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Segment and Interim Reporting

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Electronic Presentation by

Douglas Cloud
Pepperdine University

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The Management Approach

FASB 131 specified the Management Approach to the definition of segments. Revenue, profits or losses, and assets for each segment are defined by the management as used for internal decision making purposes. Operating segments can be product lines, geographical areas, service lines of business, or other segments of the entity determined by management. The segment reporting footnote presents information on operating segments in the same manner as used for internal decision making.
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FASB 131 Defines an Operating Segment

as a component of an enterprise- That engages in business activities from which it

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may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise). Whose operating results are regularly reviewed by the enterprises 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.
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Ten Percent Quantitative Thresholds

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The FASB specified three 10 percent significance rules. Separate What is the 10 percent disclosures are required if an significance rule operating segment meets at least one concerning segment of the tests on Slides 5 and 6. disclosure?

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Ten Percent Quantitative Thresholds

Its reported revenue, including both sales to

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external customers and intersegment sales or transfers, is 10 percent or more of the combined revenue, internal and external, of all operating segments, The absolute amount of its reported profit or loss is 10 percent or more of the greater, in absolute amount, of (a) the combined reported profit of all operating segments that reported a profit or (b) the combined reported loss of all segments that reported a loss. Continued
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Ten Percent Quantitative Thresholds

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

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Illustration of 10 Percent Tests

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Peerless owns 80 percent of Special Foods common stock. Special Foods reports a profit of $50,000 for 20X1 and pays dividends of $3,000. The December 31, 20X1, balances in Special Foods stockholders equity accounts total $300,000, of which the noncontrolling interest is 20 percent.
The equity method is used to account for the Barclay investment.

Peerless acquires 40 percent of Barclay Company stock on January 1, 20X1, for a cost of $160,000, which is equal to the book value of the stock on that date. Barclay Company earns $80,000 in profit during 20X1 and pays $20,000 in dividends.
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Ten Percent Revenue Test

Segment Revenue

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Segment

Percent of Combined Reportable Revenue of $600,000 Segment

Food Products $323,000 Plastic and Packaging 113,000 Consumer and Commercial 45,000 Health and Scientific 86,000 Chemicals 33,000 Total $600,000

53.8% 18.8 7.5 14.3 5.5 * 100.0%

Yes Yes No Yes No

*Unrounded percents for segments total to 100 percent.

Separately reportable?

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Ten Percent Profit (Loss) Test

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Segment

Profit (Loss)

Percent of Test Amount of $279,000

Separately Reportable

Food Products $198,000 Plastic and Packaging 59,000 Consumer and Commercial (25,000) Health and Scientific 22,000 Chemicals (9,000)

71.0% 21.1 9.0 7.9 3.2

Yes Yes No No No

Separately reportable?
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Asset Test
Percent of Test Amount of $1,276,000

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Segment

Segment Assets

Separately Reportable

Food Products $ 411,000 Plastic and Packaging 375,000 Consumer and Commercial 100,000 Health and Scientific 310,000 Chemicals 80,000 Total $1,276,000

32.2% 29.4 7.8 24.3 6.3 100.0%

Yes Yes No Yes No

Separately reportable?
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Asset Test
Items comprising each segments assets are defined by management.

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Seventy-Five Percent Revenue Test

Sales to unaffiliated customer by reportable segments: Food Products Plastic and Packaging Health and Science Total of reportable segments Consolidated revenue Reportable segments percentage of consolidated revenue

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$317,000 95,000 86,000

$498,000 572,000 87.1%

Because this percentage if equal to or greater than 75 percent, no further operating $498,000 $572,000 segments must be separately reported.
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Reporting Segment Information

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FASB 131 states that the following must be disclosed for each segment determined to be separately reportable.

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Reporting Segment Information

General information about (a) the factors used to identify the entitys reportable segments,

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including the basis organization, and (b) types of products and services from which each reportable segment obtains its revenue. Information about the reported profit or loss, including specified revenues and expenses included in reported segment profit or loss, segment assets, and the basis of measurement used to determine profits.
Continued
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Reporting Segment Information

Information on the following if these items are included in the determination of segment assets:

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(a) the amount of investment in equity method investees and (b) the total expenditures for additions to long-term productive assets. Reconciliations of the total reportable segments revenues, measures of segment profit or loss, and segments assets to the related consolidated totals for those items.

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Enterprisewide Disclosures
Information about Products and Services
The company is required to report the revenues from external customers for each product and service, or each group of similar products and services, unless it is impractical.

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Enterprisewide Disclosures
Information about Geographic Areas
Revenues from external customers attributed to

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home country of domicile and from external customers attributed to foreign countries. Long-lived productive assets located in the entitys home country and the total assets located in all foreign in which the entity holds assets. Revenues from, and long-term productive assets in, any individual country, if material, must be separately disclosed
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Enterprisewide Disclosures
Information about Major Customers

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First issue is how to define an individual customer. For applying the disclosure test, any single

customer, the federal government, a state government, a local government, or a foreign government is considered to be an individual customer. Materiality is not defined by FASB 131, but the 10 percent guideline seems to have gained the support of practice.
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Example of a Footnote Disclosure

Geographic Information Revenues Long-Lived Assets United States Total Foreign Total Significant Countries: Canada Mexico $380,000 192,000 $572,000 $116,000 28,000 $471,000 369,000 $840,000 $220,000 102,000

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Interim Reports Generally Contain- An income statement for the most recent quarter of the current fiscal period and a comparative

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income statement for the same quarter for the prior fiscal year. Income statements for the cumulative year-todate time period and for the corresponding period of the prior fiscal year. A condensed balance sheet at the end of the current quarter and a condensed balance sheet at the end of the prior fiscal year.
Continued
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Interim Reports Generally Contain- A statement of cash flows as of the end of the current cumulative year-to-date period, and for

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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.

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Practical Modifications for Determining Interim Income

Estimated gross profit rates may be used to determine an interim periods cost of goods sold.

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Companies using lifo inventory valuation may experience a temporary liquidation of lifo-base inventories that should be charged to cost of goods sold at expected replacement cost. Such temporary reductions of inventories expected to be replaced by the end of the fiscal year should not be expensed through cost of goods sold at historical cost.

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Practical Modifications for Determining Interim Income

Inventory losses due to an apparent permanent decline in market price are recognized in the

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period of decline using the lower-of-cost-ormarket valuation method. Recoveries of market prices in later interim periods of the same fiscal year should be recognized up to the original cost. Companies using a standard cost system for inventories should use the same procedure for computing and reporting variances in an interim period as used for the fiscal year.
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Temporary Lifo Liquidation

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During the third quarter of its fiscal year, Special Foods Inc. experienced a temporary liquidation of 2,000 units in its lifo base owing to seasonal fluctuations. The lifo unit cost is $25. The liquidation is normal, and the company plans to replace the liquidation inventory during the early part of the fourth quarter. The estimated replacement cost is $35. Cost of Goods Sold (2,000 x $35) Inventory (2,000 x $25) Excess of Replacement Cost over Lifo Cost of Inventory Liquidation (2,000 x $10) Record temporary lifo inventory liquidation.
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70,000 50,000

20,000

current liability
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Temporary Lifo Liquidation

When the inventory is replaced at $36 per unit during the fourth quarter, the Excess account is cancelled.
Cost of Goods Sold (2,000 x $1) 2,000 Inventory (2,000 x $25) 50,000 Excess of Replacement Cost over Lifo Cost of Inventory Liquidation 20,000 Accounts Payable 2,000 x $25 72,000 Record replacement of lifo inventory liquidation. 2,000 x $36

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Market Write-Down and Recovery

No additional At the beginning purchases of its are fiscal made year, during Peerless the year. The Products sales and Corporation market value hasat 10,000 the end units of each of inventory on quarter hand with are as a fifo follows: cost of $10 each.
Units Sold Goods Sold Unit Market Values at End of Quarter

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Quarter

1 2 3 4

2,000 2,000 2,000 2,000

$ 7 6 7 11

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Market Write-Down and Recovery

Beginning inventory is 10,000 units. Each quarter 2,000 units are sold.
Cost Assigned to Goods Sold Ending Inventory Write-Down to Market or (Loss Recovery)

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Qtr.

Cost of Goods Sold Total

1 $20,000 = 2,000 units x $10 $24,000 = 8,000 units x $3 $44,000 2 14,000 = 2,000 units x $7 6,000 = 6,000 units x $1 20,000 3 12,000 = 2,000 units x $6 (4,000) =(4,000 units x $1) 8,000 4 14,000 = 2,000 units x $7 (6,000) =(2,000 units x $3) 8,000 Total sold 8,000 units End. Inv. 2,000 units

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Graph of Market Prices of Inventory

(11)

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11 10 9 Price ($) 8 7 6

(Cost)

(7) (6)

(7)

Date Quarter

1/1 1

3/31 2

6/30 3

9/30 4

12/31

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When an Expenditure May Be Deferred

1. Some costs such as major machinery repairs are expensed for annual reporting purposes but clearly benefit more than one interim period; therefore, the cost should be allocated to the benefited periods. 2. Quantity discounts offered to customers based on annual sales should be estimated and charged to sales during each of the interim periods.

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3. Property taxes should be deferred or accrued to ensure an appropriate allocation to each interim period. 4. Major advertising costs may be deferred in the period incurred and allocated to the other interim periods that benefit.
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Estimation of Annual Effective Tax Rate

Estimated income from continuing operations Adjust for permanent differences: Add premiums on key officers life insurance Deduct dividends received deduction Estimated annual taxable income Combined federal and state income taxes Estimated annual taxes before tax credits Deduct business tax credits Estimated income taxes for year Divided by estimated income from continuous operations Estimated effective annual tax rate on continuous operations
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$225,000 2,000 - 27,000 $200,000 x 38 % $ 76,000 - 22,000 $ 54,000 $225,000 24%

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Interim Income Tax

(1) (2) (3) (4) (5) (6) (7)

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Pd. Income Cum. Est.T rate Cum.Tax Prior This Pd.Tax I 20,000 20,000 .24 4,800 -04,800 II 25,000 45,000 III 80,000 125,000 .34 .34 15,300 42,500 4,800 15,300 10,500 27,200

IV 97,000 222,000 *rounded

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.28*

62,000

42,500

19,500

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Accounting Changes Interim Periods

Cumulative effect accounting changes
make effective as of first day of fiscal period, restating prior interim statements of this year

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Retroactive-type accounting changes

restate all prior statements, interim and annual

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Chapter Thirteen

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The End
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13-34

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