25-1 copyright 2007 mcgraw-hill australia pty ltd ppts t/a australian financial accounting 5e by...

25-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Chapter 25

Financial reporting by segments


Objectives

• Understand that consolidated financial statements provide an aggregated view of the financial performance and financial position of business operations from various industries and geographical locations

• Understand that to avoid information loss the consolidated financial statements need to be supplemented by additional disclosures pertaining to the various operating segments in which the organisation operates


Objectives (cont.)

• Understand the disclosures required in relation to separate operating segments and know that segment disclosures provide information to enable a more informed assessment of the performance and associated risks of an organisation’s various activities

• Understand how ‘operating segments’ are defined


Objectives (cont.)

• Be aware that information about an operating segment’s profit or loss must be disclosed in the notes to a reporting entity’s financial statements to the extent that the segments are deemed to be reportable pursuant to AASB 8 ‘Operating Segments’

• Understand how to determine whether a particular operating segment is of sufficient magnitude or importance to be deemed ‘reportable’

• Be able to describe the particular disclosures that must be made about an operating segment’s products and services, reliance on major customers, and the geographical dispersion pursuant to the requirements of AASB 8


Advantages and disadvantages of segment reporting

• Usual for reporting entities to be involved in a number of different activities and to be located in widely dispersed locations

• Consolidated financial statements provide aggregated results with resulting loss of information – consolidated financial statements combine the results of a multitude of subsidiaries that could be operating in widely different industries and locations

• Requirement to consolidate all entities that a company controls means there is a need for segment data

• AASB 8 ‘Operating Segments’ requires the disclosure of segment information within the notes of a company’s financial statements


Advantages and disadvantages of segment reporting (cont.)

Advantages of segment reporting• Highlights performance of the various parts of an

organisation• Enables users of financial statements to be better

able to predict the future profitability of an organisation, particularly where segments are involved in diverse activities


Advantages and disadvantages of segment reporting (cont.)

Disadvantages of providing segment information• Will lead to some costs being imposed on an

organisation– management less likely to take business risks in particular

segments if each segment’s results available– competitors will have access to information concerning

segment profitability– may also provide encouragement for further entrants into

the industry– risk of takeover bids if losses made in particular segments

and other parties consider that they can manage the particular segment more effectively


An introduction to AASB 8• AASB 8 ‘Operating Segments’ was released in 2007 and

replaced AASB 114• Issued as part of a process on converging standards issued by

the IASB with those issued by the FASB• Relative to the requirements of the former standard (AASB

114), AASB 8 has less prescription and relies upon the ‘management approach’ adopted for segment reporting

• AASB 8 is more principles-based than rules-based. Indeed, the core principle of the standard is identified at paragraph 1 of AASB 8, which states in the section entitled ‘Core Principle’

An entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates.


Introduction to AASB 8 (cont.)• The ‘management approach’ embraced within AASB 8 requires

that the identification of operating segments for disclosure purposes will be based upon the internal reports that are regularly reviewed by the chief operating decision maker of the entity in order to allocate resources to the segment and assess its performance

• Rather than providing specific criteria to identify the respective operating segments of an entity, AASB 8 requires that the segments identified for internal management purposes should be the segments that are used for external reporting purposes (subject to some allowed aggregation)

• Exhibit 25.2 (p. 840) provides an example of segment disclosures


Rationale for adopting the ‘management approach’

From press release of IASB

The IASB believes that adopting the management approach will improve financial reporting. First, it allows users of financial statements to review the operations through the eyes of management. Secondly, because the information is already used internally by management, there are few costs for preparers and the information is available on a timely basis. This means that interim reporting of segment information can be extended beyond the current requirements.


Identification of segments

• The former standard, AASB 114, required the separate identification of two categories of segments, these being– business segments– geographical segments

• By contrast AASB 4 refers to ‘operating segments’


Definition of an operation segment

The Appendix to AASB 8 states

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


Identification of segments

• Given the definition of operating segments (just provided) we can see that AASB 8 relies upon how the organisation identifies its operating segments, rather than imposing a particular basis of segment identification upon an entity

• That is, AASB 8 requires identification of operating segments on the basis of internal reports that are regularly reviewed by the entity’s chief operating decision maker in order to allocate resources to the segment and assess its performance


But, who is the chief operating decision maker?• As we now know, an operating segment is a component of an

entity about which separate financial information is available and which is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

• In this regard, paragraph 7 of AASB 8 statesThe term ‘chief operating decision maker’ identifies a function, not necessarily a manager with a specific title. That function is to allocate resources to and assess the performance of the operating segments of an entity. Often the chief operating decision maker of an entity is its chief executive officer or chief operating officer but, for example, it may be a group of executive directors or others.

• The focus of the chief operating decision maker (whether an individual or a group of individuals) therefore dictates which components of an entity are deemed to be operating segments for the purposes of AASB 8.


Can all components of an organisation be deemed to be part of an operating segment?

• Not all parts of an entity will be considered to be part of an operating segment. As paragraph 6 of AASB 8 states

Not every part of an entity is necessarily an operating segment or part of an operating segment. For example, a corporate headquarters or some functional departments may not earn revenues or may earn revenues that are only incidental to the activities of the entity and would not be operating segments. For the purposes of this IFRS, an entity’s post-employment benefit plans are not operating segments.


Inter-firm comparability

• Allowing management to determine what components of their operation will constitute ‘operating segments’ leads to concerns about comparing the results of operating segments of different organisations operating across similar industries

• However, the standard setters decided that the increased relevance of the information outweighs this concern pertaining to comparability


Defining a reportable segment• A reportable segment is an operating segment or an aggregation

of operating segments than meet specific criteria provided in AASB 8

• A reportable segment is an operating segment for which segment information is disclosed pursuant to AASB 8

• In relation to reportable segments, paragraph 11 of AASB 8 requiresAn entity shall report separately information about each operating segment that(a) has been identified in accordance with paragraphs 5 -10 or results from aggregating two or more of those segments in accordance with paragraph 12; and(b) exceeds the quantitative thresholds in paragraph 13Paragraphs 14 to19 specify other situations in which separate information about an operating segment shall be reported


Aggregation of segmentsParagraph 12 of AASB 8 states

Operating segments often exhibit similar long-term financial performance if they have similar economic characteristics. For example, similar long-term average gross margins for two operating segments would be expected if their economic characteristics were similar. Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the core principle of this Standard, 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.

Clearly, whether or not we aggregate two or more operating segments for the purposes of external reporting will be a matter of professional judgment.


Quantitative thresholds for disclosing operating segments

Paragraph 13 of AASB 8 states: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 inter-segment sales or transfers, is 10 per cent 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 per cent 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 per cent or more of the combined assets of all operating segments.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.


Combining operating segments for the purposes of disclosure

In relation to combining operating segments that might not otherwise be deemed to be reportable, paragraph 14 of AASB 8 states

An entity may combine information about operating segments that do not meet the quantitative thresholds with information about other operating segments that do not meet the quantitative thresholds to produce a reportable segment only if the operating segments have similar economic characteristics and share a majority of the aggregation criteria listed in paragraph 12.


Sufficient segment data being disclosed?• In addition to determining whether or not a specific operating segment

should be disclosed, we also need to consider whether, in total, a sufficient number of operating segments have been disclosed.

• AASB 8 requires a specific proportion of an entity’s total revenue to be attributed to operating segments.

• If total external revenue attributable to reportable segments constitutes less than 75% of the total consolidated or entity revenue, additional segments shall be identified as reportable segments, even if they do not meet the 10% thresholds in paragraph 35, until at least 75% of total consolidated or entity revenue is included in reportable segments Specifically, paragraph 15 requires

If the total external revenue reported by operating segments constitutes less than 75 per cent of the entity’s revenue, additional operating segments shall be identified as reportable segments (even if they do not meet the criteria in paragraph 13) until at least 75 per cent of the entity’s revenue is included in reportable segments.


Combining segments in order to satisfy ‘75% of revenue’ test

Paragraph 16 of AASB 8 states

Information about other business activities and operating segments that are not reportable shall be combined and disclosed in an ‘all other segments’ category separately from other reconciling items in the reconciliations required by paragraph 28. The sources of the revenue included in the ‘all other segments’ category shall be described.


Identifying reportable operating segments

• See worked example 25.1 (p. 854) for details about how to identify reportable segments


Growth or contraction of operating segments

• Across time, an entity’s operating segments may grow or contract relative to the sizes of other operating segments and this has implications for identifying reportable segments. It could mean that some operating segments that met the quantitative criteria for disclosure in previous periods no longer do so, and vice versa. In this regard, paragraphs 17 and 18 of AASB 8 state

17. If management judges that an operating segment identified as a reportable segment in the immediately preceding period is of continuing significance, information about that segment shall continue to be reported separately in the current period even if it no longer meets the criteria for reportability in paragraph 13.


Growth or contraction of operating segments (cont.)

18. If an operating segment is identified as a reportable segment in the current period in accordance with the quantitative thresholds, segment data for a prior period presented for comparative purposes shall be restated to reflect the newly reportable segment as a separate segment, even if that segment did not satisfy the criteria for reportability in paragraph 13 in the prior period, unless the necessary information is not available and the cost to develop it would be excessive.


Measurement of segment items

• The previous standard on segment reporting, AASB 114, provided detailed guidance on measuring segment items, such as segment revenue, segment profit, segment assets and segment liabilities.

• This is no longer the case with our new accounting standard, AASB 8.

• Now, much discretion is left to management• Generally, financial information is required to be

reported on the same basis as is used internally for evaluating operating segment performance and deciding how to allocate resources to operating segments.


Measurement of segment items (cont.)• Hence, for the purposes of reporting the results of operating

segments, entities may depart from the requirements of accounting standards.

• That is, they may depart from the rules they apply to generate their financial reports and supporting notes.

• Entities will therefore have more discretion in determining what comprises segment profit or loss pursuant to AASB 8, with their calculations being limited only by their internal reporting practices.

• Obviously the accounting standard setters believe it is more efficient and relevant for reporting entities to provide information using their preferred accounting approach when it comes to segment disclosures.

• However, when it comes to disclosing balance sheet, income statement, statement of cash flows and statement of changes in equity information then the accounting standards must be applied.


Measurement of segment items (cont.)• AASB 8 requires the amount (for example, profit,

assets, liabilities) reported for each operating segment item to be the measure reported to the chief operating decision maker for the purposes of allocating resources to the segment and assessing its performance. This can be the case regardless of the accounting methods being used.

• By contrast, AASB 114 (the former standard) required segment information to be prepared in conformity with the accounting policies adopted for preparing and presenting the external financial statements.


Measurement of segment items (cont.)

• AASB 114 (the former standard) provided relatively detailed definitions of segment revenue, segment expense, segment result, segment assets and segment liabilities.

• Again, by contrast, AASB 8 does not define these terms, nor require particular measurement approaches to be adopted. But it does require an explanation of how segment profit or loss, segment assets and segment liabilities are measured for each reportable segment.

• Judgment is being delegated to the management of the reporting entity.


Measurement of segment items (cont.)

• While entities are required to provide segment disclosures based on the measures utilised internally, some accompanying explanation is required to assist users of financial reports to understand the basis of the measurements used. Specifically, paragraph 27 of AASB 8 requires a number of disclosures that provide an explanation of the measurements of segment profit or loss, segment assets and segment liabilities for each reportable segment (p. 858 provides details of these disclosures)


Required financial disclosures

• See paragraphs 23 and 24 of AASB 8 for details of the specific disclosure requirements (pp. 858 – 859 of textbook)


Reconciliation of segment information to financial statement• As we know, the financial statements such as the income

statement and the balance sheet must be compiled in accordance with accounting standards.

• As we also now know, segment disclosures are reported on the basis of whatever accounting methods the entity utilises to generate information for the ‘chief operating decision maker’.

• Some readers might have trouble understanding how segment information relates or reconciles to that provided elsewhere in the financial reports.

• To this end, AASB 8 requires reconciling information to be produced.

• It requires reconciliations of total reportable segment revenues, total profit or loss, total assets, total liabilities and other amounts disclosed for reportable segments to corresponding amounts in the entity’s financial statements.

• See the reconciliation provided at Exhibit 25.3 (p. 860)


Non-financial disclosures• AASB 8 also requires entity-wide, non-financial information to be

disclosed • AASB 8 requires the disclosure of information about

– products or services (or groups of similar products and services) – the countries in which the entity earns revenues and holds assets– major customers, regardless of whether the information is used by

management in making operating decisions

• These disclosures apply to all entities subject to AASB 8, including those that have a single reportable segment. These entity-wide disclosures are required by paragraphs 32 - 34 of AASB 8, which require that the additional information be provided only if it is not provided as part of the reportable segment information required elsewhere pursuant to AASB 8.

• See Exhibit 25.4 (p. 862) for an example of the additional disclosures that might be made


Summary• Segment reporting provides information about the performance

and financial position of various operating segments• It provides a useful supplement to consolidated financial

statements where data is aggregated• Benefits of segment reporting include that it allows

– for more informed decision making relating to future profitability and risk exposure of an entity

– management to demonstrate greater accountability– interested parties to know in which sectors and locations the

entity operates


Summary (cont.)

• Perceived costs in relation to segment data include the following– creation of a competitive disadvantage– possibility encourages takeover bids for poorly

performing segments– possibility of profitable segments attracting

unwelcome attention from government and interest groups


Summary (cont.)

• The relevant Australian Accounting Standard pertaining to segment disclosures is AASB 8 ‘Operating Segments’, which was released in 2007 and which replaced AASB 114

• The standard requires the disclosure of financial information about an entity’s operating segments.

• Operating segments are identified on the basis of the components of the organisation that the chief operating decision maker reviews in making decisions about resources to be allocated to the segments, and as part of the process of assessing their performance.


Summary (cont.)

• Once a component of an entity is deemed to be an operating segment, quantitative criteria are provided to determine whether the segment is reportable (any of 10 per cent of total segment revenues; 10 per cent of the absolute amount of the greater of total profitable segments’ profit or the total of the loss making segments’ losses; 10 per cent of total segment assets).

• In addition, ‘reportable segments’ are required to constitute not less than 75 per cent of the entity’s total revenues.


Summary (cont.)

• In providing financial information about operating segments’ revenues, profits, assets and liabilities, the entity is to provide measurements that utilise the amounts used for internal decision making.

• That is, segment disclosures do not have to be based on the measurements that are required to be used to generate the entity’s financial statements.


Summary (cont.)

• AASB 8 requires a number of financial disclosures relating to reportable segments. It also requires reconciliations of total reportable segment revenues, total profit or loss, total segment liabilities and total segment assets to corresponding amounts in the entity’s financial statements.

• AASB 8 also requires a number of entity-wide disclosures. Such disclosures relate to the entity’s products and services, geographical information, and information about major customers.

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