This article was first published in the November/December 2007 edition of Accounting and Business magazine.
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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.
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|Total for the entity||98,000||45,000||16,500||87,000|
Which of the segments would be reportable under the criteria identified in IFRS 8?
Components 1 and 2 would be separately reportable since they meet all three size criteria. Components 3 and 4 do not meet any of the size criteria and on the face of it are not separately reportable. The external revenue of component 1 is 82% of the total external revenue so the '75% threshold' is comfortably achieved. However if they had similar economic characteristics then when aggregated they would be over the 10% threshold for revenue and so could be reported as a combined segment.
IFRS 8 requires that current period and comparative segment information be reported consistently. This means that if a segment is identified as reportable in the current period but was not in the previous period then equivalent comparative information should be presented unless it would be prohibitively costly to obtain.
IFRS 8 gives entities discretion to report information regarding segments that do not meet the size criteria. Entities can report on such segments where, in the opinion of management, information about the segment would be useful to users of the financial statements.
Disclosures by reportable operating segments
IFRS 8 provides a framework on which to base the reported disclosures.
- Entities are required to provide general information on such matters as how the reportable segments are identified and the types of products or services from which each reportable segment derives its revenue.
- Entities are required to report a measure of profit or loss and total assets for each reportable segment. Both should be based on the information provided to the chief operating decision maker. If the chief operating decision maker is regularly provided with information on liabilities for its operating segments then these liabilities should also be reported on a segment basis.
IFRS 8 specifies disclosures that are needed regarding profit or loss and assets where the amounts are included in the measure of profit or loss and total assets:
- Revenues - internal and external.
- Interest revenues and interest expense. These must not be netted off unless the majority of a segment's revenues are from interest and the chief operating decision maker assesses the performance of the segment based on net interest revenue.
- Depreciation and amortization.
- Material items of income and expense disclosed separately.
- Share of profit after tax of, and carrying value of investment in, entities accounted for under the equity method.
- Material non-cash items other than depreciation and amortization.
- The amount of additions to non-current assets other than financial instruments, deferred tax assets, post-employment benefit assets and rights arising under insurance contracts.
The measurement basis for each item separately reported should be the one used in the information provided to the chief operating decision maker. The internal reporting system may use more than one measure of an operating segment's profit or loss, or assets or liabilities. In such circumstances the measure used in the segment report should be the one that management believes is most consistent with those used to measure the corresponding amounts in the entity's financial statements.
Entities are required to provide a number of reconciliations:
- the total of the reportable segments' revenues to the entity's revenue
- the total of the reportable segments' profit or loss to the entity's profit or loss
- the total of the reportable segments' assets to the entity's assets
- where separately identified, the total of the reportable segments' liabilities to the entity's liabilities and
- the total of the reportable segments' amounts for every other material item disclosed to the corresponding amount for the entity.
Unless otherwise provided in the segment report IFRS 8 requires entities to provide information about its revenue on a geographical and 'class of business' basis. Entities also need to provide information on non-current assets on a geographical basis, but not on a 'class of business' basis.
If revenues from single external customer amount to 10% or more of the total revenue of the entity then the entity needs to disclose that fact plus:
- the total revenue from each customer (although the name is not needed) and
- the segment or segment reporting the revenues.
The 'entity-wide disclosures' are needed even where the entity has only a single operating segment, and therefore does not effectively segment report.
Effective date of the standard outside the European Union
The standard applies to financial statements beginning on or after 1 January 2009. Earlier application is permitted but if this happens the entity needs to disclose that it is applying IFRS 8 early in the relevant financial statements.
Endorsement of IFRS by the European Union (EU)
For accounting periods beginning on or after 1 January 2005 listed entities within the EU are required to use adopted international standards in their consolidated financial statements. The EU has not yet adopted IFRS 8 and until it does IAS 14 will continue to apply here. Some stakeholders believe the standard to be flawed due to the amount of discretion it gives to management. In May, the European Commission carried out research into the issue of adopting IFRS 8 and presented a report to the EU on 3rd September 2007. The main conclusions were as follows.
The detailed analysis of effects of IFRS 8 has shown the following main results:
- The use of the management approach has an overall positive effect on the quality of the segment information, whose usefulness and relevance would increase.
- The increased usefulness and relevance of the segment information based on the management approach outweigh concerns expressed about the comparability of financial reports.
- IFRS 8 appropriately addresses the global needs of financial statements' users for geographical disclosures and would not reduce this information in practice compared to IAS 14.
- IFRS 8 does not create problems relating to corporate governance in the EU.
- IFRS 8 provides appropriate segment reporting rules for smaller listed companies.
The conclusion in the report was that a swift endorsement of IFRS 8 would remove uncertainty about the treatment of financial statements for the year ended 31st December 2007 and support the EU's overarching objective of IFRSs being recognised in all jurisdictions, including the US, without requirement for reconciliation. We await the decision of the EU with interest!
Paul Robins is a training consultant for Kaplan Financial - Regional Corporate Division