Solution manual advanced accounting 9e by hoyle ch08

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CHAPTER 8
SEGMENT AND INTERIM REPORTING
Chapter Outline
I.

In the past, consolidation of financial information made the analysis of diversified companies
quite difficult.
A. The consolidation process tends to obscure the individual characteristics of the various
component operations.
B. Many groups called for the presentation of disaggregated financial data as a means of
enhancing the information content of corporate financial reporting.

II.

The move toward dissemination of disaggregated information culminated in December 1976
with the release by the FASB of Statement 14, “Financial Reporting for Segments of a
Business Enterprise.”
A. This pronouncement required extensive disclosures pertaining to industry segments,
domestic and foreign operations, export sales, and major customers.
B. Although financial analysts found segment information to be very useful, they consistently
requested that financial information be disaggregated to an even greater extent than was
done in practice.
C. Of particular concern was SFAS 14’s “dominant industry rule” which allowed many
companies to avoid providing disaggregated data by industry segment.

III. In response to the demand by financial analysts for improvements in segment reporting, the
FASB issued Statement 131, “Disclosures about Segments of an Enterprise and Related
Information” in June 1997.
A. SFAS 131 adopts a management approach in which segments are based on the way that

management disaggregates the enterprise for making operating decisions; these are
referred to as operating segments.
B. Operating segments are components of an enterprise which meet three criteria.
1. Engage in business activities and earn revenues and incur expenses.
2. Operating results are regularly reviewed by the chief operating decision-maker to
assess performance and make resource allocation decisions.
3. Discrete financial information is available from the internal reporting system.
C. Once operating segments have been identified, three quantitative threshold tests are then
applied to identify segments of sufficient size to warrant separate disclosure. Any segment
meeting even one of these tests is separately reportable.
1. Revenue test—segment revenues, both external and intersegment, are 10 percent or
more of the combined revenue, external and intersegment, of all reported operating
segments.
2. Profit or loss test—segment profit or loss is 10 percent or more of the greater (in
absolute terms) of the combined reported profit of all profitable segments or the
combined reported loss of all segments incurring a loss.
3. Asset test—segment assets are 10 percent or more of the combined assets of all
operating segments.

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D. SFAS 131 also sets several general restrictions on the presentation of operating
segments.

1. Separately reported operating segments must generate at least 75 percent of total
sales made by the company to outside parties.
2. Ten is suggested as the maximum number of operating segments that should be
separately disclosed. If more than ten are reportable, the company should consider
combining some operating segments.
E. Information to be disclosed by operating segment.
1. General information about the operating segment including factors used to identify
operating segments and the types of products and services from which each segment
derives its revenues.
2. Segment profit or loss and the following components of profit or loss.
a. Revenues from external customers.
b. Revenues from transactions with other operating segments.
c. Interest revenue and interest expense (reported separately).
d. Depreciation, depletion, and amortization expense.
e. Other significant noncash items included in segment profit or loss.
f. Unusual items (discontinued operations and extraordinary items).
g. Income tax expense or benefit.
3. Total segment assets and the following related items.
a. Investment in equity method affiliates.
b. Expenditures for additions to long-lived assets.
IV.

Enterprise-wide disclosures.
A. Information about products and services.
1. Additional information must be provided if operating segments have not been
determined based on differences in products and services, or if the enterprise has only
one operating segment.
2. In those situations, revenues derived from transactions with external customers must
be disclosed by product or service.
B. Information about geographic areas.

1. Revenues from external customers and long-lived assets must be reported for (a) the
domestic country, (b) all foreign countries in which the enterprise has assets or derives
revenues, and (c ) each individual foreign country in which the enterprise has material
revenues or material long-lived assets.
2. The FASB does not provide any specific guidance with regard to determining
materiality of revenues or long-lived assets; this is left to management’s judgment.
C. Information about major customers.
1. The volume of sales to a single customer must be disclosed if it constitutes 10 percent
or more of total sales to unaffiliated customers.
2. The identity of the major customer need not be disclosed.

V.

To provide investors and creditors with more timely information than is provided by an annual
report, the U.S. Securities and Exchange Commission (SEC) requires publicly traded
companies to provide financial statements on an interim (quarterly) basis.
A. Quarterly statements need not be audited.

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VI. APB Opinion No. 28 requires companies to treat interim periods as integral parts of an annual
period rather than as discrete accounting periods in their own right.
A. Generally, interim statements should be prepared following the same accounting

principles and practices used in the annual statements.
B. However, several items require special treatment for the interim statements to better
reflect the expected annual amounts.
1. Revenues are recognized for interim periods in the same way as they are on an
annual basis.
2. Interim statements should not reflect the effect of a LIFO liquidation if the units of
beginning inventory sold are expected to be replaced by year-end; inventory should
not be written down to a lower market value if the market value is expected to recover
above the inventory's cost by year-end; and planned variances under a standard cost
system should not be reflected in interim statements if they are expected to be
absorbed by year-end.
3. Costs incurred in one interim period but associated with activities or benefits of
multiple interim periods (such as advertising and executive bonuses) should be
allocated across interim periods on a reasonable basis through accruals and
deferrals.
4. The materiality of an extraordinary item should be assessed by comparing its amount
against the expected income for the full year.
5. Income tax related to ordinary income should be computed at an estimated annual
effective tax rate; income tax related to an extraordinary item should be calculated at
the margin.
VII. FASB Statement No. 154, “Accounting Changes and Error Corrections,” provides guidance for
reporting changes in accounting principles including those made in interim periods.
A. Unless impracticable to do so, an accounting change is applied retrospectively, that is,
prior period financial statements are restated as if the new accounting principle had
always been used.
B. When an accounting change is made in other than the first interim period, information for
the interim periods prior to the change should be reported by retrospectively applying the
new accounting principle to these pre-change interim periods.
C. If retrospective application of the new accounting principle to interim periods prior to the
change of change is impracticable, the accounting change is not allowed to be made in an

interim period but may be made only at the beginning of the next fiscal year.
VIII. Many companies provide summary financial statements and notes in their interim reports.
A. APB Opinion No. 28 imposes minimum disclosure requirements for interim reports.
1. Sales, income tax, extraordinary items, cumulative effect of accounting change, and
net income.
2. Earnings per share.
3. Seasonal revenues and expenses.
4. Significant changes in estimates or provisions for income taxes.
5. Disposal of a business segment and unusual items.
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6. Contingent items.
7. Changes in accounting principles or estimates.
8. Significant changes in financial position.

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B.

Disclosure of balance sheet and cash flow information is encouraged but not required. If
not included in the interim report, significant changes in the following must be disclosed:
1. Cash and cash equivalents.
2. Net working capital.
3. Long-term liabilities.
4. Stockholders' equity.

IX. Four items of information must also be disclosed by operating segment in interim financial
statements: revenues from external customers, intersegment revenues, segment profit or
loss, and, if there has been a material change since the annual report, total assets.

Learning Objectives
Having completed Chapter 8 of this textbook, “Segment and Interim Reporting,” students should be
able to fulfill each of the following learning objectives:
1. Identify the financial analysis problems associated with consolidated financial statements.
2. Discuss the method by which an enterprise determines its operating segments and the factors
that influence this determination.
3. Identify and apply the three tests that are used to determine which operating segments are of
significant size to warrant separate disclosure.
4. List the basic disclosure requirements for operating segments.
5. Describe the various limitations within which the number of separately disclosed operating
segments should fall.
6. Explain when enterprise-wide disclosures related to products and services is required.
7. Explain when and what types of information about geographic areas must be disclosed.
8. Describe the criterion by which sales to a single unaffiliated customer are measured to
determine whether disclosure is required.
9. Explain the "integral" approach followed in preparing interim reports and distinguish it from the

"discrete" approach.
10. Describe and apply procedures used in interim reports for LIFO liquidations, costs associated
with more than one interim period, income taxes, and accounting changes.
11. List the minimum disclosure requirements for interim financial reports.

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Answer to Discussion Question
In his well-publicized “The Numbers Game” speech delivered in September 1998, former SEC
chairman Arthur Levitt cited “materiality” as one of five gimmicks used by companies to manage
earnings. Although his remarks were not specifically directed toward the issue of geographic
segment reporting, the intent was to warn the corporate America that materiality should not be used
as an excuse for inappropriate accounting. To make the point even more salient, the SEC issued
Staff Accounting Bulletin (SAB) 99, “Materiality,” in August 1999, which warns financial statement
preparers that reliance on a simple numerical rule of thumb, such as 5% of net income, is not
sufficient. SAB 99 reminds financial statement preparers that:
“The omission or misstatement of an item in a financial report is material if, in the light of
surrounding circumstances, the magnitude of the item is such that it is probable that the judgment
of a reasonable person relying upon the report would have been changed or influenced by the
inclusion or correction of the item.”
Further, SAB 99 reminds companies that both quantitative and qualitative factors should be
considered in determining materiality. With respect to segment reporting, SAB 99 states:
“The materiality of a misstatement may turn on where it appears in the financial statements. For

example, a misstatement may involve a segment of the registrant's operations. In that instance, in
assessing materiality of a misstatement to the financial statements taken as a whole, registrants
and their auditors should consider not only the size of the misstatement but also the significance of
the segment information to the financial statements taken as a whole. "A misstatement of the
revenue and operating profit of a relatively small segment that is represented by management to be
important to the future profitability of the entity" is more likely to be material to investors than a
misstatement in a segment that management has not identified as especially important. In
assessing the materiality of misstatements in segment information - as with materiality generally
situations may arise in practice where the auditor will conclude that a matter relating to segment
information is qualitatively material even though, in his or her judgment, it is quantitatively
immaterial to the financial statements taken as a whole.
Thus, in addition to quantitative factors, such as the relative percentage of total revenues generated
in an individual foreign country, companies should consider qualitative factors as well. Qualitative
factors that might be relevant in assessing the materiality of a specific foreign country include: the
growth prospects in that country and the level of risk associated with doing business in that country.
There are competing arguments for the FASB establishing a significance test for determining
material foreign countries. On one hand, such a quantitative materiality test flies in the face of the
warning provided in SAB 99. For example, a 10% of total revenue or long-lived asset test might
give companies an excuse to avoid reporting individual countries that would be material for
qualitative reasons. Assume that from one year to the next a company increases its revenues in
China from 2% of total revenues to 6% of total revenues. Although 6% of total revenues would not
meet a 10% test, the relatively large increase in total revenues generated in China could be
material in that it could affect an investor’s assessment of the company’s future prospects. This
company might be reluctant to disclose information about its revenues in China because of
potential competitive harm.
On the other hand, the FASB could establish a materiality threshold low enough, for example, 5% of
total revenues, that would be likely to ensure that “material” countries are disclosed regardless of
whether they are material for quantitative or qualitative reasons. A bright-line materiality threshold
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would ensure a minimum level of disclosure and would enhance the comparability of financial
disclosures provided across companies.

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Answers to Questions
1.

Consolidation presents the account balances of a business combination without regard for the
individual component companies that comprise the organization. Thus, no distinction can be
drawn as to the financial position or operations of the separate enterprises that form the
corporate structure. Without a method by which to identify the various individual operations,
financial analysis cannot be well refined.

2.

The word disaggregated refers to a whole that has been broken apart. Thus, disaggregated
financial information is the data of a reporting unit that has been broken down into components
so that the separate parts can be identified and studied.

3.

According to SFAS 131, the objective of segment reporting is to provide information to help
users of financial statements:
a. better understand the enterprise’s performance,
b. better assess its prospects for future net cash flows, and
c. make more informed judgments about the enterprise as a whole.

4.

Defining segments on the basis of a company’s organizational structure will remove much of
the flexibility and subjectivity associated with defining industry segments under SFAS 14. In
addition, the incremental cost of providing segment information externally should be minimal
because that information is already generated for internal use. Analysts should benefit from
this approach because it reflects the risks and opportunities considered important by
management and allows the analyst to see the company the way it is viewed by management.
This should enhance the analyst’s ability to predict management actions that can significantly
affect future cash flows.

5.

SFAS 131 defines an operating segment to be a component of an enterprise:
a. that engages in business activities from which it earns revenues and incurs expenses,
b. whose operating results are regularly reviewed by the chief operating decision maker to
assess performance and make resource allocation decisions, and
c. for which discrete financial information is available.

6.

Two criteria must be considered in this situation to determine an enterprise’s operating
segment. If more than one set of organizational units exists, but there is only one set for which
segment managers are held responsible, that set constitutes the operating segments. If
segment managers exist for two or more overlapping sets of organizational units, the
organizational units based on products and services are defined as the operating segments.

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7.

The Revenue Test. An operating segment is separately reportable if its total revenues amount
to 10 percent or more of the combined total revenues of all operating segments.
The Profit or Loss Test. An operating segment is separately reportable if its profit or loss is 10
percent or more of the greater (in absolute terms) of the combined profits of all profitable
segments or the combined losses of all segments reporting a loss.
The Asset Test. An operating segment is separately reportable if its assets comprise 10
percent or more of combined assets of all operating segments.

8.

For reportable operating segments, the following information must be disclosed:
a. Revenues from sales to unaffiliated customers.
b. Revenues from intercompany transfers.
c. Profit or loss.
d. Interest revenue.
e. Interest expense.
f. Depreciation, depletion, and amortization expense.
g. Other significant noncash items included in profit or loss.
h. Unusual items included in profit or loss.
i. Income tax expense or benefit.
j. Total assets.
k. Equity method investments.
l. Expenditures for long-lived assets.
m. Description of the types of products or services from which the segment derives its
revenues.

9.

If operating segments are not based upon products or services, or a company has only one
operating segment, then revenues from sales to unaffiliated customers must be disclosed for
each of the company’s products and services.

10. Information must be provided for the domestic country, for all foreign countries in which the
company generates revenue or holds assets, and for each foreign country in which the
company generates a material amount of revenues or has a material amount of assets.
11. Two items of information must be reported for the domestic country, for all foreign countries in
total, and for each foreign country in which the company has material operations: (1) revenues
from external customers, and (2) long-lived assets.
12. The minimum number of countries to be reported separately is one: the domestic country. If
no single foreign country is material, then all foreign countries would be combined and two

lines of information would be reported; one for the United States and one for all foreign
countries. SFAS 131 does not provide any guidelines related to the maximum number of
countries to be reported.
13. The existence of a major customer and the related amount of revenues must be disclosed
when sales to a single customer are 10 percent or more of consolidated sales.
14. U.S. publicly traded companies are required to prepare quarterly financial reports to provide
investors and creditors with relevant information on a more timely basis than is provided by an
annual report.
15. Companies are required to follow an "integral" approach in which each interim period is
considered to be an integral part of an annual accounting period, rather than a "discrete"
accounting period in its own right. For several items, the integral approach requires deviation
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from the general rule that the same accounting principles used in preparing annual statements
should also be used in preparing interim statements.
16. Cost-of-goods-sold should be adjusted in the interim period to reflect the cost at which the
liquidated inventory is expected to be replaced, thus avoiding the effect of the LIFO liquidation
on interim period income.
17. Income tax expense related to interim period income is determined by estimating the effective
tax rate for the entire year. That rate is then applied to the cumulative pre-tax income earned
to date to determine the cumulative income tax to be recognized to date. The amount of
income tax recognized in the current interim period is the difference between the cumulative
income tax to be recognized to date and the income tax recognized in prior interim periods.

18. When an accounting change occurs in other than the first interim period, information for the
pre-change interim periods should be reported based on retrospective application of the new
accounting principle. If retrospective application of the new accounting principle to pre-change
interim periods is not practicable, the accounting change may be made only at the beginning of
the next fiscal year.
19. The following minimum information must be disclosed in an interim report:
a. Sales, income tax, extraordinary items, cumulative effect of accounting change, and
net income.
b. Earnings per share.
c. Seasonal revenues and expenses.
d. Significant changes in estimates or provisions for income taxes.
e. Disposal of a business segment and unusual items.
f. Contingent items.
g. Changes in accounting principles or estimates.
h. Significant changes in the following items of financial position:
1. Cash and cash equivalents.
2. Net working capital.
3. Long-term liabilities.
4. Stockholders' equity.
20. Four items of segment information are required to be included in interim reports: revenues
from external customers, intersegment revenues, segment profit or loss, and total assets if
there has been a material change in assets from the last annual report.

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Answers to Problems
1. D
2. C
3. A
4. C
5. B
6. D
7. C
8. A
9. B
10. B
11. C
12. C
13. C With regard to major customers, SFAS 131 only requires disclosure of the
total amount of revenues from each such customer and the identity of the
segment or segments reporting the revenues.
14. D
15. A
16. C
17. D
18. C If there has been a material change from the last annual report, total
assets, but not individual assets, for each operating segment must be
disclosed.

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19. D Sales to outsiders
Intersegment transfers
Combined segment revenues
10% criterion
Minimum

$18,000
3,000
$21,000
x 10%
$ 2,100

20. A Revenues from a single customer must be disclosed if the amount is 10
percent or more of consolidated sales. Consolidated sales only includes
sales to outsiders; intersegment sales are eliminated.
Consolidated sales (combined sales to outsiders) $376,000
10% criterion
x 10%
Minimum
$ 37,600
21. D Total operating losses of $1,020,000 (K and M) are larger than total operating
profits of $770,000. Thus, based on the 10 percent criterion, any segment
with a profit or loss of $102,000 or more must be separately disclosed. K, O,
and P do not meet that standard while L, M, and N do.
22. C Revenues Test

Combined segment revenues
10% criterion
Minimum

$32,750,000
x 10%
$ 3,275,000

Segments meeting test—A, B, C, E
Profit or Loss Test
Since there are no segments with a loss, this test is applied based on total
combined segment profit.
Combined segment profit
$5,800,000
10% criterion
x 10%
Minimum
$ 580,000
Segments meeting test—A, B, C, E
Asset Test
Combined segment assets
10% criterion
Minimum

$67,500,000
x 10%
$ 6,750,000

Segments meeting test—A, B, C, D, E
Five segments are separately reportable.

23. D
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24. B The test to verify that a sufficient number of industry segments is being
disclosed is based on revenues generated from unaffiliated customers. The
four segments that are to be separately disclosed show outside sales of
$520,000 out of a total for the company of $710,000. Since this portion is only
73.2 percent of the company’s total, the 75 percent criterion established by
the FASB has not been met.
25. C $60,000 x 1/4 = $15,000
$120,000 x 1/4 = 30,000
$45,000
26. C Income as reported
Less: Extraordinary loss (recognized in full
in the interim period in which it occurs)
Add: Cumulative effect loss (handled through
adjustment of retained earnings balance
at the beginning of the year)

$100,000
(20,000)

16,000

$ 96,000

27. C $1,000,000 x 1/4 = $250,000
28. C $480,000 x 1/4 = $120,000
29. C Dr. Property Tax Expense
Dr. Prepaid Property Taxes
Cr. Cash

$120,000
360,000
$480,000

30. A 5,000 units x $80 = $400,000
300 units x $50 =
15,000
5,300 units
$415,000
31. C 5,000 units x $80 = $400,000
300 units x $82 =
24,600
5,300 units
$424,600

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32. (10 minutes) (Apply the Profit or Loss Test to Determine Reportable Operating
Segments)
Calculation of profit or loss.
Revenues
Intersegment Operating
from Outsiders
Transfers
Expenses

Profit

Cards
$1,200,000 + $ 100,000 – $900,000 = $400,000
Calendars
900,000 +
200,000 – 1,350,000 =
Clothing
1,000,000
– 700,000 = 300,000
Books
800,000 +
50,000 – 770,000 =
80,000
Total
$ 780,000

Loss

$250,000

$250,000

Any segment with an absolute amount of profit or loss greater than or equal to
$78,000 (10% x $780,000) is separately reportable. Based on this test, each of the
four segments must be reported separately.

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33. (25 minutes) (Apply the Three Tests Necessary to Determine Reportable
Operating Segments)
Revenue Test (numbers in thousands)
Segment
Plastics
Metals
Lumber
Paper
Finance
Total

Revenues
$ 6,425

2,294
738
455
186
$10,098

Percentage
63.7% (reportable)
22.7% (reportable)
7.3%
4.5%
1.8%
100.0%

Profit or Loss Test (numbers in thousands)
Segment
Plastics
Metals
Lumber
Paper
Finance
Total

Revenues
$ 6,425
2,294
738
455
186

Expenses
$ 3,975
1,628
967
610
103

Profit
$2,450
666

Loss
$
(reportable)
(reportable)
229
155

83
$3,199

$384

Since $3,199 is larger in absolute terms than $384, it will serve as the basis for
testing. Each of the profit or loss figures will be compared to $319.90 (10% x
$3,199).
Asset Test (numbers in thousands)
Segment
Plastics
Metals

Lumber
Paper
Finance
Total

Assets
$1,363
3,347
314
609
768
$6,401

Percentage
21.3% (reportable)
52.3% (reportable)
4.9%
9.5%
12.0% (reportable)
100.0%

The plastics, metals, and finance segments meet at least one of the three tests
and therefore are reportable.

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34. (20 minutes) (A Variety of Computational Questions about Operating Segment
and Major Customer Testing)
a. Total revenues for Fairfield (including intersegment revenues) amount to
$4,200,000. Minimum revenues for required disclosure are 10% or $420,000.
b. Disclosure of operating segments is considered adequate only if the
separately reported segments have sales to unaffiliated customers that
comprise 75% or more of total consolidated sales. In this situation that
requirement is met. Red, Blue, and Green have total sales to outsiders of
$3,137,000 (or 86%) of total consolidated sales of $3,666,000. Thus,
disclosure of these three segments would be adequate.
c. Major customer disclosure is based on a level of sales to unaffiliated
customers of at least 10% or, for Fairfield, $366,600 ($3,666,000 x 10%).
d. This test is based on the greater (in absolute terms) of profits or losses. In
this problem, the total profit of Red, Blue, Green, and White ($1,971,000) is
greater than the total loss of Pink and Black ($316,000). Therefore, any
segment with a profit or loss of $197,100 or more (10% x $1,971,000) is
reportable. Using this standard, Red, Blue, Black, and White are of significant
size.

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35. (25 minutes) (Apply the Three Tests Necessary to Determine Reportable
Operating Segments and Determine Whether a Sufficient Number of Segments is
Reported)
Revenue Test (numbers in thousands)
Segment
Books
Computers
Maps
Travel
Finance
Total

Revenues
$ 205
936
455
432
184
$2,212

Percentage
9.3%
42.3% (reportable)
20.6% (reportable)
19.5% (reportable)
8.3%
100.0%

Profit or Loss Test (numbers in thousands)

Segment
Revenues
Books
$ 205
Computers
936
Maps
455
Travel
432
Finance
184
Total
$2,212

Expenses
$ 218
899
400
314
132
$1,963

Profit Loss
$ 13
$ 37
55
118
52
$262 $ 13

(reportable)
(reportable)
(reportable
(reportable)

This test is based on the greater (in absolute amount) of total profit from
profitable segments or total loss from segments with a loss. In this case, any
segment with profit or loss greater than or equal to $26,200 (10% x $262,000)
is separately reportable.
Asset Test (numbers in thousands)
Segment
Books
Computers
Maps
Travel
Finance
Total

Assets
$ 206
1,378
248
326
1,240
$3,398

Percentage
6.1%
40.5% (reportable)

7.3%
9.6%
36.5% (reportable)
100.0%

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35. (continued)
Test for Sufficient Number of Segments Being Reported
Four of Mason’s segments (computers, maps, travel, and finance) meet at
least one of the tests carried out above. To determine whether a sufficient
number of segments is being reported, revenues from unaffiliated parties for
these four segments must comprise at least 75% of total consolidated
revenues. Consolidated revenues (sales to outside parties and interest
income-external) for the company amount to $1,644. These four segments do
make up over 75% (actually $1,463 or 89%) of this total. Therefore, this
company is presenting disaggregated information for enough of its segments.
Segment
Computers
Maps
Travel
Finance
Total

Sales to Outsiders
$ 696
416
314
37
$1,463

36. (15 minutes) (Apply Materiality Tests Adopted by a Company to Determine
Countries to be Reported Separately)
Revenue Test (sales to unaffiliated parties)
United States
Spain
Italy
Greece
Total

$4,610,000
80.3%
395,000
6.9%
272,000
4.7%
463,000
8.1%
$5,740,000 100.0%

Long-lived Asset Test
United States
Spain

Italy
Greece
Total

$1,894,000
83.7%
191,000
8.4%
106,000
4.7%
72,000
3.2%
$2,263,000 100.0%

None of the individual foreign countries meets either the revenue or long-lived
asset materiality test, so no foreign country must be reported separately.
However, information must be presented for the United States separately and
for all foreign countries combined.

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37. (20 minutes) (Allocate Costs Incurred in One Quarter that Benefit the Entire Year
and Determine Income Tax Expense)

a. Determination of Income by Quarter—Estimated Annual Tax Rate 40%
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Sales
$1,000,000 $1,200,000 $1,400,000 $1,600,000
Cost of goods sold
(400,000)
(480,000)
(550,000)
(600,000)
Administrative costs
(175,000)
(180,000)
(185,000)
(195,000)
Advertising costs
(25,000)
(25,000)
(25,000)
(25,000)
Executive bonuses
(20,000)
(20,000)
(20,000)
(20,000)
Provision for bad debts
(13,000)
(13,000)
(13,000)
(13,000)
Annual maintenance costs

(15,000)
(15,000)
(15,000)
(15,000)
Pre-tax income
$352,000
$467,000
$592,000
$732,000
Income tax*
(140,800)
(186,800)
(236,800)
(292,800)
Net income
$211,200
$280,200
$355,200
$439,200
* Calculation of income tax by quarter:
Pre-tax income this quarter $352,000
Cumulative pre-tax income $352,000
Estimated income tax rate
x 40%
Cumulative income tax
to be recognized to date
$140,800
Cumulative income tax
recognized in earlier periods
-0Income tax this quarter

$140,800

$467,000
$592,000
$732,000
$819,000 $1,411,000 $2,143,000
x 40%
x 40%
x 40%
$327,600

$564,400

$857,200

140,800
$186,800

327,600
$236,800

564,400
$292,800

b. Determination of Income by Quarter—Change in Estimated Annual Tax Rate

Pre-tax income
Income tax**
Net income

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
$352,000
$467,000
$592,000
$732,000
(140,800)
(186,800)
(208,580)
(278,160)
$211,200
$280,200
$383,420
$453,840

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37. (continued)
** Calculation of income tax by quarter:
Pre-tax income this quarter $352,000
Cumulative pre-tax income $352,000
Estimated income tax rate
x 40%
Cumulative income tax

to be recognized to date
$140,800
Cumulative income tax
recognized in earlier periods
-0Income tax this quarter
$140,800

$467,000
$592,000
$732,000
$819,000 $1,411,000 $2,143,000
x 40%
x 38%
x 38%
$327,600

$536,180

$814,340

140,800
$186,800

327,600
$208,580

536,180
$278,160

38. (15 minutes) (Treatment of Accounting Change Made in Other than First Interim

Period)
Retrospective application of the FIFO method results in the following
restatements of income for 2008 and the first quarter of 2009:
2008
1st Q.
Sales
Cost of goods sold (FIFO)
Operating expenses
Income before income taxes
Income taxes (40%)
Net income

2nd Q.

3rd Q.

2009
4th Q.

1st Q.

$10,000 $12,000 $14,000 $16,000 $18,000
3,800
2,000
4,200
1,680
$2,520

4,600
2,200

5,200
2,080
$3,120

5,200
2,600
6,200
2,480
$3,720

6,000
3,000
7,000
2,800
$4,200

7,400
3,200
7,400
2,960
$4,440

Net income in the second quarter of 2009 is $4,560 [$20,000 – 9,000 – 3,400 =
$7,600 – 3,040 (40%) = $4,560].
The accounting change is reflected in the second quarter of 2009, with year-todate information, and comparative information for similar periods in 2008 as
follows:

Net income
Net income per common share

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Three Months Ended
June 30
2008
2009
$3,120
$4,560
$3.12
$4.56

Six Months Ended
June 30
2008
2009
$5,640
$9,000
$5.64
$9.00

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39. (10 minutes) (LIFO Liquidation in Interim Report)
Determination of Cost-of-Goods-Sold and Gross Profit
Sales (110,000 units @ $20)

Cost-of-goods-sold
100,000 units @ $14
10,000 units @ $15 (replacement cost)
Gross profit

$2,200,000
$1,400,000
150,000

1,550,000
$650,000

Journal Entries to Record Sales and Cost-of-Goods-Sold
Dr. Cash or accounts receivable
Cr. Sales revenue
Dr. Cost-of-goods-sold
Cr. Inventory
Cr. Excess of replacement cost over
historical cost of LIFO liquidation

$2,200,000
$2,200,000
$1,550,000
$1,520,000
30,000

To record cost-of-goods-sold with a historical cost of $1,520,000 and an excess of
replacement cost over historical cost for beginning inventory liquidated of $30,000
(($15 – $12) x 10,000 units).

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Answers to Develop Your Skills Cases
Research Case 1—Segment Reporting
This assignment requires the student to select a company and find the note on
operating segments in that company’s annual report. The responses to this
assignment will depend upon the company selected by the student for analysis.
Research Case 2—Interim Reporting
This assignment requires students to select a company, find the most recent
quarterly report for that company, and then determine whether the company
provides the minimum disclosure required by APB Opinion 28 as listed in the
text. The responses to this assignment will depend upon the company selected
by the student for analysis.
Research Case 3—Operating Segments
This assignment requires students to find the note on operating segments in
each company's annual report, determine three items of information (answer
three questions) from those notes, and prepare a written summary of their
findings. The primary objective of this requirement is to help students develop
their ability to present such findings in a written format. In answering these
questions, students will become familiar with the different formats and
terminology used by companies in providing operating segment information.
The answers to these questions will change depending upon the most recent
annual report available on the company’s website. The following general

observations indicate how these questions might be answered.
1. The answer to this question is determined by calculating the ratio
―segment revenues/total segment revenues‖ for each segment of each
company. Different terms can be used for revenues including net sales
and net sales to external customers. Companies are required to disclose
both revenues from sales to external customers and revenues from
intersegment sales. This question should be answered using revenues
from sales to external customers if reported separately. In 2006, four of the
five companies defined operating segments on the basis of
products/services. However, Cisco Systems identified its operating
segments as geographic areas.
2. This question is answered by calculating the ratio ―(current year segment
revenues – previous year segment revenues)/previous year segment
revenues‖ for each segment of each company.
3. This question is answered by calculating the ratio ―segment
profit/segment revenues‖ for each segment of each company (again using
revenues from sales to external customers if separately reported). Segment
profit goes under a variety of names including operating earnings, income
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from continuing operations, standard margin, and operating profit. Cisco
Systems uses gross margin by segment in making decisions. Some
companies might provide information for more than one measure of profit,

e.g., income before income taxes and income from continuing operations,
in which case the instructor might wish to indicate which measure of profit
to consider in answering this question. There is no right or wrong
measure of profit to use. General Electric does not include segment profit
in its operating segment note, but instead (in 2006) refers the reader to a
―Summary of Operating Segments‖ table on page 40 of the annual report,
which is part of Management's Discussion and Analysis.
After reviewing the information provided by each of these companies in its
segment footnote, instructors might wish to add additional questions to this
assignment. For example, do these companies use generally accepted
accounting principles in preparing segment information? Does each company
provide a reconciliation to consolidated totals?
Research Case 4—Comparability of Geographic Area Information
This assignment requires students to find the note on geographic areas in each
company's annual report and then prepare a report describing the comparability
of this information. In preparing this assignment, students will see the different
formats used by companies in providing this information, and the different
levels of detail on geographic areas provided. The comparability of this
information will change depending upon the most recent annual report
available on the company’s website. The following comparison based upon the
2006 annual reports represents the type of analysis students might perform in
solving this assignment.
Geographic Areas Reported by Four Pharmaceutical Companies—2006
Bristol-Myers Squibb
Eli Lilly
Merck
Pfizer
U.S.
U.S.
U.S.

U.S.
Europe/MidEast/Africa
E/ME/A
E/ME/A
Other Western Hemi.
Pacific
Japan
Japan
Other
Other
All Other
The only geographic area that can be directly compared across these four
pharmaceutical companies is the United States. Bristol-Myers Squibb provides
more detailed (and perhaps more useful) information than the other companies.
Only Merck and Pfizer reports an individual country (Japan) other than the U.S.
Issues that could be discussed include different quantitative thresholds used
by companies in determining what is a material country, and the fact that
disclosure of geographic areas aggregated above the individual country level
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(e.g., E/ME/A, Pacific) is not required by SFAS 131. One can assume that BristolMyers Squibb does not have a material amount of revenues or assets in any
single country and voluntarily provides information on a more aggregated,
regional basis. Pfizer, on the other hand, has elected not to provide such

voluntary information, only reporting individual countries (Japan) and ―all other
countries.‖
Research Case 5—Within Industry Comparison of Segment Information
The purpose of this assignment is to show students how segment information
can be used to gain insights into the nature and location of a company’s
operations, and give them an opportunity to compare and contrast this
information for two companies in the same industry. The responses to this
assignment will depend upon the companies selected by the student for
analysis. Students should discuss both the operating segments and geographic
areas in which the companies operate. They might discuss the extent to which
the two companies compete with each other in terms of product lines or
geographic areas, as well as the extent to which this information can be
compared. For example, if one company defines operating segments on the
basis of products and another company in the same industry defines operating
segments geographically, meaningful comparisons between the two companies
will be difficult to make.

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FARS Case 1—Interim Reporting
1. Using the advanced query function in FARS to search for the phrase
―material seasonal variations‖ returns two hits: APBO 28, paragraph 18, and
the dissent to APBO 28 by one member of the Board.

2. APBO 28, paragraph 18 requires firms with material seasonal variations to
disclose this fact to avoid the possibility that interim results with material
seasonal variations are taken as indicative of the estimated results for a full
year.
FARS Case 2—Segment Reporting
1. Using the advanced query function in FARS to search for the phrases
―competitive harm‖ and ―segments‖ returns five hits: FAS 131, paragraphs
74, 75, 97, 109, and 111.
2. FAS 131, paragraph 109 indicates that concerns were raised about publicly
traded companies being at a disadvantage compared to nonpublic
companies or foreign competitors who do not have to disclose segment
information, and that segment information might put a company at a
disadvantage in price negotiations with customers or in competitive bidding
situations.
3. FAS 131, paragraph 111 indicates that the FASB decided not to provide a
competitive harm exemption because it would provide a means for
noncompliance with FAS 131.
4. FAS 131, paragraph 97 describes three reasons why the FASB decided not to
require the disclosure of research and development expense by segment.
First, it might result in competitive harm by providing competitors with early
insight into a company’s strategic plans.
Second, research and
development is only one item that indicates where a company is focusing its
efforts and is more significant for some companies than for others. Third,
research and development activities often are centralized and not allocated
to segments.

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