Solution Manual Advanced Accounting 9E by Hoyle 08 chapter PDF

Preview

Summary

Find more slides, ebooks, solution manual and testbank on CHAPTER 8 SEGMENT AND INTERIM REPORTING Chapter Outline I. In the past, consolidation of financial information made the analysis of diversified companies quite difficult. A. The consolidation process tends to obscure the individual characteri...

Description

CHAPTER 8 SEGMENT AND INTERIM REPORTING Chapter Outline I.

In the past, consolidation of financial information made the analysis of diversified companies quite difficult. A. The consolidation process tends to obscure the individual characteristics of the various component operations. B. Many groups called for the presentation of disaggregated financial data as a means of enhancing the information content of corporate financial reporting.

II.

The move toward dissemination of disaggregated information culminated in December 1976 with the release by the FASB of Statement 14, “Financial Reporting for Segments of a Business Enterprise.” A. This pronouncement required extensive disclosures pertaining to industry segments, domestic and foreign operations, export sales, and major customers. B. Although financial analysts found segment information to be very useful, they consistently requested that financial information be disaggregated to an even greater extent than was done in practice. C. Of particular concern was SFAS 14’s “dominant industry rule” which allowed many companies to avoid providing disaggregated data by industry segment.

III. In response to the demand by financial analysts for improvements in segment reporting, the FASB issued Statement 131, “Disclosures about Segments of an Enterprise and Related Information” in June 1997. A. SFAS 131 adopts a management approach in which segments are based on the way that management disaggregates the enterprise for making operating decisions; these are referred to as operating segments. B. Operating segments are components of an enterprise which meet three criteria. 1. Engage in business activities and earn revenues and incur expenses. 2. Operating results are regularly reviewed by the chief operating decision-maker to assess performance and make resource allocation decisions. 3. Discrete financial information is available from the internal reporting system. C. Once operating segments have been identified, three quantitative threshold tests are then applied to identify segments of sufficient size to warrant separate disclosure. Any segment meeting even one of these tests is separately reportable. 1. Revenue test—segment revenues, both external and intersegment, are 10 percent or more of the combined revenue, external and intersegment, of all reported operating segments. 2. Profit or loss test—segment profit or loss is 10 percent or more of the greater (in absolute terms) of the combined reported profit of all profitable segments or the combined reported loss of all segments incurring a loss. 3. Asset test—segment assets are 10 percent or more of the combined assets of all operating segments.

Irwin/McGraw-Hill Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009 8-1

D. SFAS 131 also sets several general restrictions on the presentation of operating segments. 1. Separately reported operating segments must generate at least 75 percent of total sales made by the company to outside parties. 2. Ten is suggested as the maximum number of operating segments that should be separately disclosed. If more than ten are reportable, the company should consider combining some operating segments. E. Information to be disclosed by operating segment. 1. General information about the operating segment including factors used to identify operating segments and the types of products and services from which each segment derives its revenues. 2. Segment profit or loss and the following components of profit or loss. a. Revenues from external customers. b. Revenues from transactions with other operating segments. c. Interest revenue and interest expense (reported separately). d. Depreciation, depletion, and amortization expense. e. Other significant noncash items included in segment profit or loss. f. Unusual items (discontinued operations and extraordinary items). g. Income tax expense or benefit. 3. Total segment assets and the following related items. a. Investment in equity method affiliates. b. Expenditures for additions to long-lived assets. IV.

Enterprise-wide disclosures. A. Information about products and services. 1. Additional information must be provided if operating segments have not been determined based on differences in products and services, or if the enterprise has only one operating segment. 2. In those situations, revenues derived from transactions with external customers must be disclosed by product or service. B. Information about geographic areas. 1. Revenues from external customers and long-lived assets must be reported for (a) the domestic country, (b) all foreign countries in which the enterprise has assets or derives revenues, and (c ) each individual foreign country in which the enterprise has material revenues or material long-lived assets. 2. The FASB does not provide any specific guidance with regard to determining materiality of revenues or long-lived assets; this is left to management’s judgment. C. Information about major customers. 1. The volume of sales to a single customer must be disclosed if it constitutes 10 percent or more of total sales to unaffiliated customers. 2. The identity of the major customer need not be disclosed.

V.

To provide investors and creditors with more timely information than is provided by an annual report, the U.S. Securities and Exchange Commission (SEC) requires publicly traded companies to provide financial statements on an interim (quarterly) basis. A. Quarterly statements need not be audited.

McGraw-Hill/Irwin 8-2

© The McGraw-Hill Companies, Inc., 2009 Solutions Manual

VI. APB Opinion No. 28 requires companies to treat interim periods as integral parts of an annual period rather than as discrete accounting periods in their own right. A. Generally, interim statements should be prepared following the same accounting principles and practices used in the annual statements. B. However, several items require special treatment for the interim statements to better reflect the expected annual amounts. 1. Revenues are recognized for interim periods in the same way as they are on an annual basis. 2. Interim statements should not reflect the effect of a LIFO liquidation if the units of beginning inventory sold are expected to be replaced by year-end; inventory should not be written down to a lower market value if the market value is expected to recover above the inventory's cost by year-end; and planned variances under a standard cost system should not be reflected in interim statements if they are expected to be absorbed by year-end. 3. Costs incurred in one interim period but associated with activities or benefits of multiple interim periods (such as advertising and executive bonuses) should be allocated across interim periods on a reasonable basis through accruals and deferrals. 4. The materiality of an extraordinary item should be assessed by comparing its amount against the expected income for the full year. 5. Income tax related to ordinary income should be computed at an estimated annual effective tax rate; income tax related to an extraordinary item should be calculated at the margin. VII. FASB Statement No. 154, “Accounting Changes and Error Corrections,” provides guidance for reporting changes in accounting principles including those made in interim periods. A. Unless impracticable to do so, an accounting change is applied retrospectively, that is, prior period financial statements are restated as if the new accounting principle had always been used. B. When an accounting change is made in other than the first interim period, information for the interim periods prior to the change should be reported by retrospectively applying the new accounting principle to these pre-change interim periods. C. If retrospective application of the new accounting principle to interim periods prior to the change of change is impracticable, the accounting change is not allowed to be made in an interim period but may be made only at the beginning of the next fiscal year. VIII. Many companies provide summary financial statements and notes in their interim reports. A. APB Opinion No. 28 imposes minimum disclosure requirements for interim reports. 1. Sales, income tax, extraordinary items, cumulative effect of accounting change, and net income. 2. Earnings per share. 3. Seasonal revenues and expenses. 4. Significant changes in estimates or provisions for income taxes. 5. Disposal of a business segment and unusual items. Irwin/McGraw-Hill Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009 8-3

6. Contingent items. 7. Changes in accounting principles or estimates. 8. Significant changes in financial position.

McGraw-Hill/Irwin 8-4

© The McGraw-Hill Companies, Inc., 2009 Solutions Manual

B.

Disclosure of balance sheet and cash flow information is encouraged but not required. If not included in the interim report, significant changes in the following must be disclosed: 1. Cash and cash equivalents. 2. Net working capital. 3. Long-term liabilities. 4. Stockholders' equity.

IX. Four items of information must also be disclosed by operating segment in interim financial statements: revenues from external customers, intersegment revenues, segment profit or loss, and, if there has been a material change since the annual report, total assets.

Learning Objectives Having completed Chapter 8 of this textbook, “Segment and Interim Reporting,” students should be able to fulfill each of the following learning objectives: 1. Identify the financial analysis problems associated with consolidated financial statements. 2. Discuss the method by which an enterprise determines its operating segments and the factors that influence this determination. 3. Identify and apply the three tests that are used to determine which operating segments are of significant size to warrant separate disclosure. 4. List the basic disclosure requirements for operating segments. 5. Describe the various limitations within which the number of separately disclosed operating segments should fall. 6. Explain when enterprise-wide disclosures related to products and services is required. 7. Explain when and what types of information about geographic areas must be disclosed. 8. Describe the criterion by which sales to a single unaffiliated customer are measured to determine whether disclosure is required. 9. Explain the "integral" approach followed in preparing interim reports and distinguish it from the "discrete" approach. 10. Describe and apply procedures used in interim reports for LIFO liquidations, costs associated with more than one interim period, income taxes, and accounting changes. 11. List the minimum disclosure requirements for interim financial reports.

Irwin/McGraw-Hill Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009 8-5

Answer to Discussion Question In his well-publicized “The Numbers Game” speech delivered in September 1998, former SEC chairman Arthur Levitt cited “materiality” as one of five gimmicks used by companies to manage earnings. Although his remarks were not specifically directed toward the issue of geographic segment reporting, the intent was to warn the corporate America that materiality should not be used as an excuse for inappropriate accounting. To make the point even more salient, the SEC issued Staff Accounting Bulletin (SAB) 99, “Materiality,” in August 1999, which warns financial statement preparers that reliance on a simple numerical rule of thumb, such as 5% of net income, is not sufficient. SAB 99 reminds financial statement preparers that: “The omission or misstatement of an item in a financial report is material if, in the light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.” Further, SAB 99 reminds companies that both quantitative and qualitative factors should be considered in determining materiality. With respect to segment reporting, SAB 99 states: “The materiality of a misstatement may turn on where it appears in the financial statements. For example, a misstatement may involve a segment of the registrant's operations. In that instance, in assessing materiality of a misstatement to the financial statements taken as a whole, registrants and their auditors should consider not only the size of the misstatement but also the significance of the segment information to the financial statements taken as a whole. "A misstatement of the revenue and operating profit of a relatively small segment that is represented by management to be important to the future profitability of the entity" is more likely to be material to investors than a misstatement in a segment that management has not identified as especially important. In assessing the materiality of misstatements in segment information - as with materiality generally situations may arise in practice where the auditor will conclude that a matter relating to segment information is qualitatively material even though, in his or her judgment, it is quantitatively immaterial to the financial statements taken as a whole. Thus, in addition to quantitative factors, such as the relative percentage of total revenues generated in an individual foreign country, companies should consider qualitative factors as well. Qualitative factors that might be relevant in assessing the materiality of a specific foreign country include: the growth prospects in that country and the level of risk associated with doing business in that country. There are competing arguments for the FASB establishing a significance test for determining material foreign countries. On one hand, such a quantitative materiality test flies in the face of the warning provided in SAB 99. For example, a 10% of total revenue or long-lived asset test might give companies an excuse to avoid reporting individual countries that would be material for qualitative reasons. Assume that from one year to the next a company increases its revenues in China from 2% of total revenues to 6% of total revenues. Although 6% of total revenues would not meet a 10% test, the relatively large increase in total revenues generated in China could be material in that it could affect an investor’s assessment of the company’s future prospects. This company might be reluctant to disclose information about its revenues in China because of potential competitive harm. On the other hand, the FASB could establish a materiality threshold low enough, for example, 5% of total revenues, that would be likely to ensure that “material” countries are disclosed regardless of whether they are material for quantitative or qualitative reasons. A bright-line materiality threshold McGraw-Hill/Irwin 8-6

© The McGraw-Hill Companies, Inc., 2009 Solutions Manual

would ensure a minimum level of disclosure and would enhance the comparability of financial disclosures provided across companies.

Irwin/McGraw-Hill Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

© The McGraw-Hill Companies, Inc., 2009 8-7

Answers to Questions 1.

Consolidation presents the account balances of a business combination without regard for the individual component companies that comprise the organization. Thus, no distinction can be drawn as to the financial position or operations of the separate enterprises that form the corporate structure. Without a method by which to identify the various individual operations, financial analysis cannot be well refined.

2.

The word disaggregated refers to a whole that has been broken apart. Thus, disaggregated financial information is the data of a reporting unit that has been broken down into components so that the separate parts can be identified and studied.

3.

According to SFAS 131, the objective of segment reporting is to provide information to help users of financial statements: a. better understand the enterprise’s performance, b. better assess its prospects for future net cash flows, and c. make more informed judgments about the enterprise as a whole.

4.

Defining segments on the basis of a company’s organizational structure will remove much of the flexibility and subjectivity associated with defining industry segments under SFAS 14. In addition, the incremental cost of providing segment information externally should be minimal because that information is already generated for internal use. Analysts should benefit from this approach because it reflects the risks and opportunities considered important by management and allows the analyst to see the company the way it is viewed by management. This should enhance the analyst’s ability to predict management actions that can significantly affect future cash flows.

5.

SFAS 131 defines an operating segment to be a component of an enterprise: a. that engages in business activities from which it earns revenues and incurs expenses, b. whose operating results are regularly reviewed by the chief operating decision maker to assess performance and make resource allocation decisions, and c. for which discrete financial information is available.

6.

Two criteria must be considered in this situation to determine an enterprise’s operating segment. If more than one set of organizational units exists, but there is only one set for which segment managers are held responsible, that set constitutes the operating segments. If segment managers exist for two or more overlapping sets of organizational units, the organizational units based on products and services are defined as the operating segments.

McGraw-Hill/Irwin 8-8

© The McGraw-Hill Companies, Inc., 2009 Solutions Manual

7.

The Revenue Test. An operating segment is separately reportable if its total revenues amount to 10 percent or more of the combined total revenues of all operating segments. The Profit or Loss Test. An operating segment is separately reportable if its profit or loss is 10 percent or more of the greater (in absolute terms) of the combined profits of all profitable segments or the combined losses of all segments reporting a loss. The Asset Test. An operating segment is separately reportable if its assets comprise 10 percent or more of combined assets of all operating segments.

8.

For reportable operating segments, the following information must be disclosed: a. Revenues from sales to unaffiliated customers. b. Revenues from intercompany transfers. c. Profit or loss. d. Interest revenue. e. Interest expens e. f. Depreciation, depletion, and amortization expense. g. Other significant noncash items included in profit or loss. h. Unusual items included in profit or loss. i. Income tax expense or benefit. j. Total assets. k. Equity method investments. l. Expenditures for long-lived assets. m. Description of the types of products or services from which the segment derives its revenues.

9.

If operating segments are not based upon products or services, or a company has only one operating segment, then revenues from sales to unaffiliated customers must be disclosed for each of the company’s products and services.

10. Information must be provided for the domestic country, for all foreign countries in which the company generates revenue or holds assets, and for each foreign country in which the company generates a material amount of revenues or has a material amount of assets. 11. Two items of information must be reported for the domestic country, for all foreign countries in total, and for each foreign country in which the company has material operations: (1) revenues from external customers, and (2) long-lived assets. 12. The minimum number of countries to be reported separately is one: the domestic country. If no single foreign country is material, then all foreign co...