Rationale for Segment Reporting

Segment reporting provides information to help users of financial statements to:

Better understand the entitys performance. Better assess the entitys prospects for future cash flow. Make more informed judgments about the enterprise as a whole.

Determining Segments

An operating segment is a component of an enterprise: That engages in business activities from which it earns revenues and incurs expenses Whose operating results are regularly reviewed by the chief operating decision maker to

assess performance and make resource allocation decisions For which discrete financial information is available

Determining Segments Operating segments should be combined based on the: nature of the products or services provided by each operating segment. nature of the production process. type or class of customer. distribution methods. nature of the regulatory environment.

A Segment is considered reportable if it satisfies one of these tests:

Revenue test - Its revenues are 10% or more of the combined revenue of all segments. Profit or Loss test - Its profit or loss is 10% or more of the combined profit (or combined loss if larger) of all segments reporting a profit. Asset test - Its assets are 10% or more of the combined assets of all operating segments.

Revenue Test: Atkinson Company is a business with the following six segments. Segment Automotive Furniture Textbook Motion Picture Appliance Finance Total *In millions Total Revenues $41.6* 9.0 6.8 22.8 5.3 12.3 $97.8

Based on the test for revenue, the three following segments will be reportable (they exceed 10% of $97.8 million) Automobile Motion Picture Finance

Atkinsons six segments had the following financial results: Segment Automotive Furniture Textbook Motion Picture Appliance Finance Total *In millions 0.5 3.0 $16.5 0.0 $3.9 Profit $11.0* 2.0 $1.2 2.7 Loss

The individual profits and losses are compared to 10% of the LARGER of the profit and loss totals, and four are determined to be reportable because they are greater than $1.65 million = ($16.5 X .10).

Atkinsons segments have the following total assets in each segment. Any segment with assets that are 10% or more of the combined assets total is reportable.

Three of Atkinsons segments have at least 10% of the total assets ($4.43 million): Automotive Motion Picture Finance

Because four of Atkinsons operating segments meet at least one of the quantitative tests, they are considered reportable.

Operating Segment Tests Other Guidelines The combined sales revenues of the disclosed segments must be at least 75% of total company sales, excluding intra-entity sales. Segments must be added until the 75% test is met (even if the additional segments do not meet the reportable segment criteria). Although a maximum number is not prescribed, authoritative literature suggests that 10 separately reported segments might be the practical limit.

Required Segment Disclosures

For each reportable segment, a company is required to disclose: General information Segment profit or loss
Revenues. Interest revenue and expense. depreciation, depletion and amortization expense. Significant noncash and unusual

items. Income Tax expense

Investment in equity method affiliates. Total assets. Capital expenditures.

The company must also disclose additional information regarding products and services, geographic areas, and major customers.

GAAP requires disclosure of revenues derived from transactions with external customers from each product or service if operating segments have not been determined based on differences in products and services.

Revenues from external customers and long-lived assets must be disclosed for: The domestic country. All foreign countries where the enterprise derives revenue or holds assets. Each foreign country in which a material amount of revenue is derived or assets are held.

When 10% or more of a companys revenue is derived from a single customer, the company must disclose that it has a major customer. The IDENTITY of the major customer need not be disclosed.

IFRS and GAAP are substantially the same, except IFRS requires disclosure of total assets AND liabilities if that information is provided to the chief decision maker. IFRS specifically includes intangible assets as long-lived assets. In a company with a matrix form of organization, IFRS permits operating segments to be based on geographic area, as opposed to products/services.

To provide more timely information, the SEC requires quarterly statements from publicly-traded companies in the U.S. But how do the statements fairly reflect expenses that do not occur evenly throughout the year??

There are two possible approaches: Discrete the accounting period stands on its own. Integral treat the accounting period as a

portion of a longer period. Current GAAP requires companies to use the Integral Approach

Revenues are recognized in the interim periods in which they are earned. Revenues from long-term contracts should be recognized using the same methodology as used on an annual basis. A company should recognize projected losses on long-term contracts to their full extent in the interim period in which it becomes apparent that a loss will arise.

LIFO Liquidations Interim period gross profit should not reflect gains resulting from temporary LIFO liquidations. Lower -of-Cost-or-Market Inventory write-downs should be reflected in interim period numbers if the market value is not expected to recover by year-end. Standard Costing Variances that are expected to be absorbed by year-end should not be recognized in the interim period.

To provides for less volatility of information: Expenses that are not incurred evenly throughout the year should be predicted early in the year and allocated to each of the interim reporting periods. Costs not directly matched to revenues should be allocated among interim periods on a reasonable basis through the use of accruals and deferrals.

Extraordinary Items should be reported separately and in full in the interim period in which they occur. Income Taxes for each interim period should be computed based on an estimated annual effective tax rate. A change in accounting principles should be reported as if it occurred in the first interim period shown. (This may require restatement.)

Authoritative accounting literature requires companies to provide the following minimum information in their interim reports: Sales or gross revenues, provision for income taxes, extraordinary items, and net income. Earnings per share. Seasonal revenues and expenses. Significant changes in estimates or provisions for income taxes. Disposal of a segment of a business and unusual or infrequently occurring items. Contingent items. Changes in accounting principles or estimates. Significant changes in financial position.

GAAP requires the following interim disclosure for each reportable operating segment: Revenues from external customers Intersegment revenues Segment profit or loss Total assets (if there has been a material change from the last

annual report)

IAS 34 requires the following minimum components in an interim report: A condensed statement of financial position (balance sheet). A condensed statement of comprehensive income, presented as: a.A condensed single statement of net income and comprehensive income, or b.b. Separate condensed statements of net income and comprehensive income. A condensed statement of changes in equity. A condensed statement of cash flows. Selected explanatory notes.

IAS 34 requires the following minimum components in an interim report: A condensed statement of financial position (balance sheet). A condensed statement of comprehensive income, presented as: a.A condensed single statement of net income and comprehensive income, or b.b. Separate condensed statements of net income and comprehensive income. A condensed statement of changes in equity. A condensed statement of cash flows. Selected explanatory notes.

Summary Segment reporting allows users to have more detailed information so that they can make better decisions. Segment disclosures are based on how management reviews the operating segments internally. Three quantitative tests are applied to identify reportable segments. With interim reporting, GAAP requires an integral approach.