advanced accounting 6e by jeter chaney chapter 14

Standards of Financial Accounting and Reporting• FASB ASC topic 280 Segment Reporting: Segmental disclosures have limitations as well as strengths.. Standards of Financial Accounting and

Learning Objectives

• Understand the need for disaggregated financial data.

• Describe the basic requirements of public companies in reporting segmental data.

• Determine an operating segment.

• Define a reportable segment.

• Identify the information to be presented for each reportable segment.

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Need for Disaggregated Financial Data

• Users need information to determine conditions, trends, and ratios that assist in predicting cash flows of firms.

• Different industries or geographic areas have different – rates of profitability,

– opportunities for growth, and – types of risk.

• Disaggregated information is useful to assist in analyzing uncertainties surrounding the timing and amounts of expected cash flows.

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LO 1 The need for disaggregated financial data.

Standards of Financial Accounting and Reporting

• FASB ASC topic 280 (Segment Reporting): Segmental disclosures have limitations as well as strengths.

• Primary benefit - unveiling information that has been merged and possibly buried in the consolidated data.

• Arguments against segmental disclosures include:

– May be misleading or meaningless due to accounting and allocation problems, lack of user knowledge, different measurement techniques.

– Disclosures to competing firms, labor unions, etc.

– Adds to already excessive amount of accounting detail.

• Most people believe the advantages outweigh the disadvantages.

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LO 2 Basic disclosure requirements.

Standards of Financial Accounting and Reporting

• In general, the FASB implemented a management approach: – Focusing on the way in which management organizes segments internally

• To make operating decisions.

• To assess performance.

• The objective of the management approach:

– To facilitate consistence between internal and external reporting.

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LO 2 Basic disclosure requirements.

Basic Disclosure Requirements ( Management Approach ):

Objective is to facilitate consistency between internal and

 Segmental profit or loss,

 Certain items of revenue and

expense,

 Segmental assets, and

 Other items.

Standards of Financial Accounting and Reporting

Operating Segment - Component of an enterprise that – May earn revenues and incur expenses.

– Chief operating decision maker regularly reviews the component’s operating results.

– Discrete financial information is available.

Reportable Segment

– Significant to an enterprise’s operations.

• Has passed one of three 10% tests or

• Determined to be reportable by other criteria.

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LO 3 Determine an operating segment LO 4 Reportable segment.

Standards of Financial Accounting and Reporting

Common Cost Allocation

– If portions of assets are allocated internally and used by the chief operating decision maker,

• those amounts should be allocated on a reasonable basis and disclosed for external reporting purposes as well.

– Two of the most difficult tasks in applying the segment

disclosure requirements are those of determining

1 An appropriate basis for the allocation of common costs and

2 Appropriate operating segments

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LO 4 Reportable segments.

Standards of Financial Accounting and Reporting

Standards of Financial Accounting and Reporting

Determining Operating Segments

Operating segments of the firm are determined using a modified management approach.

– An operating segment is a component that exhibits all of the following characteristics.

• Engages in business activities that may earn revenues and incur expenses (including transactions with other components of the entity).

• Results are reviewed regularly by the chief operating decision maker.

• Discrete financial information is available.

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LO 3 Determine an operating segment.

Standards of Financial Accounting and Reporting

Determining Operating Segments

• Aggregation Criteria - entity is permitted (but not required) to aggregate operating segments that have similar economic

characteristics and are similar in all the following:

– Nature of their products or services.

– Nature of the production processes.

– Types or class of customers.

– Methods used to distribute products or provide services.

– Nature of the regulatory environment.

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LO 3 Determine an operating segment.

Standards of Financial Accounting and Reporting

Question

An entity is permitted to aggregate operating segments if the segments are similar regarding the

a) nature of the production processes.

b) types or class of customers.

c) methods used to distribute products or provide

Standards of Financial Accounting and Reporting

Determining Operating Segments

• Quantitative Thresholds - Segment is reportable if it meets one or

more of the following tests:

– Combined (external and internal) revenue is 10% or more of

combined revenue of all reportable segments.

– Absolute amount of its profit or loss is 10% or more of the greater

absolute amount of:

• Combined profit of all segments not reporting a loss.

• Combined loss of all segments that reported a loss.

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

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LO 3 Determine an operating segment

Standards of Financial Accounting and Reporting

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Problem 14-1: Significance Tests—Segmental Reporting

Bacon Industries operates in seven different segments Information concerning the operations of these segments for the most recent fiscal period follows:

Standards of Financial Accounting and Reporting

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Problem 14-1: Determine which of the segments must be treated as reportable segments.

Revenue Test

Standards of Financial Accounting and Reporting

Standards of Financial Accounting and Reporting

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Problem 14-1: Determine which of the segments must be treated as reportable segments.

Identifiable Assets Test

Summary: Segments 3, 4, 5, 6, and 7

are reportable segments.

Standards of Financial Accounting and Reporting

Seventy-Five Percent Combined Revenue Test

• The reportable segments taken together must represent a substantial portion of the firm’s total operations

– The combined revenue from sales to unaffiliated customers of all reportable segments must constitute at least 75% of the combined revenue from sales to unaffiliated customers of all operating

segments.

– If the 75% test is not satisfied, additional segments must be

identified until the test is met

• The FASB standard implies that the number of reportable

segments should probably not exceed 10 segments.

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LO 3 Determine an operating segment.

Standards of Financial Accounting and Reporting

Review Question

To determine whether a substantial portion of a firm's operations are explained by its segment information, the combined revenue from sales to unaffiliated customers of all reportable segments must constitute at least a) 10% of the combined revenue of all operating segments

b) 75% of the combined revenue of all operating segments.

c) 10% of the combined revenue from sales to unaffiliated customers of all operating segments.

d) 75% of the combined revenue from sales to unaffiliated customers of all operating segments.

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Standards of Financial Accounting and Reporting

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Nonaffiliated revenue (reportable segments) $176,100 Total nonaffiliated revenue $184,300

Nonaffiliated Revenue from reportable segments

$176,100

= 95.6%

For each of a firm’s reportable segments, and in the aggregate for the segments not separately reported.

 Reconciliation of segment amounts and consolidated amounts for revenue,

profit or loss, assets, and other significant items.

 Enterprisewide disclosures.

 Product or service.

 Geographic area.

 Major customer (10%).

LO 5 Reportable segment information to be presented.

Standards of Financial Accounting and Reporting

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Information to be Presented

Standards of Financial Accounting and Reporting

Geographic Areas

• Where operations in foreign countries are grouped into geographic areas, the groupings should consider

– proximity, – economic affinity, – similarities of business environments, and – the nature, scale, and degree of interrelationship of the operations in the various countries.

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LO 6 Reporting on geographical areas.

Standards of Financial Accounting and Reporting

Information about Major Customers

To provide information about the potential effects of dependency on one or more major customers,

• If 10% or more of the revenue of a firm is derived from sales to any

single customer, or

• If 10% or more of the revenue is derived from sales to the federal government, a state government, a local government, or a foreign government,

– those facts and the amount of revenue must be disclosed.

• These disclosures are required even if the firm has only one reportable segment.

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LO 7 Reporting on major customers.

Standards of Financial Accounting and Reporting

LO 9 Current interim reporting requirements.

Interim Financial Reporting

• Interim financial statements are presented to provide information concerning financial status and progress for time periods of less than one year.

– Normal time period is a quarter of a year.

– Prepared for most recent interim period, as well as on a cumulative or year-to-date basis.

– May consist of statements of financial position, income, and cash flows.

– SEC requires some public companies to file Form 10-Q

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LO 10 Problems in interim reporting.

Interim Financial Reporting

Problems in Interim Reporting

• Seasonal nature of operations in many industries can cause wide fluctuations in revenues and expenses.

• Short time period to determine interim results and added costs of determining accurate amounts encouraged the use of estimation techniques.

– Some accountants hold that each interim period should stand alone (discrete view)

as a basic accounting period.

– Other accountants view each interim period as essentially an integral part of the annual period.

• In response to SEC complaints and general pressure, the APB issued APB Opinion

No 28 in May 1973 (now included in FASB ASC topic 280, Interim Reporting).

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Interim Financial Reporting

• The Board concluded that “each interim period should be

viewed as an integral part of an annual period”.

– Financial statements for each interim period should be

based on the same accounting practices used for annual statements.

– Revenue should be recognized on same basis as used for the full year.

– Costs and expenses that are associated directed with or allocated to the products sold (or services rendered) should

be similarly treated for interim purposes

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LO 10 Problems in interim reporting.

Interim Financial Reporting

• Acceptable alternatives for inventory costing:

– COGS can be estimated using gross profit rates

– Liquidated LIFO base that is expected to be replaced by year end: cost of goods sold should be charged at expected

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LO 10 Problems in interim reporting.

Interim Financial Reporting

Interim Financial Reporting

• All Other Costs and Expenses (other than product costs) – Charged to income as incurred or allocated based on

• an estimate of time expired,

• benefit received or

• activity associated with the periods.

– Costs not readily identified with activities or benefits should be charged when incurred.

– Arbitrary assignment of costs should not be made.

– Gains and losses that would not be deferred at year-end should not be deferred at interim periods

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LO 10 Problems in interim reporting.

Interim Financial Reporting

c) As reporting of an integral part of an annual period

d) As reporting of a basic accounting period.

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Interim Financial Reporting

Provision for Income Taxes

• The basic technique for computing income tax provisions for interim financial statements is described in FASB ASC subtopic 740-270 (Income Taxes – Interim Reporting).

– At the end of each interim period the company should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year.

• The effective rate should reflect anticipated tax credits, foreign tax rates, percentage depletion, and other available tax planning

Copyright © 2015 John Wiley & Sons, Inc All rights reserved.

Interim Financial Reporting – Income Taxes

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Exercise 14-8: Spur Company’s actual earnings for the first two quarters of

2014 and its estimate during each quarter of its annual earnings are:

Actual first-quarter earnings $ 400,000

Actual second-quarter earnings 510,000

First-quarter estimate of annual earnings 1,350,000

Second-quarter estimate of annual earnings 1,420,000

Spur Company estimated its permanent differences between accounting income and taxable income for 2014 as:

Environmental violation penalties $ 25,000

Dividend income exclusion 180,000

The combined state and federal tax rate for 2014 is 42%.

Interim Financial Reporting – Income Taxes

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Exercise 14-8: Prepare journal entries to record Spur Company’s provisions for income taxes for the first two quarters of 2014.

* ($1,195,000 x 42%) ** ($501,900 / $1,350,000) First Quarter

x

Interim Financial Reporting – Income Taxes

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Exercise 14-8: Prepare journal entries to record Spur Company’s provisions for income taxes for the first two quarters of 2014.

First Quarter Journal Entry

Income Tax Expense 148,800

Income Tax Payable 148,800

Interim Financial Reporting – Income Taxes

Est Effective Combined Cumulative Income to Date ($400,000 + $510,000) $ 910,000 Estimated Income Tax Rate: 0.374 ***

Cumulative Tax Provision Needed 340,340 Tax Provision in 1st Quarter 148,800

Tax Provision in 2nd Quarter $191,540  

Interim Financial Reporting – Income Taxes

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Exercise 14-8: Prepare journal entries to record Spur Company’s provisions for income taxes for the first two quarters of 2014.

Second Quarter Journal Entry

Income Tax Expense 191,540

Income Tax Payable 191,540

1st Quarter tax provision =

$148,800

Year-to-Date tax provision =

$340,340

2nd Quarter tax provision =

$191,540 *

* $340,340 - $148,800

Interim Financial Reporting

Accounting Changes in Interim Periods

• Changes in Estimate – Accounted for in the interim period in which the change is made – No restatement of previous interim reports should be made.

– Effect on earnings disclosed for current and subsequent interim periods.

• Current GAAP requires retrospective application to financial statements of prior periods where practical.

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LO 10 Problems in interim reporting.

Interim Financial Reporting

Minimum Disclosures in Interim Reports

• Sales or gross revenues, provision for income taxes, extraordinary items (including related income tax effects), and net income.

• Basic and diluted earnings-per-share data.

• Seasonal revenue, costs, or expenses.

• Significant changes in estimates or provisions for income taxes.

• Disposal of a segment of a business and extraordinary, unusual, or infrequently occurring items

• Contingent items.

• Changes in accounting principles or estimates.

• Significant changes in financial position.

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LO 10 Problems in interim reporting.

International Issues in Interim Reporting

• IAS 34, “Interim Financial Reporting”, does not state which

entities should prepare and publish interim financial statements

– Determines the minimum content of the interim reports if the entity elects or is required to prepare interim financial statements – Generally requires that the interim period be a discrete reporting period.

– Applies when an entity publishes an interim financial report in accordance with International Financial Reporting Standards (IFRS).

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