💰Intermediate Financial Accounting II Unit 9 – Segment and Interim Financial Reporting

Key Concepts and Definitions

• Segment reporting involves providing financial information about a company's different business activities or geographical areas
• Operating segments are components of a company that engage in business activities from which they may earn revenues and incur expenses
• Reportable segments are operating segments or aggregations of operating segments that meet certain quantitative thresholds
• Interim financial reporting refers to the preparation and presentation of financial statements for periods shorter than a full fiscal year (quarterly or half-yearly)
• Discrete approach in interim reporting treats each interim period as a separate accounting period
• Integral approach in interim reporting views interim periods as an integral part of the annual period
  • Allocates certain annual costs and expenses to interim periods based on estimates or budgets
• Materiality concept applies to both segment reporting and interim financial reporting
  • Information is considered material if its omission or misstatement could influence the economic decisions of users

Purpose and Importance of Segment Reporting

• Provides investors and other stakeholders with more detailed and disaggregated financial information about a company's different business activities or geographical areas
• Enables users to better understand a company's performance, risks, and prospects by providing insights into the different sources of revenue, profitability, and growth
• Helps investors make more informed investment decisions by allowing them to assess the relative performance and potential of different segments
• Enhances transparency and comparability of financial information across companies and industries
• Facilitates better management decision-making by providing segment-level performance data
• Allows for better resource allocation and performance evaluation within a company
• Meets the information needs of various stakeholders (investors, creditors, analysts, regulators)

Regulatory Framework for Segment Reporting

• In the United States, segment reporting is primarily governed by the Financial Accounting Standards Board (FASB) through Accounting Standards Codification (ASC) Topic 280, "Segment Reporting"
• ASC 280 establishes standards for the way public companies report information about operating segments in annual and interim financial statements
• The International Accounting Standards Board (IASB) addresses segment reporting in International Financial Reporting Standard (IFRS) 8, "Operating Segments"
  • IFRS 8 is largely converged with ASC 280, ensuring a high degree of comparability in segment reporting across jurisdictions
• The Securities and Exchange Commission (SEC) also has requirements related to segment disclosures in financial reports filed by public companies
• Companies are required to disclose segment information based on the "management approach"
  • Segments are identified and reported based on the structure of a company's internal organization and financial reporting system
• Segment reporting requirements apply to public companies and certain non-public entities that meet specific criteria (e.g., size, public debt)

Identifying Reportable Segments

• The process of identifying reportable segments begins with the identification of operating segments
• Operating segments are determined based on the "management approach"
  • Segments are identified based on how management organizes the company for making operating decisions and assessing performance
• Reportable segments are determined by applying quantitative thresholds to the identified operating segments
  • Revenue test: External revenue of the segment is 10% or more of the combined revenue of all operating segments
  • Profit or loss test: Absolute amount of the segment's profit or loss is 10% or more of the greater, in absolute amount, of (i) the combined reported profit of all operating segments that did not report a loss or (ii) the combined reported loss of all operating segments that reported a loss
  • Assets test: Assets of the segment are 10% or more of the combined assets of all operating segments
• Operating segments that do not meet any of the quantitative thresholds may be considered reportable if management believes that information about the segment would be useful to users of the financial statements
• Segments that do not meet the quantitative thresholds can be combined with other segments if they share similar economic characteristics and meet certain aggregation criteria

Segment Information Disclosure Requirements

• Companies are required to disclose various types of information about their reportable segments in the notes to the financial statements
• General information disclosures include:
  • Factors used to identify the reportable segments
  • Types of products and services from which each reportable segment derives its revenues
• Information about segment profit or loss, segment assets, and the basis of measurement
  • Measure of segment profit or loss reviewed by the chief operating decision maker (CODM)
  • Reconciliation of segment revenues, profit or loss, assets, and other material items to corresponding amounts in the company's financial statements
• Revenues from external customers and intersegment revenues
  • Revenues from transactions with other operating segments of the same company
• Interest revenue and interest expense for each reportable segment (if included in segment profit or loss reviewed by the CODM)
• Depreciation, depletion, and amortization expense for each reportable segment (if included in segment profit or loss reviewed by the CODM)
• Material items of income and expense disclosed for each reportable segment
• Equity method investments and the amount of investment in associates and joint ventures for each reportable segment
• Significant non-cash items other than depreciation, depletion, and amortization expense

Interim Financial Reporting: Basics and Objectives

• Interim financial reporting involves preparing financial statements for periods shorter than a full fiscal year
  • Commonly prepared on a quarterly or half-yearly basis
• Objectives of interim financial reporting include:
  • Providing timely and relevant financial information to investors and other users
  • Enabling users to assess a company's performance and financial position throughout the year
  • Facilitating comparability of financial information across different periods and companies
  • Helping investors make informed decisions based on up-to-date financial data
• Interim financial statements typically include a condensed balance sheet, income statement, statement of comprehensive income, statement of cash flows, and selected explanatory notes
• Interim financial statements are generally unaudited but may be subject to review by an independent auditor
• Companies are required to apply the same accounting policies in their interim financial statements as those used in their annual financial statements
  • Ensures consistency and comparability of financial information across periods

Preparing Interim Financial Statements

• Companies can choose between the discrete approach and the integral approach when preparing interim financial statements
• Under the discrete approach:
  • Each interim period is treated as a separate accounting period
  • Revenues, expenses, gains, and losses are recognized in the period in which they occur
  • Income tax expense is calculated based on the estimated annual effective tax rate applied to the interim period's pre-tax income
• Under the integral approach:
  • Interim periods are viewed as an integral part of the annual period
  • Certain annual costs and expenses are allocated to interim periods based on estimates or budgets
  • Income tax expense is calculated based on the estimated annual effective tax rate applied to the year-to-date pre-tax income
• Companies should disclose the accounting policies followed in preparing interim financial statements
  • Includes the basis of presentation (discrete or integral approach) and any significant accounting policies that differ from those used in the annual financial statements
• Interim financial statements should include comparative information for the corresponding interim period of the preceding financial year
• Companies should also disclose any significant events or transactions that occurred during the interim period and any changes in accounting policies or estimates

Special Considerations in Interim Reporting

• Seasonality or cyclicality of operations can significantly impact interim financial results
  • Companies should disclose the seasonal nature of their business and the effects on interim financial statements
• Unusual or infrequent items that occur during an interim period should be disclosed separately
  • Helps users understand the impact of these items on the company's financial performance
• Changes in accounting estimates made in an interim period should be applied prospectively
  • If the change in estimate is material, the nature and amount of the change should be disclosed
• Costs and expenses that are incurred unevenly during the financial year should be anticipated or deferred in interim reporting only if it would be appropriate to anticipate or defer that type of cost or expense at the end of the financial year
• Inventory valuation and provisions for inventories are subject to the same principles in interim periods as in annual periods
  • Write-downs of inventory to net realizable value and any subsequent reversals should be recognized in the interim period in which they occur
• Income tax expense should be recognized based on the best estimate of the weighted average annual effective income tax rate expected for the full financial year
  • Reflects the tax consequences of items recognized in the interim period

Challenges and Limitations

• Preparing interim financial statements can be challenging due to the shorter reporting period and the need for estimates and judgments
• Allocating costs and expenses to interim periods under the integral approach requires significant estimates and assumptions
  • May result in less precise financial information compared to the discrete approach
• Interim financial results may be affected by seasonal or cyclical factors, making it difficult to extrapolate full-year performance based on interim data
• Unusual or infrequent items can distort interim financial results and make comparisons across periods or companies challenging
• Changes in accounting estimates or policies during the year can impact the comparability of interim financial statements
• Interim financial statements are often unaudited or reviewed, providing less assurance than audited annual financial statements
• Users of interim financial statements should be aware of the inherent limitations and exercise caution when making decisions based on interim data
• Management may face pressure to meet short-term financial targets, potentially leading to earnings management or manipulation of interim results