IFRS 8 - Operating Segments (detailed review)

Thursday, March 27, 2014 Print Email

Objective

This standard sets out requirements for the disclosures of information about an entity’s operating segments, products, services, the geographical areas in which it operates, and regarding its major customers to enable users of financial statements to analyze the nature and financial effects of its business activities.

Scope

The disclosure requirements of this standard are applicable to:

(a) The individual financial statements of an entity:

(i) Whose debt or equity instruments are traded in a public, domestic, or a regional markets or in a foreign stock exchange and

(ii) Which is in the process of filing its financial statements with the relevant regulatory authorities to issue any class of its instruments in a public market

(b) The Group financial reports of a group having parent:

(i) Whose debt or equity instruments are traded in a public, domestic, or a regional market or in a foreign stock exchange and

(ii) Which is in the process of filing its financial statements with the relevant regulatory authorities to issue any class of its instruments in a public market

If financial reports contain both, the individual financial statements of the parent that comes within the scope of this IFRS as well as group financial reports of a group disclosure of segment information will be placed in consolidated financial reports only.

Operating Segments

 It is a function of an entity with the following aspects:

  • Which involves in a business activity to generate revenues and incur costs, it also include incomes and costs relating to dealings with the other internal business functions of the same entity
  • Whose financial results are regularly evaluated by the chief operating decision maker of the entity for the purpose of resource allocation to the business segments  and performance assessment, and
  • For which discrete or absolute financial information is available.

Other Related Points with the Definition

  • A business activity which is under development age and it will start earning its revenues in future can be treated as operating segments such as a business segment with its start-up operations.
  • Every function of the entity is not treated as operating segment. The parts of the entity which do not earn revenues such as cost centers are not regarded as operating segment for example research and development department or a head quarter.
  • The term ‘chief operating decision maker’ indicates the function of the entity which allocate resources and evaluate the performance of the operating segments, it may include CEO or board of directors.
  • Operating segments may be identified on the basis of product, services or regions depending upon the internal reporting structure of the entity.

Reportable Segment

The entity is required to disclose information separately as required by this standard in respect of the operating segment which satisfies the following:

1) It should satisfy the definition of operating segment and

2) It should satisfy at least one of the following quantitative thresh hold:

(a) Its reported revenue from all the internal and external sources is 10 percent or more than the total internal and external revenue of all operating segments of the entity.

(b) Its reported profit or loss is 10 per cent or more than the higher of:

(i) The total reported profit of all the profitable operating segments

(ii) The total reported loss of all loss making operating segments

(c) Its assets are 10 per cent or more than the total assets of all operating segments of the entity.

 

  • The operating segment which will satisfy the above mentioned criteria will be classified as reportable segment, and entity is required to disclose information separately as per the requirements of this standard
  • At least 75 per cent of the total external revenue of the entity must be reflected by the identified reportable segment, if this is not the case the entity will be required to identify additional reportable segments until at least 75 per cent of the total external revenue of the entity is reflected by reportable segments.
  • An entity may combine financial results of two or more operating segments that are below the quantitative threshold to generate a single reportable segment, if such operating segments have similar attributes in majority of the following aggregation criteria:

    (a) The nature and specification of the products and services of the operating segments

    (b) The production processes of the operating segments

    (c) The distribution regions or markets of the operating segments

    (d) The category or class of customer of the operating segments;

    (e) The nature of the distribution channels used by the operating segments for their goods or services

    (f) The nature of the regulatory environment and requirements such as banking, insurance or public usage

  • If the management identifies that an operating segment which was classified as a reportable segment in the immediately previous reporting period contains material information for the users of financial statements, the entity will continue to classify such operating segment as reportable segment in the current reporting period even though it is below than the quantitative thresholds, and will disclose its information separately as per the requirements of this standard.
  • If the management identifies that an operating segments that is below than all of the quantitative thresholds, contains useful information for the users of financial statements, then such operating segment can be classified as reportable segment and disclosed separately as per the requirements of this standard.
  • The operating segments that are not classified as reportable segments will be disclosed aggregately in a separate category titled as ‘all other segments’.

Disclosures require for Reportable Segments

The entity will disclose the following in respect of the reportable segment to enable users of financial statements to analyze the nature and financial effects of its business activities:

  • The description of the products and services from which each reportable segment generate its incomes
  • The basis used by the entity for the determination of the operating segments such as product, services or geographical region basis or combination of such factors.
  • The entity is required to disclose also the following factors in respect of reportable segments:

(a) Segment’s revenues from the external sources;

(b) Segment’s revenues from the other internal segments of the same entity

(c) The depreciation oramortization charge related to assets of the segment

(d) Any finance cost related to the reportable segment

(e) Any finance income related to the reportable segment

(f) Any share in the profit or loss of associate or joint venture held by the segment

(g) Segment’s tax charge or any tax refundable

(h) Any other significant item which in non-cash

(i) Total assets held by the segment and any addition to the segment assets

(j) Total liabilities related to the segment 

 

  • If the interest income is a primary source of income for the reportable segment, then the entity should report interest income separately from the interest expense otherwise these components may be netted of.
  • The measurement method use to determine the profit or loss of the reportable segment such as accounting policies.
  • The basis for the allocation of common expenses to the operating segments
  • The accounting polices used to determine the amounts of the segment assets and any difference in accounting policies from those of the other assets of the entity
  • Any change in accounting policy in the current reporting period from that of the previous period.
  • A statement showing the reconciliation of the following components:

(a) The profit or loss of the reportable segments to the total profit or loss of the entity

(b) The revenue of the reportable segments to the total revenue of the entity

(c) The assets of the reportable segments to the total assets of the entity

(d) The liabilities of the reportable segments to the total liabilities of the entity

  • Any change in the internal structure of the entity which results in change in the basis of segmentation along with such circumstances, the entity will report both the new and old segmental information.
  • If the business functions of the entity are not organized on the basis of products, services or differences in geographical areas of operations and the reportable segments of the entity report revenues from a broad range of essentially different products and services, or more than one of its reportable segments provide the similar products and services, in such a case the entity is required to report external revenue in respect of its each product, service and from each geographical location, if it is not costs excessive.
  • The amounts used in disclosure should be the same which are presented in the financial statements of the entity
  • The entity is required to disclose separately the information about its reliance on its major customers. Such a disclosure is required if revenue from a single external customer is 10% or more of the total revenue of the entity. The entity is also required to disclose the total revenues from each such customer and the identification of the segment or segments reporting those revenues. However, no disclosure is required about the identity of such major customers.

 

Worked Example

AB Ltd, a private limited company that has the following business segments which are reported in its financial statements. AB Ltd is an international car manufacturing group which reports to management on the basis of regions for the internal reporting purposes. It does not currently report segmental information as required by IFRS 8 Operating segments. The results of the regional segments for the year ended 31 December 2011 are as follows.

Region

Segment

Segment

Segment

External

Internal

Profit/(Loss)

Assets

Liabilities

$m

$m

$m

$m

$m

South Asia

400

6

(20)

600

200

East Asia

600

4

120

1,600

600

Other regions

1,000

10

210

4,000

2,800

There were no significant intra-group balances in the segment assets and liabilities.

Required

Explain the requirements in IFRS 8 Operating segments for the determination of a company’s reportable operating segments and how these requirements would be applied for AB Ltd using the information given above in the financial statements for the year ended 31 December 2011.

Solution:

The entity will classify the operating segment as reportable segment if:

1) It satisfies the definition of operating segment as given in IFRS 8 and

2) It satisfies at least one of the following quantitative threshold:

(a) Its reported revenue from all the internal and external sourcesis 10 per cent or more of thanthe total internal and externalrevenue of all operating segments of the entity.

(b) Its reported profit or loss is 10 per cent or more than the higher of:

  • The total reported profit of all the profitable operating segments
  • The total reported loss of all loss making operating segments

(c) Its assets are 10 per cent or more than the total assets of all operating segments of the entity.
 

  • The operating segment which will satisfy the above mentioned criteria will be classified as reportable segment, and entity is required to disclose information separately as per the requirements IFRS 8
  • At least 75 per cent of the total external revenue of the entity must be reflected by the identified reportable segment, if this is not the case the entity will be required to identify additional reportable segments until at least 75 per cent of the total external revenue of the entity is reflected by reportable segments.
  • An entity may combine financial results of two or more operating segments that are below the quantitative threshold to generate a single reportable segment, if such operating segments have similar attributes in majority of the following aggregation criteria:

    a) The nature and specification of the products and services of the operating segments

    b) The production processes of the operating segments

    c) The distribution regions or markets of the operating segments

    d) The category or class of customer of the operating segments;

    e) The nature of the distribution channelsused by the operating segments for their goods or services

For AB Ltd, the thresholds are as follows.

  1. Total internal and external revenue is $2,020 million, so 10% is $202 million.
  2. Total reported profit is $330 million, so 10% is $33 million.
  3. Total reported loss is $20 million, so 10% is $2 million.
  4. Total assets of the entity are $6,200 million, so 10% is $620 million.

The South Asian segment meets only one threshold. Its reported revenue of $406 million is more than 10% of total internal and external revenue of the entity. However, its loss of $20 million is less than the higher of 10% of total profit and 10% of total loss, so it fails this test. It also fails the assets threshold test, as its assets of $600 million are less than 10% of the total assets of the entity.

The East Asia segment meets all three tests. Its reported revenue is $604 million; its reported profit is $120 million, and its assets are $800 million.

Therefore, the first two segments will be classified as reportable segments and these will be disclosed as per the requirements of this standard. However, IFRS 8 requires at least 75 per cent of the total external revenue of the entity must be reflected by the identified reportable segment, but the identified reportable segment as above represent
Only 50% external revenue of the entity, so AB Ltd needs to identify additional reportable segments out of non-reportable segments after applying aggregation criteria.

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