Christensen 12e Chap13 SM PDF

Preview

Summary

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent13- 1CHAPTER 13SEGMENT AND INTERIM REPORTINGANSWERS TO QUESTIONSQ13-1 Information on a company's operations in different industries would be helpful to investors in their ass...

Description

Chapter 13 - Segment and Interim Reporting

CHAPTER 13 SEGMENT AND INTERIM REPORTING ANSWERS TO QUESTIONS Q13-1 Information on a company's operations in different industries would be helpful to investors in their assessments concerning the different profit rates, different degrees and types of risk, and different opportunities for growth of each of the different industries. In general, this breakdown helps the investors look behind the consolidated totals to the individual components that comprise the company. Q13-2 The relationship between the FASB's segment disclosure requirements and a company's profit centers focuses on the management viewpoint in ASC 280. The FASB requires that the definitions of operating segments used for internal decision-making purposes be used for presenting segment information for financial statement purposes. Q13-3 The three ten percent significance tests used to determine reportable segments under ASC 280 are the 10 percent revenue test, the 10 percent operating profit (loss) test, and the 10 percent assets test. For the 10 percent revenue test, the numerator and denominator are as follows: Each operating segment's total revenue (including intersegment transfers and sales) Combined revenue of all operating segments (including intersegment transfers and sales)

For the 10 percent profit (loss) test, the numerator and denominator are as follows: Absolute value of each operating segment's profit (loss) Absolute value of the combined profit or combined losses of the operating segments (whichever is greater)

For the assets test, the numerator and denominator are as follows: Each operating segment’s assets Combined assets of all industry segments excluding general corporate assets

Q13-4 Whatever items are used for internal decision-making purposes to measure the operating segment’s profit or loss shall be reported in the external disclosure.

13-1 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 13 - Segment and Interim Reporting

Q13-5 Any segments passing one of the 10 percent tests would also be disclosed. The lower limit for the number of segments to be disclosed is set by the 75 percent revenue test. If the assumption is made that the largest four segments fail the 75 percent test and the largest five segments pass the 75 percent test, then the five segments should be separately reported. The remaining segments, if they fail the 10 percent tests, are combined under the heading of "Other Segments" and not defined further. Q13-6 First, ASC 280 specifies that all companies should disclose revenues and longlived, productive assets domestically and, in total, for all foreign activities. The two materiality tests applied to country-based foreign operations are the 10 percent revenue test and the 10 percent long-lived asset test. Q13-7 A company must disclose for each of its significant customers (those with 10% or more of the entity’s revenue) the amount of sales to these customers and the associated industry segment. The names of the individual customers need not be disclosed, although some companies do disclose the names of the customers. Q13-8 Interim reports can be used by investors to identify a company's seasonal trends by identifying the pattern of revenue and expenses as they occur each interim period. Q13-9 Revenue from products sold or services rendered should be recognized as earned during an interim period on the same basis as followed for the full year. Revenue from seasonal businesses cannot be manipulated to eliminate seasonal trends. Q13-10 Those costs and expenses that are associated directly with or allocated to the products sold or to the services rendered for annual reporting purposes should be treated similarly for interim reporting purposes. The following practical modifications are allowed to the general rule: a. Estimated gross profit rates may be used to determine an interim period's cost of goods sold. b. 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 if the company uses the LIFO inventory valuation method. The expected replacement cost of the liquidated portion of the LIFO base should be used for the interim period's cost of goods sold. c. Inventory losses due to a decline in market prices are recognized in the period of decline using the lower-of-cost-or-market valuation method. Recoveries of market prices in later interim periods of the same fiscal year should be recognized as gains (recoveries of prior losses) in the later interim period. d. Companies using a standard cost system for inventories should use the same procedures for computing and reporting variances in an interim period as used for the fiscal year. Purchase price variances or volume or capacity variances that are expected to be absorbed by the end of the fiscal year should be deferred at the interim period and should not be included in the interim income. Costs and expenses other than product costs should be charged to income in interim periods as incurred or be allocated among interim periods based on an estimate of the time expired, benefit received, or activity associated with the periods.

13-2 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 13 - Segment and Interim Reporting

Q13-11 The application of the lower-of-cost-or-market valuation method differs between interim statements and annual statements when temporary market declines are expected to reverse by the end of the fiscal year. When a temporary market decline is experienced, the decline need not be recognized at the interim date because no loss is expected for the fiscal year. Q13-12 At the end of the second interim period, the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate so determined should be used in providing for income taxes on a current year-to-date basis. The effective annual tax rate should reflect anticipated investment tax credits, foreign tax rates, percentage depletion, capital gains rates, and other available tax planning alternatives. In arriving at this effective annual tax rate, no effect should be included for the tax related to significant unusual items that will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year. Q13-13 If the future realizability of the tax benefit is not assured beyond a reasonable doubt, the tax benefit is not shown in the interim statements. Q13-14 Discontinued operations should be disclosed separately, included in the determination of net income for the interim period in which they occur, and shown net of applicable taxes. In determining materiality, discontinued operations should be related to the operating income for the interim period in which the discontinued operations are first reported. Q13-15 A change in accounting principle made in an interim period is reported using the retrospective application process. The balance sheet for the earliest period presented (usually an annual period) is adjusted for the cumulative amount of the change as of the beginning of that year. Then, all subsequent annual and interim financial statements shall be adjusted to the newly adopted accounting principle. In the example of an inventory change, all the financial statements presented must be adjusted to the new method, the average cost method. The balance sheet for the earliest period presented must include the cumulative effect as of the change computed as of the beginning of that first period presented.

13-3 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 13 - Segment and Interim Reporting

SOLUTIONS TO CASES C13-1 Segment Disclosures [CMA Adapted] a. The purpose for requiring segment information to be disclosed in financial statements is to assist financial statement users in analyzing and understanding the enterprise's financial statements by permitting better assessment of the enterprise's past performances and future prospects. b. The determination of the segments appropriate for an enterprise is the responsibility of management; that is, management should use its judgment in deciding how to report its segment information. Specific characteristics or sets of characteristics management can use in determining how to group its products into segments include the following: 1. Use of existing profit centers. 2. A segment shall be regarded as significant and identified as a reportable segment if one or more of the following are satisfied: i. 10% or more of the total revenue is derived from one segment. ii. 10% or more of the greater in absolute amount of the aggregate profits or aggregate losses is contributed by the segment. iii. 10% of the combined assets can be associated with the segment. 3. Management has the ability to define the breakdown of the segments, but the segment definitions used for external purposes must be the same as used for internal decision making purposes. c. The options available to Chemax Industries are as follows: 1. Segment by product line — antihistamines. This single product meets the 10 percent test and can be anticipated as a significant product line in the future. 2. Segment by product group — pharmaceutical, medical instruments, and medical supplies. Antihistamines can be carried as a part of the pharmaceutical group. 3. Disaggregate pharmaceutical into ethical and proprietary drugs and carry antihistamines under whichever industry segment is appropriate (probably proprietary drugs, in this case).

13-4 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 13 - Segment and Interim Reporting

C13-2 Matching Revenue and Expenses for Interim Periods a. Revenue, product costs, gains, and losses should be recognized for interim periods on the same bases as for an annual period. These items should be recognized in the period earned or incurred and should not be deferred or allocated to other interim periods. b. Cost of goods sold and inventory valuation requires several estimations because physical counts typically are not made for interim periods. Cost of goods sold may be estimated using the gross profit method. Temporary liquidations of LIFO layers are priced using the replacement costs of the goods, not the LIFO cost. Temporary reductions in the market value below cost under the lower-of-cost-or-market rule do not need to be recognized in an interim period. However, reductions in value that may be permanent must be recognized. A loss recovery is allowed for recoveries of market value from one interim to another. c. Period costs are those such as depreciation or other amortizations and allocations. These should be allocated to each interim period based on a reasonable allocation method such as straight-line or percentage of the interim period's revenue to expected annual revenue. d. Accounting treatment for interim statements: 1. Long-term contracts — These contracts are accounted for on the same basis as for the annual period. Percentage-of-completion estimates are made each interim period and gross profit is recognized. If the completed contract method is used, then profit is recognized only for projects completed within the interim period. 2. Advertising costs — These costs may be capitalized and allocated to the interim periods that benefit. However, no advertising costs are deferred beyond the end of the annual fiscal period. The allocation should be on a reasonable basis such as the percentage of interim revenue to expected annual revenue. Advertising costs or other costs that will benefit more than one interim period may be deferred under the integral approach used for interim reporting. 3. Seasonal revenue — Revenue must be recognized in the period earned. The company may not defer revenue from one interim period to another in an attempt to smooth the revenue stream. 4. Flood loss — Significant unusual items must be recognized in the interim period in which the event occurs. 5. Annual major repairs and maintenance — Unusually large and nonrecurring costs may be capitalized to the asset and carried past the end of the fiscal period. However, normal maintenance and repairs may not be carried beyond the end of the fiscal year. Some accountants account for repairs on an interim basis by charging each of the interim periods with a proportionate amount of the annual repair cost and establishing an allowance for repairs contra account to the plant and equipment account. The expenditure is then charged against the allowance account. Other accountants would charge the entire cost off in the interim period in which the expenditure is made.

13-5 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 13 - Segment and Interim Reporting

C13-3 Segment Disclosures in the Financial Statements [CMA Adapted] a. A subdivision of an entity is a reportable segment if one of the following tests is met: 1. Revenue, both unaffiliated and intersegment revenue, is ten percent or more of total revenue, which includes intersegment revenue. For each of Bennett's segments, divide the sum of the unaffiliated sales and intersegment sales by total company sales of $63,000. If the result is ten percent or more, the revenue test is met for that specific segment. 2. The absolute value of profit or loss is ten percent or more of the greater of either the total profit of segments that did not incur a loss or the total, in absolute amounts, of the segments that did incur a loss. For each segment, divide the absolute value of the profit or loss by the sum of the segment profits of $6,200. If the result is ten percent or more, the segment profit or loss test is met for that specific segment. 3. Assets are ten percent or more of total assets. For each segment, divide the value of the assets by total assets of $100,000. If the result is ten percent or more, the assets test is met for that specific segment. The calculations for the segments of Bennett Inc. yield results that show that all segments are reportable with the exception of Security Systems, which does not meet any of the tests. See the results of all the tests in the table below. Bennett Inc. Results of Required Tests for Determining Segment Reporting For the Year Ended December 31, 20X5

Revenue Profit Assets Reportable

Power Tools 0.67 0.73 0.50 Yes

Fastening Systems 0.16 0.16 0.23 Yes

Household Products 0.08 0.10 0.17 Yes

Plumbing Products 0.06 0.11 0.06 Yes

Security Systems 0.03 0.02 0.04 No

b. For the reportable segments of Bennett Inc. to represent a substantial portion of total operations, the combined revenue from sales to unaffiliated customers of all reportable segments must be at least 75 percent of the total sales for the company as a whole. Since the sales to unaffiliated customers of Bennett's reportable segments are $44,300 and represent approximately 96 percent of the company's total sales ($44,300 / $46,300), this criterion would be met.

13-6 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 13 - Segment and Interim Reporting

C13-4 Determining Industry and Geographic Segments a. This is an actual case adapted from experiences with a large, publicly-held U.S. company. The U.S. company's management was reluctant to disclose information about the Canadian operation's profitability because of the desire to maintain its economic competitiveness, and because of fear that Canadian authorities might want to increase regulation of non-Canadian owned companies operating in Canada. b. Under ASC 280, the U.S. company must present its segmental disclosures based on the definition of operating segments as used for internal decision making. Therefore, if the management of the company felt that the two product lines were sufficiently comparable, management could aggregate the two product lines in the same operating segment for internal decision-making purposes. Then, because the two product lines were in one operating segment for internal decision-making purposes, they would be considered one operating segment for external disclosure purposes under ASC 280. However, ASC 280 also requires separate disclosure of revenues by product line. The company could still be required to disclose revenue information about the pasta product line. One interpretation the company could use to postpone separately disclosing detailed information about its pasta business is to argue that the pasta business passed one of the 10 percent tests in the current year because of some unusual, one-time events that are not expected to continue. Thus, if a segment becomes reportable in a single period because of some significant one-time events, the company may choose not to include it as a separately reportable segment. However, if in the next year, the pasta business continues to meet the separately reportable segment tests, then the company’s management would not be able to use this argument. c. ASC 280 requires separate disclosure of total revenues from external customers attributed to the domestic operations and the total attributed to all foreign operations. In addition, disclosure is required of the total of long-lived assets located in the country of the domestic operations and the total long-lived assets in all foreign countries. If the revenues or the long-lived assets in any individual country are material, then separate disclosure of the material revenues or significant amount of long-lived assets must be made for those specific countries. ASC 280 did not specifically state a measure of materiality to be used in assessing foreign operations. Management does have the flexibility to determine the basis of assigning revenues to specific countries. For example, in this case, management may argue that the revenues should be based on the point-ofsale to the eventual consumer. Thus, sales of the pasta products in the U.S. would be assignable to the U.S. domestic market even though the product may have been manufactured in Canada.

13-7 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 13 - Segment and Interim Reporting

C13-5 Segment Reporting a. A great amount of information can be found on a company’s homepage ranging from financial information to product information and company profiles. The internet address for many companies includes their company name. Your students may simply use a web browser to do a search for a specific company. b. EDGAR is a comprehensive database of SEC filings for all publicly held firms. The URL is http://www.sec.gov and EDGAR can be accessed from there. All SEC filings for publicly held firms are available in this database and the filings can be easily printed off for further use, if required. C13-6 Interim Reporting a & b.

Internet URL: http://www.sec.gov

The above Internet address provides access to the SEC’s EDGAR database. From this page, the user is able to select "Search for Filings” on the left-hand side of the page. The user then selects the link to search by “Company or fund name…" This link takes you to EDGAR Company Search page at which you will enter the Company name. After clicking on the “Find Companies” button at the bottom of the screen, students will be taken to a listing of the companies with that name, and can select their specific company which will t...