CHAPTER THIRTEEN OPERATING SEGMENTS Learning Outcomes At the end of this chapter you should be able to: Explain

n the need to identify operating segments ; Describe principles for identifying operating segments; and Recognize segment information to be provided with financial statements. 13.1 Introduction It is quiet usual for reporting entities to be involved in a number of different activities and these activities to be located in widely dispersed locations. The consolidated financial statements provided to stakeholders of these entities report aggregated results, with some eliminations and adjustments, derived from these different activities and locations. This aggregation process results in a loss of information. For example, the profitable or unprofitable subsidiaries and divisions are hidden in this process. Subsidiaries which could consider as high risk owing to excess debt levels can escape as their assets and liabilities are consolidated with those of the parent company and the other subsidiaries. Owing to these reasons, the aggregated information presented in the consolidated financial statements needs to be disaggregated and presented to facilitate the decision making of stakeholders. In this context, reporting disaggregated information enjoys a vital position in financial reporting. It provides information about the performance and financial position of various sub-units of an organisation, broken up into operating segments. Reporting information based on operating segments is discussed in this chapter based on SLFRS 8 Operating Segments. The core principle identified in the Standard is that an entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates. This chapter deals with reporting of information based on operating segments of an entity in line with the principles laid down in SLFRS 8. 13.2 Defining Operating Segments Paragraphs 5-10 of the Standard deal with defining the term operating segment and it is defined in Paragraph 5 of SLFRS 8 as a component of an entity: (a) that engages in business activities from which it may earn revenue and incur expenses (including revenues and expenses relating to transactions with other components of the same entity); (b) whose operating results are regularly reviewed by the entity's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance; and (c) for which discrete (separate) financial information is available. An operating segment may engage in business activities for which it has yet to earn revenue for example, startup operations may be operating segments before earning revenue. However, every 1

part of an entity is not necessarily an operating segment or part of an operating segment (Paragraph 6). For example, a corporate headquarters or some functional departments may or may not earn revenue that are only incidental to the activities of the entity and would not be operating segments. The term chief operating decision maker identifies a function, not necessarily a manager with a specific title. That function is to allocate resources to and assess the performance of operating segments of an entity (Paragraph 7). Often the chief operating decision maker of an entity is its chief executive officer or chief operating officer. 13.3 Identifying Reportable Segments According to Paragraph 11, an entity shall report separately information about operating segment that: (a) has been identified in accordance with paragraphs 5-10 or results from aggregating two or more of those segments in accordance with paragraph 12 and (b) exceeds quantitative thresholds in paragraph 13.

Paragraph 12(aggregation criteria) requires two or more operating segments to be aggregated into a one if the aggregation is consistent with the core principle of the Standard, the segments have similar economic characteristics and the segments are similar in the following respects: the nature of the products or services; the nature of the production processes; the type or class of customer for their products and services; the methods used to distribute the products or provide their services; and the nature of the regulatory environment (if applicable). Paragraph 13 (quantitative thresholds) states that an entity shall report separately information about an operating segment that meets any of the following thresholds: (a) its reported revenue, including sales to external customers and inter-segment sales or transfers, is 10% or more of the combined revenue, internal and external, of all operating segments; (b) the absolute amount of the reported profit or loss is 10% or more of the greater, in absolute amount, of (i) the combined reported profit of all operating segments that did not report a loss and (ii) the combined reported loss of all operating segments that reported a loss; (c) its assets are 10% or more of the combined assets of all operating segments. Operating segments that do not meet any of the quantitative thresholds may be considered as reportable and separately disclosed, if management believes that information about the segment would be useful to users of the financial statements. Further, Paragraph 14 states that an entity may combine information about operating segments that do not meet the quantitative thresholds with information about other operating segments that do not meet the quantitative thresholds to produce a reportable segment only if the operating segments have similar economic characteristics and share a majority of the aggregation criteria listed in paragraph 12.

According to the Paragraph 15, if the total external revenue reported by operating segments constitutes less than 75% of the entitys revenue, additional operating segments shall be identified as reportable segments (even if they do not meet the criteria in paragraph 13) until at least 75% of the entitys revenue is included in reportable segments. This rule will prevent an entity from avoiding reporting some segmental information by bundling it up in all other segments, which are indentified in Paragraph 16. Information about other business activities and operating segments shall be combined and disclosed in an all other segments category separately from other reconciling items in the reconciliations required by paragraph 28. 13.4 Disclosure Paragraph 20 states that an entity shall disclose information to enable users of financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environment in which it operates. To give effect these provisions, Paragraph 21 requires an entity to disclose the following for each period for which an income statement is presented: (a) General information as described in paragraph 22; (b) Information about reported segment profit or loss including the specified revenue and expenses included in reported segment profit or loss, segment assets, segment liabilities and the basis of measurement, as described in paragraphs 23-27; and (c) Reconciliations of the totals of segment revenues, reported segment profit or loss, segment assets, segment liabilities and other material segment items to corresponding entity amounts as described in paragraph 28. On the other hand, reconciliations of the amounts in the statement of financial position for reportable segments to the amounts in the entitys statement of financial position are required for each date at which a statement of financial position is presented. 13.5 Conclusion Reporting information based on the operating segments of an entity has been an area of interest since the emergence and growth of the multinational conglomerates. This has led to the introduction of an international accounting standard in this respect. The first international accounting standard issued in this respect was IAS 14 - Segment Reporting. It was replaced by IFRS 8 Operating Segments. IFRS 8 is a shorter standard than IAS 14 and differs from it in relation to the identification of segments, measurement of segment information and disclosures. The objective of IFRS 8 is expressed as a core principle, being that an entity should provide information to enable users of financial statements evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates. References SLFRS 8 Operating Segments (Recommended for further reading) Questions

1.

Gama PLC, which engages in the manufacture of consumer products, in its reporting structure consists of a chief operating officer (CEO) who oversees two chief operating officers. Each of the COOs is responsible for their continental regions which consist of several countries. Identify the chief operating decision maker in the following circumstances. (a) When each country engages in revenue generating business activities (b) When separate financial information is available for each country. 2. The following business segment information is presented for Oak PLC. Determine which segments are reportable according to the guidelines provided in SLFRS 8.
Segment Iron Cement Steel Aluminum Cooper Limestone Total Segment Revenue (Rs000) External Sales Inter-segmental Sales 250 120 20 60 60 80 200 20 230 230 10 990 290 Segment Profit (Rs000) 90 160 -30 -10 60 80 350 Segment Assets (Rs000) 810 510 160 160 270 50 1960

3.

Given below is segment information of Jain Motors PLC. All the figures are presented in Rs000. Segment Cars Bikes Tractors Cranes Forklifts Cycles Total Revenue External 240 120 100 260 120 0 840 Sales Inter500 20 160 40 40 140 900 segment Sales Total 740 140 260 300 160 140 1740 Revenue Determine the reportable segments.

4.

Providing segment information to financial statement users will enable the management to demonstrate greater accountability. Discuss.