Module 8 is about Segment Reporting and Goodwill Impairment Test. In lesson 1, we will discuss the segment reporting. Public companies must disclose segment information in the notes to the annual and interim financial statements. So why is segment reporting is needed? Let's assume a company has different operation segments. It's manufactures and sells, ice cream, computer, and office chairs. In it's consolidated income statement, the company reports it's total revenues and its income for all of its operating segments. But the users of the financial statements will benefit from knowing a more detailed information about how much each specific major operating segments contributed to the total revenue net income. Even though the company report net income for the period, some operating segment might not be profitable at all. Thus the objective of segment reporting is to provide information about the different business activities of the company and the economic environments in which the company operates. This information will help the use of the financial statements to better understand the company's performance, assess company's prospects for future cash flows, and make more inform judgment about the company. Segment reporting is done on an operating segment level. An operating segment is a component of a public entity that has all of the following characteristics. It engages in business activities from which it may recognize revenue and incur expenses, including revenue and expenses relating to transactions with other components of the same public entity. It's operating results are regularly reviewed by the public entity chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance. Its discreet financial information is available. The chief operating decision maker, the CODM, is the high level executive of the company. For example, the CEO or the COO of the company that is responsible for the allocation of resources to and assessment of the operating results of the operating segments. To identify the operating segments, the company uses the CODM approach. The idea is to allow the use of the financial statements to see the reporting structure of the company through the eyes of the management. So if some information was important enough to be reviewed by the chief operating decision maker, it is also important enough for the users of the financial statements. Two or more operating segments may be aggregated into a single operating segments if doing so is consistent with the objective, they have similar economic characteristics, and they have similar products and services, production processes, classes of customers, distribution methods, and regulatory environments. Once we identify the operating segments, the next step is to determine which of those operating segments are reportable segment. Reportable segments are operating segments that must be separately disclosed in the notes to the financial statements. A company can not separate disclose information for all of its operating segments. It must identify the most material operating segments that should be individually reported. To identify the most material operating segments, the company will apply the three quantitative thresholds that retain percentage test. So a reportable segment is an operating segment that exceeds at least one of the following quantitative threshold. So if the operating segments meet at least one of the following three 10 percentage test it is a reportable segment. The first step is the 10 percentage revenue tests. So if an operating segment's reported revenue, including sales to external customers and intersecting sales, is at least 10 percentage of the combined revenue, internal and external of all the operating segments, the operating segments is a reportable segments. Let's see the following example. A company identifies six operating segments, operating segments A, B, C, D, E, and F. The following is the revenue information for the company's operating segments. So we have the external sales for each operating segment, the intersegment sales, and the total sales for the period. The quantitative threshold for the revenue test is $100, $1,000 the total revenues which includes internal sales and external sales multiplying by 10 percentages. Thus operating segments, these total revenue of $100 or more are reportable segments. So based on the revenue test, operating segments A, C, E, and F are reportable segments. The second 10 percentage test is the 10 percentage assets test. Operating segment's assets are at least 10 percentages of the combined assets of all operating segments. The third test is the 10 percentage profit or loss test. The absolute amount of operating segment's reported profit or loss is at least 10 percentage of the greater, in absolute amount of either; the combined reported profit of all operating segments that did not report a loss, or the combined reported loss of all the operating segments that did report the loss. Please note not all the three 10 percentage test must be met. If at least one of the three percentage test was met, an operating segment is a reportable segment. So the revenue test and the asset test are very simple and straight forward, but the profit and loss test is slightly more complicated. Let's see the following example for the profit or loss test. A company identified six operating segments, operating segments A, B, C, D, E, and F. The following is the profit and loss information for the company's operating segments. As we can see, the total loss for the period was $100. The question is, which operating segments are identified as reportable under the profit or loss tests? First of all, we need to calculate the total profit of all the profitable operating segments. The total profit of all the profitable operating segments is $800. Then we need to calculate the total loss of all the loss reporting segments. The total loss of all the loss reporting segments is $900. Now, we need to take the greater of the two numbers in absolute amount. Thus $900 will be taken in the calculation of the quantitative threshold for the profit or loss test. The quantitative threshold for the profit or loss test is $90, $900 multiplying by 10 percentages. So although operating segments view the profit or loss of more than 90 are identified as reportable segments under the profit or loss test. Based on the profit or loss test, operating segments B, D, and E are reportable segments. Public entities are encouraged to report information about segments that do not meet the quantitative thresholds if management believe that this is material. So even if a specific operating segment did not meet any of the three 10 percentage test, the management can still make it as a reportable segment if they believe it is really material. Now we have one more test, the 75 percentage external revenue test. If the total external revenue of all operating segments meeting the 10 percentage test is less than 75 percentage of consolidated revenue, additional operating segments are identified as reportable until the 75 percent level is reached. So first of all, we identify the operating segments as a component of a public company that engages in the business activities from which it may recognize revenue and incur expenses and for which discrete financial information is available. Then if it was necessary, we aggregated several operating segments into a single operating segment. After that, we apply the three 10 percentage test, the revenue tests, the asset test, and the profit or loss test to identify which of the operating segments are reportable segments. Now we must apply the 75 percentage external revenue test. So if the external revenue of the operating segment that meet the 10 percentage test is 75 percentage or more of the consolidated revenue, our work is done. No more additional operating segments should be identified as reportable. But if the external revenue was less than 75 percentages of the consolidated revenue, we need to take additional operating segment that did not meet any of the 10 percentage test and make them reportable segments until the 75 percentage threshold is met. So what information must be disclosed for each reportable segment? A public entity must report a measure of profit or loss and total assets for each reportable segment. The following is an example of an additional information that should be separately reported for each reportable segment. Revenues from external customers and other operating segment, interest revenue and expenses, depreciation and amortization, unusual items, equity in the net income of equity method investees, and income tax expense or benefits. The relevant information for all the operating segments that are not reportable and other business activities that are not operating segments must be combined and disclosed in all other category. The all other category is also very important as it's solved as a reconciliation item between the information provided for the reportable segments and the corresponding consolidated financial statements amounts. In addition, the company must describe the sources of revenue included in the all other category. The following reconciliations must be provided: the total of the reportable segments' revenues to the consolidated revenues, the total of the reportable segment assets to the consolidated assets, the total of the reportable segments' profit or loss to the consolidated income before income taxes and discontinued operations, the total of the reportable segments' amounts for every other significant item of information disclosed to the corresponding consolidated amounts. Now, let's see an example of segment reporting from the 2018 annual report, the 10-K document of Intel Corporation. The company identified the following five operating segments. Only operating segments client computing group and data center group meet the quantitative thresholds based on the three 10 percentage test and they were identified as reportable segments. The remaining operating segments did not meet the 10 percentage test but the management decided to separate the disclose information about its operating segments since they are material. The company also described the sources of revenue included in the all other category. The company disclosed the fact that the CEO is the chief operating decision maker that allocates resources to and assesses the performance of each operating segment. On this page, we can see the information that was provided for the reportable segments and the reconciliation to the consolidated amounts. For example, the company disclosed the total revenue and operating income or loss for all the reportable segments, and the reconciliation to the total net revenue and total operating income from the consolidated income statement. The total revenue was $70,848 million and the total operating net income was $23,316 million. As we can see, these were exactly the amounts of net revenue and operating income reported in the consolidated income statement of Intel Company.
