10.2 Reportable segments

Reportable segments provide crucial insights into a company's diverse operations. They're distinct components regularly reviewed by top management for resource allocation and performance assessment. Understanding these segments is key to grasping a company's structure and financial health.

Segment reporting enhances transparency and decision-making for investors and management alike. It offers a detailed view of different business units, helping users identify growth areas, assess risks, and make informed choices about resource allocation and investment strategies.

Definition of reportable segments

• Reportable segments are distinct components of a company that engage in business activities from which they may earn revenues and incur expenses
• These segments are regularly reviewed by the company's chief operating decision maker (CODM) to make decisions about resource allocation and assess performance
• Reportable segments are determined based on the management approach, which aligns with how the company is internally organized and managed

Criteria for segment reporting

Quantitative thresholds

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• A segment must meet certain quantitative thresholds to be considered reportable
• Generally, a segment is reportable if it represents 10% or more of the combined revenue, profit or loss, or assets of all operating segments
• These thresholds ensure that only significant segments are separately disclosed in the financial statements

Aggregation criteria

• Segments that do not meet the quantitative thresholds may be combined with other similar segments if they share similar economic characteristics
• Aggregation criteria include similar products or services, production processes, customer types, distribution methods, and regulatory environments
• Aggregating segments helps streamline the reporting process and provides a more concise view of the company's operations

Disclosure requirements

General information

• Companies must disclose general information about their reportable segments, including factors used to identify the segments and the types of products and services offered by each segment
• This information helps users understand the basis for segmentation and the nature of the company's business activities

Profit or loss

• Segment profit or loss is a key metric that must be disclosed for each reportable segment
• This includes segment revenues, expenses, and operating results, which provide insights into the financial performance of individual segments
• Segment profit or loss is often used by investors and analysts to assess the relative contributions of different business units to the company's overall profitability

Assets and liabilities

• Companies must disclose the total assets and liabilities for each reportable segment
• Segment assets include tangible and intangible assets directly attributable to the segment or reasonably allocated to it (property, plant, and equipment)
• Segment liabilities include operating liabilities directly attributable to the segment or reasonably allocated to it (accounts payable, accrued expenses)
• Disclosing segment assets and liabilities helps users assess the resources and obligations associated with each segment

Reconciliations

• Reconciliations between segment amounts and the consolidated financial statements must be provided
• This includes reconciling segment revenues, profit or loss, assets, and liabilities to their corresponding consolidated totals
• Reconciliations help users understand how segment information relates to the company's overall financial position and performance

Identifying operating segments

Management approach

• The management approach is used to identify operating segments based on how the company is internally organized and managed
• This approach aligns segment reporting with the way management views and runs the business
• Operating segments are identified based on the internal reporting structure and the information provided to the CODM for decision-making purposes

CODM's role

• The chief operating decision maker (CODM) is the function or individual responsible for allocating resources to and assessing the performance of the operating segments
• The CODM uses segment information to make strategic decisions, evaluate segment performance, and allocate resources accordingly
• Identifying the CODM is crucial in determining the operating segments and the level of detail required in segment disclosures

Segment reporting issues

Changes in reportable segments

• Companies may change their reportable segments due to reorganizations, acquisitions, divestitures, or changes in the CODM's information needs
• When segment changes occur, companies must restate prior period segment information for comparability
• Disclosures about the nature and reasons for segment changes help users understand the impact on the financial statements

Allocation of costs

• Certain costs, such as corporate overhead or shared services, may not be directly attributable to individual segments
• Companies must develop reasonable and consistent allocation methods to assign these costs to the appropriate segments
• Allocation methods should be based on relevant drivers (revenue, headcount) and applied consistently across periods

Intercompany transactions

• Transactions between segments within the same company (intercompany transactions) must be properly accounted for in segment reporting
• Intercompany revenues, expenses, assets, and liabilities should be eliminated in the consolidated financial statements
• Segment disclosures should include the basis for pricing intercompany transactions and the nature and extent of such transactions

Segment disclosures vs consolidated statements

• Segment disclosures provide disaggregated financial information for individual segments, while consolidated statements present the company as a single economic entity
• Segment information offers insights into the performance and resources of different business units, enabling users to make more informed decisions
• Consolidated statements provide a holistic view of the company's overall financial position, performance, and cash flows
• Segment disclosures complement consolidated statements by providing additional granularity and transparency

Auditing segment information

Materiality considerations

• Auditors must consider materiality when auditing segment information to focus on areas with the greatest potential impact on the financial statements
• Materiality assessments may be performed at both the consolidated and segment levels
• Misstatements or omissions in segment disclosures that could reasonably influence users' decisions are considered material

Internal controls assessment

• Auditors must evaluate the effectiveness of internal controls over segment reporting to ensure the reliability and accuracy of segment information
• This includes assessing controls over segment identification, data capture, allocation methods, and disclosure preparation
• Weaknesses in internal controls over segment reporting may lead to misstatements or omissions in the financial statements

Advantages of segment reporting

Increased transparency

• Segment reporting enhances transparency by providing detailed information about different aspects of a company's operations
• Users can better understand the performance, risks, and opportunities associated with each segment
• Increased transparency promotes informed decision-making and helps users assess the company's overall financial health

Improved decision-making

• Segment information enables users to make more informed decisions by analyzing the performance and prospects of individual business units
• Investors can identify growth areas, assess risk exposure, and make investment decisions based on segment-specific factors
• Management can use segment information to allocate resources effectively, set performance targets, and make strategic decisions

Limitations of segment reporting

Subjectivity in segment identification

• The management approach to segment identification involves subjectivity, as it relies on the judgment of the CODM
• Different companies may define and report segments differently, even within the same industry
• Subjectivity in segment identification can reduce comparability across companies and limit the usefulness of segment information

Comparability challenges

• Differences in segment definitions, allocation methods, and accounting policies across companies can hinder comparability
• Changes in reportable segments over time within the same company can also impact comparability
• Users must carefully consider the basis for segmentation and any changes when comparing segment information across periods or companies

Examples of segment reporting

Geographic segments

• Geographic segments are based on the location of a company's operations or markets (North America, Europe, Asia)
• Disclosures for geographic segments may include revenues, assets, and other relevant information by region
• Geographic segment information helps users assess the company's exposure to regional economic conditions and growth opportunities

Business segments

• Business segments are based on the nature of a company's products, services, or business activities (automotive, electronics, financial services)
• Disclosures for business segments may include revenues, profits, assets, and other relevant information by product line or service offering
• Business segment information helps users evaluate the performance and prospects of different business units within the company

Matrix approach

• The matrix approach combines geographic and business segments to provide a more comprehensive view of a company's operations
• Disclosures may include a grid or table presenting key financial metrics by both geographic region and business unit
• The matrix approach offers a granular analysis of the company's performance and helps users identify the most significant segments