💠Complex Financial Structures Unit 10 – Segment Reporting & Disclosures

Key Concepts and Definitions

• Segment reporting provides disaggregated financial information about a company's operating segments
• Operating segments are components of a company that engage in business activities from which they may earn revenues and incur expenses
• Reportable segments are operating segments that meet certain quantitative thresholds and are required to be separately disclosed in financial statements
  • Quantitative thresholds include revenue, profit or loss, and assets
• Segment managers are responsible for the performance and resource allocation decisions of their respective segments
• Segment disclosures enhance transparency and provide insights into the different business activities and economic characteristics of a company
• Segment reporting allows users to assess the performance, risks, and opportunities of each significant component of the company
• Materiality concept applies to segment reporting, requiring disclosure of segments that are significant to the company as a whole

Regulatory Framework

• Segment reporting is governed by various accounting standards and regulations, such as IFRS 8 and ASC 280
• IFRS 8 "Operating Segments" is the international standard that sets out the principles for identifying and reporting operating segments
  • Adopted by companies following International Financial Reporting Standards (IFRS)
• ASC 280 "Segment Reporting" is the U.S. GAAP standard that prescribes the disclosure requirements for segment reporting
  • Applicable to companies following U.S. Generally Accepted Accounting Principles (U.S. GAAP)
• The standards aim to provide users with relevant and decision-useful information about a company's operating segments
• The "management approach" is central to segment reporting, requiring segments to be identified based on internal reporting and how the chief operating decision maker (CODM) views the business
• Consistency and comparability of segment information across companies within the same industry are important considerations in the regulatory framework

Segment Identification Criteria

• Operating segments are identified based on the "management approach" prescribed by the accounting standards
• The chief operating decision maker (CODM) plays a crucial role in identifying operating segments
  • CODM allocates resources to and assesses the performance of the operating segments
• Operating segments typically have a segment manager who is directly accountable to the CODM and maintains regular contact with them
• Segments are determined based on the internal reporting structure and how the CODM evaluates financial information for decision-making purposes
• Aggregation criteria allow companies to combine operating segments with similar economic characteristics into a single reportable segment
  • Similar economic characteristics include the nature of products or services, production processes, customer types, distribution methods, and regulatory environments
• Segments that do not meet the quantitative thresholds for separate disclosure can be combined into an "all other segments" category

Reportable Segments

• Reportable segments are operating segments that meet certain quantitative thresholds specified in the accounting standards
• The quantitative thresholds are based on revenue, profit or loss, and assets of the individual segments relative to the company as a whole
  • Revenue threshold: Segment revenue (including both external and intersegment revenue) is 10% or more of the combined revenue of all operating segments
  • Profit or loss threshold: Segment's absolute profit or loss is 10% or more of the greater, in absolute amount, of the combined reported profit of all profitable operating segments or the combined reported loss of all loss-making operating segments
  • Assets threshold: Segment assets are 10% or more of the combined assets of all operating segments
• Segments that meet any of the above thresholds are considered reportable and must be separately disclosed in the financial statements
• The 75% test ensures that the total external revenue of the reportable segments constitutes at least 75% of the company's total consolidated revenue
  • If the 75% threshold is not met, additional segments must be identified as reportable until the threshold is satisfied

Measurement and Allocation Methods

• Segment information is reported using the same accounting policies as those used for the company's consolidated financial statements
• Segment revenue includes both external revenue from transactions with third parties and intersegment revenue from transactions between segments of the same company
  • Intersegment revenue is based on transfer prices between operating segments and is eliminated in the consolidated financial statements
• Segment expenses are those that are directly attributable to the segment or can be reasonably allocated to the segment
  • Allocation methods for common costs (shared expenses) should be reasonable, consistently applied, and disclosed in the financial statements
• Segment assets include those assets that are directly attributable to the segment or can be reasonably allocated to the segment
  • Allocation of shared assets among segments should be based on a reasonable and consistent methodology
• Non-current assets, such as property, plant, and equipment, are typically allocated to segments based on their physical location or the segment that primarily benefits from their use
• Segment liabilities are not required to be disclosed under IFRS 8 but may be reported if such information is regularly provided to the CODM

Disclosure Requirements

• Companies are required to disclose information about their reportable segments in the notes to the financial statements
• Disclosure requirements include general information about how the operating segments were determined and the products and services offered by each segment
• Financial information to be disclosed for each reportable segment includes:
  • External revenue
  • Intersegment revenue
  • Segment profit or loss
  • Segment assets
  • Other material items (depreciation, amortization, significant non-cash items)
• Reconciliations of segment amounts to the consolidated financial statements are required to explain the differences between segment reporting and the company's overall results
• Entity-wide disclosures, such as information about products and services, geographical areas, and major customers, are required regardless of the company's organizational structure
  • Geographical information includes revenue from external customers and non-current assets attributed to the company's country of domicile and foreign countries
  • Major customer disclosure is required if revenue from a single external customer amounts to 10% or more of the company's total revenue

Practical Applications

• Segment reporting provides valuable insights into the performance and risks of different business units within a company
• Investors and analysts use segment information to assess the growth potential, profitability, and cash flow generation of each segment
  • Helps in making informed investment decisions and understanding the company's overall value
• Management uses segment reporting to evaluate the performance of individual business units and make resource allocation decisions
  • Identifies underperforming segments that may require restructuring or divestment
• Segment information assists in understanding the company's diversification strategy and the balance of its portfolio of businesses
• Comparability of segment information across companies within the same industry allows for benchmarking and peer analysis
  • Helps identify industry trends, market share, and competitive positioning
• Segment reporting enhances transparency and accountability by providing a more detailed view of the company's operations
  • Enables stakeholders to assess the company's risk profile and the sustainability of its business model

Challenges and Considerations

• Determining the appropriate level of aggregation or disaggregation of operating segments can be challenging
  • Requires judgment in assessing the similarity of economic characteristics and the relevance of segment information to users
• Consistency and comparability of segment information across periods and companies may be affected by changes in organizational structure, segment composition, or measurement methods
  • Restatement of prior period segment information may be necessary to maintain comparability
• Transfer pricing policies between segments can impact the reported segment profit or loss and should be carefully considered
  • Arm's length principle should be applied to ensure the reasonableness of intersegment transactions
• Allocation of common costs and assets to segments requires judgment and may affect the comparability of segment information
  • Allocation methodologies should be reasonable, consistently applied, and clearly disclosed
• Segment reporting may be subject to management bias, as the determination of operating segments and the allocation of resources are based on the management approach
  • Robust internal controls and governance mechanisms are necessary to ensure the integrity and reliability of segment information
• Disclosure of sensitive or strategic information through segment reporting may be a concern for companies operating in highly competitive industries
  • Need to balance transparency with the protection of commercially sensitive information