Operating

Segment

Intermediate Accounting 3
Introduction
- Globally, many diversified entities or entities
operating in several different industries have emerged.
Entities that previously operated in a single industry
moved into additional industries as a result of natural
growth or by acquiring other entities. These entities
diversified their operations for several reasons,
including the desire of management to spread the risks
of investment over a number of industries and product
lines to reduce dependence on any one set of suppliers
and customers.
Introduction
- When an entity is diversified, the different industry
segments in effect operate as separate entities within
an overall corporate umbrella. When a highly
diversified entity presents only total entity
information, the results of operations and growth
potential of major operating segments cannot be
analysed and compared.
Introduction
- One product or geographical area may be performing
well and another product or geographical area may not
be performing as well. It becomes necessary to present
not only a “total management performance” but also
an “individual segment performance”.
Segment Reporting
- PFRS 8 sets out the requirements for disclosure of
information about operating segments.
- The core principle of segment reporting is as
follows:
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.
Segment Reporting
- In accordance with the core principle of PFRS 8,
segment reporting is the disclosure of certain financial
information about the products and services an entity
produces and the geographical areas in which an entity
operates.
- The purpose of such disclosure is to enable investors
and users make better assessment of each business
activity leading to the understanding of the
performance of the entity as a whole.
Scope of PFRS 8
- PFRS 8 shall apply to the separate or individual
financial statements of an entity and to the
consolidated financial statements of a group with a
parent:
a. Whose debt or equity instruments are traded in a
public market
b. That files or is in the process of filing the
consolidated financial statements with a securities
commission or other regulatory organization for the
purpose of issuing any class of instruments in a public
market
Scope of PFRS 8
- However, if a financial report contains both the
consolidated financial statements of a parent and the
parent’s separate financial statements, segment
information is required only in the consolidated
financial statements.
Operating Segment
- An operating segment is a component of an entity:
a. That engages in business activities from which it
may earn revenue and incur expenses, including
revenue 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
Operating Segment
c. And for which discrete financial information is
available
- Accordingly, an operating segment can generally be
thought of as a distinguishable component of an entity
that is engaged in business activities which generate
revenue and incur expenses.
- Moreover, to be classified as an operating segment,
separate financial information must be available about
the segment and its operating results shall be regularly
reviewed by a chief operating decision maker.
Operating Segment
- An operating segment may engage in business
activities for which it has yet to earn revenue. For
example, start-up operations may be operating
segments before earning revenue.
Operating Segment
- Not every part of an entity is necessarily an
operating segment or part of an operating segment.
For example, corporate headquarters or some
functional departments that may not earn revenue or
may earn revenue that is incidental only to the
activities of the entity would not be operating
segments.
- An entity’s post-employment benefit plan is not also
an operating segment.
Chief Operating Decision Maker
- The term “chief operating decision maker” identifies
a function and not necessarily a manager with a
specific title. This function is “to allocate resources to
the segments and assess their performance”.
- The chief operating decision maker may be the
entity’s chief executive officer, chief operating officer
or a group of executive directors depending on who
within the organization is responsible for the
allocation of resources and assessing the performance
of operating segments.
Identifying Operating Segments
- The “management approach” is used in identifying
operating segments.
- The management approach means that the operating
segments are identified on the basis of internal reports
about components of an entity that are regularly
reviewed by the chief operating decision maker in
order to allocate resources to the segment and to
assess its performance.
Identifying Operating Segments
- In other words, operating segments are identified
based on the components of the entity that are
considered to be important for internal management
reporting purposes.
- A component of entity that sells primarily or
exclusively to other operating segments is included in
the definition of an operating segment if the entity is
managed that way.
Identifying Operating Segments
- The idea is that reporting of segment information is
seen through the “eyes of management” and users
would wish to see the business as the chief operating
decision maker sees it.
- PFRS 8 has abandoned the “risks and rewards
approach” of identifying operations by business
segments and geographical segments.
Reportable Segments
- An entity shall report information about an operating
segment that meets any of the following quantitative
thresholds:
1. The segment 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.
Reportable Segments
2. The absolute amount profit or loss of the segment is
10% or more of the greater in absolute amount of:
a. Combined profit of all operating segments that
reported a profit
b. Combined loss of all operating segments that
reported a loss
Reportable Segments
3. The assets of the segment are 10% 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 on a voluntary basis if
management believes that information about the
segment would be useful to the users of the financial
statements.
Overall Size Test – 75% Threshold
- If the total external revenue of reportable operating
segments constitutes less than 75% of the entity
external revenue, additional operating segments shall
be identified as reportable segments even if they do
not meet the 10% quantitative thresholds until at least
75% of the entity external revenue is included in
reportable segments.
Aggregation of Segments
- Two or more operating segments may be aggregated
into a “single operating segment” if the segments have
similar economic characteristics and the segments
share a majority of the following five aggregation
criteria:
Aggregation of Segments
a. Nature of product or service
b. Nature of production process
c. Type or class of customers
d. Marketing method or the method used to distribute
the product
e. The nature of the regulatory environment, for
example, banking, insurance or public utility
Aggregation
- Two or more operating segments may be aggregated
into “one reportable segment” to achieve the “75% of
entity external revenue” threshold. However, the
operating segments to be aggregated must have similar
economic characteristics and share a majority of the
five aggregation criteria.
Limit to the Number of Segments
- There may be a practical limit to the number of
reportable segments to be disclosed separately by an
entity beyond which segment information may
become too detailed.
- Although no precise limit has been determined, as
the number increases above ten, the entity shall
consider whether a practical limit has been reached.
- If the number of reportable segments exceeds ten, it
is likely that the information may become too detailed
and consequently lose its usefulness.
Segment No Longer Reportable
- If the management judges that an operating segment
identified as a reportable segment in the immediately
preceding period is of continuing significance,
information about the segment shall continue to be
reported separately in the current period even if it no
longer meets any of the 10% quantitative thresholds
for reportability.
Segment Becoming Reportable
- If an operating segment is identified as a reportable
segment in the current period in accordance with the
10% quantitative thresholds, segment data for a prior
period presented for comparative purposes shall be
restated to reflect the newly reportable segment even if
that segment did not satisfy any of the quantitative
thresholds in the period.
- However, prior period segment information shall not
be restated if the necessary information is not
available and the cost to develop it would be
excessive.
Information to be Disclosed
for each Segment
- An entity shall disclose the following for each
reportable operating segment:
1. General information about the operating segment
2. Information about profit or loss, including specified
revenue and expenses included in the measure of profit
or loss, segment assets, segment liabilities and the basis
of measurement
3. Reconciliations of the totals of segment revenue,
profit or loss, segment assets, segment liabilities and
other material segment items to corresponding items in
the entity’s financial statements
Disclosure about
General Information
- An entity shall disclose the following general
information about an operating segment:
1. Factors used to identify the reportable segments,
including the basis of organization
2. Type of products and services from which each
reportable segment derives its revenue
Examples of Disclosure about the
Type of Products and Services
- An entity has three reportable operating segments,
namely car parts, motor vessels and software.
- The car parts segment produces replacement parts
for sale to car parts retailer.
- The motor vessels segment produces small motor
vessels to serve the offshore oil industry and similar
businesses
- The software segment produces application software
for sale to computer manufacturers and retailers
Disclosure of Profit or Loss, Assets
and Liabilities
- An entity shall disclose for each reportable segment
a measure of profit or loss, total assets and total
liabilities.
- An entity shall disclose a measure of profit or loss
under all circumstances.
- However, an entity shall disclose a measure of total
assets and total liabilities for each reportable segment
if such an amount is regularly provided to the chief
operating decision maker
Profit or Loss Disclosures
- An entity shall disclose the following if the specified
amounts are included in the measure of segment profit
or loss or otherwise regularly provided to the chief
operating decision maker even if not included in the
measure of segment profit or loss:
1. Revenue from external customers
2. Revenue from transactions with other operating
segments of the entity
3. Interest revenue
4. Interest expense
Profit or Loss Disclosures
5. Depreciation and amortization
6. Material items of income and expenses as required
by paragraph 97 of PAS 1
7. The entity’s interest in the profit or loss of associate
and joint venture accounted for by the equity method
8. Income tax expense
9. Material noncash items other than depreciation and
amortization
Profit or Loss Disclosures
- Interest revenue and interest expense must be
reported separately, unless a majority of the segment
revenue is interest.
- However, the chief operating decision maker relies
primarily on net interest revenue in assessing the
performance of the segment and in making decisions
about resources to be allocated to the segment.
Profit or Loss Disclosures
- The specified amounts are disclosed because these
are included in the measure of profit or loss reviewed
by the chief operating decision maker or otherwise
regularly provided to the chief operating decision
maker even if not included in the measure of profit or
loss.
Segment Revenue and
Segment Expense
- PFRS 8 does not define any more segment revenue
and segment expense. As a consequence, entities shall
have a wide discretion in determining the
measurement of these items.
- PFRS 8 simply states that the amount of segment
revenue and segment expense shall be the measure
reported to the chief operating decision maker. The
definition in the old standard may be of help.
Segment Revenue and
Segment Expense
- Segment revenue is revenue that is directly
attributable to a segment and the relevant portion of
entity revenue that can be allocated on a reasonable
basis to the segment. Specifically, segment revenue
includes sales to external customers and intersegment
sales.
- Segment expense is expense resulting from the
operating activities of the segment that is directly
attributable to the segment and the portion of an
expense that can be allocated on a reasonable basis to
the segment.
Segment Assets
- PFRS 8 does not also define segment assets.
- The amount of total assets disclosed for a reportable
segment shall be the measure reported to the chief
operating decision maker. The old definition of
segment assets may be of help.
Segment Assets
- Segment assets are those operating assets that are
employed by a segment in its operating activities that
are either directly attributable to the segment or can be
allocated to the segment on a reasonable basis.
- Examples of segment assets include current assets
that are used in the operating activities of the segment,
property, plant and equipment, intangible assets and
goodwill directly attributable to segment.
Disclosure not Required
- Segment assets such as deferred tax assets, post-
employment benefit assets, financial instruments, and
rights arising under insurance contracts are not
required to be disclosed.
Specific Information about
Segment Assets
- An entity shall disclose for each reportable segment
the following if the specified amounts are included in
the measure of total assets or if not included, are
regularly provided to the chief operating decision
maker:
1. The amount of investment in associate and joint
venture accounted for by the equity method
2. The amount of additional to non-current assets,
other than financial assets, deferred tax assets, post-
employment benefit assets, and rights arising under
insurance contracts
Segment Liabilities
- PFRS 8 does not also define segment assets.
- The amount of total liabilities disclosed for a
reportable segment shall be the measure reported to
the chief operating decision maker. The old definition
of segment liabilities may be of help.
- Segment liabilities are those liabilities that result
from the operating activities and that are either
directly attributable to the segment or can be allocated
to the segment on a reasonable basis.
Segment Liabilities
- Examples of segment liabilities include trade and
other payables, accrued liabilities, customer advances,
product warranty liabilities and other claims relating
to provision of goods and services.
Reconciliations
- An entity shall provide reconciliations of segment
amounts and amounts shown in the entity’s financial
statements related to all of the following:
1. The total revenue of all reportable segments to the
entity revenue
2. The total profit or loss of all reportable segments to
the entity profit or loss before income tax expense and
discontinued operations
Reconciliations
3. The total assets of all reportable segments to the
entity total assets
4. The total liabilities of all reportable segments to the
entity total liabilities
5. The total for every other material item of
information disclosed by the reportable segments to
the corresponding amount for the entity
Change in Internal Organization
- If an entity changes the structure of its internal
organization in a manner that causes the composition
of its reportable segments to change, the
corresponding information for earlier periods,
including interim periods, shall be restated.
- However, no restatement is made if the
corresponding information for earliest periods is not
available and the cost to develop it would be
excessive.
Entity-Wide Disclosures
- Additional information that is required to be
disclosed by all entities if such information is not
provided as part of the reportable segment information
- An entity shall disclose information about the
following:
1. Information about products and services
2. Information about geographical areas
3. Information about major customers
Revenue from Products and Services
- An entity shall disclose the revenue from external
customers for each product and service, or each group
of similar products and services, unless the necessary
information is not available and the cost to develop it
would be excessive
Revenue and Assets from
Geographical Areas
- An entity shall disclose the following geographical
information:
a. Revenue from external customers in the entity’s
country of domicile, and in all foreign operations in
total
b. Separate disclosure of material revenue from
external customers in an individual foreign country
Revenue and Assets from
Geographical Areas
c. The basis for attributing revenue from external
customers to individual countries
d. Non-current assets, other than financial instruments,
deferred tax assets, post-employment benefit assets
and rights under insurance contracts, located in the
entity’s country of domicile and in all foreign
countries in total
Major Customer
- A single external customer providing revenue which
amounts to 10% or more of an entity’s external
revenue
- The following shall be considered a single customer:
a. A group of entities under a common control
b. A government and entities under the control of such
government
Disclosure about Major Customer
- The major customer disclosure means that “an entity
shall provide information about the extent of its
reliance on its major customers”.
- The entity shall disclose such fact of reliance on
major customers, the total amount of revenue from
major customers and the identity of the segment or
segments reporting the revenue.
- The entity is not required to disclose the identity of
the major customer or the amount of revenue that each
segment reports from that customer.