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CHAPTER 12

CHAPTER 12. REPORTING SEGMENT AND RELATED INFORMATION. FOCUS OF CHAPTER 12. Objectives and Applicability of FAS 131 Reporting Operating Segment Information Reporting Enterprise-wide Information Products & services Geographic areas Major customers.

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CHAPTER 12

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  1. CHAPTER 12 REPORTING SEGMENT AND RELATED INFORMATION

  2. FOCUS OF CHAPTER 12 • Objectives and Applicability of FAS 131 • Reporting Operating Segment Information • Reporting Enterprise-wide Information • Products & services • Geographic areas • Major customers

  3. Segment and Related Information Reporting: Objectives • To provide information about a reporting entity’s different types of: • Business activities. • Economic environments.

  4. Segment and Related Information Reporting: Objectives • This information should help financial statement users: • Better understand pastperformance. • Better assess prospects for future net cash flows. • Make more informed judgments about the entity as a whole.

  5. Segment and Related Information Reporting: Overview & Applicability • Segment and related information reporting underFAS 131 consists of disclosing the following 4 informational items:Operating segments. Products & services. Foreign operations/sales. Major customers. #1 #2 FAS 131 #3 #4 #2, #3, & #4 are “entity-wide disclosures.” They apply to ALL entities—even those having only l segment.

  6. Segment and Related Information Reporting: Overview & Applicability • Segment and related information reporting is: • Needed because of the limitations of consolidated financial statements. • Done in notes to the financial statements. • Applicable to: • Both ANNUAL & INTERIM statements. • PUBLIC BUSINESS ENTERPRISES ONLY (excludesnot-for-profit entities).

  7. Segment and Related Information Reporting: Overview & Applicability • Public business enterprises are entities that: • Have issued debt or equity securitiesthat are traded in a public market, • Are required to file financial statements with the SEC, or • Provide financial statements for the purpose of issuing any class of securities in the public market.

  8. Segment and Related Information Reporting: Overview & Applicability • Segment and related information reporting even applies to the following entities if they issue “separate company ” statements that are NOT in the same FINANCIAL REPORT as a set of consolidated statements: • Parent enterprises. • Subsidiaries. • Joint ventures. • Investees—if the equity method is used.

  9. Segment Reporting:Basis of Segmentation • Disaggregated financial information could be presented in several ways, for example: • By products & services (rejected). • By geographic area(rejected). • By legal entity (rejected). • By type of customer(rejected). • By organization of the segments for reporting to management for decision-making (the “management” approach).

  10. Segment Reporting:Basis of Segmentation • FAS 131 requires : • A SINGLE basis of segmentation. • The MANAGEMENT approach basis of segmentation. In contrast, FAS 14 (which was superseded by FAS 131) required TWO bases of segmentation— by industry and by geographic areas.

  11. Segment Reporting:Basis of Segmentation • Merits of the “Management” Approach: • Facilitates consistent descriptions in (1) annual reports and (2) various other published information. • Entities need not develop a separate measure of profitability solely for segment reporting purposes. Thus: • A non-GAAP method used internally is also used for segment reporting.

  12. Segment Reporting:Basis of Segmentation • The components that management establishes for reporting & decision-making are called OPERATING SEGMENTS. Such components: • Engage in activities from which they mayearn revenues and incur expenses. • Such activities include revenues and expenses resulting from transactionswith other segments (calledintersegmenttransactions). #1

  13. Segment Reporting:Basis of Segmentation • Such components (continued): Have their operating results regularly reviewed by a chief operating decision maker. #2 Have discrete financial information available. #3

  14. Segment Reporting:Basis of Segmentation • What Could Be an Operating Segment: • A start-up operation that has yet to report any revenues. • A component of a vertically integrated operation—providing these operations are managed that way.

  15. Segment Reporting:Basis of Segmentation • What CouldNot Be an Operating Segment: • A corporate headquarters. • Functional departments that earn eitherno revenues or only incidental revenues. • What Is DefinitelyNot an Operating Segment: • An entity’s pension plan. • An entity’s postretirement benefit plan.

  16. Segment Reporting:Disclosures Required • An entity must disclose 4types of information about its REPORTABLE OPERATING SEGMENTS: • General information. • Specified amounts. • Reconciliations of specified amountsto consolidated amounts. • Certain interim period information. TYPE 1 2 3 4

  17. Segment Reporting: Disclosures Required—General Information • TYPE 1—General Information Disclosures: • Factors used to identify the entity’s reportable segments, including the basisof organization, such as based on: • Products and services. • Geographic areas. • Regulatory environments. • A combination of factors. • Types of products & services from which eachreportable segment derives its revenues.

  18. Segment Reporting: Disclosures Required—Specified Amounts Information • TYPE 2—Specified Amounts Disclosures: • For eachreportable segment, a measure of: • Profit or loss. • Total assets (but not liabilities). • Certain account amounts (listed on next slide) if they are included in the measure of segment profit or loss.

  19. Segment Reporting: Disclosures Required—Specified Amounts Information • Certain Account Amounts That May Have to Be Disclosed: • Revenues from external customers. • Intersegment revenues. • Interest revenue and interest expense. • Depreciation & amortization expense and significant other NONCASH items. • Unusual items & extraordinary items. • Equity method income on investees. • Income tax expense or benefit.

  20. Segment Reporting: Disclosures Required—Specified Amounts Information • Key Point #1—LACK OF UNIFORMITY: FAS 131 does NOT define segment operating profit or loss (as did FAS 14, its predecessor). • Thus any measure of performance may be displayed—AS LONG AS THAT MEASURE OF PERFORMANCE IS REVIEWED BY THE CHIEF OPERATING DECISION MAKER.

  21. Segment Reporting: Disclosures Required—Specified Amounts Information • Key Point #2—Terminology: In dealing with segment reporting, the term “intercompany” is NOT RELEVANT. The RELEVANT terms are: • Intersegment (sales between segments). • Intrasegment (sales between components of a vertically integrated operation deemed to be a single operating segment).

  22. Segment Reporting: Disclosures Required—Specified Amounts Information • Key Point #3—Terminology: In presenting operating segment information: • Intersegment sales must be disclosed separately ONLY IF they are included in the measure of profitability. • Intrasegment sales need NOT be disclosed.

  23. Segment Reporting: Disclosures Required—Specified Amounts Information • Key Point #4—Transfer Pricing: • FAS 131 did not establish a basisfor setting prices for sales or transfers either between or within segments. • Transfer pricing is more likely to bean issue withinvertically integrated operations thanbetweennonvertically integrated segments.

  24. Segment Reporting: Disclosures Required—Specified Amounts Information • Key Point #5—Allocations: A segment’s expenses (used in its measure of operations) may include BOTH: • Directly traceable costs and • Allocated common costs (costs thatbenefit two or more segments). • Costs that are allocated must be allocated on a reasonable basis. #1 #2

  25. Segment Reporting: Disclosures Required—Specified Amounts Information • Key Point #6—Nonallocations: • Common costs need not be allocatedto or between segments. • Costs accounted for on a consolidated basis need not be allocated to segments (e.g. pension costs).

  26. Segment Reporting: Disclosures Required—Specified Amounts Information • Key Point #7—Asymmetrical Allocations: Permitted in determining a segment’s: • Measure of profitability and • Total assets. • Thus depreciation expense could be allocated to a segment but the relatedfixed assets could not.

  27. Segment Reporting: Disclosures Required—Specified Amounts Information • Key Point #8—R&D Costs: Disclosure of segment research & development costs is NOT required because: • Doing so could result in competitive harm by providing competitors with early insight into strategic plans. • R& D costs are often (1) incurred centrally and (2) NOTallocated to segments.

  28. Segment Reporting: Disclosures Required—Specified Amounts Information • Key Point #9—Liabilities: Disclosure of segment liabilities is NOT required: • The value of information about segment liabilities in assessing segment performance was deemed limited, partly because in many cases liabilities are: • Incurred centrally and NOTallocated to segments.

  29. Segment Reporting: Disclosures Required—Specified Amounts Information • Additional Asset-Related Disclosures for Reportable Segments—if the items are included in the determination of segment assets: • The amount of investment in equity method investees. • Total expenditures for additions tolong-lived assets.

  30. Segment Reporting: Disclosures Required—Specified Amounts Information • MEASUREMENT—BASIC RULE: Each segment item amount reported must be the measure reported to the chief operating decision maker for assessing performance & allocating resources to the segment. • Eliminations & Adjustments Made in Consolidation: Allocate to a segment ONLY IF they are included in the measure of profit and loss used by the chief operating decision maker.

  31. Segment Reporting: Disclosures Required—Specified Amounts Information • MEASUREMENT—MULTIPLE MEASURES: If more than one measure of a segment’s profit or loss and assets is used by the chief operating decision maker, the measure selected for segment reporting must be the measure most consistent with: • Those used in measuring those items in the entity’s consolidated financial statements.

  32. Segment Reporting: Disclosures Required—Specified Amounts Information • MEASUREMENT—DISCLOSURES: For reportable segment’s profit or loss and assets, disclose as a minimum: • The basis of accounting for intersegment transactions. • The nature of differences reported on the specified reconciliations (for P/L and for assets), if not apparent thereon. #1 #2

  33. Segment Reporting: Disclosures Required—Specified Amounts Information • MEASUREMENT—DISCLOSURES (cont.): • The nature and effect of any changes from prior periods in the measurement methods used to determine a reported segment P/L . • The nature and effect of any asymmetrical allocations to segments. #3 #4

  34. Segment Reporting: Disclosures Required—Reconciliations • TYPE 3—Reconciliations of SPECIFIED Amounts to CONSOLIDATED Amounts: • Reconcile the total of the reportable segments’: • Revenues. • Measure of profit or loss. • Assets. • Other significant items of information disclosed for reportable segments (e.g. liabilities, R&D expense).

  35. Segment Reporting: Disclosures Required—Interim Period Information • TYPE 4—Certain Interim Period Information: • For each reportable segment, disclose: • Revenues from external customers. • Intersegment revenues. • A measure of profit or loss. • Total assets, if a material change from amount disclosed in last annual report. • Changes in the segmentation basis or in basis of measurement of segment P/L. • Reconciliations to consolidated amounts.

  36. Segment Reporting: Disclosures Required—Cash Flow Information • Reporting segment cash flows is NOT required. • An indication of both an operating segment’s cash-generating ability and its cash requirements may be gathered from the required profitability and asset related disclosures.

  37. Segment Reporting:Aggregation of Similar Segments • Operating segments that have similar economic characteristics often have similar long-term financial performance. • Thus two or more operating segments may be combined into a single operating segment if 3 criteria (on thenext two slides) are met.

  38. Segment Reporting:Aggregation Criteria • The Three Aggregation Criteria: • Aggregation must be consistent with the objectives & principles of FAS 131. • The segments must have similar economic characteristics. • The segments are similar in each of the following 5 areas: • The nature of the products & services. #1 #2 #3

  39. Segment Reporting:Aggregation Criteria • Segments similar in 5 areas (Cont’d): • The nature of the production processes. • The type or class of customer for their products & services. • The methods used to distribute their products or provide services. • If applicable, the nature of the regulatory environment (e.g. banking, insurance, or public utilities).

  40. Segment ReportingQuantitative Thresholds—Overview • Not all operating segments are REPORTABLE operating segments.Three 10% tests are performed to determine if an operating segment is a reportable operatingsegment. • ONLYONEof the three 10% tests need bepassed. The tests involve: • REVENUES, PROFITABILITY, and ASSETS.

  41. Segment Reporting: Quantitative Thresholds—The 10% Tests • REVENUES: Are the segment’s reported revenues [includes both sales to external customers and intersegment sales or transfers] 10% or more of the combined revenue, internal and external, of ALL reported operating segments? #1

  42. Segment Reporting: Quantitative Thresholds—The 10% Tests • PROFITABILITY: Is the absolute amount of the segment’s reported profit or loss 10% or more of the greater, in absolute amount, of the combined reported: • PROFIT of all operating profitsthat DIDNOTreport a lossor • LOSS of all operating segmentsthat DID report a loss? #2 Winners Losers

  43. Segment Reporting:Quantitative Thresholds—The 10%Tests • ASSETS: Are the segment’s assets 10%or more of the combined assets of ALL operating segments? • Operating segments that do NOT meet any of the three 10% tests may be COMBINED with • Other such operating segments to produce a reportable segment—ONLY IF they share a majority of the specified aggregation criteria (listed on slides #38 & #39). #3

  44. Segment Reporting:Nonreportable Operating Segments • Nonreportable operating segments and other business activities are: • Combined and • Disclosed in an “ALL OTHER” category. • The Judgment Factor: A reportable segment in the preceding period that does NOT qualify as a reportable segment in the current period may be presented if management deems it to be of continuing significance.

  45. Segment Reporting:The 75% Test • DeterminingReportable Operating Segments: • Enough operating segments must be selected so that at least 75% of the total consolidated revenues (sales to external customers) is included in reportable operating segments. • DescribingReportableOperatingSegments: • The product or service of each industry segment must be identified.

  46. Enterprise-Wide Disclosures: The Three Categories of Information • Three types of enterprise-wide disclosures are called for. Information about: • Products and Services. • Geographic Areas. • Major Customers. #1 #2 #3

  47. Enterprise-Wide Disclosures: Products and Services • An entity must report REVENUES FROM EXTERNAL CUSTOMERS—unless it is impractical to do so—for: • Each product and service, or • Each group of similar products and services. • If it isimpracticalto disclose this product and service information, disclose that fact.

  48. Enterprise-Wide Disclosures: GeographicAreas—General • An entity must report geographic information—unless it is impractical to do so—for : • REVENUES • LONG-LIVED ASSETS • If it is impractical to disclose this geographicinformation, disclose that fact. #1 #2

  49. Enterprise-Wide Disclosures: GeographicAreas—Revenues • REVENUES—Disclose: • Revenues from external customers located: • In the United States. • Outside the United States, in total. • Revenues attributed to an individual foreign country, if material.

  50. Enterprise-Wide Disclosures:GeographicAreas—Long-Lived Assets • LONG-LIVED ASSETS—Disclose: • Long-lived assets located: • In the United States. • Outside the United States, in total. • In an individual foreign country, if material.

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