Chapter 8: Segment and Interim Reporting

The *Rationale* of Requiring Segment Information in F/S

1) *Provide information to help* the *users* of financial statements. A. *Better understand* the entity's performance. B. *Better assess* the entity's prospects for future cash flow. C. Make *more informed* judgments about the enterprise *as a whole*.

Disclosure of Segment Information

- Segment reports may be presented in a separate schedule or in footnotes. - The segment disclosures are based on the same measures used by the chief operating decision maker to internally evaluate the operating performance of the segments.

*Two possible approaches* to the preparation of interim statements

1) *Discrete* - an interim period is a discrete, *separate accounting period that stands on its own*. Transactions occurring during the interim period are accounted for in full during that period. 2) *Integral* - an interim period is *an integral part of an annual period*. Transactions occurring in one interim period that relate to several interim periods are accrued/deferred to those periods. - APBO 28 treates interim periods as *integral* parts of an annual period. *Special rules* are to be followed in dealing with: A. inventory and cost-of-goods-sold, B. other costs and expense, C. income taxes, and D. accounting changes

Inventory - Temporary LIFO Liquidation

*Temporary* LIFO liquidations: LIFO liquidation occurs in one interim period, but the inventory is expected to be replaced by the end of the fiscal year. Temporary liquidations of LIFO base-period inventory should be charged to COGS at expected replacement cost. The reason the interim treatment of temporary LIFO inventory liquidations differs from the annual treatment of LIFO liquidations is that since the inventory is expected to be replaced by the end of the fiscal year, *interim income for the period of the* temporary liquidation would be overstated if COGS were charged with the lower LIFO inventory costs in a time of rising prices.

Determine a segment is *separately REPORTABLE*

1) Determination of an *operating segment*. 2) Separately reportable operating segments are defined using the three 10% significance tests. If *any of these tests are met, THE SEGMENT IS REPORTABLE*. 3) The *comprehensive disclosure test*.

The *Rationale* of requiring interim information

To provide investors and other interested parties *contemporary reports* on the operating progress of the entity. Therefore, the SEC requires U.S. publicly traded companies to provide financial statements on a *quarterly basis*.

IFRS - Segment Reporting

IFRS 8, "Operating Segments," is based on U.S. GAAP. Major differences between IFRS 8 and U.S. GAAP are: 1) *IFRS 8* requires disclosure of *total assets and total liabilities* by operating segment if these are regularly reported to the chief operating decision maker. *U.S. GAAP* requires disclosure of segment *assets* but does not require disclosure of segment liabilities. 2) *IFRS 8* specifically includes *intangibles* in the scope of "non-current assets" to be disclosed by geographic area. *U.S. GAAP* indicates that "long-lived assets" to be disclosed by geographic area *excludes intangibles*. 3) *U.S. GAAP* requires an entity with a matrix form of organization to determine operating segments based on *products or services*. *IFRS 8* allows such an entity to determine operating segments based on either *products and services or geographic areas*.

*Enterprise-wide Disclosures*

- In addition to disclosures bu operating segment, SFAS 131 also requires certain "enterprise-wide" disclosures to be made. 1) *Information about products and services*: If operating segments are not based on products or services or if a company has only one operating segment, SFAS 131 requires disclosure of revenues derived from transactions with external customers from each product or service. 2) *Information about geographic areas*: Geographic are information must be disclosed even if the company has only one operating segment and therefore does not otherwise provide segment information. 3) *Disclosures about major customers*: If a company generates 10 percent or more of its revenues from a single customer this fact must be disclosed. The existence of all major (10% or more) customers must be disclosed along with the related amount of revenues and the identity of the operating segment earning the revenues. The *identity* of the customer need *not* be disclosed. Major customer disclosures are required even if a company operates only in one segment and therefore does not provide segment information.

The *Comprehensive Disclosure Test*

A. For the reportable segments to represent a substantial portion of total operations, the *total external revenue* of all separately reportable segments *must be at least 75 percent of the total consolidated* (=external) *sales* for the company as a whole. B. The reporting company must *identify additional operating segments as reportable* until this test is met.

Determination of an *Operating Segment*

A. An operating segment is a component of an enterprise: a. That engages in *business activities* from which *it earns revenues and incurs expenses* b. Who operating results are *regularly reviewed* by the *chief operating decision maker* to *assess performance* and *make resource allocation decisions* c. For which *discrete financial* information is *available* B. Operating segments *could be combined*, based on the: a. nature of the products or services provided by each operating segment. b. nature of the production process. c. type or class of customer. d. distribution methods. e. nature of the regulatory environment.

Separately reportable operating segments are defined using the three 10% significance tests. If *any of these tests are met, THE SEGMENT IS REPORTABLE*

A. the *Revenue Test*: its revenue >/= 10% of the Total revenue of all operating segments (external and intersegment sales) B. the *Profit or Loss Test*: its profit or loss (absolute amount) >/= 10% of the Larger, in absolute value terms, of the combined profits from profitable segments or the combined losses from segment with a loss C. the *Asset Test*: its assets >/= 10% of the Total assets of all operating segments.

LIFO Liquidation

The number of units of ending inventory is smaller than the number of units of beginning inventory. If inventory costs are rising, LIFO liquidation causes abnormally high gross profit.

Inventory - Lower of Cost or Market Value

1) *Permanent inventory* losses due to a *decline in market prices* (not *expected to recover* by year end) *are recognized in* the period of decline using the lower-of-cost-or-market valuation method. Many companies report this write-down as part of their COGS. 2) *Recoveries of market prices* (due to an increase in inventory *replacement costs*) in later interim periods of *the same fiscal year should be recognized as gains* (recoveries of prior valuation losses) in the later interim period. Note that the inventory may not be valued at an *amount in excess* of cost recorded on prior year's *annual* B/S. 3) Temporary declines in inventory market value need *not* be recognized.

IFRS and Interim Reporting

1) IAS 34, "Interim Financial Reporting," provides guidance in IFRS with respect to interim financial statements. 2) Unlike U.S. GAAP, *IAS 34* requires each interim period to be treated as a *discrete accounting period* in terms of the amounts to be recognized. As a result, expenses that are incurred in one quarter are expenses in that quarter even though the expenditure benefits the entire year. And there is no accrual in earlier quarters for expenses expected to be incurred later in the year.