note This explains how it is possible to report divisional results using hedge accounting even
when a companys consolidated results do not use hedge accounting.
Segment Results May Use Non-GAAP Earnings Metrics
Segment results are not required to present amounts that are in conformity with GAAP at the
divisional level. All that is required is that the combined segment results are reconciled to a
GAAP amount appearing in the financial statements. That is how Pepsi was able to report
divisional results in its segment footnote as if hedge accounting had been applied even for
contracts that did not qualify for hedge accounting.
(The reason GAAP metrics are not required at the divisional level is so that management has the
flexibility to report those measures it believes are most relevant to evaluating divisional
performance.)
An Example
We will illustrate with the following example. In November 2011 a company entered into a
forward purchase of oranges, thereby locking in a price of $900,000 for a particular quantity.
The settlement date for the contract was March 31, 2012. On December 31, 2011, the forward
contract had a value to the company of +$100,000. On March 31, 2012, the value was still
+$100,000, meaning the oranges would cost $1,000,000 to purchase in the spot market.
The following are the journal entries the company would use to record the above activity. The
entries are separated into two units corporate and division. The division results would be
included in the operating income amounts reported by the division in the segment footnote and
also affect the consolidated GAAP amounts. Amounts attributable to corporate would affect the
consolidated GAAP numbers but not any operating division. They would therefore be
reconciling items between the combined divisional results and the consolidated GAAP amounts.
November 2011, into
Forward Enter Purchase Contract
December 31, 2011, Mark
forward contract to fair value
March 31, 2012, Settle
forward contract;
Corporate
No entry.
Division
No entry.
Fwd contract $100,000
Gain
$100,000
Cash
$100,000
Fwd contract
$100,000
No entry.
Purchase goods;
Inventory
Cash
Transfer gain to division;
Gain
$100,000
Due to division $100,000
Record cost of sales
$1,000,000
$1,000,000
Due from corp. $100,000
Gain
$100,000
Cost of sales $1,000,000
Inventory
$1,000,000
The effects of the above transactions on the segment operating earnings disclosure are as shown
below. It is assumed that the related sales revenue for the goods covered by the forward
purchase is $1.5 million.
Juicedivision
Otherdivisions
Combineddivisionalresults
Corporateunallocated:
Gainsandlossesonderivatives
Consolidatedoperatingincome
2012
600,000
2011
600,000
(100,000)
500,000
100,000
100,000
On a consolidated basis, the company reports a $100,000 gain on the derivative in 2011, as
required by GAAP because the contract does not qualify for hedge accounting. But the
divisional results show $600,000 of operating profit in 2012, the year the goods are sold. This
profit reflects the lower purchase price that was obtained through the use of the forward contract.
The segment report shows reconciling items between combined segment operating earnings and
GAAP operating earnings in both years. In 2011 there is a positive reconciling item indicating
that consolidated operating earnings are $100,000 greater than the combined segment results,
while in 2012 the reconciling item is negative in the same amount. In 2012, consolidated
operating profit reflects the spot price for the juice actually paid in 2012 even though the
divisional results do not.
Note that over the two-year period, the combined operating income effect is the same, $600,000.