18 Segment Reporting

Ms. Deepika Gautam

Learning Objectives:

The students may able to know the concept of segment reporting, the purpose of preparing such reports their advantages and limitations. They may also be able to understand the concept deeply in context to India and how Segment reporting is intended to give financial information to all the interested parties.

MEANING:

Segment reporting is the reporting of the operating segments of a company in the disclosures accompanying its financial statements. It is required for only publicly-held entities, and is not required for privately held ones. Segment reporting is intended to give financial information to all the interested parties like investors, creditors, stakeholders related to the operating units of a company, which they can use as the basis for decisions related to the company. Information to be included in Segment reporting includes (i) The factors used to identify reportable segments, (ii) The types of products and services sold by each segment, (iii) The basis of organization (such as being organized around a geographic region, product line, and so forth), Revenues, Interest expenses and Depreciation. Segment is a business sub unit for internal reporting purpose. This ensures to give a performance report in terms of money on particular segment. Profit center need segment in their master data.

An operating segment engages in business activities from which it may earn revenue and incur expenses, has discrete financial information available, and whose results are regularly reviewed by the entity’s chief operating decision maker for performance assessment and resource allocation decisions.

Generally Accepted Accounting Principles (GAAP)

Important Segments to be reported:

1. Segments having similar products, services, processes, customers, distribution methods, and regulatory environments.

2. Report a segment if it has at least 10% of the revenues, profit or loss, the combined assets of the entity.

Companies use segment reporting to analyze the performance of different areas of the business. Some businesses are required to by national and international accounting standards. Others do it on their own to show which segments are performing to expectations and which are not. The advantages and disadvantages depend on how the information is used and may vary from company to company.

Different Definitions as per Accounting Standard 17:

1.  Business Segment:

It is a distinguishable component of an enterprise that is engaged in providing an individual product or service or a group of related products or services and that is subject to risks and returns that are different from those of other business segments. Factors that should be considered in determining whether products or services are related include:

 a. the nature of the products or services;

b. the nature of the production processes;

c. the type or class of customers for the products or services;

d. the methods used to distribute the products or provide the services; and

e. if applicable, the nature of the regulatory environment, for example, banking, insurance, or public utilities.

2. Reportable Segment:

It is a business segment or a geographical segment identified on the basis of foregoing definitions for which segment information is required to be disclosed by this Standard. Reportable segments are operating segments that report any of:

(i) revenues (including intersegment revenues) of at least 10% of total revenues (including intersegment revenues) of all reported operating segments

(ii) profit (loss) of at least 10% of the combined profit (loss) of all operating segments reporting a profit (loss)

(iii) assets of at least 10 percent of the combined revenues, profit or loss, or assets of all operating segments.

A reportable segment may aggregate two or more operating segments if their products and services, production processes, type of customer, distribution, and regulatory environments are similar. Reportable segments must total at least 75% of external revenues; if not, additional segments must be reported until that threshold is reached.

3. Segment Expense is the aggregate  of

(i) Expenses resulting from the operating activities of a segment that is directly attributable to the segment, and

(ii) the relevant portion of enterprise expense that can be allocated on a reasonable basis to the segment, including expense relating to transactions with other segments of the enterprise.

4. Segment liabilities

Those operating liabilities that result from the operating activities of a segment and that either are directly attributable to the segment or can be allocated to the segment on a reasonable basis.

5. Segment assets

Those operating assets that are employed by a segment in its operating activities and that either are directly attributable to the segment or can be allocated to the segment on a reasonable basis.

The definitions of segment revenue, segment expense, segment assets and segment liabilities include amounts of such items that are directly attributable to a segment and amounts of such items that can be allocated to a segment on a reasonable basis. An enterprise looks to its internal financial reporting system as the starting point for identifying those items that can be directly attributed, or reasonably allocated, to segments. There is thus a presumption that amounts that have been identified with segments for internal financial reporting purposes are directly attributable or reasonably allocable. In some cases, however, a revenue, expense, asset or liability may have been allocated to segments for internal financial reporting purposes on a basis that is understood by enterprise management but that could be deemed arbitrary in the perception of external users of financial statements. Such an allocation would not constitute a reasonable basis under the definitions of segment revenue, segment expense, segment assets, and segment liabilities in this Standard. Conversely, an enterprise may choose not to allocate some item of revenue, expense, asset or liability for internal financial reporting purposes, even though a reasonable basis for doing so exists. Such an item is allocated pursuant to the definitions of segment revenue, segment expense, segment assets, and segment liabilities in this Standard.

6. Inter-segment transfers: Segment revenue, segment expenses and segment result include transfers between business segments and between geographical segments.Such transfers are accounted for at competitive market prices charged to unaffiliated customers for similar goods. Those transfers are eliminated in consolidation.

7. Primary Segment Reporting:

A primary target market is the segment of a marketplace a business believes will give it the best chance to sell. A primary target market may not be the largest segment of a marketplace. A primary target market is the segment of a marketplace a business believes will give it the best chance to sell. A primary target market may not be the largest segment of a marketplace. Under primary reporting format for each reportable segment the enterprise should disclose external and internal segment revenue, segment result, amount of segment assets and liabilities, cost of fixed assets acquired, depreciation, amortization of assets and other non cash expenses.

Characteristics of Segment Reporting:

1. A Segment is any part or activity of a business organization which managers needs cost, revenue, or profit data.

2. The traceable fixed costs of one segment can be common fixed cost of other segments.

3. Segment reporting is the reporting of the operating segments of a company in the disclosures accompanying its financial statements.

4. Segment information is vital, essential, fundamental, indispensable, and integral in the process of projecting companies‟ performance.

5. The definitions of segment revenue, segment expense, segment assets, and segment liabilities are interrelated, and the resulting allocations should be consistent.

Objectives of Segment Reporting

The objective of this Standard is to establish principles for reporting financial information, about the different types of products and services an enterprise produces and the different geographical areas in which it operates. Such information helps users of financial statements:

(a) better understand the performance of the enterprise;

(b) better assess the risks and returns of the enterprise; and

(c) make more informed judgments about the enterprise as a whole.

Many enterprises provide groups of products and services or operate in geographical areas that are subject to differing rates of profitability, opportunities for growth, future prospects, and risks. Information about different types of products and services of an enterprise and its operations in different geographical areas – often called segment information – is relevant to assessing the risks and returns of a diversified or multi-location enterprise but may not be determinable from the aggregated data. Therefore, reporting of segment information is widely regarded as necessary for meeting the needs of users of financial statements.

Advantages or Need for Segment Reporting:

Segment information is a part of the financial statements that provides useful information about a company’s revenues, operating results and assets, by business segment and geographical segment

1. Sorting out most Profitable Segments:

Segment reporting helps the businesses that operate in different categories or geographic areas and through segment reporting business can reveal which areas are more profitable and which are drains on the bottom line. If the segment reporting shows a business its overseas operations are more profitable than domestic operations, it could prompt a change in strategic direction. If segment reporting process is done carefully, it keeps managers from hiding unprofitable ventures.

2. Improved Context

Segment reporting allows all its stakeholders to get a better sense of the fluctuations that might affect overall earnings. If a business reports much higher earnings than expected, for example, segment reporting shows where those earnings are coming from. A stakeholder can look at the same report to determine if the numbers are sustainable. It’s designed to help investors better understand the business and its potential flow of cash.

3. Weightage to Present

Segment reporting doesn‟t focus too much on short-term losses. If these losses are outweighed by the company’s overall performance, they might not stand out on the financial statements. However, breaking out those numbers as a data point via segment reporting can lead to pressure to reduce those losses to enhance short-term earnings.

4. Modification of the Data:

Segment reporting lends itself to data modification if the information is reported in the “through management‟s eyes” style. This gives company leaders more discretion in how it determines how segments are constructed and what metrics are reported. Managers may group together businesses with different business models. It can also cherry-pick metrics to send the desired message to stakeholders. Losses in an Internet division, for example, could be grouped with an unrelated profitable business unit to paint a better picture of performance.

5. Diversify Operation:

The concept of segment reporting is applicable to a diversified enterprise. A diversified company may be defined as a company which has diversified operations, i.e., activity or operations engaged in different industries and/or foreign operations and sales where those activities (or operations) are significant in terms of sales revenue, profit or losses generated or assets employed.

6. Useful for Investors:

Investors are provided with information about the profitability, risk and growth of the different segments of a company‟s operations, they will be better able to assess the earnings potential and the risk of the company as a whole because through this they can calculate their dividend as well.

7. Useful for Employees and Trade Unions:

Besides the investors, the segmental reports are likely to be useful to employees and trade unions, consumers, the general public, government and also for the managers of a company to promote managerial efficiency. Employees and trade unions are interested in the performance and prospects of the firm from the standpoint of wage negotiations and job security and hence, segmental reports may be just as relevant to them as to investors.

8. Useful for Consumers:

The interests of consumers and the public may also be promoted by segmental disclosure in the sense that social responsibility in terms of the removal of price discrimination could be encouraged by disclosure of profits by segment. Consumers may also benefit from the increased competition that may result.

9. Useful for Government:

Governments, at national and also international level in the case of multinational companies, are becoming increasingly concerned by the activities of large companies and the balance of payments. Segmental disclosures by geographical location seem likely to promote a better understanding of corporate strategy and its impact, and will thus provide a more reliable base for governmental policy-making.

Limitations of Segment Reporting:

The Limitations of Segment Reporting relate to implementation of segment reporting rather than to its concept and theory.

1. Selection of base of Segmentation:

A company may be divided for segment reporting purposes in terms of organization division, industry, market, customer product, etc. Each base of segmentation may create segments that differ significantly in profitability, growth and risk and each implies a different basis for identifying segments. Moreover, more than one form of diversification may be present in the same. Unless the base (or bases) selected actually represent the company and the way it operates, unless they reflect the difference within the company regarding rate of profit, degree of risk, and potential for growth, reports-of operating data by segments are unlikely to be of any real use.

2. Proper allocation of Cost:

In a business enterprise producing more than one product or engaged in different activities, there are likely to be costs which are common to two or more of the products. Because these costs are common to more than one segment, they cannot be associated in entirety with a single segment. The problem of allocating common costs is particularly great for assets, liabilities, and equity so that reporting for business segments is suggested less often for information from the balance sheet, statement of shareholders equity, and funds statements than for information from the income statement. Because of the diversity of methods employed, cross-company comparison of similar segments are likely to be misleading and the reliability of segment operating results varies depending on how closely the basis of allocation approximates results that would have been produced by market transactions.

3. Pricing Problems:

There are different methods for inter-segment transfers such as cost, cost plus, market price, and negotiated price. The basic purpose (in selecting a method of transfer pricing) is to motivate employees, and to actually measure the success of the several segments as accurately as possible. Different methods results in different operating results for the segments. For a meaningful segment reporting, there is a need for selecting a reasoned method for inter-segment transfers.

4. Disclosure Cost:

Another important cost argument relates to the increased competition that may result from segmental disclosures. It is argued that the disclosure of profitable segments will attract competitors, whilst loss-making segments may become the subject of take-over bids or put pressure on management to sell them off, with the purpose of improving profits in the short- term and to take on less risky projects. A competitive disadvantage may also occur where foreign companies are not required to provide segmental reports.

5. Conservatism Approach:

Another argument is that, where there is no regulatory provision to disclose segmental reports, voluntary disclosures are likely to be perceived by managements to be beneficial only in certain instances; for example, where management believes that the company‟s attractiveness to investors will be enhanced and the costs of finance reduced. Few companies are likely to take voluntary action that may benefit their competitors or reveal weaknesses.

SEGMENT REPORTING IN INDIA

The Institute of Chartered Accountants of India has issued AS 17 titled „Segment Reporting‟ in October 2000. As per Accounting Standards 17 it is mandatory for companies who are listed on the stock exchange or who are in the process of issuing equity or debt securities and are listed on the stock exchange in India to provide segmental information in compliance with AS 17 issued by Accounting Standards Board of ICAI.

Major Guidelines to be followed are as follows:

(i) All listed companies must provide Primary and Secondary Segment Reporting along with

(ii) Business and Geographical Segment

Apart from these all segment reports must disclose the necessary information relating to Segment revenue, Expenses, Profitability, the details of various Assets & Liabilities and Accounting policies.

Summary:

Segment reporting is the reporting of the operating segments of a company in the disclosures accompanying its financial statements. Segment reporting is intended to give financial information to all the interested parties. A reportable segment may aggregate two or more operating segments if their products and services, production processes, type of customer, distribution, and regulatory environments are similar. Segment information is a part of the financial statements that provides useful information about a company’s revenues, operating results and assets, by business segment and geographical segment. Segment reporting helps the businesses that operate in different categories or geographic areas and through segment reporting business can reveal which areas are more profitable and which are drains on the bottom line.

Few Suggested Readings:

• I.M. Pandey, “Financial Management”, Vikas Publishing, New Delhi
• Nitin Balwani, “Accounting and finance for Managers”, Excel Books, New Delhi
• Prasanna Chandra, “Financial Management – Theory and Practice”, Tata McGraw Hill, New Delhi
• S.Bhat, “Financial Management”, Excel Books, New Delhi