10.1 Operating segments

Operating segments are crucial components of public entities, representing distinct business activities. They're regularly reviewed by chief operating decision makers to allocate resources and assess performance. Understanding operating segments is key to grasping a company's structure and financial reporting.

Segment reporting provides insights into a company's diverse operations and economic environments. It includes criteria for reportable segments, disclosure requirements, and challenges in allocation and reporting. This information helps investors and analysts evaluate company performance across different business units.

Definition of operating segments

• Operating segments are components of a public entity that engage in business activities from which they may earn revenues and incur expenses
• The operating results of these segments are regularly reviewed by the entity's chief operating decision maker (CODM) to make decisions about resources to be allocated and assess performance
• Operating segments often have discrete financial information available, such as revenue, expenses, assets, and liabilities, which is used for internal reporting and decision-making purposes

Criteria for reportable segments

Quantitative thresholds

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• An operating segment is considered reportable if it meets any of the following quantitative thresholds:
  • Its reported revenue, including both sales to external customers and intersegment sales or transfers, is 10% or more of the combined revenue of all operating segments
  • The absolute amount of its reported profit or loss is 10% or more of the greater, in absolute amount, of (i) the combined reported profit of all operating segments that did not report a loss and (ii) the combined reported loss of all operating segments that reported a loss
  • Its assets are 10% or more of the combined assets of all operating segments
• If the total external revenue reported by operating segments constitutes less than 75% of the entity's total consolidated revenue, additional segments must be identified as reportable until at least 75% of total consolidated revenue is included in reportable segments

Aggregation criteria

• Two or more operating segments may be aggregated into a single reportable segment if the segments have similar economic characteristics and are similar in each of the following areas:
  • The nature of the products and services
  • The nature of the production processes
  • The type or class of customer for their products and services
  • The methods used to distribute their products or provide their services
  • If applicable, the nature of the regulatory environment (banking, insurance, or public utilities)

Disclosure requirements

General information

• An entity must 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
• This includes a description of how the operating segments were determined, the products and services provided by each segment, differences between the measurements used in reporting segment information and those used in the entity's financial statements, and changes in the measurement of segment amounts from period to period

Profit or loss, assets and liabilities

• An entity must report a measure of profit or loss and total assets for each reportable segment
• An entity must also disclose the following about each reportable segment if the specified amounts are included in the measure of segment profit or loss reviewed by the CODM or are otherwise regularly provided to the CODM:
  • Revenues from external customers
  • Revenues from transactions with other operating segments of the same entity
  • Interest revenue
  • Interest expense
  • Depreciation and amortization
  • Material items of income and expense disclosed in accordance with IAS 1
  • The entity's interest in the profit or loss of associates and joint ventures accounted for by the equity method
  • Income tax expense or income
  • Material non-cash items other than depreciation and amortization

Reconciliations

• An entity must provide reconciliations of the following:
  • The total of the reportable segments' revenues to the entity's revenue
  • The total of the reportable segments' measures of profit or loss to the entity's profit or loss before tax expense (tax income) and discontinued operations
  • The total of the reportable segments' assets to the entity's assets
  • The total of the reportable segments' liabilities to the entity's liabilities if segment liabilities are reported
  • The total of the reportable segments' amounts for every other material item of information disclosed to the corresponding amount for the entity

Restatement of previously reported information

• 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, must be restated unless the information is not available and the cost to develop it would be excessive
• Following a change in the composition of its reportable segments, an entity must disclose whether it has restated the corresponding items of segment information for earlier periods

Identifying operating segments

Management approach

• The management approach is used to identify operating segments, which are based on the internal reports that are regularly reviewed by the entity's CODM to allocate resources to the segments and assess their performance
• This approach allows for segment disclosures to be aligned with how management views and runs the business, providing insight into management's decision-making process

Discrete financial information

• The availability of discrete financial information is a key factor in identifying operating segments under the management approach
• Operating segments typically have revenue, expense, asset, and liability information that is regularly provided to and reviewed by the CODM
• The discrete financial information should allow for the assessment of segment performance and resource allocation decisions

Segment reporting challenges

Changes in reportable segments

• Changes in the composition of reportable segments can occur due to various reasons, such as restructurings, acquisitions, or disposals
• When the structure of an entity's internal organization changes, causing the composition of its reportable segments to change, the entity must restate the corresponding segment information for earlier periods unless the information is unavailable and the cost to develop it would be excessive
• Entities should disclose the nature of and reason for the change, as well as whether the corresponding items of segment information for earlier periods have been restated

Allocation of joint costs

• Entities may incur costs that relate to multiple operating segments, such as corporate overhead or shared services
• The allocation of these joint costs to individual segments can be challenging and may require judgment
• Entities should disclose the basis for allocating joint costs to reportable segments and ensure that the allocation method is reasonable and consistently applied

Segment vs entity-wide disclosures

• In addition to segment-specific disclosures, entities are required to provide certain entity-wide disclosures if they are not included in the segment disclosures
• Entity-wide disclosures include information about products and services, geographic areas, and major customers
• Entities should ensure that they provide all required disclosures, whether at the segment level or the entity-wide level, to give users a comprehensive understanding of their business activities and the economic environments in which they operate

Operating segments and goodwill impairment

• Goodwill acquired in a business combination is allocated to the reporting units (which may be operating segments or one level below) that are expected to benefit from the synergies of the combination
• Goodwill impairment testing is performed at the reporting unit level, which may align with the entity's operating segments
• If a reporting unit's fair value is less than its carrying amount (including goodwill), an impairment loss is recognized for the excess, limited to the total amount of goodwill allocated to that reporting unit
• Changes in reportable segments can impact the allocation of goodwill to reporting units and may trigger the need for additional impairment testing

Impact on financial ratios and metrics

• Segment reporting can have a significant impact on various financial ratios and metrics used by investors and analysts to evaluate an entity's performance
• Profitability ratios, such as operating margin and return on assets, can vary significantly across segments due to differences in the nature of their operations and the markets they serve
• Growth rates and trends in revenue, expenses, and profits can also differ among segments, providing insight into the drivers of an entity's overall performance
• Segment-level disclosures allow for a more granular analysis of an entity's financial position and results of operations, enabling users to identify strengths, weaknesses, and potential risks associated with specific business units or geographic regions

Operating segments in M&A transactions

Segment reporting by acquirer

• In an acquisition, the acquirer must determine how the acquired business will be integrated into its existing operating segments or whether it will be reported as a separate segment
• The acquirer should consider factors such as the nature of the acquired business, its target markets, and how it will be managed and reviewed by the CODM post-acquisition
• The allocation of the purchase price to the acquired assets and liabilities, including goodwill, should be performed at the reporting unit level, which may align with the acquirer's operating segments

Segment disposals and divestitures

• When an entity disposes of a component that qualifies as a discontinued operation, it must disclose the results of the discontinued operation separately from those of continuing operations
• If the disposed component represents a separate major line of business or geographical area of operations, it may have been an operating segment or part of one prior to the disposal
• Entities should consider the impact of segment disposals on their remaining reportable segments and update their segment disclosures accordingly
• Divestitures may also require the reallocation of goodwill and the reassessment of reporting units for impairment testing purposes