Final answer:
When applying the profit or loss test for reporting operating segments, the segment's revenue, share of common expenses, and net income or loss (accounting profit) are considered. An example given includes a firm with $1 million revenue and $950,000 in costs, resulting in an accounting profit of $50,000.
Step-by-step explanation:
The profit or loss test is an accounting principle used to determine whether an operating segment is significant enough to require separate reporting in the financial statements of a company. According to authoritative literature, when applying this test, several factors should be considered.
One of the key considerations is the segment's revenue, which is the income generated from the business operations. Another aspect is the segment's share of common expenses, including how costs are allocated to the segment. A critical component of the test is the segment's net income or loss, known as its accounting profit, which is calculated by subtracting explicit costs from revenues.
For example, if a firm had sales revenue of $1 million last year and spent $600,000 on labor, $150,000 on capital, and $200,000 on materials, it would have an accounting profit of $50,000. This is found by deducting the total explicit costs ($600,000 + $150,000 + $200,000 = $950,000) from the total revenues. Privately owned firms aim to earn profits, which represent the difference between revenues and costs. While accounting profit considers only explicit costs, economic profit would consider both explicit and implicit costs.