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This article was first published in the November/December 2007 edition of Accounting and Business magazine.
In November 2006 the IASB issued IFRS 8, Operating Segments. The issue of this international financial reporting standard (IFRS) is as a result of ongoing dialogue between the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB). IFRS8 is very close to SFAS 131 - the equivalent US standard. It would appear that one of the reasons for the changed standard was a goodwill gesture to the US authorities in order to facilitate a speedy removal of the 'reconciliation requirement' that is currently in place for entities seeking a listing on the US capital markets.
The scope of the standard
IFRS 8 applies to the financial statements of any entity whose debt or equity instruments are traded in a public market or who is seeking to issue any class of instruments in a public market. Other entities that choose to disclose segment information should make the disclosures in line with IFRS 8 if they describe such disclosures as 'segment information'.
Identification of operating segments
IFRS 8 defines an operating segment as a component of an entity:
- that engages in revenue earning business activities
- whose operating results are regularly reviewed by the chief operating decision maker. The term 'chief operating decision maker' is not as such defined in IFRS8 as it refers to a function rather than a title. In some entities the function could be fulfilled by a group of directors rather than an individual and
- for which discrete financial information is available.
This definition means that not every part of an entity is necessarily an operating segment. IFRS 8 quotes the example of a corporate headquarters that may earn no or incidental revenues and so would not be an operating segment.
Some commentators have criticized the 'management approach' as leaving segment identification too much to the discretion of the entity and therefore hindering comparability between financial statements of different entities.
Identification of reportable segments
Once an operating segment has been identified the entity needs to report segment information if the segment meets any of the following quantitative thresholds:
- its reported revenue (external and inter-segment) is 10% or more of the combined revenue, internal and external, of all operating segments
- its reported profit or loss is 10% or more of the greater, in absolute amount, of (i) the combined profit of all operating segments that did not report a loss and (ii) the combined loss of all operating segments that reported a loss or
- its assets are 10% or more of the combined assets of all operating segments.
IFRS 8 states that if the total external turnover reported by the operating segments identified by the size criteria is less than 75% of total entity revenue then additional segments need to be reported on until the 75% level is reached.
If segments have similar economic characteristics then they can be aggregated into a single operating segment and viewed together for the purposes of the size criteria.
An entity has identified the following business components.