identified with other interim periods, this should be indicated

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• Arbitrary assignment of costs to an interim period should not be made

• Gains and losses that arise in any interim period similar to those that would not be deferred at year end should not be deferred to later interim periods within the same fiscal year

Interim Modifications: Other, continued

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Adjustments Related to Prior Interim Periods

• The effect of the adjustment or settlement is material in relation to income from continuing operations of the current fiscal year or in relation to the trend of income from continuing operations or is material by other appropriate criteria, and

Certain items may be treated as an adjustment to a prior interim period within the current year if all of the following are met:

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Adjustments Related to Prior Interim Periods, continued

• All or part of the adjustment or settlement can be specifically identified with and is directly related to business activities of specific prior interim periods of the current fiscal year, and

• The amount of the adjustment or settlement could not be reasonably estimated prior to the current interim period

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Accounting for Income Taxes in Interim Statements

• Reflect an estimate of the effective annual tax rate• Changes in the estimated effective annual tax rate from

one interim period to the next should be accounted for as a change in estimate in the current period

The income tax expense or benefit associated with income from continuing operations should:

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Accounting for Income Taxes in Interim Statements, continued

• The estimated effective annual tax rate should reflect tax planning alternatives, such as differences and tax credits

• Changes in tax legislation should be accounted for in interim periods subsequent to the effective date of legislation

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Calculation of Effective Tax Rate

Pretax Income (Loss)

YTD Income $170,000

Projected Income 30,000

Annual Income $200,000

Permanent Differences -

Adjusted Income $200,000

Tax on Adjusted Income * $61,250

Tax Credits (13,250)

Net Tax $48,000

Effective Tax Rate ($48,000 / $200,000) 24%

*[(50,000 X 15%) + (25,000 X 25%) + (25,000 X 34%) + (100,000 X 39%)]

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Changes in the Estimated Effective Tax RateBy applying the effective rate to year-to-date (YTD) amounts, the effect of the change is included in the tax expense (benefit) of the period in which the change occurred.

EffectiveQtr Current YTD Tax Rate YTD Current1 $20,000 $20,000 25% 5,000$ 5,000$ 2 $30,000 $50,000 30% 15,000$ 10,000$

Pretax Income (Loss)

Tax Expense (Benefit)

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The $10,000 tax expense for Quarter 2 represents:

Quarter 2: $30,000 at 30% = $9,000

Quarter 1: $20,000 at (30% - 25%) = $1,000

Changes in the Estimated Effective Tax Rate, continued

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Tax Benefits Associated with YTD Operating Losses

• If the YTD loss is more likely than not (MLTN) offset by projected income, recognize a tax benefit on the YTD loss

• If the YTD loss is not entirely offset by MLTN projected income, or there is a projected loss, an operating loss will be projected for the year

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Estimating the Potential Tax Benefit of a Projected Annual Operating Loss

• The extent to which the operating loss may be offset by income of the prior two fiscal years included in the carryback period and/or

• The extent to which the operating loss may be offset by annual income which is more likely than not to be recognized in the twenty year carryforward period

The potential tax benefit is a function of:

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• The actual taxes in the prior two years would be offset

Measuring the Benefit of a Projected NOLIf the Projected Annual Operating Loss is less than the income of the prior two fiscal years, the benefit is a function of to what extent

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1. The actual taxes in the prior two years and

2. The anticipated taxes on the MLTN income associated with the next 20 years would be offset

If the Projected Annual Operating Loss is greater than the income of the prior two fiscal years, the benefit is a function of to what extent

Measuring the Benefit of a Projected NOL, continued

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Effective Tax Rate Based on Carryback YTD Loss (40,000)$ Projected Income 13,000 Annual Loss (27,000)$

Taxable Income In Prior Two Years $18,000Tax Rate In Prior Two Years 15%Current Year Tax Benefit ($18,000 x 15%) $2,700

Effective Tax Rate ($2,700 / $27,000) 10%

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Effective Tax Rate Based on Carryback and Carryforward

YTD Loss (40,000)$ Projected Income 13,000 Annual Loss (27,000)$

Taxable Income In Prior Two Years $18,000Tax Rate In Prior Two Years 15%MLTN Future Income $5,000Tax Rate In Future 15%Current Year Tax Benefit (($18,000 x 15%) + ($5,000 x 15%)) $3,450Effective Tax Rate ($3,450 / $27,000) 12.78%

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Interim Nonordinary Items of Income or Loss

• These items are not included in the determination of the estimated effective annual tax rate applied to continuing operations

• The tax on such items must be separately calculated• The tax on such items is determined on an incremental basis

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Tax Expense/Benefit Traceable to All Nonordinary Losses and/or Gains

Ordinary Total Non-ordinary Non-ordinaryIncome Income Losses Gains

Pretax Amount $100,000 $80,000 $110,000 $70,000

Tax Expense 21,250 15,250 24,650

Total Income Excluding

(A)$6,000benefit (B)

$9,400benefit

(C) plug$3,400 expense

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(A) The incremental tax expense/benefit traceable to all nonordinary items: $6,000 benefit

(B) The incremental tax benefit traceable to all nonordinary losses: $9,400 benefit

(C) The incremental tax expense traceable to all nonordinary gains: a plug of $3,400 expense

Tax Expense/Benefit Traceable to All Nonordinary Losses and/or Gains, continued

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Tax Expense/Benefit Traceable to Specific Nonordinary Losses and/or Gains

• The incremental tax expense/benefit traceable to a specific item is determined by comparing the tax associated with total income to the tax associated with total income excluding the specific item

• It is possible that the sum of the tax expense (benefits) associated with specific nonordinary gains (losses) may not equal the totals initially determined (values (B) and (C) in previous slide)

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• The tax expense (benefit) traceable to all nonordinary gains (losses) is apportioned ratably to each individual nonordinary gain (loss)

Tax Expense/Benefit Traceable to Specific Nonordinary Losses and/or Gains, continued

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Ratable Apportionment

Incremental tax expense traceable to all non-ordinary gains: $15,000

individual tax exp allocatedgain amount % of total to allocate tax exp.

Gain A $8,000 40% 15,000 $6,000Gain B 7,000 35% 15,000 5,250Gain C 5,000 25% 15,000 3,750

$20,000 100% $15,000

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Accounting For Discontinued Operations• Prior interim periods are retroactively restated in order to separate

discontinued operations from continuing operations• The tax expense/benefit from prior interim periods must be

retroactively allocated between discontinued and continuing operations

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• A new estimated effective annual tax rate must be computed for the restated continuing operations associated with prior periods

• The new estimated effective annual tax rate is based on information (projections of future income, tax planning strategies, etc.) which was originally available in the prior periods

Accounting For Discontinued Operations, continued

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Discontinued Operations - Restating Prior Periods

Type of EffectiveQuarter Income Current YTD Tax Rate YTD Current

1 Continuing Operations $20,000 $20,000 25% $5,000 $5,000

Original Prior PeriodPretax Income

(Loss)Tax Expense

(Benefit)

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Type of EffectiveQuarter Income Current YTD Tax Rate YTD Current

1 Original Continuing Operations $20,000 $20,000 25% $5,000 $5,000

Type of EffectiveQuarter Income Current YTD Tax Rate YTD Current

1 Restated Continuing Operations $32,000 $32,000 30% $9,600 $9,600Discontinued Operations (12,000) (12,000) (4,600) (4,600)

Pretax Income (Loss)

Tax Expense (Benefit)

Original Prior PeriodPretax Income

(Loss)Tax Expense

(Benefit)

Restated Prior Period

Discontinued Operations - Restating Prior Periods, continued

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Accounting for a Change in Accounting Principle

• Regardless of when the change occurs, it is accounted for as though it occurred in the first interim period of the current year

• Interim periods prior to the actual period in which the change occurs must be restated to reflect the change

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Accounting for a Change in Accounting Principle, continued

• The estimated effective annual tax rate for the prior period’s income from continuing operations, restated to reflect the change in principle, must be recomputed.– The tax rate is based on information which was originally available modified only for the

effect of the change

• The tax on the cumulative effect of a change in accounting principle (a nonordinary item) is determined on an incremental basis

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Disclosures About Segments of an Enterprise

FASB Statement No. 131

Segments are identified using a Management Approach which focuses on how management organizes information for purposes of making operating decisions and assessing performance

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Operating Segments

• That engages in business activities from which it may earn revenues and incur expense (including revenues and expenses relating to transactions with other components of the same enterprise),

Defined as a component of an enterprise:

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• Whose operating results are regularly reviewed by the enterprise’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and

• For which discrete financial information is available

Operating Segments, continued

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Observations Regarding Operating Segments• May be possible to combine two or more segments if they have

the required similarities

• Segments must be evaluated to determine if they qualify as reportable segments

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Observations Regarding Operating Segments, continued• Segments which are not considered reportable are combined into an “All

Other” category for reporting purposes

• For purposes of comparability over time, some segments will need to be separately presented in comparative statements even if they are not reportable

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Reportable Segments

• Its reported revenue, including both sales to external customers and intersegment sales or transfers, is 10 percent or more of the combined revenue, internal and external, of all reported operating segments or

Operating segments which satisfy at least one of the following:

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Reportable Segments, continued

• The absolute amount of its reported profit or loss is 10 percent or more of the greater, in absolute amount, of (1) the combined profit of all operating segments that did not report a loss or (2) the combined reported loss of all operating segments that did report a loss or

• Its assets are 10 percent or more of the combined assets of all operating segments

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Guidelines Regarding Reportable Segments

• The total of external revenues for reportable segments must constitute at least 75% of total consolidated revenue.– If not satisfied, add operating segments even if they were not reportable

• If the number of reportable segments exceeds 10, consideration should be given to reducing the number by aggregating certain reportable segments

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Content of Segmental Disclosure

• Factors used to identify reportable segments• Discussion of how segments are organized - e.g., products, geographical areas• Types of products and/or services from which revenues are derived• Profit or loss information - profit or loss is defined based on what information

is reviewed by the chief operating decision maker (CODM)

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Content of Segmental Disclosure, continued

• Segment assets which are reviewed by the CODM

• Methods of measuring various items - e.g., intersegment sales, profits, assets

• A reconciliation of revenues, profit or loss, and assets for reportable segments to the respective consolidated amounts for the enterprise as a whole

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Enterprise-Wide Disclosures

• Report revenues from external customers for each product or service or each group of related products or services.– The revenues are based on the information used for general-

purpose financial statements.

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Enterprise-Wide Disclosures, continued

• Report revenues from external customers for the enterprise’s country of domicile and all foreign countries in total.– The revenues are based on the information used for the general-purpose financial statements

– If material, revenues from separate foreign countries should be disclosed.

– Subtotals of revenue may also be disclosed by groups of foreign countries (e.g., South America).

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• Report long-lived assets located in the enterprise’s country of domicile and all foreign countries in total.– The measurement of assets is based on the information used for the general-purpose financial

statements– If material, assets traceable to separate foreign countries should be disclosed.– Subtotals of assets may also be disclosed by groups of foreign countries (e.g., South America)

Enterprise-Wide Disclosures, continued

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Disclosures Regarding Major Customers

• Required to disclose if a single customer represents 10% or more of enterprise revenues• Federal, state, local, and foreign governments each should be considered as a single

customer• For each such customer, must disclose the total amount of revenues and identify the

segment(s) revenues are traceable to. Names of major customers need not be disclosed