Lecture 2 - Accounting for Segmental Reporting and Reporting on Risk Flashcards
What is Segment Reporting?
•Most companies operate in several different business sectors and/or different geographical areas, often with different rates of profitability and degrees of risk.
•For example:
–High street stores such as Marks and Spencer operate in several trading sectors in their stores, such as food and clothing and also have other subsidiaries that operate in other sectors, such as financial sector
–Global companies such as Nike operate in sport equipment and clothing and are involved in many different markets in different countries
•The corporate risk of these companies is influenced by:
–The risk involved in the product groups
–The individual risk involved in the different markets
•The risks can offset each other and act to reduce total risk of the company (negative correlation) or compound each other and increase total risk (positive correlation)
Arguments for Segment Reporting
provides useful information for users e.g. clearer picture of business/risks etc.
– e.g. if main business is chicken production, could be affected by bird flu
– e.g. if Iraq is important area for sales, political situation could affect business
provides information consolidated accounts obscure
– i.e. group accounts aggregate sales for different types of activity. Segmental reports break it up again to provide clearer picture
helps users predict future activities, growth, risks and cash flows
– i.e. analyse each segment separately if each have different risk factors; then aggregate
partly satisfies demand for increased disclosure
may lead to greater stability in share prices if earnings can be predicted more objectively
Arguments against Segment Reporting
• insufficient evidence that it is useful
• how define reportable segments?
– E.g. Report France, Germany and Italy separately? Or show under heading of ‘Europe’?
information overload
• competitors get access to sensitive data
• may encourage management to sell/close down loss making divisions in short term, even if not in their long term interests, to avoid reporting poor results
IFRS 8 (Operating Segments)
- Issued 30 November 2006
- Replaced IAS 14
- IFRS 8 is mandatory for annual financial statements for periods beginning on or after 1 January 2009, although earlier application was permitted
- It brought IFRS and US GAAP broadly into line
Core principle of IFRS 8?
• IFRS 8’s core principle is that an entity should disclose information to enable users of its financial statements to evaluate:
– the nature and financial effects of the types of business activities in which it engages and
– the economic environments in which it operates
IFRS 8 - Segment Identification
- IFRS 8 requires operating segments to be identified on the basis of internal reports about components of the entity that are regularly reviewed by the chief operating decision maker (CODM) in order to allocate resources to the segment and to assess its performance.
- This differs from IAS 14 which specified that the primary method of identification was business and geographical, with internal systems only being a starting point.
- IFRS 8 introduces the “management-approach“: the definition of segments as well as the preparation of information used for segment reporting are both based on information prepared for internal management decisions.
- IFRS 8 requires an explanation of how profit or loss, assets and liabilities are measured for each operating segment, rather than defining revenue, expense, result, assets and liabilities for each operating segment.
What are the 5 steps in preparing segment reporting?
Identifying the CODM Identifying operating segments Aggregation of operating segments Determining reportable segments Disclosures of each reportable segment
1.Identifying the CODM
➢ The term CODM identifies a function, not necessarily a manager with a specific title.
➢ Many companies do identify the CODM in their Annual Reports, although IFRS 8 does not require such disclosure.
➢ Operating CODM identified by companies include Board of Directors, Chief Executive’s Committee, Executive Committee, Management Board and Managing Board.
2.Identifying Operating Segments
An operating segment is a component of an entity:
a) that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity),
b) whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and
c) for which discrete financial information is available.
An operating segment may engage in business activities for which it has yet to earn revenues, for example, start-up operations may be operating segments before earning revenues.
Aggregation of operating segments
Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the core principle of this IFRS, the segments have similar economic characteristics, and the segments are similar in each of the following respects:
a) the nature of the products and services;
b) the nature of the production processes;
c) the type or class of customer for their products and services;
d) the methods used to distribute their products or provide their services; and
e) if applicable, the nature of the regulatory environment, for example, banking, insurance or public utilities.
An operating segment is assumed to have a segment manager (again segment manager can be a function, not necessarily a manager with a specific title).
- Determining reportable segments
An entity shall report separately information about an operating segment that meets any of the following quantitative thresholds:
a) Its reported revenue, including both sales to external customers and intersegment sales or transfers, is 10% or more of the combined revenue, internal and external, of all operating segments.
b) The absolute amount of its reported profit or loss is 10% or more of the greater, in absolute amount, of (i) the combined reported profit of all operating segments that did not report a loss and (ii) the combined reported loss of all operating segments that reported a loss.
c) Its assets are 10% or more of the combined assets of all operating segments.
In what situation does IFRS 8 permit disclosure of segments?
However, IFRS 8 permits that operating segments that do not meet any of the quantitative thresholds may be considered reportable, and separately disclosed, if management believes that information about the segment would be useful to users of the financial statements.
If the total external revenue reported by operating segments constitutes less than 75% of the entity’s revenue, additional operating segments shall be identified as reportable segments until at least 75% the entity’s revenue is included in reportable segments.
Information about other business activities and operating segments that are not reportable shall be combined and disclosed in an “all other segments” category
- Disclosures for each reportable segment - INCOME STATEMENT
Segment income statement disclosures
IFRS 8 requires disclosure of a measure of segment profitability. These include operating profit/operating income, adjusted operating profit, profit before tax and profit after tax.
Disclosures of the following items are also required if the specified amounts are included in the measure of segment profit or loss reviewed by the CODM, or are otherwise regularly provided to the CODM, even if not included in that measure of segment profit or loss:
- revenues from external customers;
- revenues from transactions with other operating segments of the same entity;
- interest revenue;
- interest expense;
- depreciation and amortisation;
- material items of income and expense disclosed in accordance with IAS 1;
- the entity’s interest in the profit or loss of associates and joint ventures accounted for by the equity method;
- income tax expense or income; and
- material non-cash items other than depreciation and amortisation.
Disclosures for each reportable segment - BALANCE SHEET
A measure of total assets and liabilities for each reportable segment is only required if such amounts are regularly provided to the CODM.
Examples from companies’ financial statements indicate that many companies do not provide such a measure.
Disclosures of the following items are required if the specified amounts are included in the measure of segment assets reviewed by the CODM or are otherwise regularly provided to the CODM, even if not included in the measure of segment assets:
a) the amount of investment in associates and joint ventures accounted for by the equity method, and
b) the amounts of additions to non-current assets other than financial instruments, deferred tax assets, post-employment benefit assets and rights arising under insurance contracts (often referred to as capital expenditure).
What are entity wide disclosures?
In addition to disclosures relating to reportable segments, companies
are also required to provide the following entity-wide disclosures,
regardless of whether the information is used by the CODM in assessing segment performance: Information about products and services and Information about geographical areas and Information about major customers.
