Module D
Segment Reporting
SUMMARY OF ASSIGNMENT MATERIAL
Item / Topics Covered / Level / TimeQD.1 / Explain segment reporting and indicate why financial statement users may be interested in it. / Low / 5-10
QD.2 / Provide the definition of an operating segment under SFAS 131, and analyze strengths and weaknesses of the definition. / Mod / 5-10
QD.3 / Provide the thresholds qualifying an operating segment as reportable, per SFAS 131. / Low / 5-10
QD.4 / Identify financial measures to be reported in segment disclosures. / Mod / 10-15
QD.5 / Given some data on Ford Motor Company=s operations, indicate whether Ford=s claim that it has a single dominant segment seems justified. / Low / 5-10
ED.1 / Identify reportable segments using the SFAS 131 thresholds. / Mod / 20-25
ED.2 / Identify reportable segments using the SFAS 131 thresholds. / Mod / 20-25
ED.3 / Calculate segment operating profit. / Low / 10-15
ED.4 / Identify information to be reported under SFAS 131, incorporating industry operations, foreign operations, and major customers. Analyze information value. / Mod / 20-25
ED.5 / Allocate common costs among segments. / Mod / 15-20
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SUMMARY OF ASSIGNMENT MATERIAL (cont=d.)
Item / Topics Covered / Level / TimeED.6 / Present segment information following SFAS 131 guidelines. / Mod / 15-20
PD.1 / Discuss advantages, disadvantages and basic conceptual problems in segment reporting. (AICPA adapted) / Mod / 20-30
PD.2 / Define certain terms in segment reporting and discuss threshold tests for selecting reportable segments. / Mod / 20-30
PD.3 / Select segment information to be reported and organize it according to the requirements of SFAS 131. / Mod / 25-35
PD.4 / Recast a segment report so that it conforms with SFAS 131; operating profit reflects allocations of corporate administrative expenses and income taxes. / Mod / 25-35
PD.5 / Prepare a segment report conforming with the requirements of SFAS 131. / Mod / 25-35
PD.6 / Analysis of IBM Corporation=s segment disclosures. / Mod / 15-20
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CARRYBACK TABLE
The carryback table identifies the assignment items which are new in this edition and those which are carried over from the seventh edition. For the latter, the problem number in the seventh edition is shown.
New Problem Number / Source / New Problem Number / Source / New Problem Number / SourceQD.1 / QD.1 / ED.1 / ED.1 / PD.1 / PD.1
QD.2 / QD.2 / ED.2 / ED.2 / PD.2 / PD.2
QD.3 / QD.3 / ED.3 / ED.3 / PD.3 / PD.3
QD.4 / QD.4 / ED.4 / ED.4 / PD.4 / PD.4
QD.5 / QD.5 / ED.5 / ED.5 / PD.5 / PD.5
ED.6 / new / PD.6 / new
Carryforward tables for all chapters, identifying the disposition of seventh edition assignment items, appear at the beginning of the solutions manual.
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ANSWERS TO QUESTIONS
QD.1
Segment reporting refers to the disclosure of financial statement information on a less-than-total enterprise basis. Although the term has been identified with line-of-business or product-line reporting, it also includes geographical segments and major customers.
Most of the large publicly-held corporations today are active in more than one line of business and often have extensive international operations as well. Financial statement users understand that different lines of business have different risk and return characteristics and that foreign operations are not strictly comparable with domestic operations. Disclosure of disaggregated information along these lines assists the user in evaluating the company's overall prospects.
QD.2
SFAS 131 uses the management approach in determining operating segments. Operating segments for external reporting are defined as those that are reported internally for review by top management. Characteristics of an operating segment are: (1) it engages in both revenue and expense generating activities, (2) its operating results are regularly reviewed by top management, and (3) segment financial information is available from the internal reporting system.
A major strength of this definition is that the external information parallels the information reported internally for decision making, and therefore should be the information most useful for predicting future performance. Under SFAS 14, many companies did not report segment information. Many of these companies develop segment financial information internally, and therefore SFAS 131 should result in increased external segment information. In addition, the financial information should be readily available from the company's internal reporting system.
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QD.2 (cont=d.)
Weaknesses of this definition concern the lack of standardization of the required information and the increased flexibility in how segments are defined. Companies may structure internal reporting information in different ways for different decisions. The format of external segment information is subject to much more judgment than under SFAS 14.
QD.3
A reportable operating segment is an operating segment that meets one or more of the significance thresholds as specified in SFAS 131. The thresholds are: (1) reported revenue is 10% or more of the combined revenue of all operating segments; (2) the absolute amount of reported profit or loss is 10% or more of the greater of (a) the absolute amount of the combine profit of all segments reporting a profit, or (b) the absolute amount of the combined loss of all segments reporting a loss; (3) reported assets are 10% or more of the combined assets of all operating segments.
In addition, there is an overall disclosure test. Total external revenue of segments found reportable using the above thresholds must be at least 75% of total consolidated revenue. If not, additional reportable segments must be identified until the 75% test is met.
QD.4
All reportable segments must show profit or loss and total assets.
In addition, more detailed revenue and expense information must be reported if it is reported for internal evaluation of the segments. Examples include revenues from external customers, revenues from other operating segments, interest revenue and interest expense, depreciation, depletion, and amortization expense, equity in net income of investees, income tax expense, and unusual and extraordinary items.
Reconciliations must be provided for revenues, profits (including major components of profit), assets, and other significant segment disclosures.
Supplemental disclosures are required for external revenues by product or service (unless segments are defined by product or service) and for revenues and assets by geographic areas (unless segments are defined geographically). If 10% or more of a company's total revenue is from a single customer, the amount of revenue and segment(s) earning them must be disclosed.
Segmental revenues and profits must also be reported in interim external reports.
QD.5
The answer to this question turns on one's willingness to agree with the definition of the industry and market served by Ford. On a broader scale, should a company which produces cars, trucks, boats and aircraft claim that it is involved only in the manufacture and sale of transportation equipment? We believe that this is pushing the dominant segment concept a bit too far.
One could argue that Ford is active in several industries which might include: manufacture and sale of new automobiles; manufacture and sale of new trucks; manufacture and sale of replacement parts and accessories for used automobiles and trucks; and so forth. Given the new requirements of SFAS 131, it seems highly improbable that Ford's top management does not review financial information on a segmental basis, and make performance and resource allocation decisions by comparing results by segments. Given the cyclical nature of the automobile industry, financial statement users might be well-served by segment information on other aspects of Ford's business, especially trucks.
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SOLUTIONS TO EXERCISES
ED.1IDENTIFYING REPORTABLE SEGMENTS
Profit test
The absolute amount of the combined profit of all segments reporting a profit is $760. The absolute amount of the combined loss of all segments reporting a loss is $80. Therefore segments meeting the profit test must have absolute amount of profit or loss of $76 or higher. Segments meeting this test are D and E.
Asset test
Combined assets are $3,700. Therefore segments meeting this test must have assets of $370 or higher. Segments B, D and E meet this test.
Revenue test
Unaffiliated and intersegment sales of all operating segments total $ 4,700 (= $400 + 100 + 700 + 300 + 200 + 200 + 1,400 + 400 + 1,000). Therefore segments meeting this test must have total revenues of $470 or higher. Segments A, B, D, and E meet this test.
Total reportable segments are A, B, D and E.
ED.2IDENTIFYING REPORTABLE SEGMENTS
Part 1.
Profit test
The total reported profit of all segments reporting a profit is $190,000. The total reported loss of all segments reporting a loss is $90,000. Therefore the profit test is met for all segments with absolute amount of profit or loss of $19,000. Segments 2, 3, 4, 6, and 8 meet this test.
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ED.2 (cont=d.)
Asset test
Combined assets are $1,220,000. Segments meeting this test must have assets of $122,000 or more. Segments 3, 4, and 8 meet this test.
Revenue test
Total external and intersegment sales for all segments is $1,945,000 (= $1,325,000 + 620,000). Segments meeting this test must have total revenues of $194,500 or more. Segments 2, 3, 6, and 8 meet this test.
Segments 2, 3, 4, 6, 7, and 8 are reportable.
Part 2.
Total consolidated revenue is $1,325,000. Total external revenue of reportable segments is $1,130,000, which is 85% of total consolidated revenue ($1130/$1325). Therefore the 75% test is met.
ED.3MEASURING SEGMENT OPERATING PROFIT
Segment B:
Sales Revenue / $500,000Traceable costs / $225,000
Indirect operating expenses
($240,000 X ($500/$1,500) / 80,000 / 305,000
Operating profit / $195,000
Indirect operating expenses are allocated for segment reporting since they are allocated for internal reporting purposes. Other common costs are not allocated for internal purposes, and therefore are not allocated for external segment reporting.
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ED.4SEGMENT REPORTING: GEOGRAPHIC AREAS AND MAJOR CUSTOMERS
Segment information
Since combined assets of all operating segments are $400,000,000, segments A, B and C meet the asset test. Combined sales are $580,000,000. Segments A, B, and D meet the revenue test. Since no information is given on segment profit or loss, this test cannot be used, but it is redundant since all segments are reportable under the other two tests.
Segment information is required under SFAS 131 for all four segments. Of the information given, segment assets and sales would be reported. Reconciliations for assets and sales are not required since the total of reportable segment assets and sales equals consolidated assets and sales respectively.
Geographic information
Since operating segments are not defined on the basis of geographic area, additional disclosures are necessary. At a minimum, revenues should be broken down into home country and all other countries. Home country sales are $340,000,000 ($580,000,000 - $65,000,000 - $175,000,000), and sales to customers in all other countries are $240,000,000 ($65,000,000 + $175,000,000). In addition, foreign sales may be broken down further by individual country if revenues are material.
Long-lived assets are disclosed in a similar manner. It is unclear whether the assets information provided consists of long-lived assets or total assets.
Major customer information
Consolidated sales are $580,000,000, so a major customer must generate sales of $58,000,000 or more. The U.S. Department of Defense qualifies as a major customer. "U.S. auto companies" is not a single customer, and none of the individual companies meets the sales test. However, the UK Ministry of Defense and UK Office of the Admiralty may be considered one customer, with total sales of $60,000,000.
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ED.4 (cont=d.)
Disclosure under SFAS 131 requires that the company state the amount of revenues from each of the two major customers, but not their names.
Missing information
Information required under SFAS 131 which is not provided includes:
1.Profits and profit components of the reportable segments.
2.Long-lived assets by geographical area, if the "assets" information provided consists of total assets.
3.Identification of the segment(s) earning revenues from major customers.
ED.5ALLOCATING COMMON COSTS TO SEGMENTS
Allocation of common costs among divisions or business segments is often based on sales, profit before common cost allocation (i.e. sales less traceable costs) or identifiable assets. There is, however, no need to use the same allocation basis for each cost category. Indeed, this problem illustrates the use of different allocation bases for different costs. Our preferences are given below.
Cost Category / Discussion of Allocation BasisComputer Center / Ideally, this allocation should be based on the volume of transactions generated by the segments. The best surrogate for this is sales, assuming equal proportions of "big-ticket" items among the segments.
Industrial Relations and Personnel / Here, the number of employees is best.
Central Purchasing Department / Traceable costs, which reflect purchases of materials and supplies, is the best surrogate. this assumes roughly equivalent ratios of material cost to conversion (labor, overhead, etc.) in each segment.
Note to Instructor:The following schedule reflects these allocation bases.
If a student used a single basis for all cost categories, it must be defended.
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ED.5 (cont=d.)
Allocation to SegmentCost
Category / A(%) / B(%) / C(%) / D(%) / Total / Allocation
Basis
Computer Center / $2,000,000 (40) / $500,000 (10) / $1,000,000 (20) / $1,500,000 (30) / $ 5,000,000 / Sales
Ind. Rel. and Pers. / 600,000 (30) / 100,000 (05) / 1,000,000 (50) / 300,000 (15) / 2,000,000 / Employees
General Purchasing / 1,140,000 (38) / 300,000 (10) / 660,000 (22) / 900,000 (30) / 3,000,000 / Traceable Costs
Total / $3,740,000 / $900,000 / $2,660,000 / $2,700,000 / $10,000,000
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ED.6IDENTIFICATION OF REPORTABLE SEGMENTS AND PRESENTATION OF SEGMENT INFORMATION
Requirement 1:
Determination of reportable segments:
Revenue test: Total revenues are $162,000, so reportable segment revenues must be $16,200 or more. The engines, appliances, and software segments are reportable under the revenue test.
Profit test: Segment profits are calculated as follows:
Engines / Appliances / Plastics / Software / MediaSales revenue / $80,000 / $50,000 / $2,000 / $20,000 / $10,000
Traceable expenses / 56,000 / 60,000 / 3,500 / 18,000 / 8,000
Segment profit (loss) / $24,000 / $(10,000) / $(1,500) / $2,000 / $2,000
Reportable segments must have absolute value of profit (loss) of 10% of $24,000 + $2,000 + $2,000 = $28,000, or $2,800 or greater. The engines and appliances segments are reportable under the profit test.
Asset test: Total assets of operating segments are $350,000, so assets of reportable segments must be $35,000 or more. The engines and appliances segments are reportable under the asset test.
The engines, appliances, and software segments are reportable.
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ED.6 (cont=d.)
Required disclosures:
Engines / Appliances / SoftwareExternal revenues / $ 70,000 / $ 50,000 / $ 18,000
Intersegment revenues / 10,000 / C / 2,000
Total revenues / $ 80,000 / $ 50,000 / $ 20,000
Profit (loss) / $ 24,000 / $ (10,000) / $ 2,000
Assets / $200,000 / $ 120,000 / 15,000
Requirement 2:
The segment disclosures should include narrative describing the segments and the factors used in determining the segments.
Additional financial information on components of profit and on assets may be required, if this segment information is reviewed by top management. The basis of measurement for financial information must be disclosed.
Reconciliations to consolidated revenues, profits, and assets must be included.
Since segments are organized by products and services, additional product and service information is not required.
Geographic disclosures must be included if segment sales revenue includes revenue from customers outside the home country. Minimum disclosures are external segment revenue from the home country and from all other countries. Asset information follows the same requirements.
If the company has one or more major customers, this information must be disclosed.
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SOLUTIONS TO PROBLEMS
PD.1ISSUES IN SEGMENT REPORTING
Requirement 1:
Financial reporting for segments of a business enterprise involves reporting financial information on a less-than-total enterprise basis. These segments are defined as components that have both revenues and expenses, where separate operating results are reviewed by top management for internal decision making, and discrete financial information is available from the company's internal reporting system. In addition, financial information by geographical area and major customer is also required.
Requirement 2:
The reasons for requiring financial data to be reported by segments include the following:
!They provide more detailed disclosure of information needed by investors, creditors, and other users of financial statements.
!Appraisers can evaluate major segments of a business enterprise before considering the business in its entirety.
!The growth potential of an enterprise can be better evaluated by reviewing the growth potential of its major segments.
!Users can better assess management decisions to drop or add a segment.
!Projection of future earning power is made more effective when approached on a segment basis, because different segments may have differing rates of growth, profitability, and degrees of risk.
!Managerial ability is better assessed with segment data because managerial responsibility within the enterprise is frequently decentralized.
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PD.1 (cont=d.)
Requirement 3:
The possible disadvantages of requiring financial data to be reported by segments include the following:
!They could be misinterpreted due to the public's general lack of appreciation for the limitations of any arbitrary allocations of common costs used in generating segment information.
!They may disguise the interdependence of all the segments.
!They might result in misleading comparisons of segments of different enterprises.
!Confidential information may be revealed to competitors about profitability of products, plans for new products or entries into new markets, apparent weaknesses that might induce competitors to increase their own efforts to take advantage of the weaknesses, and existence of advantages not otherwise indicated.
!Information thus made available might cause customers to challenge prices to the disadvantage of the company.
!Operating data reported by segments might be misleading to those who read them. Segment data prepared for internal management purposes often include arbitrary judgments that are known to those using the data and taken into account in making evaluations. The difficulty in making such background information available and understandable to outside users is considered by many to be unsurmountable.
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PD.1 (cont=d.)
Requirement 4:
The accounting difficulties inherent in segment reporting include the following:
!The basis of segmentation must be established.
!Transfer prices must be determined (the price one segment charges another segment for goods transferred between them).
!The method of reporting segment sales must be defined. A company may or may not include in its sales intercompany transactions with other segments within the enterprise.
!The computation of segment profit must be defined. This would be the same computation that is used for internal reporting purposes. Issues that must be resolved include the following:
(a)Determining whether common costs should be allocated to segments.
(b)Selecting allocation bases if common costs are to be allocated.
(c)Determining which costs of capital (interest expense) should be attributed to the segments.
(d)Determining whether extraordinary items and the cumulative effect of change in accounting principle should be attributable to segments.
(e)Determining if and how income tax should be allocated to segments.
(f)Determining how a minority interest's share of income, and income from investee companies, should be attributed to segments.