LESSON 10 INTERIM AND SEGMENT REPORTING Lesson Objectives After completing this lesson and the corresponding readings assigned in the Textbook Key, you should be able to: 1. explain the need for and uses of interim financial reporting; 2. distinguish between the discrete and integral views of interim reporting; 3. apply the requirements of the Section 1750 CICA Handbook for interim reporting; 4. discuss the need for segment reporting and identify reportable segments; .. explain the disclosures required by the Section 1701 CICA Handbook for segment reporting. Introduction In today’s business world, the 12-month reporting period of the annual reports may be too long to permit timely evaluation of a company’s financial position, operating results and cash flows. Investors and creditors make decisions throughout the year and need timely data in order to assess the riskiness of these decisions. Hence, there is need for interim reporting, that is, the issuance of financial reports between the dates of annual reports. Similarly, when finan- w ‘Advanced Accounting ICial statements are consolidated, important information regarding the opera- tions and activities of the companies within the reporting entity could be masked by the aggregation of information. Consequently, there is need for seg- ment reporting or the provision of disaggregated information about the operat- ing segments of the enterprise. This lesson covers interim reporting in Part A and segment reporting in Part B. Part A — Interim Reporting Although interim financial reporting to shareholders may be prepared for any Period within the fiscal year and at any time, interim reporting is generally Prepared for a period of 3 months (quarterly reporting). The purpose of quar- terly reports is to provide financial statement users with more frequent and timely information for their investment and credit decisions. In addition, quar- terly reports can yield significant information concerning business points and seasonality, both of which could be “buried” in annual reports. Interim financial reporting is required for many companies by regulatory au- thorities. Companies whose securities are publicly traded are required to issue interim reports three times a year, at the end of the first, second and third quar- ters. They must also present comparative information for the same periods. The form and contents of the interim reports are specified by the CICA Hand- book, Section 1750. Essentially, the reports are income statements and must, for the period under review, include the operating revenues of the company, any investment income received, operating expenses such as amortization and in- terest, income taxes and certain information relating to segment disclosures. The Ontario Securities Actalso requires a cash flow statement; however, a bal- ance sheet need not be included. ‘Two distinct views of interim reporting have developed over the years: the dis- crete and integral views. Under the first view, the interim period is considered to bea discrete and separate accounting period. Thus, there are no estimations or allocations different from those used for annual reporting and accounting policies are applied as if the interim period were a year. The same expense rec- ognition rules apply as under annual reporting, and no special interim accruals or deferrals are applied. Annual operating expenses are usually recognized in the interim period incurred, irrespective of the number of interim periods ben- fitted. bia LESSON 10On the other hand, proponents of the integral view consider the interim period tobe an integral part of the annual accounting period. Annual operating ex- penses are estimated and then allocated to the interim periods based on the forecasted annual activity levels such as sales volume. The results of subse- quent interim periods must be adjusted to reflect estimation errors. Those in favour of the integral view argue that the integral view results in in- terim earnings which are indicative of annual earnings and, thus, are more use- ful for predictive purposes. On the other hand, proponents of the discrete view argue that the smoothing of interim results for purposes of forecasting annual earnings has undesirable effects. For example, a turning point during the year in an earnings trend may be obscured. Section 1750 of the CICA Handbook was issued in 1971. It reflects the CICA’s view that interim financial statements should be based on the same accounting practices and principles as those used for the preparation of annual financial statements, which is consistent with the discrete approach. Although the CICA has taken the discrete view, it does recognize that in certain situations the inte- gral approach could be taken for interim reporting. Table 10.1 summarizes the main recommendations of Section 1750 of the CICA Handbook regarding in- terim reporting to shareholders. In addition, accounting changes are handled in similar fashion as in annual re- ports. For example, a change in accounting principle would require retroactive treatment of previously issued interim reports. Businesses with seasonal varia- tions in their operations should disclose the seasonality of their activities to avoid the possibility of misleading interim reports. In most cases, financial data included in interim financial reports are not au- dited and it is desirable that such financial data be marked unaudited. Hence, the information presented in interim reports may not possess the same credi- bility as that in the audited financial statements. In addition, interim reporting has certain inherent limitations. As the reporting period is shortened, the effect of errors in estimation and allocation are magnified and the proper allocation of annual operating expenses is a significant concern. All these factors could decrease the quality of information provided in interim reports. Advanced Accounting i 3