solution manual advanced financial accounting 8th edition baker chap013

decision-Q13-3 The three ten percent significance tests used to determine reportable segments under FASB 131 are the 10 percent revenue test, the 10 percent operating profit loss test,

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 FASB 131 The

FASB requires that the definitions of operating segments used for internal making purposes be used for presenting segment information for financial statement purposes

decision-Q13-3 The three ten percent significance tests used to determine reportable

segments under FASB 131 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:

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

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

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, FASB 131 specifies that all companies should disclose revenues and

long-lived, 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 The profit or loss test is not used for foreign operations because of the many differences in tax structures and accounting practices in different geographic areas

Q13-7 A company must disclose for each of its significant customers 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 The discrete view of interim reporting holds each interim period as a basic

accounting period to be evaluated as if it were an annual accounting period Any of-period adjustments and deferrals would be determined using the same accounting principles used for the annual report The integral view of interim reporting holds each interim period as an installment of an annual period Recognition and adjustment of certain income or expense items may be affected by judgments about the expected

end-results of the entire year's operations APB Opinion 28 uses the integral view of

interim reporting

Q13-10 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

Q13-11 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

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

Q13-12 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

Q13-13 The integral theory of interim reporting would allocate the expenditure over

the interim periods benefited Thus, a portion of the $200,000 might be recognized over one or more interim periods The discrete theory of interim reporting would recognize the entire $200,000 in the interim period when the expenditure was made

Q13-14 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 or extraordinary 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

Q13-15 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

Q13-16 Extraordinary items 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, extraordinary items should be related

to the estimated income for the full fiscal year

Q13-17 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

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)

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 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 to another in an attempt to smooth the revenue stream

4 Flood loss — Extraordinary 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

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

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

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 FASB 131, 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 FASB 131 However, FASB 131 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 FASB 131 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 FASB 131 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-of-sale 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

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 homepage that has a link

to the EDGAR database From this page, the user is able to select "Search for Company Fillings” and then on the Search the EDGAR Database page that comes

up, to select “Companies & Other Filers” under the General Purpose Searches heading 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 then take them to the listing of all SEC filings for that company and they can then quickly scroll down to find a Form 10-Q

In comparison to the Form 10-K, several differences in Form 10-Q are noted The interim financial statements and footnotes are entirely unaudited As the interim financial statements are unaudited, no report from the independent public accountants is provided in the Form 10-Q

C13-7 Defining Segments for Disclosure

MEMO

To: Randy Rivera, CFO, Stanford Corporation

From:

Re: Segment Disclosures

For the current annual reporting period, Stanford Corporation has identified four operating segments that meet the quantitative thresholds to be considered reportable segments

under FASB Statement No 131 (FASB 131) Neither the cereals segment nor the sports

beverage segment meets any of the three quantitative thresholds in the current period

[FASB 131, Par 18]

However, the FASB 131 quantitative thresholds are intended to insure that information

about significant business segments is included in the disclosures, not to limit the information that can be provided

The cereals segment, which was disclosed as a reportable segment last year, can continue to be reported this year if its disclosure provides significant information for the users of the financial statements, even though the segment does not meet the specific

criteria for separate disclosure specified in paragraph 22 of FASB 131

In addition, the segment disclosure standard allows companies to designate additional operating segments as reportable segments Management may decide to provide separate disclosure of segment information for other segments that management feels that the disclosure would be of information value to the users of the financial statements

Finally, paragraph 24 of FASB 131 addresses the possibility that identification of too

many reportable segments might result in overly detailed segment information As a general guideline, the standard suggests that a reasonable limit of 10 segments should

be used and smaller, somewhat comparable segments can then be combined for purposes of the footnote disclosure

As a result of my research, I conclude that it would be acceptable for Stanford to report information about six segments, including the cereals and sports beverage segments Disclosure of information for six segments does not approach the practical limit on the

number of segments suggested in FASB 131 The continuing significance of the cereals

segment and the developing significance of the sports beverage segment make their

inclusion appropriate even though these segments do not meet the FASB 131

quantitative thresholds in the current year

C13-8 Income Tax Provision in Interim Periods

MEMO

To: Andrea Meyers, Controller's Department, Vanderbilt Company

From:

Re: Income Tax Provision in Interim Periods

In computing the income tax provision for interim periods, APB 28 states that the

company should make its best estimate of the effective tax rate expected to be applicable

for the year [APB 28, Para 19] This estimate should reflect all expected tax credits, and

other tax rates, such as foreign taxes Therefore, anticipated tax credits available to Vanderbilt should be included in the computation of the expected effective annual tax rate

However, the first quarter calculation of this tax rate cannot include the anticipated energy tax credit benefits because the tax law providing the energy tax credit has not yet been enacted into law

Vanderbilt's first quarter estimate of the effective annual tax rate should not include the expected tax benefits of the energy tax credit Changes in the tax rate are to be

recognized as changes in estimate, according to APB 28 If the legislation is enacted as

expected, the effect of the tax credit should be factored into the estimate of the effective annual tax rate made at the end of the third quarter, which would reduce the income tax provision for the third quarter of 20X5

C13-9 Questions about Interim Reporting

1 In their third-quarter 10-Q, a company would have the following four income statements for the respective reporting periods:

a An income statement for the third quarter and a comparative income statement for the third quarter of the prior year

b An income statement for the cumulative first three quarters of the current year and

a comparative cumulative income statement for the first three quarters of the prior year

2 FASB 154 requires that a change in depreciation method be accounted for as a

change in accounting estimate effected by a change in accounting principle The current and prospective application is used and prior financial statements are not restated Thus, the third quarter and subsequent periods would report with the new depreciation method

3 The company would report a condensed balance sheet as of the end of the third quarter and a condensed balance sheet as of the end of the prior fiscal year However, a company should also provide a comparative, condensed balance sheet as of the end of the third quarter of the prior fiscal year if it is necessary for understanding the seasonal fluctuations on the company’s financial condition

4 No, interim financial statements do not need to be audited However, some companies choose to have their interims audited Summary amounts from the interim reports are included in the annual financial report and are subject to audit review at that time

5 FASB 131 requires segment disclosures in each interim report However, the level of

detail of information required in the interim report is less than that required in the annual report

6 Publicly owned companies classified as accelerated filers must file their 10-Q within

35 days after the end of each of their first three quarters Companies not meeting the criteria of accelerated files must file within 45 days after the end of each of their first three quarters

7 The methods of computing revenues for interim reporting should be the same as those used for the annual financial statements The reason for this is so that financial statement users may properly determine the revenue patterns during the year However,

if a company makes a change in accounting principle that affects the computation of its revenues, the company must retroactively apply the new accounting principle to all prior interims

8 No, a company is not required to take a physical inventory at the end of each quarter although a physical inventory is required as part of the annual audit procedures A company usually estimates ending inventory for each quarter based on beginning inventory plus purchases, less the cost of sales The cost of sales is estimated using the normal mark-up percentages from cost to retail

9 Many companies allocate costs incurred in a quarter that benefit the entire year A common example of this are the costs associated with retooling efforts during the short period the company is shut down each year for retooling to take place Several allocation methods are allowed such as allocating a fourth of the retooling cost to each quarter or

relating the retooling cost to proportional sales revenue during the year The key point to selecting an allocation method is that the method must be rational and relate to the benefits received from the cost

C13-9 (continued)

10 This is a change in accounting principle for which FASB 154 requires a

retrospective application All prior periods, including prior interims, are restated to the new accounting principle (percentage-of-completion) for the direct effects of the change This presumes that the company is able to determine the effects of the change on previous interim periods Otherwise the company must wait until the first day of the next fiscal year to make the change

E13-1 Reportable Segments

a Segment Revenuea Profit (loss)b Assetsc

a Segment revenue greater than $77,500 ($775,000 x 10)

b Segment profit or loss greater than $10,370

($103,700 total profit, excluding loss segments x 10)

c Segment assets greater than $118,500 ($1,185,000 x 10)

All segments but Electronics and Sporting Goods are separately reportable

b The 75 percent test is applied to revenue from unaffiliated customers

Revenue from unaffiliated customers

of reportable segments = $655,000 = 87.3%

Total revenue from unaffiliated customers $750,000

Yes, the 75 percent test is met

E13-2 Multiple-Choice Questions on Segment Reporting [AICPA Adapted]

Indirect operating expenses

E13-3 Multiple-Choice Questions on Interim Reporting [AICPA Adapted]

11 b According to APB 28, gains and losses arising from events such as

discontinued operations, unusual or infrequent events, and extraordinary items should be reported in the interim period in which the event occurs On the other hand, expenses incurred in one interim period that benefit other interim periods should be allocated to the interim periods benefited In the case of Park Corp., the $40,000 of property taxes should be allocated to all interim periods For the six months ended June 30, 20X5, Park should recognize 50% of the $40,000,

or $20,000, as an expense However, the entire $100,000 net loss from the disposal of the business segment should be recognized as a loss for the six months ended June 30, 20X5 Therefore, a total of $120,000 should be included in the determination of Park's net income for the six months ended June 30, 20X5

E13-4 Temporary LIFO Liquidation

Case a: Partial replacement of LIFO base by year-end

Excess of Replacement Cost over LIFO

Sold 1,240 units of LIFO base of which 900 units

are expected to be replaced:

$22,320 = 1,240 units x $18 LIFO cost

$8,100 = 900 units x $9 ($27 expected

replacement cost less $18 LIFO cost)

(2) The account, Excess of Replacement Cost over LIFO Cost of Inventory

Liquidation, is often reported on the quarterly balance sheets as a current liability Some companies report this valuation account as a reduction of inventory The account is not reported on the annual balance sheet because the LIFO inventory at year-end is based on the actual units remaining in inventory at year end

Excess of Replacement Cost over LIFO

Replace 900 units of LIFO base:

$16,200 = 900 units x $18 LIFO cost

$3,600 = 900 units x $4 difference between

$31 actual and $27 estimated

replacement cost

$27,900 = 900 units x $31 actual cost of

replacement

Case b: No replacement of LIFO base by year-end

Excess of Replacement Cost over LIFO

Sold 1,240 units of LIFO base of which 300 units

are expected to be replaced:

$22,320 = 1,240 units x $18 LIFO cost

$2,700 = 300 units x $9 ($27 expected

replacement cost less $18 LIFO cost)

(2) December 31 entry:

Excess of Replacement Cost over LIFO

Eliminate remaining balance in LIFO valuation

account because company did not replace LIFO

inventory sold in July

E13-5 Inventory Write-Down and Recovery

Case a: Market reductions assumed permanent

Quarter Units Sold +/- to Market Goods Sold

E13-5 (continued)

Case b: Market reductions assumed temporary and price will recover by year-end

If market reductions are assumed to be temporary, the company is not required to recognize in its interim financial statements the effects of the seasonal changes in prices (and few companies would under the assumption of temporary reductions recovering by year-end) However, the company would be required to revalue its year-end inventory to lower-of-cost-or-market for its annual financial statements

Quarter Units Sold +/- to Market Goods Sold

(400 x $850)

$850 is unit cost from 20X0

E13-6 Multiple-Choice Questions on Income Taxes at Interim Dates [AICPA

6 b Deferred taxes are computed only for temporary

differences The other items are permanent differences

E13-7 Significant Foreign Operations

Percent of Sales to Consolidated

Percent of Total Long-

E13-8 Major Customers

Major customers are those to whom sales equal or exceed $4,300,000 ($43,000,000 x 10) Government units under common control are classified as a single customer However, counties are not under the common control of the state government Therefore, Cook County is a separate customer from the State of Illinois

Addback: Premiums for life insurance $ 12,000

Tax-exempt income to be received (20,000) (78,000)

(Note that the estimated income taxes for the

year include both federal and state income

taxes.)

Record first-quarter tax provision:

$170,000 total pre-tax earnings

+ 30,000 addback extraordinary loss that is

reported separately with its own

income tax effect

$200,000 first-quarter income from continuing

operations

x .34 effective annual tax rate

$ 68,000 first quarter tax provision for

continuing operations

(Note that the problem requires only the tax provision for the continuing operations The tax effect of the extraordinary loss would be recognized separately.)

E13-10 Operating Loss Tax Benefits

Income (Losses) Estimated Tax (Benefit) Before Taxes Effective Less Reported

Year- Annual Year- Previously In Period Period to-Date Tax Rate to-Date (a) Provided Period

E13-11 Industry Segment and Geographic Area Revenue Tests

a Operating segments revenue test (in thousands)

Combined Percent of Combined Separately Operating Segment Revenue Revenue of $1,385 Reportable

b Geographic Area revenue test (in thousands)

Unaffiliated Percent of Consolidated Separately Geographic Area Revenue Revenue of $1,165 Reportable

c Disclosure of operating segments' revenue (in thousands)

Nonpre- Ethical scription Generic Com- Elimina- Consol- Drugs Drugs Drugs Other bined tions idated Sales to

Intersegment