After discussing “interim reporting” in my previous posts, you may want to know about “segmental reporting” as well. So let’s discuss about this a bit. Through this post, I am trying to answer some basic questions may arise around segental reporting.
The financial reporting for business segments is useful in appraising segmental performance, earning prospects, and risk. Segmental reporting may be by industry, foreign geographic area, major customers, and government contracts. The financial statement presentation for segments may appear in the body, footnotes, or separate schedule to the financial statements. Some segmental information is required in interim reports.
An industry segment sells products or renders services to outside customers. Segmental data occur when a company prepares a full set of financial statements (balance sheet, income statement, statement of cash flows, and related footnotes).
Segmental information is shown for each year presented. Accounting principles employed in preparing financial statements should be used for segment information, except that inter-company transactions eliminated in consolidation are included in segmental reporting.
What Are the Requirements of FASB Statement No. 131?
FASB Statement No. 131 (Disclosures about Segments of an Enterprise and Related Information) mandates that the amount reported for each segment item be based on what is used by the ‘‘chief operating decision maker’’ to determine how many resources to assign to a segment and how to evaluate the performance of that segment.
The term chief operating decision maker may apply to the chief executive officer or chief operating officer or to a group of executives. It may also relate to a function and not necessarily to a particular person.
Revenue, gains, expenses, losses, and assets should be allocated to a segment only if the chief operating decision maker takes it into account in measuring a segment’s profitability to formulate a financial or operating decision.
The same applies to allocating to segments eliminations and adjustments applying to the entity’s general-purpose financial statements. Any allocation of financial items to a segment should be rationally based.
In measuring a segment’s profitability or assets, the following points should be disclosed for explanatory reasons:
- Measurement or valuation basis used.
- A change in measurement method.
- Differences in measurements used for the general purpose financial statements compared to the financial data of the segment.
- A symmetrical allocation, referring to an allocation of depreciation or amortization to a segment without a related allocation to the associated asset.
An operating segment is a distinct revenue-producing component of the business for which internal financial information is generated. Expenses are reported as incurred in that segment. It should be noted that a start-up operation would be considered an operating segment even though revenue is not being earned. The chief operating decision maker periodically reviews an operating segment to analyze performance and to ascertain what and how many resources to allocate to the segment.
What Reconciliation Is Required for Segmental Reporting?
A business need not use the same accounting principles for segmental reporting as that used to prepare the consolidated financial statements. A reconciliation must be made between segmental financial information and general-purpose financial statements. The reconciliation is for revenue, operating profit, and assets. Any differences in measurement approaches between the company as a whole and its segments should be explained. The Controller and the CFO must describe the reasoning and methods in deriving the composition of its operating segments.
What Segments Should Be Reported On?
A segment must be reported if one or more of these conditions are satisfied:
- Revenue is 10 percent or more of total revenue.
- Operating income is 10 percent or more of the combined operating profit.
- Identifiable assets are 10 percent or more of the total identifiable assets.
The factors to be taken into account when determining industry segments are:
- Nature of the market – Similarity exists in geographic markets serviced or types of customers.
- Nature of the product – Related products or services have similar purposes or end uses (e.g., similarity in profit margins, risk, and growth).
- Nature of the production process – Homogeneity exists when there is interchangeable production of sales facilities, labor force, equipment, or service groups.
Reportable segments are determined by:
- Identifying specific products and services
- Grouping those products and services by industry line into segments
- Selecting material segments to the company as a whole
There should be a grouping of products and services by industry lines. A number of approaches exist. However, no one method is appropriate in determining industry segments in every case. In many instances, management judgment determines the industry segment. A starting point in deciding on an industry segment is by profit center. A profit center is a component that sells mostly to outsiders for a profit. When the profit center goes across industry lines, it should be broken down into smaller groups. A company in many industries not accumulating financial information on a segregated basis must disaggregate its operations by industry line.
Although worldwide industry segmentation is recommended, it may not be practical to gather. If foreign operations cannot be disaggregated, the firm should disaggregate domestic activities. Foreign operations should be disaggregated where possible, and the remaining foreign operations should be treated as a single segment.
What Should Be Disclosed?
Disclosures are not required for 90 percent enterprises (e.g., a company that derives 90 percent or more of its revenue, operating profit, and total assets from one segment). In effect, that segment is the business. The dominant industry segment should be identified. Segmental disclosure includes:
- Allocation method for costs.
- Capital expenditures.
- Aggregate depreciation, depletion, and amortization expense.
- Transfer price used.
- Unusual items affecting segmental profit.
- Company’s equity in vertically integrated unconsolidated subsidiaries and equity method investees (Note the geographic location of equity method investees).
- Effect of an accounting principle change on the operating profit of the reportable segment. (Also include its effect on the company).
- Material segmental accounting policies not already disclosed in the regular financial statements.
- Type of products.
What If Consolidation Is Involved?
If a segment includes a purchase method consolidated subsidiary, segmental information is based on the consolidated value of the subsidiary (e.g., fair market value and goodwill recognized) and not on the book values recorded in the subsidiary’s own financial statements.
Segmental information is not required for unconsolidated subsidiaries or other unconsolidated investees. Each subsidiary or investee is subject to the rules of FASB Statement No. 13 that segment information be reported. Some types of typical consolidation eliminations are not eliminated when reporting for segments. For example: revenue of a segment includes inter-segmental sales and sales to unrelated customers. A complete set of financial statements for a foreign investee that is not a subsidiary does not have to disclose segmental information when presented in the same financial report of a primary reporting entity except if the foreign investee’s separately issued statements already disclose the required segmental data.