CHAPTER FIVE

SEGMENTS AND INTERIM REPORTS

5.1. SEGMENT REPORTING
5.1.1 Meaning of segments
The Accounting Principles Board defined a business segment as a component of an entity whose
activities represent a separate major line of business or class of customers. The wave of conglomerate
business combinations in past years, involving companies in different industries or markets, led to
consideration of appropriate methods for reporting disaggregated financial data for business segments.
Financial analysts and other interested in comparing one diversified business enterprise with another
found that consolidated financial statements did not supply enough information for meaningful
comparative statistics regarding operations of the diversified enterprises in specified industries. In other
words a segment is part of an organization or particular activity of an organization which is providing
separate information. The concept of segment reporting was controversial because it was opposed to the
philosophy that consolidated financial statements rather than separate financial statements fairly
represent the financial position and operating result of an economic entity.
5.2Allocation of non-traceable expenses to segments
Those expenses that are directly identifiable with a particular segment is known as traceable expenses,
while commonly incurred expenses are known as non-traceable expenses and cannot be recognized
separately. The FASB required that non traceable expenses should be allocated to each segment on
reasonable basis. The reasonable basis is upon the pronouncement of Cost Accounting Standard Board
(CASB) in Cost Accounting Standard CAS -403. Allocation of home office expenses commonly
incurred for the segments should be made on the basis of Arithmetic average of three factor ratio.
These three factors are
1. Ratio of segment Pay roll to total pay roll of all segments.
2. Ratio of segment operating revenue to total revenue of all segments
3. Ratio of segment Average Plant assets and inventory to total of all segments plant assets and
inventories.

WU,COBE,ACFN,ADVANCED FINANCIAL ACCOUNTING CHAPTER

1
FIVE HANDOUT
Illustration 1
Data for Home office and two industrial segments of a Multiproduct corporation is given below.
Home Segments
Office Chemical Food Total
Product Product
Net Sales ( Operating
revenue $550,000 $450,000 $1,000,000
Traceable Expenses 300,000 350,000 650,000
Non traceable expenses
of segments $200,000 ---- ----- 200,000
Total Expenses 200,000 300,000 350,000 850,000
Income before tax 150,000
Income tax 60,000
Net Income 90,000
Pay roll total 60,000 160,000 240,000 460,000
Average Plant assets &
Inventories 80,000 620,000 1,380,000 2,080,000

Required:
1. Compute Three Factor Ratios under CAS 403
2. Allocate Non traceable expenses
3. Find Operating profit of loss for two segments

WU,COBE,ACFN,ADVANCED FINANCIAL ACCOUNTING CHAPTER

2
FIVE HANDOUT
Solution:
1 Computation of three factor ratio under CAS 403
Chemical Food
Product % Product %
1.Ratio of segment pay roll 160,000 x100 240,000 x 100
to Total pay roll of segments 400,000 40% 400,000 60%
2. Ratio of segment revenue 550,000 x 100 450,000 x 100
to total revenue of segments 1,000,000 55% 1,000,000 45%
3. Ratio segment Plant 620,000 x 100 1380,000 x 100
assets & inventory 2,000,000 31% 2,000,000 69%
Total 126 174
Average 126/3 174/3
= 42% 58%

2. Allocation of Non Traceable Expenses

To Chemical Product segment = 200,000 x 42% = $ 84,000
To Food Products = 200,000 x 58% =116,000
Total 200,000
3. Computation of Operating Profit or (Loss)
Chemical Food
Products Products Total
Net sales $550,000 $450,000 $1,000,000
Less: Cost & Expenses
Traceable Expenses 300,000 350,000 650,000
Non traceable expenses 84,000 116,000 200,000
Total Expenses 384,000 466,000 850,000
Operating Profit or (Loss ) 166,000 (16,000) 150,000

WU,COBE,ACFN,ADVANCED FINANCIAL ACCOUNTING CHAPTER

3
FIVE HANDOUT
5.3 Determination of significant segments
If a segment is significant, its financial statements should be reported. The FASB decided that an
industry segment is significant, if it meets one or more or the following tests. There are three tests
namely
1. Revenue test
2. Profit and loss test and
3. Asset test.
1. Revenue Test: If a segments revenue (including sales to un affiliated customers and inter segment
sales or transfer) is 10% or more of the combined revenue of all enterprise’s industry segments.
2. Profit and loss test: A segment’s operating profit or loss is 10% or more of the greater of
a) The combined profit of all that did not incur an operating loss
b) The combined operating loss of all that did incur a loss.
3. Assets test: A segment’s identifiable assets are 10% or more of combined assets of all segments.
Illustration: 2
Determine the significant industry segments of a business enterprise having four segments. The
following details are given for the year ended December 31, Year 5.
SEGMETNTS
A B C D TOTAL
Revenue $60,000 80,000 20,000 50,000 $210, 0000
Operating Profit (loss) (20,000) 30,000 (10,000) 30,000 30,000
Identifiable Assets 500,000 400,000 100,000 300,000 1,300,000
Solution:
1. Revenue Test.
10% of the combined revenue = 210,000 X 10% = 21,000
Segments A , B & D meet the requirement of revenue test. So they are significant segments. Segment
C is not significant according to revenue test. So it is to apply the Profit and loss test for segment C
2. Profit and loss Test
a) Combined profit of all that did not incur a loss
B 30000 + D 30000 = 60000

WU,COBE,ACFN,ADVANCED FINANCIAL ACCOUNTING CHAPTER

4
FIVE HANDOUT
 b) Combined Loss of all that did incur a loss
A 20,000 + C 10,000 = 30,000
Greater of the two above = 60,000
10% of the greater = 6,000
Segment C’s loss (10000) is greater than the calculated amount above. So Segment C also is significant.
So All Segments are significant.
Applying third test
3. Asset Test.
Combined assets of all segments = 1.300,000
10% of the combined = 130,000
According to this test Segment C is not significant, but it is significant as per profit and loss test.
So, final conclusion is that all segments are significant.
5.4 INTERIM FINANCIAL REPORTS
The APB established guidelines for interim financial reports. It is to provide investors and creditors with
more timely information than is provided by annual report. Companies provide financial information for
periods to time less than one year. It may be for monthly, quarterly, or half yearly. According to
guidelines given by APB, the following components should be included in interim financial reports.
1. Revenue: Revenue should be recognized in the interim period in the same way as they are recognized
on an annual basis. For example, revenue from long term construction project accounted for under
percentage of completion for annual purpose should also be recognized in interim statements on a
percentage of completion basis.
2. Cost associated with revenue: Enterprise using Gross profit method to estimate cost of goods sold
should disclose the fact in the interim financial report. Enterprise that use LIFO method and deplete the
base layer of inventories or LIFO liquidation should include in cost of goods sold the estimated cost of
replacing the depleted LIFO base layer. For example: Inventories on hand 200 units on the beginning
date. Purchase during the interim period 400 units, sold during the interim period 450 units, (under
LIFO, 400 unit’s purchased and 50 units from the inventory on hand) is sold, the 50 units are termed as
depletion of base layer of inventories.

WU,COBE,ACFN,ADVANCED FINANCIAL ACCOUNTING CHAPTER

5
FIVE HANDOUT
Illustration: 3
Liquid Products Company began the first quarter with 100 units of inventory that cost $10 per unit.
During the first quarter 200 units were purchased at a cost of $15 per unit and sales of 240 units at $20
per unit were made. During the second quarter, the company expects to replace the units of beginning
inventory sold at a cost of $17 per unit.
Required:
1. Calculate the gross profit for the first quarter.
2. Show Journal entry to record cost of goods sold in the first quarter.
3. Show journal entry to record the purchase of 500 units @$17 in the second quarter.
Solution
1. Computation of Gross Profit for the first quarter.
Sales (240 x 20) $4,800
Less: Cost Of Goods sold
200x 15 = 3000
40x 17 = 680 3,680
Gross Profit 1,120
2. Cost of goods Sold 3680
Inventory 3400
Liability from depletion 280
(To record the Cost of goods for first quarter)
INVENTORY ACCOUNT
Beginning Balance 100x10 1000 Cost of Goods Sold
Account Payable 200x15 3000 200x15= 3000
40x 10= 400 3400
Balance 600
COST OF GOODS SOLD
Inventory 3400 Income statement (transfer) 3680
Liability from depletion (40x7)
280
Total 3680 Total 3680

WU,COBE,ACFN,ADVANCED FINANCIAL ACCOUNTING CHAPTER

6
FIVE HANDOUT
3. Inventories (8500- 280) 8220
Liability from depletion 280
Account Payable 8500
(To record purchase and restoration of depleted base layer)

WU,COBE,ACFN,ADVANCED FINANCIAL ACCOUNTING CHAPTER

7
FIVE HANDOUT