 Welcome to the session. This is Professor Farhad. In this session, I would look at segment reporting. This topic is covered in advanced accounting as well as intermediate accounting. It's covered on the CPA exam, specifically the FAR section. I always, I would like to remind you to connect with me on LinkedIn. YouTube is where you need to subscribe. I have 1500 plus accounting, auditing and tax lectures. This is my Instagram account. This is my Facebook account. Please, if you watch my lectures, if you like them, please like them, share them, put them in playlists. If you're benefiting, someone else might benefit as well. This is my website. On my website, I always have authors. For example, right now, I have a special offer for the CPA prep course, the best CPA prep course, which is Becker. Right now, they're offering $1,000 off. And specifically, it's unlimited access. So simply put, you buy the course. You have access to it until you pass. This is unheard of. Becker obviously is trying to compete. And now it's the best time to buy because you get a $1,000 off. It's a slow season. Also, although you may not be studying for the exam now, since you have unlimited access, I strongly encourage you to buy it because you could use it as a supplemental topic for your, as a supplemental tool for your accounting topics in college. So we need to talk about reportable segment. And the first thing I talk about when I talk about reportable segment is I want you to think about this company. And hopefully we all know what this company is. This is Pepsi, PepsiCo. So when you think of PepsiCo, what do you think of? I'm assuming you're thinking about beverages. You're thinking about soda beverages, PepsiCo. Okay. Well, let's see. Let's look at PepsiCo annual report and look to see what business PepsiCo is in. So this is from their annual report. And this is what PepsiCo is. PepsiCo is organized under six reportable segments. And this is our topic for today. Our topic for today is reportable segment, also referred to as division. So they have six different divisions. And let's take a look at those divisions. They have the Frito-Lay division of North America, which include food and snack, the Quaker food of North America, which includes cereal, rice and pasta. They have the North America beverages, which include beverages on businesses in the United States and Canada. And this is what you are mostly familiar with. When you think of PepsiCo, you're thinking of this division. They have the Latin America, which include beverages, food and snack business, the Europe and Sub-Saharan Africa division, and the Asia, Middle East and North Africa division. Okay. But I'm pretty sure you are not thinking that PepsiCo sells pasta, rice and snacks. Well, they do. And let me show you the Frito-Lay division account for 25% of the revenue versus the division that you are thinking of, the beverages only account for 33% of the revenue. And notice the Quaker division also account for 4%. This is also not beverages. So these together, they account for approximately 30% of their business. So the point is companies are composed of various division of various businesses. And that's why we need to have different segments, different segments, different reportable segments. So the question is why do we need those segments? Why do we need to report those businesses in a different segment? Well, the users would need information in order to predict the cash flow of the firm. Because if you are in the cereal business, it's different than the beverage business. The beverage business is different than the chips business, the snacks business. Okay. So I want to have information about the business. Tell me what business are you in, so I can evaluate my cash flow option. I can evaluate my gross profit. Also, different geographical area and different industries might have different rate of profitability. For example, you might be earning 20% on your beverages in the US, but in South America, you're only earning 15%. So don't include everything together. The rate of profitability is different between industries as well as different geographical area. For example, the snacks, the profit margin could be 50%. On the beverages could be only 30%. I'm just throwing these numbers out. Okay. Opportunities for growth. If I know you are, for example, if I know you are operating in Africa, there's a tremendous growth in Africa. And the type of risk. If you're, for example, operating in the Middle East, there's always risk of a war. Well, you have a risk there. If you're 40% of your revenue coming from that area, there's always that risk. Okay. And this aggregating information is useful in analyzing uncertainties surrounding expected cash flow back to the first point is you want to give me information that's going to help me evaluate my option. There are some argument against segmental reporting. Okay. It could be misleading because we might be using different accounting standards. The user may not understand it, may not understand the technique. Disclosure might give information to competitors, to labor union, which is not in our best interest. And it might add to an already excessive amount of disclosure. So having additional information might confuse the users. That's the argument against segmental disclosure. Management approach. What's the management approach? This is a term that we need to be familiar with. So how does a company determine if a segment is a reportable segment or if it's a separate division? Well, we're going to look at management. How does management run this operation? Okay. Focusing on the why in which management organizes segment internally to make operating decision and to assess performance. How does the company look at this division? Do they treat it separately internally? Do they keep record of their revenues, expenses, cash flow, assets, expenses, so on and so forth. If that's what they do, then that's a management approach. Then we can consider it that's a separate division or a separate reporting segment. So why do we use the management approach? That's the recommended approach because it facilitate consistency between internal and external reporting. So whatever you report externally, the company is compliant with internally. Now, what are some potential operating segments that we can identify? Well, we can identify different segments if we are in a different industry. For example, soda versus the snack food. Those are two different industries. Geographical area, North Africa versus the Europe. Or sometime we could identify a segment just by a major customer. If a customer is too large, that's a segment on its own. Okay. So those are the three ways that we could look at, we could segment our business. Now, we're going to look at terms specific to segmental reporting. Just we're going to look at few terms that are important for us. For example, what is an operating segment? Well, an operating segment is a component of an enterprise. Just like you saw the Frito-Lay is a component of PepsiCo. That might earn revenue and incur expenses. And those revenues and expenses could be generated internally and externally. Simply put, you sell to external customers, you sell to internal customers, you incur expenses from internal customers, and you incur expenses from external customers. You have the chief operating officer make decision on a regular basis to review the components operating response, operating results. So we're evaluating this division separately. And it has discrete financial statement. Discrete financial statements means it has its own income statement, its own balance sheet, its own cash flow. And disclosure are required for that division. We have disclosure. This is what operating segment is. And this is what we need to kind of, what is an operating segment? A small business that stands on its own. And that small business could be a different in a different industry, different geographical area or a major customer. Okay? Now, what is a reportable segment? It's a significant division to an enterprise. And how do we consider significant? What is significant? It has passed something called a 10% test. It has passed one of the three of 10% tests to be discussed shortly. We're going to see what those are. And it's determined to be reportable, the reportable segment by other criteria, which would see what the other criteria are. So let's take a look at those, the 10% test. You know, it has to pass those 10% test, one of those tests. Okay? The first thing is segment revenue. It has to pass the segment revenue test, 10% of the segment revenue. What is that segment revenue? It's the revenue from sales to outsiders and affiliate customers, as well as intersegment sales or transfer. So sales, when we look at the 10% test, we include sales both the outside and inside, internal and external customers. So we don't exclude the internal because we're going to eliminate them for the purpose of this test. The revenue is internal and external. And the reason is we want to see the importance of this operating segment. How important is it? Well, if you're selling a lot to internal division, you might be important as well. Okay? The other thing we can look at is segment operating profit and loss. That's also one of the 10% test. So this is the first 10% test. This is the second one. Well, we look at all segments revenue minus expenses. We include any allocated revenue and expenses, including common cost. We execute corporate expenses from this computation, such as interest and taxes. So simply put, it's revenue minus expenses for that particular operation, including any common cost that executes the corporate expenses. That's another test. We're going to look at the details of it shortly. Segment asset, what are the segment asset? The tangible and intangible asset directly associated with the segment, including any allocated portion of the asset that's used jointly by one or more segment. It doesn't matter if it's used by one or more segment. Again, 10% the 10% test. So when you say the 10% test, we're going to have the 10% of the segment asset. Do they represent 10% of the company total asset? So those are the three tests. We'll look at them separately. Segment revenue, segment operating, profit or loss and segment assets. Other terms you need to be familiar with just for the purpose of this chapter, corporate assets. Well, those are the assets that are maintained for the general corporate purpose and not used in the operation of a segment like the headquarter building, the HR building, the payroll, if you want to think of it that way. General corporate expenses. Well, if you have assets, you have a building, you might have to incur expenses. Any expense incurred for the benefit of the corporation as a whole, not specifically to the operation and cannot be reasonably allocated to any segment. So you're not taking that expense and dump it into one of those divisions. It cannot be reasonably allocated. There's no connection between those expenses and the division and the operating segment of the division. One more thing, transfer prices. The prices of product or services between operating segment or segment geographical area. For example, you're operating in North America, you sell to your South American division. Well, how much you will charge them is called a transfer price because it's within the same company. But let's take a look at the quantitative threshold, which is how to determine if a segment is an operating segment and need to be reported separately. We have something called the quantitative threshold. And once you hear the word quantitative, it means we are using number or percentages. Segment is reportable if it needs one or more of the following criteria. The first one is the combined revenue is 10% or more of the combined revenue of all the reportable segment. Simply put, is this segment generating 10% revenue? And when we count that 10% revenue, we include both internal and external revenue. If it does, then guess what? It becomes a reportable segment or profit or loss of that segment is 10% or more of the greater of the absolute amount of combined profit of all segment, not reporting a loss and combined loss of all segment that reported a loss. Simply put, we add all the profit from the operating segment that's making a profit. We add up all the loss separately. So we compute all the profit or the loss. And we choose the greater. So if this is $100, if this is $10 and losses, 100 is greater. So it's going to be 10% of that. Well, let's use something other than 100. Let's use 200. 10% of that is 20. Therefore, it has to be 20. It has to be more than 20. And assets are 10% or more of the combined total assets. So those are the three tests, revenue test, profit and loss test, and the asset test. So the best way to illustrate those concepts is to do what? Look at an example. So let's take a look at an example. So we have this company here. Bacon industries operate in seven different segments. So those are the seven different segments. Information concerning operation of these segments for the most physical period. We have revenues, total revenue, intercompany revenue, operating loss or profit and identifiable asset. Remember we have three tests to complete revenue, profit loss and three assets. So we have to know which one of these seven are considered reportable segment. We have to show them separately. Well, let's start with the revenue. For the revenue, we have to look at the revenue of the division in comparison to the total revenue. Okay. And we include both internal and external. So this is the total revenue. So we're going to add up all the total revenue. And if you add up all the total revenue, they end up to 198,700. So that's the total revenue, 198,700. Now we need to know if segment one, operating segment one, represent 10% of the revenue. If we take 4200 divided by 198,700, I could assure you this is not 10%. Basically, if we want 10%, just basically the easiest way to do it. Let me just go ahead. So if we take 198,700 times 0.1, times 0.1, that's 19,750. 19,870. So I need a division that exceeds and sales 19,870. Well, guess what? Well, this one does not, this one does not, this one does, this one does, this one does not, this one does, and this one does not. So simply based on revenue, three, four, and six, they are considered, they are considered separate reportable segments because the revenue is 10% or more of total revenue. Now we need to know the profit and the loss because we are done with this test. Well, what we do is we combine the losses and the profit. Let's combine the losses first. We have 600, whoops, we have a 600 and 3000. So the losses altogether is 3,600 and the profit are 2,040,100. Let me just add them real quick on the calculator. Let's go back to this slide and add all the profits 2,000 plus 2,100 plus 8,800 plus 3,200 plus 4,000 equal to 20,100. So the profit is 20,100. Now this is the loss and this is the profit. We choose the greater of the two. The greater is 20,100. We're going to take 20,100 times 10%, 20,100, 20,100 times 10% and that's going to give us 2,010, 2,010. Well, anything that's greater than 2,010. Well, what's greater than 2,010? Let me use a different color. This is reportable because it's greater than 2,010. This is reportable, which has already been reportable. Now this is reportable because it's 32. Now five is reportable. This is reportable. This is reportable. This is not reportable. This is not reportable and one was not reportable. So right now 3, 4, 5, 6, 7 are reportable. The last test is the asset test and for the asset test, you will do the same thing. You add up all the assets and if you add them all up, they will add up to 100, 70, 1,200. 10% of that is 17,120. That's 10%. Not reportable, not reportable and the rest are reportable. So simply put 3, 4, 5, 6 and 7, those are reportable. So we did the revenue test and this was the revenue test and those three were reportable under the revenue test. We did the operating profit and loss. We separated the losses. We separated the profit. The profit was greater. We multiplied by 10% and those were all more than 10%. Then we did the asset test and for the asset test, this was 10%, 10%, 10%. Those were reportable, but they were reportable anyway. Now so in summary, 3, 4, 5, 6 and 7, those are reportable segment. Those operating segments are reportable segments. We have to report them separately. Now we have another test to make. There is the 10% test, which we just did. Then we have to have the 75% test and what's the 75% test? The 75% test mean the combined revenue from sales to an affiliate customer. What we're doing is we're taking the revenue from sales to external for the all reportable segment must constitute at least 75% of the combined revenue from the sales to an affiliate customers of all operating segments. So we selected those divisions. We selected 3, 4, 5, 6 and 7. Now those 3, 4, 5, 6 and 7, we have to add up the sales to revenue or sales to outsider. And the revenue from these divisions in comparison to the total revenue to the outsiders, it should represent 75%. So let's take a look if that's the case. Well revenue from non-affiliate 4, 2 is 44,000. For 3, 48,000 they have no internal. For 5 is 13,000. For division 6 is 61,000. Division 7, 10,000. And those are the external. This is the external for division 1, the external for division 2. We add them all up. The total external sales is 184,300. So that's in the denominator. In the numerator, we add the divisions that are reportable, which are 176,100. And they represent 95.6%. Well, they pass the second test. So they also have to pass, not pass a second test. If they don't pass this test, then what we have to do, we have to add other divisions that are not, they don't pass the 10% test until we reach 75%. But here we already, we already reached 75%. But if we did not reach 75%, we just keep adding more divisions. Another divisions are separate operating divisions, although they don't meet the 10% test. Because why? Because we need them, we need to meet the 75% threshold. One more thing we want to be aware of, or another major topic. If a 10% or more of the revenue of a firm derived from a sale to any single customer, hopefully this is clearly an important statement. Or if 10% or more of the revenue is derived from a sale to the federal government, state government, or a local government, or a foreign government. So simply put, if you have a single customer that's buying from you more than 10% of your sales, or if you have part of the government, whether it's the federal, state, local, or foreign, and that unit, that governmental unit represent more than 10% of your sales, then guess what? You have to disclose this information, you have to disclose this information separately. A case in point is Caterpillar. In a particular year, I believe that right here, in 1989, Caterpillar generated 25% of the revenue from one Brazilian customer, 25% of revenue. Caterpillar did not disclose this information. And that customer, Caterpillar, no, it's not a repeated customer. That customer bought whatever they bought from them, whatever you want to call it, the bulldozers, the trucks, whatever they bought from them, and they knew this is not going to be a repeat transaction. But since that particular customer represented a large portion of the revenue for that particular year, Caterpillar should have disclosed, they should have told their investors, look, just want to let you know that we sold, for example, if it's a million dollar or a billion dollar, 250 million of sales is coming from one single customer. And don't count on this customer next year. Don't count on this customer because it's not going to happen again. What information need to be presented for each reportable unit? So what information need to be presented? What information need to be presented for each reportable segment and an aggregate for the segment that's separately reported? We need to show the general information. We need to show the general information. We need to show the operating profit or loss, which is obviously how do we compute this revenue minus expenses? We need to show their assets, their long term assets, their intangible asset, including depreciation, amortization, basis for measurement. How are we measuring those? Cost, fair value, interim disclosure, which we'll talk about interim disclosure in the next session. We have to do reconciliation of segment amount and consolidated amount of revenue profit and other significant item. We have to connect it to the main company, information about product and services and geographical areas, if material, that information must be reported in the enterprise country of domicile where they operate and in each other country, if that's important. One more thing, we also can determine an operating segment. What we can do is we can have aggregation criteria. What's the aggregation criteria? You are permitted to add up divisions together or segment together. As long as they have the following common characteristic, nature of their similar economic characteristic, the nature of their product or services, nature of their production or process, type of class or customers, method of distribution used or provide services and the nature of regulatory environment. Simply put, sometimes you can take several divisions or several different operating segments and combine them together as long as they have those similar economic characteristics. 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