Segmental reporting

1Introduction to segmental reporting2
2Origin of segmental reporting2
2.1The fineness-theorem2
2.2Market efficiency theory2
2.3Agency theory2
2.4Accounting theory3
3The most important segmental reporting standards3
3.1International Accounting Standard 14 (IAS 14)3
3.1.1The International Accounting Standards Committee3
3.1.2The International Accounting Standards Board4
3.1.3IAS 14: Segment reporting4 of IAS 14 (revised)4 of IAS 14 (revised)4 of segments5 that has to be disclosed5
3.2SSAP 256
4Comparison with local GAAP’s6
5Evaluation of segmental reporting6
5.2.1Costs of segmental reporting7 costs7 time of management7 in venture sense7
5.2.2Difficulties one can experience with the introduction of the reporting requirements7 concerning the identification of segments8 related to the information to be disclosed8
Segmental reporting
1Introduction to segmental reporting
Segmental reporting can be seen as “the analysis of the financial information of an enterprise or group between the different business activities and/or the different geographic areas in which it operates” . The reason for this reporting division into different business activities and geographic areas is that these have different profit potentials, growth opportunities, degrees and type of risk, rates of return and capital needs. Because of these differences, it is possible that consolidated financial statements are not sufficient (these financial statements summarize the results and financial position for the reporting entity as a whole). The disclosure of information about an enterprise’s operation in different industries, its foreign operations and export sales, and its major customers, as an integral part of financial statements, may provide a solution to this problem (Thoen and Lefebvre, 2001).

2Origin of segmental reporting
Four theorems that are characterized by an accounting or a financial background can be considered as factors that created a need for the segmentation of information. In the following paragraphs, a brief description of these theorems will be given.
2.1The fineness-theorem
This theorem states that “given two sets containing the same information, if one is broken down more finely, it will be at least as valuable as the other set.” Applied to segmental reporting, this means that the segmented information will always contain information that is as usual and valuable as the information provided by aggregated financial statements.

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2.2Market efficiency theory
According to Fama (1970), three kinds of efficiency can be distinguished, depending on the available information: (1) weak form efficiency, (2) semi-strong form efficiency, and (3) strong form efficiency. A market is efficient in the weak form’ when all past prices are reflected in today’s price. A market is efficient in the semi-strong form’ when prices reflect all public information. At last, a market is efficient in the strong form’ when all information in a market, whether public or private, is reflected in the price.

The reporting of segmented information by companies may be useful to create more efficient markets. This is because this kind of information increases the transparency of the company which may help to make more accurate predictions about future gains.
2.3Agency theory
The agency theory concerns the relationship between a principal (e.g. users and shareholders of financial information) and an agent of the principal (e.g. company’s managers)1. Because both the principal and the agent want to maximize their own utility and because these utilities are not equal, agency costs and suspicion of the shareholders towards management arise (Emmanuel ; Garrod, 1992). As both parties have different utilities that they want to maximize, they also have a different opinion on the quantity, the level of detail and by what means the information regarding the company should be made public. Agents, for example, have the tendency to withhold information because they are afraid that competitors will take advantage of this information or because they do not want trade unions or employees to use the information to compare earning figures from different segments (Thoen ; Lefebvre, 2001).
Nowadays, financial analysts look very negative toward companies that do not supply segmental information. Their bad evaluation of such companies entails a negative influence on the share values of those companies which on their turn forces the company to provide more information.
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2.4Accounting theory
This theory states that the provision of segmented information is necessary in order to be able to judge uncertainty and to better value the company’s activities. The reason here fore, is that such information makes it possible to make profound judgments of risks and to predict future earnings in a more accurate way.
3The most important segmental reporting standards
3.1International Accounting Standard 14 (IAS 14)
3.1.1The International Accounting Standards Committee
The IASC was formed in 1973 at the initiative of Henry Benson, a British chartered accountant, who was at that time head of the company that would later become PricewaterhouseCoopers.
The objectives of this committee were (Flower and Ebbers, 2004):
To formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance.

To work generally for the improvement and harmonization of regulations, accounting standards and procedures relating to the presentation of financial statements.

Between 1974 and 2000, the IASC issued some forty standards, but these were so vague and permitted so many alternative accounting treatments that they did little to reduce the diversity of financial reporting practice throughout the world.
However by the end of the 90s, two developments made it more probable that the IASC’s standards would become applied and accepted worldwide. The first concerned the decision of the EU to ally itself with the IASC with the ultimate aim of permitting European MNEs to use the IAS standards for their accounts. Secondly, an important agreement was made in order to improve the acceptability of the IASs by the world’s stock exchanges. More exactly, the IASC agreed with the International Organisation of Securities Commissions (IOSCO), which represents the national stock exchange regulatory bodies at the international level, that the latter would recommend the national regulatory bodies to permit foreign multinational corporations to use the IASs on the condition that the IASC would deliver more qualitative IASs. These two developments were very important to enhance the status and the acceptability of the standards.

3.1.2The International Accounting Standards Board
In April 2001, the IASC was replaced by a new body, the International Accounting Standards Board (IASB). This body issues International Financial Reporting Standards (IFRSs) instead of IASs. All International Accounting Standards (IASs) and Interpretations issued by the former IASC continue to be applicable unless and until they are amended or withdrawn.
3.1.3IAS 14: Segment reporting
The first direction for the treatment of segment reporting was proposed by the IASC in 1981. This standard, IAS 14: Reporting Financial Information by Segments’ was issued in August 1981 and became van kracht (effective?) the first of January 1983. IAS 14 applied to accounting periods beginning from January 1, 1983. This IAS 14 is revised in 1994 and was implemented as the new IAS 14 (revised): Segment reporting’ in August 1997. This revised standard applies to accounting periods beginning on or after July 1, 1998.

In the following paragraphs, IAS 14 (revised) will be discussed in more detail. of IAS 14 (revised)
The objective of IAS 14 (revised) is to establish principles for reporting financial information by line of business and by geographical area. It applies to enterprises whose equity or debt securities are publicly traded and to enterprises in the process of issuing securities to the public. In addition, any enterprise voluntarily providing segment information should comply with the requirements of the Standard . of IAS 14 (revised)
IAS 14 must be applied by enterprises whose debt or equity securities are publicly traded and those in the process of issuing such securities in public securities markets. If an enterprise that is not publicly traded chooses to report segment information and claims that its financial statements conform to IAS, then it must follow IAS 14 in full2.
Segment information need not be presented in the separate financial statements of a (a) parent, (b) subsidiary, (c) equity method associate, or (d) equity method joint venture that are presented in the same report as the consolidated statements. of segments
An enterprise must look to its organisational structure and internal reporting system to identify reportable segments. In particular, IAS 14 presumes that segmentation in internal financial reports prepared for the board of directors and chief executive officer should normally determine segments for external financial reporting purposes. Only if internal segments aren’t along either product/service or geographical lines is further disaggregation appropriate. This is a “management approach” to segment definition. The same approach was recently adopted in Canada and the United States.
Geographical segments may be based either on where the enterprise’s assets are located or on where its customers are located. Whichever basis is used, several items of data must be presented on the other basis if significantly different.
For most enterprises one basis of segmentation is primary and the other is secondary, with considerably less disclosure required for secondary segments. The enterprise should determine whether business or geographical segments are to be used for its primary segment reporting format based on whether the enterprise’s risks and returns are affected predominantly by the products and services it produces or by the fact that it operates in different geographical areas. The basis for identification of the predominant source and nature of risks and differing rates of return facing the enterprise will usually be the enterprise’s internal organisational and management structure and its system of internal financial reporting to senior management. that has to be disclosed
IAS 14 has detailed guidance as to which items of revenue and expense are included in segment revenue and segment expense. All companies will report a standardised measure of segment result – basically operating profit before interest, taxes, and head office expenses. For an enterprise’s primary segments, revised IAS 14 requires disclosure of:
sales revenue (distinguishing between external and internsegment)
the basis of intersegment pricing
capital additions
non-cash expenses other than depreciation
equity method income.
Segment revenue includes “sales” from one segment to another. Under IAS 14, these intersegment transfers must be measured on the basis that the enterprise actually used to price the transfers.
For secondary segments, disclose:
capital additions.
Other disclosure matters addressed in IAS 14:
Disclosure is required of external revenue for a segment that is not deemed a reportable segment because a majority of its sales are intersegment sales but nonetheless its external sales are 10% or more of consolidated revenue.
Special disclosures are required for changes in segment accounting policies.
Where there has been a change in the identification of segments, prior year information should be restated. If this is not practicable, segment data should be reported for both the old and new bases of segmentation in the year of change.
Disclosure is required of the types of products and services included in each reported business segment and of the composition of each reported geographical segment, both primary and secondary.
An enterprise must present a reconciliation between information reported for segments and consolidated information. At a minimum:
segment revenue should be reconciled to consolidated revenue
segment result should be reconciled to a comparable measure of consolidated operating profit or loss and consolidated net profit or loss
segment assets should be reconciled to enterprise assets
segment liabilities should be reconciled to enterprise liabilities.
3.2SSAP 25
4Comparison with local GAAP’s
5Evaluation of segmental reporting
On the first place, segmental reporting
The disadvantages of segmental reporting can be divided into two broad groups. The first category is related to the increasing costs. The second group of disadvantages is related to the difficulties one can experience when introducing the reporting requirements. In the following paragraphs, both categories will be discussed in more detail.

5.2.1Costs of segmental reporting
According to Mautz (1968), the increasing costs of segmental reporting can be divided into three groups, (1) monetary costs, (2) costs resulting from the lost time of management, and (3) the cost resulting from the decrease in venture sense. costs
These costs are costs for additional personnel, for the extension of the system that gathers information and for the additional audit of the segmented information. However, Radebaugh and Gray (1993) mean that, in general, these additional costs are not material when you realize that management has a lot of freedom to choose the different segments. Thus, management has the possibility to let these segments correspond as good as possible to the structure of the company. Moreover, companies already collect information for internal purposes, so the extra costs for external reporting are minimized. time of management
This type of cost has to do with the time management loses when it has to answer questions related to the additional information. in venture sense
This type of costs rises from the short-term thinking of investors and other users of financial information. Management has to think about the cost-effectiveness of their company both on the long and the short run. Just because it also has to look at the long run cost-effectiveness, it is possible that it will make losses in the short run. If the users of the additional information will only evaluate management on their short run results, big chances exists that these managers will not look at the long run anymore and just focus on short term gains. Of course, this is disadvantageous for the company.

5.2.2Difficulties one can experience with the introduction of the reporting requirements
Here, at least two kinds of problems can be distinguished. First of all, difficulties concerning the identification of segments can arise. Questions here can be on which basis the segments have to be distinguished, what size the different segments need to have and how many segments have to be disclosed. A second difficulty is related to the identification of information to be disclosed. concerning the identification of segments
A first difficulty is to determine the right basis on which the different segments have to be distinguished. An important point that has to be kept in mind is that the activities who belong to one segment have to be similar (homogeneous) to each other and that the activities who belong to different segments have to be heterogeneous to each other.
A second difficulty concerns the decision of a segmentation dimension. Companies have the choice between four methods that are available for the identification of segments: (1) segmentation based on line-of-business, (2) segmentation based on geographical areas of activities, (3) segmentation based on the internal corporate structure, and (4) segments for each individual market in which the company is operating. Corporations may obviously also make a combination of these dimensions. The choice of the segmentation base depends on the type of company and on should be made with the intention to optimise the entity’s financial reporting. related to the information to be disclosed
Emmanuel, C. ; N. Garrod (1992). Segment reporting: International issues and evidence. Prentice Hall, ICAEW
Fama, E. (1970). Efficient capital markets: A review of theory and empirical work. Journal of finance, Vol. 25, pp. 383-417.

Flower J. ; G. Ebbers (2004). Global Financial Reporting. Palgrave Basingstoke.

Mautz R.K. (1968). Financial Reporting by Diversified Companies. Financial Executives
Research Foundation, New York.

Radebaugh L.H. ; S.J. Gray (1993). International Accounting and Multinational Enterprises. John Wiley ; Sons (USA), 3rd edition.

Thoen V. ; C. Lefebvre (2001). A critical analysis of segmental reporting based on an international perspective: a ground for better regulation. DTEW Research Report 0152, K.U.Leuven, 34 pp.


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