SEGMENT REPORTING

Introduction

An IFRS 8 Operating segment requires disclosure of information about operating segments.

The purpose is to enable users of the 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.

IFRS 8 defines an operating segment as a component of an entity:

That engages in business activities from which it may earn revenues and incur expenses

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

For which discrete financial information is available.

Reportable segments

An entity’s reportable segments (its operating segments) are those that are used in its internal management reports. Therefore management identifies the operating segments.

Start-up operations may be operating segments even before they begin to earn revenue.

A part of an entity that only sells goods to other parts of the entity is a reportable segment if management treats it as one.

Corporate headquarters and other similar departments do not earn revenue and are therefore not operating segments. An entity’s pension plan is not an operating segment.

Management may use more than one set of segment information. For example, an entity can analyse information by classes of business (different products or services) and by geographical areas.

If management uses more than one set of segment information, it should identify a single set of components on which to base the segmental disclosures. The basis of reporting information should be the one that best enables users to understand the business and the environment in which it operates.

Operating segments can be combined into one reportable segment provided that they have similar characteristics.

Quantitative thresholds

Any segment that meets any of the following quantitative threshold: should be treated as a reportable segment

Its reported revenue, including both sales to external customers and inter-segment sales, is ten per cent or more of the combined revenue of all operating segments

Its reported profit or loss is ten per cent or more of the greater, in absolute amount, of:

The combined reported profit of all operating segments that did not report a loss and

The combined reported loss of all operating segments that reported a loss.

Its assets are ten per cent or more of the combined assets of all operating segments.

At least 75% of the entity’s external revenue should be included in reportable segments. So if the quantitative test results in segmental disclosure of less than this 75%, other segments should be identified as reportable segments until this 75% is reached.

Information about other business activities and operating segments that are not reportable are combined into an ‘all other segments’ category.

There is no precise limit to the number of segments that can be disclosed, but if there are more than ten, the resulting information may become too detailed

Although IFRS 8 defines a reportable segment in terms of size, size is not the only criterion to be taken into account. There is some scope for subjectivity.

Illustration

Diverse carries out a number of different business activities. Summarized information is given below.

Revenue Profit Total

Before tax assets

Manufacture and sale of $m $m $mcomputer hardwareDevelopment and supply of 83 32 34bespoke software:

to users of the company’shardware products 22 12 6to other users 5 3 1Technical support and training 10 2 4Contract work on informationtechnology products 30 10 10

150 50 55

Which of the company’s activities should be identified as separate/reportable operating segments?

Illustration solution

Manufacture and sale of computer hardware and contract work on information technology products are clearly reportable segments by virtue of size. Each of these two operations exceeds all three ‘ten per cent thresholds’.

On the face of it, it appears that development of bespoke software is a third segment. It would make logical sense for both parts of this operation to be reported together, as supply to users of other hardware forms only three per cent of total revenue and six per cent of total profit before tax.

Although technical support and training falls below all three ‘ten per cent thresholds’, it should be disclosed as a fourth reportable segment if (as seems likely) management treat it as a separate segment because it has different characteristics from the rest of the business.

INDENTIFYING REPORTABLE SEGMENT

The ‘managerial approach’

The ‘managerial’ approach bases both the segments reported and the information reported about them on the information used internally for decision making. This means that management defines the reportable segments.

Arguments for the ‘managerial approach’ include the following.

Segments based on an entity’s internal structure are less subjective than those identified by the ‘risks and returns’ approach.

It highlights the risks and opportunities that management believes are important.

It provides information with predictive value because it enables uses of the financial statements to see the entity through the eyes of management.

The cost of providing the information is low (because it should already have been provided for management’s use).

It will produce segment information that is consistent with the way in which management discuss their business in other parts of the annual report (e.g. in the Chairman’s Statement and the Operating and Financial Review).

Arguments against the ‘managerial approach’ include the following.

Segments based on internal reporting structures are unlikely to be comparable between entities and may not be comparable from year to year for an individual entity. (For example, organization structures, or the way in which they are perceived, may change as a result of new managers being appointed.)

The information is likely to be commercially sensitive (because entities are organized strategically).

In theory, segmental information could be given other than by products or services or geographically. This might be more difficult to analyze.

Using the managerial approach could lead to segments with different risks and returns being combined.

Analysts define their area of expertise by industry segment, usually based on product or service.

Disclosing reportable segment

General information

IFRS 8 requires disclosure of the following.

Factors used to identify the entity’s reportable segments, including the basis of organization (for example, whether segments are based on products and services, geographical areas or a combination of these).

The types of products and services from which each reportable segment derives its revenues.

Information about profit it or loss and other segment items

For each reportable segment an entity should report:

a measure of profit or loss a measure of total assets a measure of total liabilities (if such an amount is regularly

used in decision making).

IFRS 8 does not define segment revenue, segment result (profit or loss) or segment assets.

Therefore, the following amounts must be disclosed if they are included in segment profit or loss:

revenues from external customers

revenues from inter-segment transactions interest revenue interest expense depreciation and amortization material items of income and expense (exceptional items) interests in the profit or loss of associates and joint

ventures accounted for by the equity method income tax expense material non-cash items other than depreciation or

amortization.

Interest revenue can be disclosed net of interest expense only if a majority of the segment’s revenues are from interest and net interest revenue is used in decision making.

The following amounts must be disclosed if they are included in segment assets:

investments in associates and joint ventures accounted for by the equity method

amounts of additions to non-current assets other than financial instruments.

An entity must provide reconciliations of the totals disclosed in the segment report to the amounts reported in the financial statements as follows:

segment revenue

segment profit or loss (before tax and discontinued operations unless these items are allocated to segments)

segment assets

segment liabilities (if reported)

any other material item of segment information disclosed.

Entity Wide disclosure

IFRS 8 also requires the following disclosures about the entity as a whole, even if it only has one reportable segment.

The revenues from external customers for each product and service or each group of similar products and services.

Revenues from external customers split between the entity’s country of domicile and all foreign countries in total.

Non-current assets split between those located in the entity’s country of domicile and all foreign countries in total.

Revenue from a single external customer which amounts to ten per cent or more of an entity’s revenue. The identity of the customer does not need to be disclosed.

Measurement

IFRS 8 requires segmental reports to be based on the information reported to and used by management, even where this is prepared on a different basis from the rest of the financial statements.

Therefore, an entity must provide explanations of the measurement of segment profit or loss, segment assets and segment liabilities, including:

the basis of accounting for any transactions between reportable segments

the nature of differences between the measurement of segment profit or loss, assets and liabilities and the amounts reported in the financial statements. Differences could result from accounting policies and/or policies for the allocation of common costs and jointly used assets to segments

the nature of any changes from prior periods in measurement methods

the nature and effect of any asymmetrical allocations to segments (for example, where an entity allocates depreciation expense but not the related non-current assets).

Preparing segmental reports

The illustration provides a useful format to follow when preparing a segmental report.

Format

Segment Segment Segment Segment All TotalsOther

A B C D $000 $000 $000 $000 $000 $000

Revenues fromExternal 5,000 9,500 12,000 5,000 1,000 32,500customersRevenues frominter-segment - 3,000 1,500 - - 4,500transactionsinterest revenue 800 1,000 1,500 1,000 - 4,300interest expense 600 700 1,100 - - 2,400Depreciationandamortization 100 50 1,500 900 -

2,500

Exceptional - - - 200 - 200costsSegment profit 70, 900 2,300 500 100 3,870Impairment of 200 - - - - 200assetsSegment assets 5,000 3,000 12,000 57,000

2,000 79,000Additions to non- 700 500 800 600 - 2,600current assetsSegment 3,000 1,800 8,000 30,000 - 42,800 Liabilities

Notes

1) The ‘all other’ column shows amounts relating to segments that fall below the quantitative thresholds.

2) Impairment of assets is disclosed as a material non-cash item.

3) Comparatives should be provided. These should be restated if an entity changes the structure of its internal organization so that its reportable segments change, unless the information is not available and the cost of preparing it would be excessive.

Problem areas in segmental reportingSegmental reports can provide useful information, but they also haveimportant limitations.

IFRS 8 states that segments should reflect the way in which the entity is managed. This means that segments are

defined by the directors. Arguably, this provides too much flexibility. It also means that segmental information is only useful for comparing the performance of the same entity over time, not for comparing the performance of different entities.

Common costs may be allocated to different segments on whatever basis the directors believe is reasonable. This can lead to arbitrary allocation of these costs.

A segment’s operating results can be distorted by trading with other segments on non-commercial terms.

These limitations have applied to most systems of segmental reporting, regardless of the accounting standard being applied. IFRS 8 requires disclosure of some information about the way in which common costs are allocated and the basis of accounting for inter-segment transactions.

IFRS 1 Firstime Adoptions

Introduction

IFRS I First-time adoption of international financial reporting standards sets out the procedures to follow when an entity adopts IFRS in its published financial statements for the first time.

Before adopting IFRS it will have applied its own national standards. This is called previous GAAP.

Definition

A first-time adopter is an entity that, for the first time, makes an explicit and unreserved statement that its annual financial statements comply with IFRS.

There are five issues that need to be addressed when adopting IFRS.

1. Date of transition

Definition

The date of transition is the beginning of the earliest period for which an entity presents full comparative information under IFRS in its first IFRS financial statement i.e.

IFRS should be applied from the first day of the first set of financial statements published in compliance with IFRS. This is called the opening IFRS statement of financial position.

IFRS require comparative statements to be published. The opening IFRS statement of financial position for an entity adopting IFRS for the first time in its 31 December 2012 financial statements and presenting one year of comparative

information will bet 1st January, 2011. This is the transaction date-the first day of the earliest comparative period.

The opening IFRS statement of financial position itself need not be published, but it will provide the opening balances for the comparative period (i.e. statement of financial position as at 1st January, 2011.

If full comparative financial statements for preceding periods are published, then these too must comply with IFRS.

If only selected information is disclosed about preceding periods, then these need not comply with IFRS. However, this noncompliance must be disclosed.

2. Which IFRS?

The entity should use the same accounting policies for all the periods presented; these policies should be based solely on IFRS in force at the reporting date. (The term IFRS includes any lAS and Interpretations still in force.)

A major problem for entities preparing for the change-over is that IFRSs themselves keep changing.

Entities will have to collect information enabling them to prepare statements under previous GAAP, current IFRS and any proposed new standards or amendments.

IFRS I states that the opening IFRS statement of financial position must: recognize all assets and liabilities required by IFRS not recognize assets and liabilities not permitted by

IFRS reclassify all assets, liabilities and equity components in

accordance with IFRS measure all assets and liabilities in accordance with

IFRS.

3. Reporting gain and losses Any gains or losses arising on the adoption of IFRS should be recognized directly in retained earnings,

4. Explanations and disclosures Entities must explain how the transition to IFRS affects

their reported financial performance, financial position and cash flows. Two main disclosures are required, which reconcile equity and profits.

(a) The entity’s equity as reported under previous GAAP must be reconciled to the equity reported under IFRS at two dates.

i. The date of transition. This is the opening reporting date.

ii. The last statement of financial position prepared under previous GAAP.

(b) The last annual reported under previous GAAP must be reconciled to the same year’s total comprehensive income prepared under IFRS.

Any material differences between the previous GAAP and the IFRS cash flows must also be explained.

When preparing its first IFRS statements, an entity may identify errors made in previous years, or make or reverse impairments of assets. These adjustments must be disclosed separately.

Improvements to IFRS issued May 2010 clarified the following points:

When an entity changes an accounting policy after issue of interim statements, but before the first set of IFRS annual statements, it must explain those changes and update reconciliations between previous GAAP applied

and IFRS. lAS 8 relating to change of accounting policy does not apply to such changes.

An entity adopting IFRS for the first time is able to use revaluation basis for deemed cost at the measurement date (usually the start of the accounting period) based upon measurement events that occurred at any point during the period covered by the first IFRS financial statements.

An entity adopting IFRS for the first time may elect to use the previous GAAP carrying amount for items of property, plant and equipment or intangible assets that were used in operations subject to rate regulation.

The above three points, are effective for accounting periods commencing on or after 1 January 2011, although earlier adoption is permitted.

5. ExemptionsIFRS 1 grants limited exemptions in situations where the cost of compliance would outweigh the benefits to the user. For example:

(a) Previous business combinations do not have to be restated in accordance with IFRS. In particular, mergers (pooling of interests) do not have to be re-accounted for as acquisitions, previously written off goodwill does not have to be reinstated and the fair values of assets and liabilities may be retained. However, an impairment test for any remaining goodwill must be made in the opening statement of financial position.

(b) ED 2009/11 Improvements to IFRS issued in August 2009 identifies that, if there are any changes to accounting policies in the first year of adoption of )FRS, but after the issue of the first interim statements, the changes need to be explained and reconciliations required should also be updated.

(c) ED 2009/11 also confirms that revaluations used as a basis for deemed cost may arise during the period covered by the first IFRS financial statements, rather than having been done in the period prior to this. Normally, deemed cost would be either fair value, determined in accordance with lAS 39, or the carrying value under previous national standards.

(d) An entity may elect to use fair values for property, plant and equipment, investment properties and intangibles as the deemed cost under IFRS. This fair value may have been a market-based revaluation or an indexed amount. This means that even if the cost model is used for these assets under IFRS, this valuation can be used to replace cost initially. Therefore, the entity can use fair value as the deemed cost but then not have to revalue the assets each year.

(e) Some actuarial gains and losses on pension schemes are left ‘unrecognised under lAS 19 Employee benefits. A first-time adopter may find it easier to recognise all gains and losses at the date of transition and this option is given in IFRS 1.

(f) Past currency translation gains and losses included in revenue reserves need not be separated out into the currency translation reserve.

(g) Under lAS 32 Financial instruments: presentation part of the proceeds of convertible debt is classified as equity. If the debt had been repaid by the date of transition, no adjustment is needed for the equity component.

(h) If a subsidiary adopts IFRS later than its parent, then the subsidiary may value its assets and liabilities either at its own transition date its parent’s transition date (which would normally be easier).

Note There are also three situations where retrospective application of IFRS is prohibited. These relate to derecognition of financial assets and liabilities, hedging and estimates.

The IASB thought that it would be impractical to obtain the information necessary to restate past financial statements, and that restating past fair values and estimates was open to manipulation.

Implications of adoption of IFRSThere are a number of considerations to be made when adopting IFRS for the first time. The key factors on converting from local GAAP to IFRS are discussed below.

Factors to consider in implementing IFRS

Initial evaluation

The transition to IFRS requires careful and timely planning. Initially there are a number of questions that must be asked to assess the current position within the entity.

a) Is there knowledge of IFRS within the entity?

b) Are there any agreements (such as bank covenants) that are dependent on local GAAP?

c) Will there be a need to change the information systems?

d) Which IFRSs will affect the entity?

e) Is this an opportunity to improve the accounting systems?

Once the initial evaluation of the current position has been made, the entity can determine the nature of any assistance required.

They may need to:

engage IFRS experts for assistance. Such experts can provide staff training and assistance on the preparation of the opening statement of financial position and first set of accounts. They can inform the entity of the information that will be needed to ensure a smooth transition to IFRS. It is essential that the entity personnel understand the key differences between local GAAP and IFRS and in particular the IFRS that will most affect the entity

inform key stakeholders of the impact that IFRS could have on reported performance. This includes analysts, bankers, loan creditors and employees. Head office personnel will not be the only staff to require training; managers of subsidiaries will need to know the impact on their finance functions as there will be budgeting and risk management issues

produce a project plan that incorporates the resource requirements, training needs, management teams and timetable with a timescale that ensures there is enough time to produce the first IFRS financial statements

investigate the effect of the change on the computer systems. Establish if the current system can easily be changed and, if not, what the alternatives will be. Potentially the IT cost could be significant if changes need to be made.

Other considerations

Aside from the practical aspect of implementing the move to IFRS, there are a number of other factors to consider:

(i) Debt covenants The entity will have to consider the impact of the

adoption of IFRS on debt covenants and other legal contracts.

Covenants based on financial position ratios (for example the gearing ratio) and income statement

measures such as interest cover will probably be affected significantly by the adoption of IFRS.

Debt covenants may need to be renegotiated and rewritten, as it would not seem to be sensible to retain covenants based on a local GAAP if this is no longer to be used.

(ii) Performance related pay There is a potential impact on income of moving to IFRS,

which causes a problem in designing an appropriate means of determining executive bonuses, employee performance related pay and long-term incentive plans.

With the increase in the use of fair values and the potential recycling of gains and losses under IFRS (e.g. lAS 21 The effects of changes in foreign exchange rates), the identification of relevant measures of performance will be quite difficult.

If there are unrealisecl profits reported in the income statement/statement of comprehensive income, the entity will not wish to pay bonuses on the basis of profits that may never be realised in cash.

There may be volatility in the reported figures, which will have little to do with financial performance but could result in major differences in the pay awarded to a director from one year to another.

(iii) Views of financial analysts

It is important that the entity looks at the way it is to communicate the effects of a move to IFRS with the markets and the analysts.

The focus of the communication should be to provide assurance about the process and to quantify the changes expected. Unexpected changes in ratios and profits could adversely affect share prices.

Presentations can be made to interested parties of the potential impact of IFRS. Analysts should have more transparent andcomparable data about multinational entities once IFRS has been adopted.

Consistency over account classifications, formats, disclosures and measurement will assist the analyst’s interpretation.

Analysts will be particularly concerned about earnings volatility that may affect how they discount future profits to arrive at a present fair value for the business.

Benefits of harmonisationThere are a number of reasons why the harmonisation of accounting standards would be beneficial. Businesses operate on a global scale and investors make investment decisions on a worldwide basis. There isthus a need for financial information to be presented on a consistent basis. The advantages are as follows.

(1) Multi-national entitiesMulti-national entities would benefit from closer harmonisation for the following reasons.

(a) Access to international finance would be easier as financial information is more understandable if it is prepared on aconsistent basis.

(b) In a business that operates in several countries, the preparation of financial information would be easier as it would all beprepared on the same basis.

(c) There would be greater efficiency in accounting departments.

(d) Consolidation of financial statements would be easier.

(2) Investors

If investors wish to make decisions based on the worldwide availability of investments, then better comparisons between entities are required. Harmonisation assists this process, as financial information would be consistent between different entities from different regions.

(3) International economic groupingsInternational economic groupings, e.g. the EU, could work more effectively if there were international harmonisation of accounting practices. Part of the function of international economic groupings is to make cross-border trade easier. Similar accounting regulations would improve access to capital markets and therefore help this