Chapter 13

Segment and
Interim Reporting

McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Segment Reporting

• Large, diversified companies can be viewed

as a portfolio of assets operated as divisions
or subsidiaries, often multinational in scope.

• The various components of a large company

may have different profit rates, different
degrees and types of risk, and different
opportunities for growth.

13-2
Segment Reporting

• A major issue for accountants is how to

develop and disclose the information
necessary to reflect these essential
differences.

• The following discussion presents the

accounting standards for reporting an
entity’s operating components, foreign
operations, and major customers.

13-3
Segment Reporting

• Generally speaking, segment reporting

refers to the supplemental disclosure
of revenue, profits, assets, and other
information for selected industry segments
of an entity as well as disclosures about
its foreign operations.

13-4
FASB 131

• FASB131 states that the segment disclosure

should include the reportable segments’
measures of profit or loss.

• Thus, the report shall be the same as used

for internal decision-making purposes.

• Stated otherwise, whatever is used for internal

decision-making purposes to measure the
operating segment’s profit or loss shall also be
used in the externally reported disclosures.
13-5
FASB 131

• FASB 131 defines an operating segment as a

component of an enterprise:

– That engages in business activities from

which it may earn revenues and incur
expenses( including revenues and
expenses relating to transactions with
other components of the same enterprise).

[Continued on next slide.]

13-6
FASB 131

– 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.

– For which discrete financial information is

available.

13-7
Defining Reportable Segments

• The process of determining separately

reportable operating segments, that is,
segments for which separate supplements
disclosures must be made, is based on
management’s specification of its operating
segments that are used internally for
evaluating the enterprise’s financial
position and operating performance.

13-8
 The Percent Quantitative Thresholds

• Separate disclosures are required for segments

meeting at least one of the following “10 percent
significance” tests:
• The Revenue Test
• The Profit (or Loss) Test
• The Asset Test

13-9
 Revenue Test

• The operating segment 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 operating segments.

13-10
 Profit (Loss) Test

• The absolute amount of the reported profit or

loss is 10 percent or more of the greater, in
absolute amount, of:
– The combined reported profit of all operating
segments that did not report a loss; or,
– The combined reported loss of all operating
segments that did report a loss.

13-11
Asset Test

• The assets of the operating segment are 10

percent or more of the combined assets of all
operating segments.

13-12
Comprehensive Disclosure Test

• After determining which of the segments

are reportable under any of the three 10
percent tests, the company must apply a
comprehensive test.

• The comprehensive test is the 75 percent

consolidated revenue test.

13-13
Seventy-Five Percent Revenue Test

• The total revenue from external sources

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

• The reporting company must identify

additional operating segments as
reportable until this test is met.

13-14
Other Considerations

• A practical limit of about 10 segments is

used as an upper limit on the number of
reportable segments because above that
number, the supplemental information may
become overly detailed.

• A company having more than about 10

reportable segments should consider
aggregating the most closely related
segments.

13-15
 Other Considerations

• In addition, companies must exercise judgment

to determine the individual segments to be
reported.

• For example, a segment may meet or fail a

specific test because of some unusual situation,
such as an abnormally high profit or loss on a
one-time contract.

13-16
 Other Considerations

• The concept of interperiod comparability should

be followed in deciding whether or not the
segment should be disclosed in the current
period.

• Companies should separately report segments

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

13-17
 Other Considerations

• Similarly, companies need not separately report

a segment that has met a 10 percent test on a
one-time basis only because of abnormal
circumstances.

• A company is required, however, to indicate why

a reportable segment is not disclosed.

13-18
Other Considerations

• Finally, 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 to obtain comparability of
financial data.

13-19
Reporting Segment Information

• In segment reporting, the following must be

disclosed for each segment determined to be
separately reportable:
– General information about the factors used
to identify the entity’s reportable segments.
– Information on items included in the
determination of segment assets.

[Continued on next slide.]

13-20
Reporting Segment Information
– Information about specified revenues and
expenses included in reported segment
profit or loss, segment assets, and the
basis of measurement used to determine
profits.
– Reconciliations of the total reportable
segments’ revenues, measures of segment
profit or loss, and segments’ assets to the
related consolidated totals for those items.

13-21
Reporting Segment Information

• Companies are allowed to present “the four

required disclosures” in separate schedules
or in the footnotes.

• Most companies present footnote disclosures

with accompanying schedules.

13-22
 Reporting Segment Information

• Interim reports must disclose the following about

each reportable segment:
– Revenues from external customers.
– Intersegment revenues.
– A measure of segment profit or loss.

[Continued on next slide.]

13-23
Reporting Segment Information
– Total assets for which there has been a
material change from the most recent
annual report.
– Any differences from the most recent
annual report in the definition of operating
segments or in how segment profit or loss
is computed.
– A reconciliation of the total of segment profit
or loss to the entity’s consolidated totals.

13-24
 Enterprisewide Disclosures

• FASB 131 established what it termed

“enterprisewide disclosure” standards to provide
users with more information about the risks of
the company.
• These enterprise disclosures focus on three
areas: products and services; geographic areas;
and, major customers.
• These enterprisewide disclosures are typically
made in a footnote to the financial statements.

13-25
Goodbye Segment Reporting!

• This concludes the discussion of segment

reporting.

• The remainder of the chapter presents

another major area of financial disclosure:
interim financial reporting.

13-26
 Hello Interim Reporting!
• Interim reports, which cover a time period of less
than one year, are as important to investors and
other statement users as annual reports.

• The interim report is, in many ways, a smaller

version of the annual report. It includes an
abbreviated income statement, balance sheet,
statement of cash flows, and selected footnotes
and other disclosures for the interim period
being reported, as well as comparative data for
prior interim periods.
13-27
 Interim Reporting
• The purpose of interim reporting is to provide
investors and other interested parties with
contemporary reports on the operating progress
of the entity.
• Interim reports are used to assess the entity’s
performance and to estimate any turning points
in the income trend of the business.
• Rapid stock market reactions to the release of
interim information indicate that investors and
other financial statement users look closely at
these reports.
13-28
 Interim Report Format

• The SEC requires quarterly financial within 45

days after the end of each quarter, except that
the annual report may be used in place of the
last interim report of the fiscal year. Interim
reports generally contain the following items:
– Comparative income statement, and the most
recent quarter of the current fiscal period.
– Income statements for the cumulative year-to-
date time period and for the corresponding
period of the prior fiscal year.
[Continued on next slide.]
13-29
Interim Report Format
– A condensed balance sheet at the end of the
current quarter and a condensed balance
sheet at the end of the prior fiscal year.
– 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.
– Footnotes that update those in the last annual
report.
– A report by management analyzing and
discussing the results for the latest interim
period.

13-30
 Accounting Issues

• Interim reporting presents accountants with

several technical and conceptual measurements
issues.

• Most of these center on the accounting concept

of periodicity and division of the annual period.

• APB 28 provides the professional guidance

regarding interim financial reporting.

13-31
 Discrete Versus Integral View

• Two divergent views of interim reporting were

held before the release of APB 28.

• 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

would be determined using the same accounting
principles used for the annual report.
13-32
 Discrete Versus Integral View

• The integral theory of interim reporting views an

interim period as an installment of an annual
period. Under this view, recognition and
adjustment of certain income or expense items
may be affected by judgments about the
expected results of the entire year’s operations.

[Continued on next slide.]

13-33
Discrete Versus Integral View

• For example, expenses that normally would be

charged to operations in one period for annual
accounting purposes could be deferred and
expensed in several interim periods based on
an allocation using sales volume, production
levels, or some other basis.

13-34
Discrete Versus Integral View

• Both views were applied in practice, and it was

up to the Accounting Principles Board to settle
the conflict.

• The integral view was selected as the primary

theory for interim reporting, although some
modifications of this theory were made so that
reports would conform closely to the results of
operations for the year.

13-35
 Reporting Revenue

• One of the most significant elements of the

interim income statement is revenue from sales.

• Investors wish to assess the revenue-generating

capability of the entity, so they compare revenue
of the current interim period with revenue of the
corresponding interim period of prior years.

13-36
 Reporting Revenue

• Thus, revenue must be recognized and reported

in the period in which earned and cannot be
deferred to other periods in order to present a
more stable revenue stream.

• Revenue from seasonal business, such as in

agriculture, food products, wholesale or retail
outlets, and amusements, cannot be
manipulated to eliminate seasonal trends.

13-37
 Reporting Revenue

• Businesses that experience material seasonal

variations in their revenue are encourage to
supplement their interim reports with information
for 12-month periods ending at the interim date
for the current and preceding years.

• Such disclosures reduce the possibility that

users of the reports might make unwarranted
inferences about the annual results from an
interim report with material seasonal variation.

13-38
 Cost of Goods Sold (CGS)
• Cost of goods sold is generally the largest single
expense on the interim income statement. In
general, the interim cost of goods sold should be
computed using the following guidance (APB
28):
– “Those costs and expenses that are
associated directly with or allocated to the
products sold or the services rendered for
annual reporting purposes…should be
similarly treated for interim reporting
purposes.”
13-39
CGS Exceptions

• Estimated gross profit rates may be used

to determine interim cost of goods sold.

• Temporary liquidations of LIFO-base

inventories are charged to cost of goods
sold using expected replacement cost of
the items.

[Continued on next slide.]

13-40
CGS Exceptions
• Lower-of-cost-or-market valuation method
allows for loss recoveries for increases in
market prices in later interim periods of the
same fiscal year.

• Standard cost systems should use same

procedures as for annual reporting except
that price variances or volume or capacity
variances expected to be absorbed by end
of the year should be deferred.

13-41
 All Other Costs and Expenses

• The integral view adopted by the APB is most

evident when dealing with period costs. A
number of allocations and estimations are
required for dealing with these costs.

• APB 28: “Costs and expenses other than

product costs should be charged to income in
interim periods as incurred, or be allocated
among interim periods based on an estimate of
time expired, benefit received or activity
associated with the periods.”
13-42
 Allocation Situations

• The following examples illustrate when an

expenditure may be deferred and allocated to
several periods:
– Some costs such as major machinery repairs should
be deferred and allocated to the interim periods that
benefit from the expenditure.

– Property taxes should be deferred or accrued to

ensure and appropriate allocation to each interim
period.

[Continued on next slide.]

13-43
Allocation Situations

– Quantity discounts offered to customers based on

annual sales should be estimated and charged to
sales during each, of the interim periods rather than
being recognized only in the fourth interim period.

– Major advertising costs should be allocated on the

basis of the expected sales volume in each interim
period that benefits from the advertising.

13-44
Accounting for Income Taxes in Interim
Periods

• The interim income tax computation poses a

particularly troublesome problem for
accountants because the actual tax burden is
computed on income for the entire fiscal year.
• In addition, temporary differences between tax
accounting and GAAP accounting require the
recognition of deferred taxes.
• Nevertheless, the interim tax provision is a
significant item and requires estimates and a
number of subjective evaluations based on the
anticipated annual tax.
13-45
 Nonoperating Items
• Nonoperating items would include the following:
disposal of a segment or extraordinary; unusual
or infrequently occurring items; and, contingent
items.
• APB 28 requires the measurement and
reporting of major nonoperating items on the
same basis as used to prepare the annual
report.
• Major nonoperating items should be recognized
in the interim period in which they occur.
13-46
 Accounting Changes

• Accounting for changes in accounting principles

or estimates should be presented in interim
reports in the same manner as in annual reports.
• APB 20 provides the guidelines for treatments of
changes in annual reports.
• Changes in estimates are handled currently and
prospectively, that is, from the change date
forward in time, because estimates are a normal
part of the accounting process.

13-47
 Accounting Changes

• Cumulative effect-type: Make effective--and

determine cumulative effect on retained
earnings--as of beginning of first interim period
of fiscal year, restating prior interims of current
fiscal year.
• Retroactive type: Restate prior interims of
current fiscal period and interims of prior years.
• Adoption of LIFO: Make effective as of first
interim period of fiscal year.

13-48
Goodbye Chapter 13!!!

Segment and Interim Reporting—now that’s

what you call CREATIVE ACCOUNTING !!!

13-49
 Chapter 13

End of Chapter

McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.