585 Exam 2

Segment Reporting

Applies to public entities Nonpublic entities are encouraged (but not required) to provide the same disclosures

Asset Test

Assets are 10% or more of the combined assets of all operating segments

Through What Date to evaluate Subsequent Events for Private companies?

Date F/S are available to be issued = complete in form + format re GAAP 855- 10-20

Subsequent Events

Events/ Transactions that occur AFTER the balance sheet date

Chief Operating Decision Maker (CODM)

A function, not necessarily a manger with a specific title The function is to allocate resources and assess performance Examples ‐ ‐ CEO, COO, President, Vice President, Strategy Committee

Major Customer Areas

Revenues from a single (external) customer of 10% or more ‐ ‐ disclose the fact No requirement to disclose the identity of the customer(s)

Income Statement

Revenues and Gains Expenditures and losses Income before taxes Provision for income taxes - current provision for income taxes - deferred Total provision for income taxes Net Income

§For public companies, non-GAAP financial measures are governed by

SEC

permanent

amounts recognized for either book income or tax income but not both ( and will never equal out)

Regulation G

covers the use of non-GAAP financial measures in any public disclosure and includes non-GAAP financial measure in any context, whether orally or in writing (and whether or not filed with or furnished to the SEC)

permanent differences

difference between book income and tax income is permanent and does not give rise to future taxable or deductible amounts therefore do not recognize deferred tax consequences - current taxes payable is based on tax income - no deferred tax effect - tax expenses for books is based on tax income

Tax Effects of Non-GAAP Financial Measures

§Company may need to provide information regarding income tax effects §Adjustments to arrive at a non-GAAP measure should not be presented "net of tax", rather they should be shown as a separate adjustment and explained

Item 10(e) of Regulation S-K (continued) - - prohibits

§Exclude charges or liabilities requiring cash settlement from non-GAAP liability measures except EBIT and EBITDA §Adjust performance to remove or smooth "infrequent" or "non recurring" items if similar item is reasonably likely to occur in 2 years or has occurred in past 2 years §Present non-GAAP measures on face of financial statements or notes or in any pro-forma information required by Article 11 of S-X §Uses titles or descriptions for non-GAAP that are identical or confusingly similar to those used for GAAP

Also explain measurement of segment amounts and disclose a reconciliation of total reportable segments' amount to the consolidated financial statements for

Total reportable segments' revenues to consolidated total revenues Total reportable segments' measures of profit or loss to consolidated income before income taxes (or after taxes if taxes are allocated to segments) Total reportable segments' assets to consolidated assets Total reportable segments' amounts for every other significant item of information disclosed to the corresponding consolidated amount

Non-GAAP financial measures may _______________ different aspects of a company's operations or ___________________ of large, unusual, or unique transactions, such as acquisitions or dispositions

- disaggregate - remove the effects

Company must recognize revenue by applying the five‐step process set forth in ASC 606‐10‐05‐4:

1. Identify the contract(s) with a customer. 2. Identify the performance obligations in the contract. 3. Determine the transaction price. 4. Allocate the transaction price to the performance obligations in the contract. 5. Recognize revenue when (or as) the entity satisfies a performance obligation.

Profit or Loss

Absolute amount of profit or loss is 10% or more of the greater in absolute amount, of either Combined profits of all operating segments that did not report a loss Combined loss of all operating segments that did report a loss

Change in Accounting Estimate Reporting Method

Account for in the period of change and future periods Do not restate or apply retrospectively and do not present pro forma amounts for prior periods

Reportable Segments [280‐10‐50‐10]

Operating segments that meet both of the following criteria: -Identified in accordance with 280‐10‐50‐1 through 50‐9 [operating segment criteria] or from aggregating two or more of those segments - Exceeds quantitative thresholds

Change in Accounting Principle Reporting Method

Retrospective Application Justification for change on the basis that it is preferable

Revenue test

Revenues are 10% or more of the combined revenue of all segments including intersegment sales and transfers

Product and Services

Revenues from external customers for each product and service or group of similar products and services unless it is impracticable to do so

Through What Date to evaluate Subsequent Events for Public companies?

Date F/S are issued - widely distributed or filed with SEC & in form + format Re GAAP

Disclosure Requirements RE: Sub Events Review: Non Public

Date through which Sub Events have been evaluated whether that date is: - Date F/S issued - Date F/S available to be issued

Geographic areas

Revenues from external customers and long‐lived assets Country of domicile Each foreign country where entity derives revenues or holds long‐lived assets

May 2016 New & Revised C&DIs

- Use of Potentially Misleading Non-GAAP Financial Measures -Prominence of Comparable GAAP Financial Measures -EBIT & EBITDA - Per Share Presentation of Non-GAAP Financial Measures - Tax Effects of Non-GAAP Financial Measures

Quantitative Thresholds A public entity shall report separately information about an operating segment that meets any of the following tests:

- revenue test - profit or loss test - asset test

The measurement of deferred tax assets is reduced,

if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized.

Common non-GAAP financial measures

§Earnings before interest, taxes, depreciation and amortization (EBITDA) §Adjusted EBITDA §Funds from operations §Adjusted earnings or adjusted earnings per share, and net debt

Per Share Presentation of Non-GAAP Financial Measures

§Non-GAAP Liquidity measures may not be presented on a per share basis §Generally, measures that report cash or funds generated from operations (i.e.: free cash flow) or that are capable of doing so (i.e.: EBIT and EBITDA) are considered liquidity measures §Non-GAAP Performance measures (i.e.: adjusted net income) presented on a per share basis are still considered acceptable

What is a non-GAAP financial measure?

§Numerical measure regarding a company's historical or future financial position, performance, cash flows, or liquidity §Portrays a measure of performance that is different from that calculated under GAAP or a measure of liquidity that differs from cash flow or cash flow from operations as calculated under GAAP

Why do companies use non-GAAP measures?

§One of the objectives of financial reporting is to provide sufficient information to allow users to consider a company's prospects for future cash flows §Companies often supplement their GAAP financial reporting with non-GAAP information that is intended to provide additional insight into the business §Such measures may convey changes to the business that are organic separate from those that may be considered unusual, infrequent, or not representative of underlying trends

Disclosure requirements for Regulation G

§Present "most directly comparable" GAAP measure §Reconcile the difference between the Non-GAAP and GAAP measure

Disclosure requirements for Item 10(e) of Regulation S-K - -

§Presentation of comparable GAAP must be of equal or greater prominence §Include a statement detailing why management believes the Non-GAAP measure is useful to investors and the purposes for which management uses each measure

Correction of Error Reporting Method

Restate previously issued F/S

Change in Reporting Entity Reporting Method

Retrospective Application

If presenting the direct method, then disclose ______________________

reconciliation of net income to net cash flow from operating activities

Deferred tax assets

represents the increase in taxes refundable or saved in future years or DEDUCTIBLE temporary differences at the end of the current year Book income < Tax income

Requires Disclosures of:

- Information about reportable segments - Entity wide information about - Revenues from (each of the entity's) products and services - Geographic areas of operations [where entity is earning revenue and holding assets] - Major Customers

Disclosure Requirements RE: Sub Events Review: Public

- No requirement to disclose date through which Sub Events evaluated

Entity‐Wide Information

- Product and Services - Geographic areas - Major Customer Areas

2 types of differences

- temporary - permanent

Operating Segments [280‐10‐50‐1]

A component of a public entity that has all of the following characteristics: - Engages in business activities from which it may recognize revenues and incurs expenses (including intra‐entity revenues and expenses) - Operating results are regularly reviewed by the chief operating decision maker (the CODM) to assess performance and make resource allocation decisions - Discrete financial information is available

Operating activities

Cash effects of transactions that enter into the determination of net income Transactions & events not defined as Investing or Financing

Investing Activities

Long-term asset transactions Non-operational asset transactions

Financing Activities

Long-term liability transactions Equity transactions

The most likely amount —

The most likely amount is the single most likely amount in a range of possible consideration amounts (that is, the single most likely outcome of the contract). The most likely amount may be an appropriate estimate of the amount of variable consideration if the contract has only two possible outcomes (for example, an entity either achieves a performance bonus or does not).

What reporting, if any, should Parent make in its consolidated financial statements for the year ended December 31 for the December 13 event?

Under ASC 810‐10‐45‐12 and Regulation S‐X, Rule 3A‐02, "recognition should be given by disclosure or otherwise to the effect of intervening events that materially affect the [parent's] financial position or results of operations." An entity may elect a policy of either disclosing, or disclosing and recognizing, all material intervening events. Either policy is acceptable and should be consistently applied to all material intervening events that meet the recognition requirements of U.S. GAAP A material intervening event would be considered a recognized subsequent event if it (1) occurs after the subsidiary's period‐end but before the year‐end of the parent's consolidated financial statements and (2) would meet the criteria for recognition under ASC 855 if the subsidiary was issuing separate stand‐alone financial statements under U.S. GAAP..

Change in Accounting Principle

a. From one generally accepted principle to another generally accepted principle b. When principle formerly used is no longer generally accepted

§Item 10(e) of Regulation S-K

applies to documents filed with the SEC

Companies may choose to exclude the impact of these transactions if they believe this will provide information that can _______________

benefit a user's assessment of a company's historical results, long-term prospects, or the effects of business decisions

Tax Income - Tax Accounting income

income before income taxes as reported in the tax return - based on tax code regulations - amount on which the income tax to be paid is based

Book Income - Pretax financial income

income before taxes as reported in the financial statements based on GAAP or other basis of accounting

Under either method for presenting cash flows from operating activities, there is no impact or change on the way the cash flows from ___________________

investing activities and financing activities are presented

§Non-GAAP Compliance & Disclosure Interpretations (CDIs)

issued by SEC division of Corporation Finance •2010 CDIs •May 17, 2016 SEC updated its non-GAAP CDIs - - 4 new CDIs + revisions to 8 others •October 2017, SEC issued additional updates to its non-GAAP CDIs •April 2018, SEC issued additional updates to its non-GAAP CDIs

Provision or benefit for income taxes - income tax expense or benefit

line item in the income statement for reporting income taxes includes the current amount and the deferred amount

An acquirer shall recognize a deferred tax asset or deferred tax liability arising from the assets acquired and liabilities assumed in a business combination and shall account for the potential tax effects

of temporary differences, carryforwards, and any income tax uncertainties of an acquiree that exist at the acquisition date, or that arise as a result of the acquisition, in 3 accordance with the guidance in Subtopic 740‐10 together with the incremental guidance provided in this Subtopic.

Deferred tax liability represents the increase in taxes ______________________ as a result of TAXABLE temporary differences at the end of the current year

payable in future years

EBIT & EBITDA

§Prohibits exclusion of charges or liabilities that require cash settlement from non-GAAP liquidity measures other than EBIT and EBITDA

Prominence of Comparable GAAP Financial Measures

§Provides expansive language and largely formulaic reading of "equal or greater prominence" §Details examples of non-compliance

Change in Accounting Estimate

Results from new information [Correction of an error is not a change in accounting estimate]

Income Taxes Payable

amount of income taxes payable for a given period as calculated by the income tax return for that period - current liability - existing legal liability Journal entry: Income tax expense Income tax payable

Indirect Method

Cash flows from operations are reported by adjusting net income to reconcile it to net cash flow from operating activities

temporary

difference equal out over a long period of time

Management Approach

Method for determining what information to report is referred to as the Management Approach Based on the way that management organizes the segments within the entity for making operating decisions and assessing performance Evident from the structure of the entity's internal organization

Statement of Cash flows Big Picture:

Cash and Cash Equivalents at the Beginning of the Year + or - Cash Flows from Operating Activities + or - Cash Flows from Investing Activities + or - Cash Flows from Financing Activities Cash and Cash Equivalents at the End of the Year

Cash and Cash Equivalents

Cash equivalents are short-term, highly liquid investments that have both of the following characteristics: a. Readily convertible to known amounts of cash b. So near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill and a three-year U.S. Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations).

Direct Method

Cash flows from operations are reported by major classes of gross cash receipts and gross cash payments and their arithmetic sum - the net cash flow from operating activities

Combining Segments

Combine information about operating segments that do not meet the quantitative tests if they have similar economic characteristics and share the majority of the criteria The EXTERNAL revenues of the reported segments must be at least 75% of total consolidated revenues Individually reportable 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

Correction of Error

Error in recognition, measurement, presentation, or disclosure in financial statements Resulting from mathematical mistakes, mistakes in the application of generally accepted accounting principles (GAAP), or oversight or misuse of facts that existed at the time the financial statements were prepared A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error.

Type 1 Subsequent Event - Recognized

Event/ Transaction After Balance sheet date provides evidence/ info re: conditions that existed as of the balance sheet date Accounting - Recognize as of balance sheet date Disclosure- no disclosure requirements

Type 2 Subsequent Event - Non-Recognized

Event/ Transaction After the Bad Sheet date provides evidence / info reconditions that did not exist as of the Balance Sheet Date Accounting - Do not recognize as of Balance Sheet date Disclosure - disclose if necessary to keep F/S from being misleading - nature of the event - estimate of financial effect or statement that estimate can't be made Consider pro forma data (recast financial info to give effect as if recognized

Reportable Segments Disclosure Requirements

For each reportable segment, disclose Net profit or loss Total assets Also disclose the following if included in measures reviewed by the CODM Revenues from external customers from transactions with other operating segments Interest revenue Interest expense Depreciation, depletion and amortization expense Unusual items as described in 225‐20‐45‐16 Equity in net income of investees accounted for by the equity method Income Tax expense or benefit Significant noncash items other than depreciation, depletion and amortization Investment in equity method investees Expenditures for additions to long‐lived assets

Cash receipts resulting from the settlement of insurance claims, excluding proceeds received from corporate‐owned life insurance policies and bank‐owned life insurance policies, shall be classified on the basis of the related insurance coverage (that is, the nature of the loss)

For insurance proceeds that are received in a lump‐sum settlement, an entity shall determine the classification on the basis of the nature of each loss included in the settlement.

Ignoring the event, is it appropriate for Parent to include Subsidiary 1 and Subsidiary 2 financial information as of and for the year ending October 31 in its consolidated financial information as of and for the year ending December 31? What considerations or policy choices should WWA make when evaluating this question?

I]f the difference is not more than about three months, it usually is acceptable to use, for consolidation purposes, the subsidiary's financial statements for its fiscal period; if this is done, recognition should be given by disclosure or otherwise to the effect of intervening events that materially affect the financial position or results of operations. (b) Different fiscal periods: Generally, registrants shall not consolidate any entity whose financial statements are as of a date or for periods substantially different from those of the registrant. Rather, the earnings or losses of such entities should be reflected in the registrant's financial statements on the equity method of accounting. However: (1) A difference in fiscal periods does not of itself justify the exclusion of an entity from consolidation. It ordinarily is feasible for such entity to prepare, for consolidation purposes, statements for a period which corresponds with or closely approaches the fiscal year of the registrant. Where the difference is not more than 93 days, it is usually acceptable to use, for consolidation purposes, such entity's statements for its fiscal period. Such difference, when it exists, should be disclosed as follows: the closing date of the entity should be expressly indicated, and the necessity for the use of different closing dates should be briefly explained. Furthermore, recognition should be given by disclosure or otherwise to the effect of intervening events which materially affect the financial position or results of operations. [Emphasis added]

Aggregation Criteria

Operating segments with similar economic characteristics and which exhibit similar long‐term financial performance can be aggregated into a single operating segment. May aggregate segments that have similar economic characteristics and are similar in all of the following areas: - Nature of the products or services - Nature of the production process - Type or class of customer for the products or services - Methods used to distribute products and services - Nature of the regulatory environment (Ex: banking, insurance, utilities)

Objectives [ASC 280‐10‐10‐1]

Provide information about different types of business activities and the different economic environments in which it operates to help users of the financial statements do all of the following: Better understand the entity's performance Better assess the entity's prospects for future cash flows Make more informed judgments about the entity as a whole

ASC 740-10-30-5E

Reduce deferred tax assets by a valuation allowance if based on the weight of available evidence it is more likely than not (a likelihood or more than 50%) that some portion or all of the deferred tax assets will not be realized. The valuation allowance shall be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized

"more likely than not" criterion for the realization of deferred tax assets.

Reduce deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or all of the deferred tax assets will not be realized. The valuation allowance shall be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized.

All available evidence, both positive and negative, shall be considered to determine whether, based on the weight of that evidence, a valuation allowance for deferred tax assets is needed. Information about an entity's current financial position and its results of operations for the current and preceding years ordinarily is readily available.

That historical information is supplemented by all currently available information about future years. Sometimes, however, historical information may not be available (for example, start‐up operations) or it may not be as relevant (for example, if there has been a significant, recent change in circumstances) and special attention is required.

Retrospective Application

The application of a different accounting principle to one or more previously issued financial statements, or to the statement of financial position at the beginning of the current period, as if that principle had always been used, or a change to financial statements of prior accounting periods to present the financial statements of a new reporting entity as if it had existed in those prior years.

Restatement

The process of revising previously issued financial statements to reflect the correction of an error in those financial statements.

ASC 740-10-10-1

There are two primary objectives related to accounting for income taxes: - to recognize the amount of taxes payable or refundable for the current year - recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity's financial statements or tax returns GAAP requires the financial statements to reflect the tax consequences of all the events recognized in the financial statements or in the tax returns whether the actual tax consequences are in the current period or in another period

Forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Other examples of negative evidence include, but are not limited to, the following:

a. A history of operating loss or tax credit carryforwards expiring unused b. Losses expected in early future years (by a presently profitable entity) 2 c. Unsettled circumstances that, if unfavorably resolved, would adversely affect future operations and profit levels on a continuing basis in future years d. A carryback, carryforward period that is so brief that it would limit realization of tax benefits if a significant deductible temporary difference is expected to reverse in a single year or the enterprise operates in a traditionally cyclical business.

Examples (not prerequisites) of positive evidence that might support a conclusion that a valuation allowance is not needed when there is negative evidence include (but are not limited to) the following:

a. Existing contracts or firm sales backlog that will produce more than enough taxable income to realize the deferred tax asset based on existing sales prices and cost structures b. An excess of appreciated asset value over the tax basis of the entity's net assets in an amount sufficient to realize the deferred tax asset c. A strong earnings history (tax loss carryforward or deductible temporary difference) coupled with evidence indicating that the loss (for example, an unusual, infrequent, or extraordinary item) is an aberration rather than a continuing condition.

Neither of the following is considered to be a change in accounting principle:

a. Initial adoption of an accounting principle in recognition of events or transactions occurring for the first time or that previously were immaterial in their effect b. Adoption or modification of an accounting principle necessitated by transactions or events that are clearly different in substance from those previously occurring.

Change in Reporting Entity

a. Presenting combined or consolidated F/S in place of F/S of individual entities b. Changing specific subsidiaries that make of the group of entities for which consolidated F/S are presented c. Changing the entities included in combined F/S d. NOT the result of Business Combination NOR Consolidation of VIE

A reporting entity shall change an accounting principle only if either of the following apply:

a. The change is required by a newly issued Codification update. b. The entity can justify the use of an allowable alternative accounting principle on the basis that it is preferable.

A good or service that is promised to a customer is distinct if both of the following criteria are met:

a. The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct). b. The entity's promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the promise to transfer the good or service is distinct within the context of the contract).

A contract is in place because the requirements of ASC 606‐10‐25‐1(a) through (e) have been met:

a. The parties to the contract have approved the contract (in writing, orally, or in accordance with other customary business practices) and are committed to perform their respective obligations. b. The entity can identify each party's rights regarding the goods or services to be transferred. c. The entity can identify the payment terms for the goods or services to be transferred. d. The contract has commercial substance (that is, the risk, timing, or amount of the entity's future cash flows is expected to change as a result of the contract). e. It is probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. [...] In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer's ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see paragraph 606‐10‐32‐7).

Deferred tax liability

amount of income taxes that will be payable in the future - expected amount of taxes on income recognized in the financial statements but not yet subject to tax - not an existing legal liability - book income > tax income Journal entry- Income tax expense Deferred tax liability

SEC prefers the

direct method

Use of Potentially Misleading Non-GAAP Financial Measures

§Problematic or Misleading Disclosures[examples which may or could result in measures that are misleading] §Presenting a performance measure that excludes normal recurring cash operating expense necessary to operate a business §Adjusting only for non-recurring charges when there were also non-recurring gains in the same period (stock-based comp is not specifically addressed but likely to be subject to the same increased scrutiny §Inconsistency Between Periods §Example - adjusting for a gain or loss in one period but not for another period unless the change is disclosed and reasons are explained §Individually Tailored Revenue Recognition §Adjusting performance measures to accelerate revenue ratably over time as though revenue were earned when customers are billed §Any individually tailored revenue recognition and measurement methods

Non Gaap measures has three different regulations

§Regulation G §Item 10(e) of Regulation S-K §Non-GAAP Compliance & Disclosure Interpretations (CDIs)