15 Fischer10e SM Ch12 Final

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CHAPTER 12
UNDERSTANDING THE ISSUES
1. Viewing an interim period as an integral back period and any more likely than not
part of a larger annual period has several pretax income in the carryforward periods.
benefits. The allocation of expense under If the pretax income in these periods were
this viewpoint provides information that al- not sufficient to absorb the remaining pre-
lows for more meaningful and insightful tax loss, then some of the third-quarter pre-
predictions of annual results. Furthermore, tax loss would not recognize a benefit. In
the effect of certain interim conditions that order to fully recognize the benefit asso-
are not expected to exist at year-end may ciated with an interim period pretax loss,
be given special accounting treatment. Ex- there must be some combination of the fol-
amples of this include special accounting lowing: sufficient pretax income in other
for temporary inventory liquidations and quarters of the current year, sufficient pre-
temporary unfavorable variances. If special tax income in the carryback period, and/or
accounting treatment were not available, sufficient more likely than not pretax in-
projections of annual amounts would be come in the carryforward period.
distorted.
4. There are a number of reasons why the
2. A number of factors are necessary in order total operating profit of the reportable seg-
to determine the estimated effective annual ments does not normally equal the consoli-
tax rate. First of all, the rate should reflect dated operating profit. First of all, not all
conditions to be experienced for the entire operating segments are reportable and yet
year. Therefore, in addition to year-to-date such amounts are included in consolidated
pretax income/loss, such amounts must be amounts. Second, there are a number of
projected for the balance of the year. Statu- intersegment transactions whose effect
tory tax rates are applied to these annual would be included in operating profits of
amounts after considering the presence of reportable segments but eliminated from
possible annual permanent differences be- consolidated amounts. Third, not all ele-
tween book and tax income. The resulting ments of consolidated income are allocated
taxes must also be reduced by possible tax to reportable segments. This is traceable
credits. The applicability of the above fac- to the fact that not all elements are used
tors becomes more complex in situations by the chief operating decision maker in
where there is an estimated annual pretax evaluating segment performance and/or
loss. This situation requires the considera- because allocation is not possible on a rea-
tion of possible tax loss and/or tax credit sonable basis. Finally, the accounting
carrybacks and carryforwards. employed from a management approach
perspective may be different from the re-
3. Several factors may explain this situation. If
quirement to use GAAP in the measure-
the third-quarter loss were greater than the
ment of consolidated amounts.
pretax income in the first two quarters plus
the forecasted pretax income for the fourth
quarter, then some of the benefit traceable
to the loss may not be recognized. Howev-
er, if this were the case, one would consid-
er any known pretax income in the carry-
559
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Ch. 12Exercises
EXERCISES
EXERCISE 12-1
(1) Wert Company

Income Statement
For 3-Month Period Ended June 30, 20X2
Sales ............................................................................. $860,000
Cost of goods sold:
Standard cost of goods manufactured ..................... $600,000
Add finished goods inventory, April 1, 20X2,
at standard cost .................................................. 71,000
Deduct finished goods inventory, June 30, 20X2,
at standard cost .................................................. (98,000)
Cost of goods sold at standard cost ......................... $573,000
Add net unfavorable cost variances ......................... 1,700*
Adjusted cost of goods sold ............................... 574,700
Gross profit ............................................................... $285,300
Selling and administrative expenses:
Selling expenses ................................................ $ 68,000
General and administrative expenses ................ 117,000 185,000
Net income ............................................................... $100,300
*Purchase price variances or volume or capacity cost variances that are planned and ex-
pected to be absorbed by the end of the annual period should ordinarily be deferred at
interim reporting dates. Therefore, the net unfavorable cost variance recognized is
$1,700 ($2,600 $900).
(2) Wert Company

Income Statement
Sales ............................................................................. $860,000
Cost of goods sold ........................................................ 648,000**
Gross profit ................................................................... $212,000
Selling expenses ...................................................... $ 68,000
General and administrative expenses ...................... 117,000 185,000
Net income.................................................................... $ 27,000
**$596,000 + [13,000 units ($11 $7)] = $648,000. Inventory at the interim reporting date
should not give effect to the LIFO liquidation, and the cost of goods sold should include
the expected cost of replacement of the liquidated LIFO base. Since it is expected that
2,000 units of beginning inventory will be part of the 20X2 cost of goods sold, only 13,000
units need to be adjusted.
560
Ch. 12Exercises
Exercise 12-1 Concluded
(3) Wert Company

Income Statement
Sales ............................................................................. $860,000
Cost of goods sold ........................................................ 493,300
Gross profit ................................................................... $366,700
Selling expenses ...................................................... $ 68,000
General and administrative expenses ...................... 117,000 185,000
Net income.................................................................... $181,700

Recoveries of inventory losses from market declines in earlier interim periods of the same
fiscal year should be recognized as gains; such gains should not exceed previously recog-
nized losses.
Cost of goods sold:
Inventory, April 1, 20X2 ............................................ $ 52,000
Purchases (18,000 $28) ........................................ 504,000
Inventory, June 30, 20X2 ......................................... (60,500)
$495,500
Write-up to offset first-quarter write-down ................ (2,200)
Cost of goods sold ................................................... $493,300
EXERCISE 12-2
(1) Although research and development (R&D) costs are generally expensed in the year in
which such costs are incurred, the question at hand is how they should be treated for inte-
rim reporting purposes. Because an interim period is considered to be an integral part of a
larger annual period, interim data are viewed as a possible predictor of annual values.
Therefore, the R&D recognized in a given interim period might become the basis for esti-
mating an annual amount. If all the R&D were expensed in a single quarter, one might sug-
gest that annual R&D is four times that amount. In order to avoid this incorrect conclusion,
the R&D should be amortized over the current and remaining quarters within the annual pe-
riod. In this specific case, the $130,000 of costs should be allocated to each of the four
quarters in the amount of $32,500 per quarter.
561
Ch. 12Exercises
Exercise 12-2, Concluded
(2) In interim reporting, the year-to-date (YTD) tax expense represents the best estimate of the
annual estimated effective tax rate. The YTD tax expense is allocated to the current and
prior quarters. If the estimated effective tax rate has been revised from a previous estimate,
this change in estimate is recognized in the new YTD values and also in the current quar-
ters tax expense. Therefore, a given quarters tax expense reflects the tax on the quarters
income and the effect of a rate change on previous quarters. To illustrate, assume the fol-
lowing:
Current YTD Tax YTD Tax Current Tax
Quarter Income Income Rate Expense Expense
1 $50,000 $ 50,0 30% $15,000 $15,000
2 70,000 120,000 35 42,000 27,000
The tax expense in quarter 2 reflects the tax on $70,000 at 35%, or $24,500, and the 5%
increase in taxes traceable to quarter 1, or $50,000 at 5%, or $2,500. The total current tax
expense of $27,000 for quarter 2 is approximately 39% (versus the effective rate of 35%) of
the second-quarter income.
EXERCISE 12-3
Granger Supply, Inc.

Interim Income Statements
For the Periods Ending Quarter 1 and 2, 20X7
Quarter 1 Quarter 2
Net sales .............................................................................. $12,000,000 $9,000,000
Cost of sales (See Schedule A) ........................................... 7,900,000 7,805,0
Gross profit .......................................................................... $ 4,100,000 $1,195,000
Selling, general, and administrative ..................................... 2,100,000 1,800,0
Income before taxes ............................................................ $ 2,000,000 $ (605,00
Income tax expense (See Schedule B) ................................ 700,800 (217,15
Net income ........................................................................... $ 1,299,200 $ (387,84
Schedule ACost of Sales

Quarter 1 Quarter 2
As stated:
Cost of salesindustrial supplies .................................. $4,300,000 $4,700,000
Cost of salescleaning equipment................................ 3,000,000 3,200,0
Adjustment for replacement cost:
400 units ($2,700 $1,500) ........................................ 480,000
Adjustment for loss due to market decline ........................... 120,000 (95,000
New cost of sales ................................................................. $7,900,000 $7,805,000
562
Ch. 12Exercises
Schedule BIncome Tax Schedule

Quarter 1 Quarter 2
YTD income before tax ........................................................ $2,000,000 $1,395,000
Projected income ................................................................. 5,100,000 4,000,000
Estimated annual income..................................................... $7,100,000 $5,395,000
Permanent differences ......................................................... 60,000 35,000
Estimated adjusted taxable income ..................................... $7,160,000 $5,430,000
Statutory tax rate .................................................................. 35.00% 35.00%
Tax on estimated adjusted taxable income .......................... $2,506,000 $1,900,500
Tax credits ........................................................................... 18,000 30,000
Net tax.................................................................................. $2,488,000 $1,870,500
Effective tax rate .................................................................. 35.04% 34.67%
Ordinary Pretax Income (Loss) Tax Expense (Benefit)

Interim Current Effective Tax Previously Current
Period Period Year-to-Date Rate Year-to-Date Reported Period
First $2,000,000 $2,000,00035.04% $700,800 $ $ 700,800
Second (605,000) 1,395,00034.67 483,646 700,800 (217,154)
EXERCISE 12-4
(1) Before After

Change Change
YTD income (loss) ............................................ $100,000 $120,000
Projected income (loss) .................................... 110,000 135,000
Total annual ...................................................... $210,000 255,000
Less exempt income ......................................... (5,000) (5,000)
Taxable income ................................................ $205,000 $250,000
Estimated tax:
On first $50,000 @ 10% ............................... $ 5,000 $ 5,000
On next $50,000 @ 20% .............................. 10,000 10,000
On next $50,000 @ 30% .............................. 15,000 15,000
On next $50,000 @ 40% .............................. 20,000 20,000
Remaining income @ 35%........................... 1,750 17,500
$ 51,750 $ 67,500
Less tax credit................................................... (8,000) (8,000)
Net tax .............................................................. $ 43,750 $ 59,500
Effective tax rate ............................................... 20.83% 23.33%
First 6 months tax expense (benefit):
Pretax income (loss) .................................... $100,000 $120,000
Effective tax rate per above ......................... 20.83% 23.33%
Tax expense (benefit) .................................. $ 20,833 $ 27,996
The change in accounting principle resulted in an increase in tax expense for the first 6
months of $7,163 ($27,996 vs. $20,833).
563
Ch. 12Exercises
(2) Total Total

Excluding Excluding
Ordinary Total Nonordinary Nonordinary
Income Income Loss Gain
First 6 months continuing.............. $120,000 $120,000 $120,000 $120,000
Third quarter continuing ................ 80,000 80,000 80,000 80,000
Projected continuing ..................... 20,000 20,000 20,000 20,000
Nonordinary loss ........................... (40,000) (40,000)
Nonordinary gain .......................... 60,000 60,000
Pretax income (loss) ..................... $220,000 $240,000
$280,000 $180,000
Tax expense (benefit) ................... $ 50,600 $ 57,600 $ 71,600 $
35,400
Incremental tax expense (benefit) traceable to:

All nonordinary items ($57,600 $50,600) .......................... $ 7,000
All nonordinary losses ($71,600 $57,600) ......................... $ (14,000)
All nonordinary gains [$7,000 ($14,000)] .......................... $ 21,000
Taxable income:
Pretax accounting income ........ $220,000 $240,000 $280,000 $180,000
Less exempt income ................ (4,000) (4,000) (4,000)
(4,000)
Taxable income ........................ $216,000 $236,000 $276,000 $176,000
Estimated tax:
On first $50,000 @ 10% ........... $ 5,000 $ 5,000 $ 5,000 $
5,000
On next $50,000 @ 20% .......... 10,000 10,000 10,000 10,000
On next $50,000 @ 30% .......... 15,000 15,000 15,000 15,000
On next $50,000 @ 40% .......... 20,000 20,000 20,000 10,400
Remaining income @ 35%....... 5,600 12,600 26,600

$ 55,600 $ 62,600 $ 76,600 $
40,400
Less tax credit............................... (5,000) (5,000) (5,000)
(5,000)
Net tax .......................................... $ 50,600 $ 57,600 $ 71,600 $
35,400
564
Ch. 12Exercises
EXERCISE 12-5
Corporation A Corporation B Corporation C Corporation D

YTD realized income (loss) ......... $ 95,000 $ 5,000 $ (80,000) $ 20,000
Projected income (loss) .............. 30,000 (70,000) (50,000) (35,000)
Total income (loss)...................... $125,000 $(65,000) $(130,000) $(15,000)
Income adjustments .................... (7,000)* 2,000
Total taxable income (loss) ......... $125,000 $(72,000) $(128,000) $(15,000)
Statutory tax rate ......................... 40% 40% 40% 40%
Tax expense (benefit) ................. $ 50,000 $(28,800) $ (51,200) $( 6,000)
Tax credit .................................... (2,000) (3,500) (1,000)
Net tax expense (benefit) ............ $ 48,000 $(32,300) $ (51,200) $ (7,000)
Limit to tax benefits ..................... $(14,400)b $ (38,860)c $ (5,000)d
Effective annual tax rate ............. 38.4%a 22.2%b 29.9%c 33.3%d
*$15,000 text exempt municipal income$8,000 deductions not allowed.
a
$48,000 $125,000 = 38.4%
b
$14,400 $65,000 = 22.2%
The tax benefit is traceable to carrying back $32,000 at 30% to 20X1 and $15,000 at 32% to
20X2.
c
$38,860 $130,000 = 29.9%
The prior two years income totals $140,000, of which $128,000 may be offset by the NOL
carryback, resulting in a tax benefit of $38,860 [($105,000 30%) + ($23,000 32%)].
d
$5,000 $15,000 = 33.3%
Tax benefit limited to projected carryforward ($12,500 40%).
565
Ch. 12Exercises
EXERCISE 12-6
Quarter 1 Quarter 2
Originally
Stated Continuing Discontinued Continuing Discontinued
YTD pretax income (loss) ............................. $ 800,000 $1,020,000 $(220,000) $1,545,000 $(700,000)
Projected pretax income (loss) ..................... 1,100,000 1,420,000 (320,000) 1,050,000
Estimated annual income.............................. $1,900,000 $2,440,000 $(540,000) $2,595,000 $(700,000)
Permanent differences ..................................
Estimated adjusted income ........................... $1,900,000 $2,440,000 $(540,000) $2,595,000 $(700,000)
Statutory tax:
At 30% rate on first $1,500,000............... $ 450,000 $ 450,000 $ 450,000
At 35% rate thereafter ............................. 140,000 329,000 383,250
Total statutory tax.................................... $ 590,000 $ 779,000 $ 833,250
Tax credits .................................................... 29,500 29,500 15,000
Net tax........................................................... $ 560,500 $ 749,500 $ 818,250
Effective tax rate ........................................... 29.50% 30.72% 31.53%
Pretax Income (Loss) Tax Expense (Benefit)

Type of Current Effective Previously Current
Interim Quarter Income Period Year-to-Date Tax Rate Year-to-Date Reported Period
First Continuing Op. $ 800,000 $ 800,000 29.50% $ 236,000 $ $ 236,000
FirstRestated Continuing Op. 1,020,000 1,020,00030.72% 313,344 313,344
FirstRestated Discontinued (220,000) (220,000) Note A (77,344) (77,344)
Second Continuing Op. 525,000 1,545,00031.53% 487,139 313,344 173,795
Second Discontinued (480,000) (700,000) Note B (245,000) (77,344) (167,656)
Note A: The difference between the first and first restated continuing operations is the tax benefit attributed to the discontinued
operations.
Note B: Continuing
Operations All Sources
Annual income (loss) ............................ $2,595,000 $1,895,000
Annual net tax expense (benefit).......... 818,250 573,250 [(30% $1,500,000) + (35% $395,000) $15,000]
The difference between $818,250 and $573,250 represents the tax benefit associated with the discontinued operation.
566
Ch. 12Exercises
EXERCISE 12-7
Quarter 1, 20X7 Quarter 2, 20X7

Before After Before After
Change Change Change Change
First-quarter income (loss) ................... $ 40,000 $ 70,000 $ 40,000 $ 70,000
Second-quarter income (loss) .............. (30,000) (10,000
YTD income (loss) ............................... $ 40,000 $ 70,000 $ 10,000 $ 60,000
Projected income (loss) ....................... (210,000) (155,000) (150,000) (130,00
Total annual ......................................... $(170,000) $ (85,000) $(140,000) $ (70,000
Estimated tax benefit:

Carryback to 20X5:
On first $50,000 @ 15% ........... $ 7,500 $ 7,500 $ 7,500 $ 7,500
On next $25,000 @ 25% .......... 6,250 6,250 6,250 5,000
On next $25,000 @ 34% .......... 8,500 3,400 8,500
Carryback to 20X6:
On first $50,000 @ 15% ........... 7,500 6,000
On next $25,000 @ 25% .......... 2,500
Total tax benefit.............................. $32,250 $17,150 $28,250 $12,500
Estimated rate of benefit ...................... 18.97% 20.18% 20.18% 17.86%
Quarter tax expense (benefit):

YTD pretax income (loss)............... $ 40,000 $ 70,000 $ 10,000 $ 60,000
Effective tax rate per above ........... 18.97% 20.18% 20.18% 17.86%
YTD tax expense (benefit) ............. $ 7,588 $ 14,126 $ 2,018 $ 10,716
Prior quarter expense (benefit) ...... 7,588 14,126
Current quarter expense (benefit) .. $ 7,588 $ 14,126 $ (5,570) $ (3,410)
567
Ch. 12Exercises
EXERCISE 12-8
Total Total
Excluding Excluding
Income Income Loss (A) Gain (B & C)
Continuing income (loss) .................. $60,000 $ 60,000 $60,000$
60,000
Nonordinary item A ........................... (30,000) (30,000)
Nonordinary item B ........................... 25,000 25,000
Nonordinary item C ........................... 5,000 5,000
Pretax income (loss) ......................... $60,000 $ 60,000 $90,000$
30,000
Tax expense (benefit) ....................... $10,000 $ 10,000 $18,850$
4,500
Estimated tax:
On first $50,000 @ 15% .............. $ 7,500 $ 7,500 $ 7,500 $4,500
On next $25,000 @ 25% ............. 2,500 2,500 6,250
On next $25,000 @ 34% ............. 5,100
Total estimated tax ...................... $10,000 $10,000 $18,850 $4,500

All nonordinary items ($10,000 $10,000) ................................ $ 0
All nonordinary losses ($10,000 $18,850)............................... (8,850)
All nonordinary gains [$0 ($8,850)] ......................................... $ 8,850
Total Total
Ordinary Total Excluding Excluding
Income Income Item B Item C
Continuing income (loss) .................. $60,000 $ 60,000 $ 60,000 $
60,000
Nonordinary item A ........................... (30,000) (30,000) (30,000)
Nonordinary item B ........................... 25,000 25,000
Nonordinary item C ........................... 5,000 5,000

Pretax income (loss) ......................... $60,000 $ 60,000 $ 35,000 $
55,000
Tax expense (benefit) ....................... $10,000 $ 10,000 $ 5,250 $
8,750
Calculation of tax expense (benefit):
On first $50,000 @ 15% .............. $ 7,500 $ 7,500 $5,250 $7,500
On next $25,000 @ 25% ............. 2,500 2,500 1,250
Total estimated tax ...................... $10,000 $10,000 $5,250 $8,750
Incremental tax expense (benefit) traceable to: Percent of Total

Item B ($10,000 $5,250) ................................. $4,750 79.2%
Item C ($10,000 $8,750) ................................. 1,250 20.8
Total ................................................................... $6,000 100.0%
568
Ch. 12Exercises
Ratable allocation of $8,850 tax expense on nonordinary gains (items B and C):
Item B .......................................... (79.2% $8,850) $7,009
Item C.......................................... (20.8% $8,850) 1,841
$8,850
569
Ch. 12Exercises
EXERCISE 12-9
The key to defining the segments of Norfo International is to analyze how information might be
structured for purposes of decision making by the chief operating decision maker. Possible al-
ternatives would be to organize the information around products or services, geographic areas,
or product/service groups within geographic areas. For example, a product/service approach
might suggest major segments of foodstuffs (including food processing, citrus groves, and
packaging), resort and travel, and paper products. The paper products and food packaging
areas could be combined to form a separate segment. Organizing the information around geo-
graphic areas might suggest the following: southeastern United States, eastern seaboard, Great
Lakes region, the Bahamas, and Europe (Spain and Italy).
Obviously, various combinations are possible and students should be encouraged to think about
which combinations seem most relevant for addressing the issues of how to evaluate perfor-
mance and allocate resources among the various activities of an enterprise. Attention should
also be focused on organizing information in such a way that the aggregation guidelines of the
FASB are not violated. For example, does it really make sense to analyze information structured
around the eastern seaboard region when that segment would include hotels, travel agencies,
and the manufacture of paper products? Would it make more sense to separate the eastern
seaboard into two segments: hotels/travel agencies and paper products? For example, if unem-
ployment in the eastern seaboard is high, the travel and leisure area would probably be affected
differently than the paper manufacturing division.
570
Ch. 12Exercises
EXERCISE 12-10
Determination of whether segments are reportable:

Revenues Reported
Segment External Intersegment Total Profit (Loss) Assets
Film Studios ............................................ $ 82,000,000 $ 0 $ 82,000,000 $(11,000,000)
Software Development ............................ 12,000,000 3,400,000 15,400,000 (2,600,000) 5,400,000
Leisure Clothing ...................................... 45,000,000 0 45,000,000 23,000,000 13,000,000
Office Design Group ............................... 22,000,000 2,700,000 24,700,000 6,700,000 5,000,0
Total ........................................................ $161,000,000 $6,100,000 $167,100,000 $ 16,100,000
Total of all reported profits ........................................................................... $ 29,700,000
Total of all reported losses ........................................................................... (13,600,000)
Is Segments
Absolute Value
Revenue of Profit or Assets
10% or Loss 10% or 10% or
More of More of More of Is Segment
Segment $167,100,000? $29,700,000? $61,400,000? Reportable?
Film Studios ............................................ Yes Yes Yes Yes
Software Development ............................ No No No No
Leisure Clothing ...................................... Yes Yes Yes Yes
Office Design Group ............................... Yes Yes No Yes
Significance of reportable segments:

Consolidated revenue ............................................................................................................... $177,000,000
Percentage requirement............................................................................................................ 75%
Dollar requirement..................................................................................................................... $132,750,000
External revenue of all reportable segments............................................................................. $149,000,000
Conclusion: The reportable segments represent a significant portion of the enterprise.
571
Ch. 12Exercises
EXERCISE 12-11
Determination of whether segments are reportable:

Revenues Reported
Publishing ............................................... $1,200,000 $110,000 $1,310,000 $ 925,000 $ 970,000
Talent Agency ......................................... 850,000 0 850,000 (449,000) 670,000
Cable Networks..................................... .. 3,771,500 672,000 4,443,500 3,185,800 3,893,500
Radio Stations......................................... 810,700 0 810,700 (238,000) 770,000
Film Production ....................................... 1,090,000 57,800 1,147,800 420,000 720,500
Total ........................................................ $7,722,200 $839,800 $8,562,000 $3,843,800 $7,024,000
Total of all reported profits ........................................................................... $4,530,800
Total of all reported losses ........................................................................... (687,000)
Is Segments
Absolute
Value of Profit
Revenue 10% or Loss 10% Assets 10%
or More of or More of or More of Is Segment
Publishing ............................................... Yes Yes Yes Yes
Talent Agency ......................................... No No No No
Cable Networks....................................... Yes Yes Yes Yes
Radio Stations......................................... No No Yes Yes
Film Production ....................................... Yes No Yes Yes
Consolidated revenue ............................................................................................................... $9,074,000
Percentage requirement............................................................................................................ 75%
Dollar requirement..................................................................................................................... $6,805,500
External revenue of all reportable segments............................................................................. $6,872,200
572
Ch. 12Exercises
Exercise12-11, Concluded
Reconciliation to Consolidated Revenue and Profit:
Revenues
Total revenues for reportable segments ............................................................ $7,712,000
Revenues for nonreportable segments .............................................................. 850,000
Elimination of intersegment revenue .................................................................. (839,800)
Corporate-level revenues (Note A) .................................................................... 1,351,800
Total consolidated revenues .............................................................................. $9,074,000
Profit or loss
Total profit or loss for reportable segments ....................................................... $4,292,800
Profit or loss of nonreportable segments ........................................................... (449,000)
Corporate-level:
Revenues (Note A)....................................................................................... 1,351,800
Expenses (Note B) ....................................................................................... (756,100)
Total consolidated income ................................................................................. $4,439,500
Note A: The corporate-level revenue is calculated by taking the consolidated revenue of

$9,074,000 less the external revenues from all segments of $7,722,200.
Note B: The expenses for all segments total $4,718,200 ($8,562,000 $3,843,800). This
total includes the cost of goods/services acquired on an intersegment basis of
$839,800. Assuming there was no intercompany profit in ending inventory, the real
total expense after eliminating intercompany costs is $3,878,400 ($4,718,200
$839,800). Therefore, the corporate-level expenses are $756,100 ($4,634,500
$3,878,400).
573
Ch. 12Problems
EXERCISE 12-12
(1) Determination of whether segments are reportable:

Revenues Reported
1 $1,540,000 $1,540,000 $ 602,000
2 724,500 $ 80,500 805,000 (208,000) 870,000
3 1,948,000 1,948,000 530,000 1,250,000
4 963,000 107,000 1,070,000 375,000 1,800,000
5 684,000 76,000 760,000 220,000 965,000
6 980,000 980,000 402,000 1,400,000
7 1,071,000 1,071,000 (106,000)
Total $7,910,500 $263,500 $8,174,000 $1,815,000 $9,265,000
Total of all reported profits .................................................. $2,129,000
Total of all reported losses.................................................. (314,000)
Is Segments
Absolute
Value of Profit
Revenue 10% or Loss 10% Assets 10%
or More of or More of or More of Is Segment
1 Yes Yes Yes Yes
2 No No No No
3 Yes Yes Yes Yes
4 Yes Yes Yes Yes
5 No Yes Yes Yes
6 Yes Yes Yes Yes
7 Yes No Yes Yes
(2) Significance of reportable segments:

Consolidated revenue ........................................................................... $8,715,700
Percentage requirement ....................................................................... 75%
Dollar requirement ................................................................................ $6,536,775
External revenue of all reportable segments ........................................ $7,186,000
(3) Information traceable to nonreportable segments should be combined into one segment
that has been referred to in the text as the all other segment. Information regarding this
all other segment would be disclosed in the reconciliations of total reportable segment
amounts to the respective consolidated enterprise amounts.
(4) Because revenues with a single external customer amount to 10% or more of enterprise
revenues, special disclosure is required. Such a disclosure might appear as follows:
Staven Supplies consolidated revenues include $1,230,000 of revenues traceable to
sales made to the federal government. The sales were generated by segment 3.
574
Ch. 12Problems
PROBLEMS
PROBLEM 12-1
(1) When publicly traded companies report summarized interim financial information to their
stockholders at interim dates, the following data should be reported, as a minimum:
(a) Sales or gross revenues, provision for income taxes, extraordinary items, cumulative
effects of changes in accounting principles, and net income.
(b) Primary and fully diluted earnings-per-share data for each period presented.
(c) Seasonal revenues, costs or expenses, and contingent items.
(d) Disposal of a segment of a business and extraordinary, unusual, or infrequently occur-
ring items (including related income tax effects).
(e) Changes in accounting principles or estimates, including significant changes in esti-
mates or provisions for income taxes.
(f) Significant changes in financial position.
When summarized interim financial data are regularly reported on a quarterly basis, the
foregoing information for the current quarter and the current YTD or the last 12 months to
date should be furnished, as well as comparable data for the preceding year. When a sepa-
rate fourth-quarter report or disclosure of the fourth-quarter results is not included in the
annual report, material year-end adjustments, extraordinary items, and disposal of seg-
ments of a business should be disclosed in the annual report in a note to the financial
statements.
Management should provide commentary relating to the effects of significant events upon
the interim financial results, similar to its commentary in annual reports. Published balance
sheet and funds flow data at interim dates are desirable, but disclosure of significant
changes in financial position or funds flow should be presented as a minimum.
(2) There are two general weaknesses in the form and content of presentation of the first-
quarter information: (1) some information in the statement needs further explanation, and
(2) additional financial statements or summarized data should be presented and explained
as appropriate in the circumstances. [See discussion presented in entry (1).]
The major weakness in the first-quarter report is that it is misleading because the company
is expecting a profit for the year, not a loss as normally would be assumed from the pub-
lished report alone. Both sales and production were equal to the units budgeted for the first
quarter, and if actual activity continues as planned for the rest of the year, Mikelson will
show a profit of $371,250 {$450,000 [$175,000 (1 0.55)]} for 20X5. Thus, Mikelson
should indicate in the interim report that sales, production, and net income (loss) are in line
with expectations, as related to budgeted data and first quarters of prior years.
No other weakness in form and content is evident, except as discussed below in entry (3).
576
Ch. 12Problems
Problem 12-1, Concluded
(3) (a) The treatment of underapplied fixed factory overhead as an asset in this situation is
the preferred method of accounting. The expected year-end result is that actual pro-
duction will exactly equal budgeted production upon which the standard was based;
thus, no volume variance should exist at year-end.
(b) The manner in which the selling, general, and administrative expenses were handled
in the report is the preferred method. These costs cannot be inventoried, they cannot
be associated directly with the product, and they have been incurred at expected le-
vels. Thus, they should be expensed as period costs when incurred or be allocated
among interim periods based on the estimate of time expired, benefit received, or ac-
tivity associated with the periods.
(c) The warehouse fire loss is an extraordinary item that should be appropriately disclosed
in the interim financial report, net of income tax effect. In this situation, the $175,000
loss should be reduced by the effective income tax benefit of $96,250. Thus, the loss
should reduce net income by $78,750 ($175,000 $96,250), and the nature of the loss
should be appropriately explained in the commentary accompanying the quarterly da-
ta.
(d) A negative income tax expense (an income tax benefit) should have been included in
the interim report. The $35,000 loss from regular operations should have been re-
duced by $19,250 ($35,000 55%), the expected tax reduction to be realized from
profitable operations during the remaining three quarters of 20X5. The tax benefits re-
sulting from losses that arise in the early portion of the year should be recognized only
when realization is more likely than not. An established seasonal pattern of losses in
early interim periods, offset by income in later interim periods, should constitute suffi-
cient evidence that realization is more likely than notunless other evidence contra-
dicts this conclusion.
577
Ch. 12Problems
PROBLEM 12-2
Quarter 1 Quarter 1 Quarter 1 Quarter 2 Quarter 3

Original Continuing DISCO Continuing Continuing
YTD income ........................................................ $(45,000) $(30,000) $(15,000) $28,000 $ 68,000
Projected income ................................................ (25,000) 15,000 (40,000) 62,000 42,000
Estimated annual income.................................... $(70,000) $(15,000) $(55,000) $90,000 $110,000
Statutory tax rate ................................................. 32% 32% 32% 32%
a b
Tax (benefit) of NOL carryback to prior 2 years $(6,400) $(4,440)
Tax expense on estimated income ..................... $28,800 $35,200
Tax credits .......................................................... (1,960)b (5,000) (8,000)
Net tax expense (benefit) .................................... $(6,400) $(6,400) $23,800 $27,200
Effective tax rate ................................................. 9.14% 42.67% 26.44% 24.73%
Pretax Income (Loss) Tax Expense (Benefit)

Interim Period Type of Current Year- Effective Year- Previously Current
(quarter) Income Period to-Date Tax Rate to-Date Reported Period
First Continuing Op. $(45,000) $(45,000) See a $ (6,400) $ $
(6,400)
FirstRestated Continuing Op. (30,000) (30,000) See b (6,400) (6,400)
FirstRestated Discontinued (15,000) (15,000) See b
Second Continuing Op. 58,000 28,000 26.44% 7,403 (6,400) 13,803
Second Discontinued (57,000)c (72,000) Note A (23,040) (23,040)
Third Continuing Op. 40,000 68,000 24.73% 16,816 7,403 9,413
Third Discontinued (13,000)d (85,000) Note B (27,200) (23,040) (4,160)
a
Because there is no future income that is more likely than not and there were carrybacks available, the tax benefit can only be
found by adding the tax expense in the past 2 years [($12,000 30%) + ($10,000 28%)].
b
Because there is no future income that is more likely than not and there were carrybacks available, the tax benefit can only be
found by carrying the $15,000 loss and tax credit back to the past 2 years [($12,000 30%) + ($3,000 28%) + $1,960 of tax cre-
dit].
c
($15,000) + ($42,000)
d
($30,000) + $25,000 + ($34,000 $42,000) + ($16,000)
578
Ch. 12Problems
Note A: Ordinary
Income All Sources
Annual income (loss) ....................... $90,000 $18,000
Annual net tax expense (benefit)..... 23,800 760 [(32% $18,000) $5,000]
The difference between $23,800 and $760 represents the tax benefit associated with
the discontinued operation.
Note B: Ordinary
Income All Sources
Annual income (loss) ....................... $110,000 $25,000
Annual net tax expense (benefit)..... 27,200 [(32% $25,000) $8,000]
The difference between $27,200 and $0 represents the tax benefit associated with the
discontinued operation.
PROBLEM 12-3
Calculation of Incremental Tax Impact

Total Income Total Income
Excluding Excluding
Income Income Losses Gains
Pretax income (loss) ................... $220,000 $65,000 $230,000 $55,000
Tax expense (benefit) ................. 69,050a 11,250 b
72,950 c
7,350d
a
($50,000 15%) + ($25,000 25%) + ($25,000 34%) + ($120,000 39%)
b
($50,000 15%) + ($15,000 25%)
c
($50,000 15%) + ($25,000 25%) + ($25,000 34%) + ($130,000 39%)
d
The total of all nonordinary items has an incremental tax benefit of $57,800 ($11,250
$69,050). Of this total incremental tax benefit, $61,700 is traceable to nonordinary losses.
Therefore, the nonordinary gains have an incremental tax expense of $3,900 ($61,700
$57,800). The incremental tax expense of $3,900 means that the tax on nonordinary gains
must be $7,350 ($11,250 $3,900).

All nonordinary items ($11,250 $69,050) .................................................. $(57,800)
All nonordinary losses ($11,250 $72,950)................................................. (61,700)
All nonordinary gains ($11,250 $7,350) .................................................... 3,900
579
Ch. 12Problems
Calculation of Incremental Tax Benefit

Traceable to Each Individual Loss Category
Total Income Total Income Total Income

Excluding Excluding Excluding
Total Nonordinary Nonordinary Nonordinary
Income Losses Loss B Loss C
Pretax income (loss) ................... $65,000 $230,000 $145,000 $150,000
Tax expense (benefit) ................. 11,250 72,950 39,800e 41,750f
e
($50,000 15%) + ($25,000 25%) + ($25,000 34%) + ($45,000 39%)
f
($50,000 15%) + ($25,000 25%) + ($25,000 34%) + ($50,000 39%)

All nonordinary losses ($11,250 $72,950)................................................. $(61,700)
Nonordinary lossCategory B ($11,250 $39,800) ................................... (28,550)
Nonordinary lossCategory C ($11,250 $41,750) ................................... (30,500)
Apportionment of Tax Benefit

Traceable to Nonordinary Losses
Each Loss Category

Incremental Apportioned
Benefit Percent Amount
LossCategory B .................................................... $28,55048.35% $29,832
LossCategory C .................................................... 30,500 51.65
...................................................................... 31,868
$59,050100.00% $61,700
Calculation of Incremental Tax

Expense Traceable to Gain Category
Because there is only one gain category, the incremental tax impact is $3,900 ($11,250
$7,350).
580
Ch. 12Problems
PROBLEM 12-4
Item A The first quarter is being restated due to a decision to discontinue an operation in the
second quarter. Therefore, the original pretax income (loss) reported for the first quar-
ter must be allocated between continuing and discontinued operations. If the original
pretax income was $70,000 and the discontinued operation accounts for a $30,000
loss, then the amount traceable to the restated continuing component must be
$100,000 (the value of A). The two restated components, continuing and discontin-
ued, now have pretax amounts that total the original amount [$100,000 + ($30,000) =
$70,000].
Item B Effective tax rate for quarter 1restated income from continuing operations:
Quarter 1
Restated
YTD income (loss)see item A above .................................................... $100,000
Projected income (loss) ($60,000 + $40,000) .......................................... 100,000*
Total annual income (loss) ....................................................................... $200,000
Carryforward of 20X3 loss ........................................................................ (80,000)
Estimated annual taxable income ............................................................ $120,000
*The original amount included a $40,000 loss that is now part of discontinued
operations.
Estimated tax:
On first $50,000 @ 15% ..................................................................... $ 7,500
On next $50,000 @ 20% .................................................................... 10,000
On next $50,000 @ 25% .................................................................... 5,000
Remaining income @ 30% .................................................................
$ 22,500
Less tax credit (5,000)
Net tax ...................................................................................................... $ 17,500
Effective tax rate ($17,500/$200,000) ...................................................... 8.75%
Quarter 1restated continuing income.................................................... $100,000
Tax expense (the value of B) ................................................................... $ 8,750
Item C The tax expense (benefit) traceable to the continuing and discontinued components of
restated quarter 1 must total the tax expense originally reported for quarter 1 as fol-
lows:
Tax expense (benefit) traceable to restated:
Continuing operations ........................................................................ $ 8,750
Discontinued operations (the value of C) ........................................... (7,406)
Tax expense originally reported for quarter 1........................................... $ 1,344
581
Ch. 12Problems
Problem 12-4 Continued
Item D Tax expense for quarter 2 income from continuing operations:

Quarter 2
Quarter 1restated income (loss) ........................................................... $100,000
Quarter 2 income (loss) ............................................................................ 50,000
YTD income (loss) .................................................................................... $150,000
Projected income (loss) ............................................................................ 60,000
Total annual income (loss) ....................................................................... $210,000
Carryforward of 20X3 loss ........................................................................ (80,000)
Estimated annual taxable income ............................................................ $130,000
Estimated tax:
On first $50,000 @ 15% ..................................................................... $ 7,500
On next $50,000 @ 20% .................................................................... 10,000
On next $50,000 @ 25% .................................................................... 7,500
Remaining income @ 30% .................................................................
$ 25,000
Less tax credit .......................................................................................... (5,000)
Net tax ...................................................................................................... $ 20,000
Effective tax rate ($20,000/$210,000) ...................................................... 9.52%

YTD income ............................................................................................. $150,000
YTD tax expense (the value of D) ............................................................ $ 14,280
Item E YTD income (loss) from discontinued operations consists of:

Quarter 1restated.................................................................................. $ (30,000)
Quarter 2:
Operating loss .................................................................................... (60,000)
Realized loss on disposal ................................................................... (25,000)
Impairment loss .................................................................................. (30,000)
The value of E .................................................................................... $(145,000)
582
Ch. 12Problems
Problem 12-4 Concluded
Item F Total Total

Excluding Excluding
Income Income Loss Gain
Pretax income (loss):
Continuing .......................... $210,000 $ 210,000 $210,000 $ 210,000
Discontinued....................... (145,000) (145,000)
Extraordinary ...................... 20,000 20,000

Pretax income (loss) ........... $210,000 $ 85,000 $230,000 $ 65,000
Tax expense (benefit)......... $ 20,000 $ $ 25,000
Taxable income:
Pretax income (loss) ........... $210,000 $ 85,000 $230,000 $ 65,000
20X3 loss............................ (80,000) (80,000) (80,000)
(80,000)
Taxable income .................. $130,000 $ 5,000 $150,000 $(15,000)
Estimated tax:
On first $50,000 @ 15% ..... $ 7,500 $ 750 $ 7,500
On next $50,000 @ 20% .... 10,000 10,000
On next $50,000 @ 25% .... 7,500 12,500
Remaining income @ 30% .
$25,000 $ $30,000
Less tax credit .......................... (5,000) (750) (5,000)
Net tax ...................................... $20,000 $ $25,000

All nonordinary items ($0 $20,000) .......................... $(20,000)
All nonordinary losses ($0 $25,000) ......................... $(25,000)
The discontinued operation is the only nonordinary loss. Therefore, there is a $25,000
tax benefit (the value of F) traceable to the discontinued item.
PROBLEM 12-5
(1) Case ACalculation of Year-to-Date Tax Expense or Benefit

Year-to-date income (loss) ................................................................... $(80,000)
Projected income (loss) ........................................................................ 60,000
Total income (loss) ............................................................................... $(20,000)
Tax exempt income .............................................................................. (3,000)
Taxable income (loss)........................................................................... $(23,000)
Because the YTD loss is greater than the annual projected loss, the YTD tax benefit is li-
mited to the amount that would be recognized if the YTD loss were the expected loss for
the entire fiscal year. Therefore, the YTD tax benefit is limited to $15,000 (the $80,000 YTD
loss can only be carried back against $50,000 of prior-year income that is taxed at 30%).
583
Ch. 12Problems
Problem 12-5, Continued
(2) Case BCalculation of Original Tax Expense

Year-to-date income (loss) ................................................................... $30,000
Total income (loss) ............................................................................... $50,000
Taxable income (loss)........................................................................... $44,000
Tax expense (benefit):

Tax ($44,000 30%) ...................................................................... $13,200
Tax credit ........................................................................................ (6,200)
Net tax ............................................................................................ $ 7,000
Estimated rate of tax ($7,000 $50,000) ............................................. 14%
Original tax expense was $4,200 ($30,000 14%).
Case BCalculation of Revised Tax Expense

Year-to-date income (loss) ................................................................... $ 50,000
Total income (loss) ............................................................................... $140,000
Taxable income (loss)........................................................................... $135,000
Tax expense (benefit):

Tax ($135,000 30%) .................................................................... $ 40,500
Tax credit ........................................................................................ (5,500)
Net tax ............................................................................................ $ 35,000
Estimated rate of tax ($35,000 $140,000) ......................................... 25%
Revised tax expense is $12,500 ($50,000 25%).
Therefore, the amount traceable to the discontinued operation is an $8,300 tax benefit cal-
culated as follows:
Original tax expense on ordinary income ............................................. $ 4,200
Restated tax expense on ordinary income ........................................... $12,500
Tax benefit traceable to discontinued operation ................................... (8,300)
Total restated tax expense ................................................................... $ 4,200
584
Ch. 12Problems
(3) Case CCalculation of Incremental Tax Impact

Total Income
Ordinary Total (Loss) Excluding
Income Income Nonordinary
(Loss) (Loss) Losses
Pretax income (loss) .................................... $60,000 $(10,000) $60,000
Tax expense (benefit) .................................. 14,000a (5,000)b 14,000
a
$60,000 30% less $4,000 tax credit
b
($10,000) carryback at 25% plus tax credit carryback of $2,500 (to eliminate remaining tax
in prior year)

All nonordinary items [($5,000) $14,000] ...................................... $(19,000)
All nonordinary losses ...................................................................... (19,000)
Case CCalculation of Incremental Tax Expense

Traceable to Each Individual Loss Category
Total Income Total Income
Total (Loss) Excluding (Loss) Excluding
Income Extraordinary Extraordinary
(Loss) Item A Item B
Pretax income (loss) .............................. $(10,000) $40,000 $10,000
Tax expense (benefit) ............................ (5,000) 8,000c (1,000)d
c
$40,000 30% less tax credit of $4,000
d
$10,000 30% less tax credit of $3,000 less tax credit of $1,000 carried back to prior year

All nonordinary losses ...................................................................... $(19,000)
Nonordinary lossextraordinary item [($5,000) $8,000] .............. (13,000)
Nonordinary lossextraordinary item [($5,000) ($1,000)] ............ (4,000)
Case CApportionment of Tax Expense

Traceable to Nonordinary Losses
Incremental Apportioned
Tax Benefit Percent Amount
Nonordinary lossextraordinary item ......... $(13,000) 76.47% $(14,529)
Nonordinary lossextraordinary item ......... (4,000) 23.53 (4,471)
$(17,000)100.00% $(19,000)
585
Ch. 12Problems
PROBLEM 12-6
Treetop Corporation
Income Statement
For the Second Quarter of the Current Fiscal Year
Sale revenue ........................................................................ $510,000
Cost of sales (see Schedule A) ............................................ 261,900
Gross profit .......................................................................... $248,100
Other items..................................................................... $110,000
Research and development ($75,000/3 quarters).......... 25,000
Management bonuses ($160,000/4 quarters) ................ 40,000 175,000
Income before taxes from continuing operations ................. $ 73,100
Income taxes (see Schedule B) ..................................... 1,234
Net income from continuing operations ............................... $ 71,866
Extraordinary items (see Schedule C):
Extraordinary gain (less tax of $5,523) .......................... $ 14,477
Extraordinary gain (less tax of $4,406) .......................... 10,594 25,071
Net income ........................................................................... $ 96,937
Schedule ACost of Sales

Purchases (1,500 units @ $120 per unit) .................................................... $180,000
Prior inventory (600 units @ $100 per unit) ................................................. 60,000
Excess replacement cost (600 units @ $24 per unit) .................................. 14,400
Subtotal ........................................................................................................ $254,400
Inventory shrinkage ($30,000/4 quarters) .................................................... 7,500
Total cost of sales ........................................................................................ $261,900
Schedule BEstimated Tax on Pretax Income from Continuing Operations (PICO)

Quarter 1 PICO ............................................................................................ $ 20,000
Quarter 2 PICO ............................................................................................ 73,100
Projected balance of year ............................................................................ (40,000)
Total annual PICO........................................................................................ $ 53,100
Tax on annual PICO ($50,000 @ 15% + $3,100
@ 25% = $8,275 less $7,000 credit) ............................................... $ 1,275
Estimated effective annual tax rate ($1,275 divided by $53,100) ................ 2.4%
YTD PICO ($93,100 2.4%*) ...................................................................... $ 2,234
Less prior quarter taxes ............................................................................... (1,000)
Tax expense traceable to current quarter .................................................... $ 1,234
*$1,275/$53,100 = 2.4%
586
Ch. 12Problems
Schedule CTax Effect of Extraordinary Items

Ordinary Total Total Income Total Income
Income Income Excluding Gain A Excluding Gain B
Pretax income ................. $53,100 $88,100* $68,100 $73,100
Tax expense.................... 1,275 11,204 5,025 6,275
*$53,100 + $20,000 + $15,000
Tax expense calculations:

Ordinary income: $50,000 @ 15% + $3,100 @ 25% = $8,275 $7,000 credit
Total income: $50,000 @ 15% + $25,000 @ 25% + $13,100 @ 34% = $18,204 $7,000
Total income excluding gain A: $50,000 @ 15% + $18,100 @ 25% = $12,025 $7,000
Total income excluding gain B: $50,000 @ 15% + $23,100 @ 25% = $13,275 $7,000
Income tax traceable to:

All extraordinary items ($11,204 $1,275) .................................................. $9,929
Extraordinary gain A ($11,204 $5,025) ..................................................... 6,179
Extraordinary gain B ($11,204 $6,275) ..................................................... 4,929
Allocation of total tax traceable to extraordinary items:

Extraordinary gain A {[$6,179 ($6,179 + $4,929)] $9,929} ..................... $5,523
Extraordinary gain B ($9,929 $5,523) ....................................................... 4,406
PROBLEM 12-7
1. The identification of a segment is based on a management approach, which focuses on

how management organizes information about business components for purposes of mak-
ing management decisions and assessing performance. In this particular case, the distribu-
tion of the products must be viewed as a single operating segment based on the manage-
ment approach. This may be explained by a number of factors such as common distribution
channels, marketing, retail sales stores (example: large grocery stores), and sales area.
2. Revenues traceable to segments generally do not agree to consolidated amounts for sev-
eral reasons. First, segmental revenues include intersegment sales or revenues that are
eliminated for the purpose of determining consolidated revenues. It is also possible that
certain components of revenue are traceable to corporate-level activities (example: rental
income) and are therefore not allocated to operating segments.
587
Ch. 12Problems
3. Public companies are required to disclose segmental data; therefore, such information is
publicly available to a wide variety of parties including ones competitors. Obviously, the
more information that is publicly available allows competitors to have increased insight into
how a company operates and its respective performance. Therefore, from a competitive
standpoint, it would be better to have fewer segments that are broadly defined rather than
many narrowly defined segments that disclose more information. For example, consider a
company that manufactures automobile batteries and automobile interior seating. If these
two products were combined into a single segment per the management approach, it would
be harder for a competing manufacturer of automobile batteries to know how much of reve-
nues, capital expenditures, and other required segmental disclosures are traceable to just
the automobile battery component.
4. The determination as to whether or not a segment is considered reportable is based on

several mutually exclusive criteria. In addition to considering reported revenues, reported
profits or losses and/or asset totals may be used as a basis for determining whether or not
a segment is reportable.
5. Interest expense on corporate bonds payable may be allocated to segments if such infor-
mation is considered by the chief operating decision maker of an enterprise for purposes of
decision making and performance evaluation related to a particular segment. However, it
would typically seem more likely that such interest expense would not be allocated to a par-
ticular segment unless the capital provided by the bond proceeds could be directly allo-
cated to a particular segment. It is highly likely that interest expense on corporate bonds
would be considered as part of the corporate-level profit or loss.
6. Once again, it is important to remember that segmental net sales would include interseg-
ment net sales that are eliminated for purposes of reporting consolidated company-wide net
sales. Therefore, if there are intersegment sales, it is likely that the total of segmental net
sales will exceed net sales for the entire company.
7. The statement of cash flows reports cash flows from operations, investing, and financing.
Certainly some, but not all, of the key information necessary to determine cash flows can
be derived from segmental reports. For example, depreciation expense for a segment could
be added back to the segments net profit or loss to give a rough measure of cash flows
from operations. Obviously, changes in net working capital are not available to complete a
measure of cash flows from operations. Information about a segments capital expenditures
would provide important information regarding investing cash outflows. A complete mea-
sure of a segments cash flows cannot be derived from segmental reports; however, rough
measures of certain areas of cash flow are possible. It would seem that the most difficult
area to measure would be cash flows from financing in that the activities impacting these
cash flows are not typically allocated to reportable segments.
588
Ch. 12Problems
PROBLEM 12-8

Revenues Reported
Semiconductors ............................... $19,920,000 $ 3,970,000 $ 23,890,000$ 90,000 $28,220
Control Devices ............................... 61,700,000 11,411,000 73,111,000 44,689,000 36,320,000
Educational and Productivity
Solutions .................................. 5,360,000 0 5,360,000 (107,000) 6,750,000
Financing Activities .......................... 3,300,000 964,000 4,264,000 (3,698,000) 6,015,0
Total ................................................. $90,280,000 $16,345,000 $106,625,000 $40,974,000 $77,305,000
Total of all reported profits................................................................... $44,779,000
Total of all reported losses .................................................................. (3,805,000)
Is Segment's
Absolute Value
Revenue 10% of Profit or Loss Assets 10%
or More of 10% or More of or More of Is Segment
$106,625,000? $44,779,000? $77,305,000? Reportable?
Semiconductors ........................................... Yes No Yes Yes
Control Devices ........................................... Yes Yes Yes Yes
Educational and Productivity Solutions ....... No No No No
Financing Activities ...................................... No No No No
Consolidated revenue ................................................................................. $98,568,000

Percentage requirement ............................................................................. 75%
Dollar requirement ...................................................................................... $73,926,000
External revenue of all reportable segments .............................................. $81,620,000
589
Ch. 12Problems
(2) Presentation of segmental values:

Reportable Segments
Semiconductors Control Devices
Revenues from:
External customers .................................................. $19,920,000 $61,700,000
Intersegment sales ................................................... 3,970,000 11,411,
Total revenues.................................................... $23,890,000 $73,111,000
Segment profit (loss)..................................................... $ 90,000 $44,689,000
Segment assets ............................................................ $28,220,000 $36,320,000
Reconciliation to Consolidated Revenue and Profit:

Revenues
Total revenues for reportable segments ......................................... $ 97,001,000
Revenues for nonreportable segments........................................... 9,624,000
Elimination of intersegment revenue .............................................. (16,345,000)
Corporate-level revenues ............................................................... 8,288,000
Total consolidated revenues ........................................................... $ 98,568,000
Profit or loss
Total profit or loss for reportable segments .................................... $ 44,779,000
Profit or loss of nonreportable segments ........................................ (3,805,000)
Elimination of intercompany profit................................................... (700,000)*
Corporate-level:
Revenues ................................................................................ 8,288,000
Expenses................................................................................. (7,020,000)
Total consolidated pretax income ................................................... $ 41,542,000
Assets
Total assets for reportable segments ............................................. $ 64,540,000
Assets of nonreportable segments ................................................. 12,765,000
Elimination of intersegment assets related to intersegment sales .. (700,000)*
Corporate-level assets .................................................................... 23,000,000
Total consolidated assets ............................................................... $ 99,605,000
*This represents the intercompany profit on the inventory sold by the Control Devices seg-
ment.
590
Ch. 12Problems
Business Segment and Geographical Area Data
The company presented manufactures, develops, and sells a diverse range of electronic
equipment and parts. Its primary targets are consumer and industrial markets. The compa-
ny's control device manufacturing is the company's strongest line and together with its sem-
iconductor technology is rapidly expanding into the global market.
The company presented has four predominate businesses: Semiconductors, Control De-
vices, Educational and Productivity Solutions, and Financing Activities. They are all busi-
ness segments and are presented in this report.
The Semiconductors segment uses innovative technology to produce semiconductor chips.

The chips are sold mainly to equipment engineers and manufacturers. The Semiconductors
segment will also customize semiconductor chips to suit customer specifications.
The Control Devices segment consists mainly of electrical control devices. The control de-
vice customer base is primarily equipment engineers and manufacturers. Control devices
are also custom-ordered to suit a manufacturers or engineer's specific needs.
Educational and Productivity Solutions produce educational and time-efficient devices. The
products are sold primarily through retailers and over the Internet.
The company's Financing Activities segment holds a diversified portfolio of investments. It

also holds several royalty and licensing agreements with operating segments in several dif-
ferent countries.
Business Segment Revenues (Including Intersegment)**

Revenues
External Intersegment
Semiconductors ............................................................ $19,920,000 $ 3,970,0
Control Devices ............................................................ 61,700,000 11,411,000
Educational and Productivity Solutions......................... 5,360,000 0
Financing Activities ....................................................... 3,300,000 964,000
Total .............................................................................. $90,280,000 $16,345,000
Business Segment Profit (Loss)**

Reported Profit
(Loss)
Semiconductors ............................................................ $ 90,000
Control Devices ............................................................ 44,689,000
Educational and Productivity Solutions......................... (107,000)
Financing Activities ....................................................... (3,698,000)
Total .............................................................................. $40,974,000
591
Ch. 12Problems
Business Segment Assets**

Assets
Semiconductors ............................................................ $28,220,000
Control Devices ............................................................ 36,320,000
Educational and Productivity Solutions......................... 6,750,000
Financing Activities ....................................................... 6,015,000
Total .............................................................................. $77,305,000
Based on the answer in part (1), students may appropriately combine the Educational and
Productivity Solutions and the Financing Activities segments in a category labeled other
segments.
Geographic Area Revenues (Excluding Intersegment)**

Revenues
United States ................................................................ $40,950,000
Japan ............................................................................ 36,157,300
Germany ....................................................................... 8,083,200
Other International ........................................................ 13,377,500
Total .............................................................................. $98,568,000
Geographic Area Long-Lived Assets**

Assets
United States ................................................................ $33,377,000
Japan ............................................................................ 20,332,900
Germany ....................................................................... 5,566,000
Other International ........................................................ 7,688,100
Total .............................................................................. $66,964,000
**If available, comparison data for prior years would be included in the presentations.
592
Ch. 12Problems
(3) Several ratios that may be helpful in analyzing segmental information are as follows:
Educational
and
Control Productivity Financing
Semiconductors Devices Solutions Activities Total
$90,000 $44,689,000 ($107,000) ($3,698,000) $40,974,000
Return on assets*
$28,220,000 $36,320,000 $6,750,000 $6,015,000 $77,305,000
0.32% 123.04% 1.59% 61.48% 53.00%
$90,000 $44,689,000 ($107,000) ($3,698,000) $40,974,000

Operating profit margin
$23,890,000 $73,111,000 $5,360,000 $4,264,000 $106,625,000
0.38% 61.12% 2.00% 86.73% 38.43%
$23,890,000 $73,111,000 $5,360,000 $4,264,000 $106,625,000

Total asset turnover*
$28,220,000 $36,320,000 $6,750,000 $6,015,000 $77,305,000
0.85 2.01 0.79 0.71 1.38
$23,890,000 $73,111,000 $5,360,000 $4,264,000 $106,625,000

Fixed asset turnover*
$18,230,000 $24,000,000 $5,540,000 $3,760,000 $51,530,000
1.31 3.05 0.97 1.13 2.07
*If available, average assets/fixed assets would be used as the denominator.
The geographical area disclosures could provide information regarding fixed asset turnover. Furthermore, one can develop a
strong sense for market concentrations regarding geographical areas.
593
Ch. 12Problems
PROBLEM 12-9

Reportable Segments All Other
A B D Segments Total
Revenues from:
External customers ............... $ 4,023,500 $ 2,556,570 $ 5,566,725 $ 1,374,500
$13,521,295
Intersegment sales ................ 192,430 618,525 810,955
Interest revenue ......................... 48,000 10,000 60,000 12,000 130,000
Gain on intersegment sale of
fixed assets ........................... 100,000a 100,000
Total revenues................. $ 4,171,500 $ 2,759,000 $ 6,245,250 $ 1,386,500
$14,562,250
Segment profit (loss):
Total revenues from above ... $ 4,171,500 $ 2,759,000 $ 6,245,250 $ 1,386,500
$14,562,250
Cost of goods sold ................ (2,154,000) (2,082,200) (1,723,200) (1,220,600) (7,180,000)
General and administrativeb .. (371,252) (245,543) (555,810) (123,395) (1,296,000)
Profit (loss) ...................... $ 1,646,248 $ 431,257 $ 3,966,240 $ 42,505 $
6,086,250
Segment assets ......................... $ 8,048,000 $ 5,324,000 $ 4,490,000 $ 3,717,000
$21,579,000
(2) Reconciliation of Significant Items to Consolidated Amounts

Revenues
Total revenues for reportable segments .......................................................... $13,175,750
Revenues of nonreportable segments ($574,500 + $800,000 + $12,000) ...... 1,386,500
Elimination of intersegment revenues and gain on sale of fixed assets .......... (910,955)
Corporate-level revenues ................................................................................ 0
Total consolidated revenues ............................................................................ $13,651,295
594
Ch. 12Problems
Profit or Loss
Total profit or loss for reportable segments ..................................................... $ 6,043,745
Profit or loss on nonreportable segments
($1,386,500 $1,220,600 $123,395) ..................................................... 42,505
Elimination of intersegment profits:
Intersegment sales and gain on sale of fixed assets ....................................... (910,955)
Cost of goods sold ........................................................................................... 798,848c
General and administrative .............................................................................. 10,000a
Corporate-level:
Revenues ($32,000 + $315,000) ............................................................... 347,000
General and administrative (20% $1,620,000) ....................................... (324,000)
Total consolidated pretax income from continuing operations......................... $ 6,007,143
Assets
Total assets for reportable segments .............................................................. $17,862,000
Assets of nonreportable segments .................................................................. 3,717,000
Elimination of intersegment assets related to intersegment sales ................... (102,107)d
Corporate-level assets ($115,000 + $1,737,000) ............................................ 1,852,000
Total consolidated assets ................................................................................ $23,328,893
a
Segment B should depreciate the original net book value of $200,000 over 10 years rather
than the new selling price of $300,000 over 10 years. Therefore, depreciation expense
should be $20,000 per year versus $30,000. The gain on the sale of $100,000 ($300,000
$200,000) is included in Segment As total revenue.
b
The total revenue for all the segments is $14,562,250 (sales + interest revenue + gain on
sale of fixed assets for all segments). The allocation of general and administrative ex-
penses of $1,296,000 (80% $1,620,000) is as follows:
Segment A: ($4,171,500 $14,562,250) $1,296,000 = $371,252
Segment B: ($2,759,000 $14,562,250) $1,296,000 = $245,543
Segment D: ($6,245,250 $14,562,250) $1,296,000 = $555,810
Other segments: ($1,386,500 $14,562,250) $1,296,000 = $123,395
c
Segment B recorded a cost of $144,000 on the sale to Segment C. Segment C in turn rec-
orded 75% of Bs selling price, or $144,323 (75% $192,430), as cost of sales. The total
cost recorded was $288,323 ($144,000 + $144,323). However, the actual cost of goods
sold was 75% of Bs cost of $144,000, or $108,000. Therefore, $180,323 ($288,323
$108,000) of cost should be eliminated along with the $618,525 cost of the goods pur-
chased by Segment A from Segment D.
d
This represents the excessive net book value of $90,000 ($100,000 gain on sale
$10,000 excessive depreciation) on the equipment sold to B and the intercompany profit of
$12,107 [($192,430 25% = $48,107) $36,000] on the inventory purchased from B.
595
Ch. 12Problems
PROBLEM 12-10

Revenues Reported
Segments External Intersegment Total Profit (Loss) Assets
Collision Repair Equipment ............. $24,840,000 $24,840,000 $ 4,800,000 $ 45,720,
Battery and Starter Parts ................. 6,470,000 6,470,000 1,100,000 14,780,000
Seating and Safety .......................... 11,650,000 $ 2,200,000 13,850,000 4,450,000
Paint and Trim Parts ........................ 20,100,000 5,400,000 25,500,000 2,280,000 47,800,000
Tire Retreading Equipment .............. 4,780,000 4,780,000 700,000 13,950,000
Miscellaneous Products ................... 5,094,000 3,556,000 8,650,000 2,200,000 16,570,
Totals ............................................... $72,934,000 $11,156,000 $84,090,000 $15,530,000 $176,320,000
Total of all reported profits................................................................... $15,530,000
Total of all reported losses .................................................................. 0
Is Segments
Absolute Value
Revenue of Profit or Assets
10% or Loss 10% or 10% or
More of More of More of Is Segment
Segments $84,090,000? $15,530,000? $176,320,000? Reportable?
Collision Repair Equipment ......................... Yes Yes Yes Yes
Battery and Starter Parts ............................. No No No No
Seating and Safety ...................................... Yes Yes Yes Yes
Paint and Trim Parts .................................... Yes Yes Yes Yes
Tire Retreading Equipment .......................... No No No No
Miscellaneous Products ............................... Yes Yes No Yes
Consolidated revenue ............................................................................ $79,684,000
Percentage requirement ......................................................................... 75%
Dollar requirement .................................................................................. $59,763,000
External revenue of all reportable segments .............................................. $61,684,000
596
Ch. 12Problems

Reportable Segments
Collision
Repair Seating and Paint and Miscellaneous All Other
Equipment Safety Trim Parts Products Segments Total
Revenues from:
External customers....... $24,840,000 $11,650,000 $ 20,100,000 $ 5,094,000 $11,250,000
Intersegment sales ....... 0 2,200,000 5,400,000 3,556,000 0 11,156,
Total revenues........ $24,840,000 $13,850,000 $ 25,500,000 $ 8,650,000 $11,250,000
Segment profit (loss)............ $ 4,800,000 $ 4,450,000 $ 2,280,000 $ 2,200,000 $ 1,800,000 $ 15,530,
Segment assets ................... $45,720,000 $37,500,000 $ 47,800,000 $16,570,000 $28,730,000
Reconciliation of Significant Items to Consolidated Amounts

Revenues
Total revenues for reportable segments ............................................................. $ 72,840,000 a
Revenues of nonreportable segments ................................................................ 11,250,000
Elimination of intersegment revenues................................................................. (11,156,000)
Corporate-level revenues ................................................................................... 6,750,000
Total consolidated revenues ............................................................................... $ 79,684,000
a
$24,840,000 + $13,850,000 + $25,500,000 + $8,650,000
Profit or Loss
Total profit or loss for reportable segments ........................................................ $ 13,730,000b
Profit or loss of nonreportable segments ............................................................ 1,800,000
Elimination of intersegment profits (Note A) ....................................................... (350,000)
Corporate-level:
Revenues ....................................................................................................... 6,750,000
Expenses ....................................................................................................... (4,730,000)
Total consolidated pretax income ....................................................................... $ 17,200,000
b
$4,800,000 + $4,450,000 + $2,280,000 + $2,200,000
597
Ch. 12Problems
Note A: The intercompany profit that is included in intersegment sales that remain in inventory is computed as follows:
Gross Profit
Ending Percent Original
Segment Inventory of Cost Cost Profit
d
Battery and Starter Parts .................. $ 420,000 40.00% $ 300,000 $120,000
Collision Repair Equipment .............. 720,000 20.00 600,000 120,000
Collision Repair Equipment .............. 440,000 33.33 330,000 110,000
$1,580,000 $1,230,000 $350,000
Assets
Total assets for reportable segments ................................................................. $147,590,000c
Total assets for nonreportable segments ........................................................... 28,730,000
Profit included in ending inventory from intersegment sales .............................. (350,000)
Corporate-level assets ........................................................................................ 29,860,000
Total consolidated assets ................................................................................... $205,830,000
c
$45,720,000 + $37,500,000 + $47,800,000 + $16,570,000
d
($3,556,000 $2,540,000) $2,540,000 = 40%
Revenues from External Customers and Long-Lived Assets by Geographic Area

United United All Other
States Kingdom Italy Mexico Foreign Total
Revenues from external
customers:
Segment revenues ....... $ 37,196,340 $14,586,800 $ 7,293,400 $ 6,564,060 $ 7,293,400 $ 72,934,
Corporate revenues...... 3,442,500 1,350,000 675,000 607,500 675,000 6,750,0
Total ............................. $ 40,638,840 $15,936,800 $ 7,968,400 $ 7,171,560 $ 7,968,400 $ 79,684,
Long-lived assets:
Segment assets............ $ 95,212,800 $37,027,200 $14,105,600 $17,632,000 $12,342,400 $176,320,000
Corporate assets .......... 16,124,400 6,270,600 2,388,800 2,986,000 2,090,200 29,860,
Total ............................. $111,337,200 $43,297,800 $16,494,400 $20,618,000 $14,432,600 $206,180,000
Revenues are attributed to geographic areas based on location of customer.
598

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UNDERSTANDING THE ISSUES

(1) Wert Company

(2) Wert Company

Exercise 12-1 Concluded

(3) Wert Company

Exercise 12-2, Concluded

Granger Supply, Inc.

Schedule ACost of Sales

Exercise 12-3, Concluded

Schedule BIncome Tax Schedule

Ordinary Pretax Income (Loss) Tax Expense (Benefit)

(1) Before After

Exercise 12-4, Concluded

(2) Total Total

Incremental tax expense (benefit) traceable to:

Corporation A Corporation B Corporation C Corporation D

Pretax Income (Loss) Tax Expense (Benefit)

Quarter 1, 20X7 Quarter 2, 20X7

Estimated tax benefit:

Quarter tax expense (benefit):

Incremental tax expense (benefit) traceable to:

Incremental tax expense (benefit) traceable to: Percent of Total

Determination of whether segments are reportable:

Significance of reportable segments:

Determination of whether segments are reportable:

Reconciliation to Consolidated Revenue and Profit:

Note A: The corporate-level revenue is calculated by taking the consolidated revenue of

(1) Determination of whether segments are reportable:

(2) Significance of reportable segments:

Problem 12-1, Concluded

Quarter 1 Quarter 1 Quarter 1 Quarter 2 Quarter 3

Effective tax rate ................................................. 9.14% 42.67% 26.44% 24.73%

Pretax Income (Loss) Tax Expense (Benefit)

Problem 12-2, Concluded

Calculation of Incremental Tax Impact

Incremental tax expense (benefit) traceable to:

Problem 12-3, Concluded

Calculation of Incremental Tax Benefit

Total Income Total Income Total Income

Incremental tax expense (benefit) traceable to:

Apportionment of Tax Benefit

Each Loss Category

Calculation of Incremental Tax

Problem 12-4 Continued

Item D Tax expense for quarter 2 income from continuing operations:

Effective tax rate ($20,000/$210,000) ...................................................... 9.52%

Item E YTD income (loss) from discontinued operations consists of:

Problem 12-4 Concluded

Item F Total Total

Incremental tax expense (benefit) traceable to:

(1) Case ACalculation of Year-to-Date Tax Expense or Benefit

Problem 12-5, Continued

(2) Case BCalculation of Original Tax Expense

Tax expense (benefit):

Case BCalculation of Revised Tax Expense

Tax expense (benefit):

Problem 12-5, Concluded

(3) Case CCalculation of Incremental Tax Impact

Incremental tax expense (benefit) traceable to:

Case CCalculation of Incremental Tax Expense

Incremental tax expense (benefit) traceable to:

Case CApportionment of Tax Expense

Schedule ACost of Sales