 Hello and welcome to this session. This is Professor Farhad in which we will discuss segment reporting. The first thing we want to know is why do we have to learn about segment reporting? Well, companies these days operate many segments, usually they're called klinglamerit. Let's take a look at a company that we all should be familiar with and that's PepsiCo. When you think of PepsiCo, what do you think of? Well, obviously you're going to think about beverage, soda, true. So, when you look at PepsiCo's financial statements, they would look at they would look at their net sales and they will show you one figure for net sales on the income statement and that's sales. But is this what sales coming from from PepsiCo? Well, let's take a look at PepsiCo various segments. Well, PepsiCo is actually this is from their annual reports organized into six reportable segments, also known as divisions. Let's take a look at them. Fritole North America, which included our branded food and snack business. Quaker Food North America, which includes cereal, rice and pasta. North America beverage, which include our beverage business in the US and Canada, which is this is what you think of when you think about PepsiCo. They have the Latin America division and they have the European and Sub-Saharan division, as well as Asia, Middle East and North Africa. So notice for one thing, I want you to see that they don't only sell sodas, they sell sodas, they sell food, they sell rice, they sell pasta, and they are operating in various segments. And let me show you also the number just so can I can I get a better idea? And this is the North American beverage. This is what you think of. This is their revenue. So it's one third 33% of total revenue. Well, that's not the whole thing. Because when you think of you think of all beverages, that's not true. And you might think mostly in the US, that's not true neither. So what they do, they break the company into various component. This is their food beverage, which is 25%. That's a substantial portion of their of their business. Well, for example, why do we need to know about, for example, the Middle East or Asia or a particular area? Think about the Russian-Ukrainian war. If PepsiCo is operating there, and let's assume 30% of their revenue is coming from that area, I want to know if they are operating in this area because with the with the Russian-Ukrainian ongoing Russian-Ukrainian war, well, PepsiCo sales might suffer. So that's why it's very important to break down the company. So the objective is to help the users understand the enterprise that performance better. If they're operating in the Middle East, there's always a risk of a war. I want to know how much exposure do they have. I want to be able to assess their future cash flow. I want to analyze the various components of the business and the company as a whole. Think about different subsidiaries, different industries. Well, for example, Soda will have a different gross margin than selling chips. Well, I cannot just look at one gross profit margin. I have to see how much are they making for their soda, for their drinks versus the chips versus their pasta versus the rice versus the cereal. If there's any opportunities for growth, think about companies like Amazon. Amazon is known for selling online, while also Amazon is in the cloud business. I want to see how well they are growing in that cloud business. So that's what those segment reporting will show me. Also the type of risk, what risk am I exposed to? Again, for talking about geographical segmentation, what am I operating? Am I operating in Russia? Am I operating in the Middle East? Am I operating in Central Africa? Am I operating in Latin America? Because they will have different types of risks. The question becomes, how do we determine this segment? How do we determine that the free to lay is a separate segment? How do we determine is the Middle Eastern segment is a separate segment? This is what we learn about. How does the company comes to that conclusion that this is its own whole separate reportable segment? And this is exactly what we need to learn in this session. Before we learn about this, most likely you are a student or a CPA candidate. This is how you landed here. That's great. If you are, please go a step further to farhatlectures.com where I provide you additional resources, lectures, multiple choice, through false exercises that's going to help you better, whether you are studying for your courses or the CPA exam. If you have not connected with me on LinkedIn, please do so. Like this recording. If you're watching, please just click on the like button. It doesn't cost you anything. Share it with other. Connect with me on Instagram, Facebook, Twitter, and Reddit. So let's talk about something called the operating segment. What is an operating segment? Well, an operating segment is a segment that's operating on its own. How do we determine this? We look at something called the management approach. We focus on how management is breaking down the organization internally to make decisions and assess and operate the business. So how the company is being operated and managed internally. This is called the management approach. And a particular segment could have many different, different divisions. For example, it could have, it could be broken down by a company could be breaking down by different industries as operating segment. Well, for example, GE, General Electric, they have various divisions. They work in various industries. They have a division financial division. I believe they sold the financial division. They have a division for airline companies, manufacturing, manufacturing airline companies. They have one for electronics, so on and so forth. You can break down your company by geographical area. We saw that PepsiCo. They have different geographical areas. You could also break down your business by major customer. For example, Boeing, they could have, for example, one customer that's large enough that they will break down the division just for that particular customer. Also, an operating segment will have to earn revenues and incur expenses. And those revenues and expenses could be internal or external. In other words, they could be generating revenues from selling to another company within the company. Well, that's fine. That's still revenue. It also would have to have a chief operating officer, someone who's in charge reviewing the results of the whole operation on a regular basis. Produce financial information and disclosure. Simply put, an operating segment, think of it in a sense, a small business that stands on its own. Now, this is good. So, we know what an operating segment is. The question becomes, is an operating segment a reportable segment? In other words, should we disclose that information separately, as we saw in the PepsiCo report, where we broken down free to lay versus the Asian market versus the North American market, the beverage market, so on and so forth. So, is a segment a reportable segment, a significant segment? Well, this is what we have to talk about here. We have to pass one of the three tests that's called 10% test plus other criteria. First, we're going to focus on this three 10% test. And we only have to meet one of three, what we call 10% test. Those tests are quantitative test because they use numbers. And what are those three tests? First is the revenue test. What does that mean? We have to look at the sales to external and internal, external and internal. The reason I'm emphasizing this, because at some point in this lecture, we're going to be using another revenue test only using the external. But for the quantitative test for the revenue test, we use both internal and external. Does the revenue represent from that operating segment 10% of all reportable segment? If the answer is yes, it's a significant segment. Two, segment operating profit or loss. Again, that's 10%. Well, we look at the profit or loss. We look at the greater of 10% of the profit or loss and absolute value. What does that mean? Let's take a look at it. We look at all the profit of all operating segment that did not incur a loss. Simply put, we add all the profit segments. Then we look at loss from operating segment that did report a loss, and we add up all the losses together. Simply put, we broke the segments into profitable segment and loss segment. Simply put, something like this. We have segment that generate profit inserting segments that generate losses. So 10, 100, 10 and 50. Negative 50, negative 10. Okay? So we have five segments. What we do is we add all the profit together. 110, 160, that's the profit, and the losses are 60. Well, then we use the absolute value. Absolute value means 160 and 60. Which one, the greater of the two, 160, we multiply this by 10%. And our threshold becomes 16. Now, bear in mind, if we have losses of 260, right, 260 versus 160, well, we have to turn the 260 into an absolute number, which is 260, then it'll be 260 times 10%. It's the absolute value, not the greater, because obviously 160, always a positive number is greater than a negative number. What we do is we turn the negative number into an absolute value, then we make our decision. Don't worry, we would look at an example. That's the second test. The third test is 10% of the asset. We look at tangible and intangible asset. Are they, do they represent 10% of the company's assets? So those are the three tests. And we only have to meet one of those three tests for our division to be considered a reportable division. We do have two additional requirements. And what are those? The segment result must equal or exceed 75% of the combined sales to an affiliate, an affiliate, which is simply put external customers. So simply put, after we identify the segment, we have to add them up. And when we add them up, and we're going to do this in a moment, in an example, when we add them up, the total sales of all these segments, total sales of all these reportable segment, will have to be represent 75% of the total sales to external customers. So in this way, we kind of have a good representation, a substantial portion of the company's reportable segment are represented. This is the assumption. Now, what happened if we have a lot of reportable segment? Well, Gap says, if you have a lot, 10 reportable segment, and you stop an upper limit. So if you have, for example, 13, you just stop at 10, because it becomes burdensome and become very not cost effective. The best way is to look at an example. Let's take a look at this example where we have segment A, B, C, D, E, and F. Here's the revenue, and it's all for this, for the purpose of this example, all the revenue is to external and affiliate. Here's the operating expenses, here's the identifiable asset. First thing you do is you add all the revenues, add all the profit, exclude the loss. So if you notice, if you add all of this, you don't include the loss because you don't include the loss in a sense when you're doing the operating profit, but this is the net, but you're going to see the profit alone is 900 and the loss is 50. This is how we come up to 850. You add up all the assets. Now what we need to do, we start with the revenue test. Well, what's 21,500 times 10%? That's the first thing. Well, it's 2150. Any division that has a revenue more than that is a reportable division. Well, let's see. We have C, we have C, we have D, and we have what's, oh, E of course. So C, D, and E meet this test. Do we stop? Not at all. Now we take a look at the operating profit or loss. Again, we'll take 900 times 10% because again, we bunch all the profit together and we keep the loss. And obviously 900 is greater than 50, an absolute value. Therefore, we'll take 900 times 10%. So notice we ignore the 50. And under this test, well 90, we have A is reportable, B is not, C is already, D is already, yes, and E is, and obviously F is not. So now we have A, C, D, and E are reportable segment. Do we stop? No, we go through the third test. Now we look at identifiable assets, 9,700 times 10%, 970. Well, A does not pass the test, B does not, C does, already C is counted, D does, E does, and F does not. F does not. So simply put our reportable segment are A, C, D, and E. Okay? So this is how we do this. Now we have to find out whether the A, C, D, and E, and they represent altogether 75% of the combined sales. So basically 75% of 21,500, because all the sales here again, we said it's an affiliate because in this test, you only use the sales to an affiliate. So the 75% is computed as follow. So as long as those divisions A, C, D, and E can account to more than 16,125, we stop. That's good. That's all we have to report in reportable segment. And if we add them up, they add up to 20,000. Obviously, 20,000 is more than 16,125. They represent more than 75% of the sales of the company. We stop. So our reportable division will be A, C, D, and E. Now we report them and talk a little bit more about them. Few terms I want you to be aware of when you are dealing with segmental reporting or segment reporting. Corporate assets, corporate assets are assets maintained for the general corporate purpose and not used in the operating segment. So you don't count those assets. Also corporate, corporate, general corporate expenses. Again, expenses incurred for the benefit of the corporation as a whole. You don't allocate those expenses to any segment and transfer prices just to term you need to be familiar with is the pricing of product between operating segment or geographical area when one company sells to the other. Now, what do we have to report when we have segment information? Well, we have to report the general information about the operating segment. For example, where does it operate? What do they do? Basically a small narrative about it. It's profit and loss and any related information like income statement, cash flow, basis for measurement. How did we measure those assets, liabilities, revenues, and expenses? Segment assets, we have to show their assets. We have to show reconciliation from the segment to the whole financial statement. Information about their product services, geographical areas. For example, we have to show their interest expense separately. Why? Interest expense tells us how much debt they have. Okay, that's important. We have to show the depreciation expense. Depreciation expense tells us how much of this asset house our property, plant, and equipment. We also have to show if we have any major customer. So what is a major customer? So that's something you need to be aware of. Information about major customer. A major customer, if they have, if 10 or more of the revenue of the firm derived from a single customer, or if 10 or more of the revenue is derived from the sale to the federal government, state government, a local government, a foreign government. So the government is considered, any government is considered a major customer if we sell to them, if our sales revenue represents more than 10% of our total, then it's sales. For example, the good example I can give you is Caterpillar. Caterpillar back in 1989, they sold to a Brazilian company a lot. And that year, that particular year, the sales represented 23% of their total sales. Well, and they did not disclose this information. They did not disclose that their Brazilian division relied on one customer and that customer represented 23% of the sales of the company. Well, why? Because if you have one customer, the investors want to know if you only have one customer, what happened if you lost that one customer? Well, your profit will be substantially lower. So I need to know if I am exposed to that risk. Therefore, if you have a major customer, which is what's what's a major customer, a customer will you're selling represent 10% or more of your revenue, that's a major customer. Let us know about it. Otherwise, the SEC will find you. And this is basically what we talked about in segment reporting. Why do we have to report the criteria? Very important information that you have to be, you have to know whether you are a student and accounting students or a CPA candidate. What should you do now? Go to farhatlectures.com, work multiple choice through false questions that's going to help you solidify your knowledge. Don't short change yourself. This import this information is important, your CPA exam, your accounting career is important, take it seriously invest in yourself. And of course, stay safe.