IFRS 8 mandates that entities with publicly traded securities, or those planning to trade publicly (as outlined in Scope), must include additional information in their financial statements to provide a clearer picture of their business performance.
Defining an operating segment
An operating segment, as per IFRS 8.5, is a component of an entity that:
- Engages in business activities generating revenues and incurring expenses, including those from intra-group transactions.
- Has its operational results regularly reviewed by the entity’s chief operating decision maker for resource allocation and performance assessment.
- Has available discrete financial information.
An operating segment may engage in activities that do not yet generate revenue, such as start-up operations, which can still be considered operating segments before they begin earning revenues. The identification of operating segments involves the role of the ‘chief operating decision maker’ (CODM), which is a function rather than a specific managerial position. This function encompasses allocating resources and assessing the performance of the entity’s operating segments. Typically, the CODM could be the CEO, COO, a group of executive directors, or others.
If an entity presents its business activities in various formats and the CODM uses multiple sets of segment information, other factors, such as the nature of business activities, the presence of responsible managers, and information provided to the board, may determine the primary set of operating segments.
An operating segment generally has a ‘segment manager,’ who directly reports to and communicates with the CODM regarding the segment’s operations, financial results, forecasts, and plans. This role, similar to that of the CODM, is defined by its function, not necessarily by a specific title. Sometimes, the CODM might also act as the segment manager for certain segments, and a single manager might oversee multiple segments.
When these characteristics are applicable to more than one set of components within an organisation, but only one set has accountable segment managers, that set is considered the operating segments. In cases of a matrix organisation structure, where responsibilities overlap across different product lines and geographical areas, and both sets of components are regularly reviewed by the CODM with available financial information, the entity must determine its operating segments based on the core principle of IFRS 8. This approach ensures that the operating segments are identified in a manner that reflects how the entity is managed and how financial information is presented for decision-making purposes (IFRS 8.6-10).
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Distinguishing between operating and reportable segments
Not all identified operating segments require disaggregated reporting (IFRS 8.11). IFRS 8 sets quantitative thresholds for segments and outlines separate aggregation criteria, with a helpful diagram for identifying reportable segments in IFRS 8.IG7:
Quantitative thresholds
A segment must be reported if it meets any of the following criteria (IFRS 8.13):
- Its revenue (including inter-segment sales or transfers) is at least 10% of the total internal and external revenue of all segments.
- Its reported profit or loss is 10% or more of the higher absolute amount of either the total profit of profitable segments or the total loss of segments incurring losses.
- Its assets comprise 10% or more of the total assets of all segments.
If the cumulative external revenue of reportable segments falls below 75% of the entity’s total revenue, additional segments should be separated until this threshold is met (IFRS 8.15).
However, there is a practical consideration regarding the number of reportable segments as too many segments can result in overly detailed information. While IFRS 8 does not specify an exact limit, it implies that when the number of reportable segments exceeds ten, the entity should assess if a practical limit has been reached (IFRS 8.19).
Aggregation criteria for operating segments
Two or more operating segments can be combined into a single segment if such aggregation aligns with the core principle of IFRS 8. This is permissible when the segments demonstrate similar economic characteristics and likeness in key areas: the nature of their products and services, their production processes, the types or classes of customers they serve, the methods used for product distribution or service delivery, and, where relevant, the nature of their regulatory environment. This aggregation facilitates a more streamlined and coherent financial reporting process (IFRS 8.12).
Disclosure of segment information
The fundamental objective of disclosing segment information under IFRS 8 is to assist users of financial statements in understanding both the nature and financial impacts of an entity’s business activities, as well as the economic environments in which it operates (IFRS 8.20). It’s important to note that IFRS 8 prohibits exemptions to these disclosure requirements, even in cases where potential ‘competitive harm’ might be argued (IFRS 8.BC43-45).
Entities must disclose factors that are instrumental in identifying their reportable segments. This includes detailing the decision-making process and any judgements made, especially concerning the application of aggregation criteria. Additionally, a clear description of each reportable segment’s business activities is mandatory (IFRS 8.22).
For each reportable segment, IFRS 8.23 requires entities to disclose:
- A measure of profit or loss.
- Total assets and liabilities, but only if these figures are regularly provided to the CODM.
- Specific items listed in IFRS 8.23, if they are factored into the segment’s profit or loss as reviewed by the CODM, or if they are regularly presented to the CODM, irrespective of their inclusion in the profit or loss measure.
- Additions to non-current assets (often referred to as ‘capex’), if they are part of the CODM’s evaluation of segment assets or are regularly made available to them, regardless of their inclusion in the segment asset measure (IFRS 8.24).
It’s not mandatory to disclose segment performance measures that integrate profit/loss, cash flow, and balance sheet data, even if these are made available to the CODM. However, in practice, entities frequently disclose such information, particularly if it forms part of other financial information presented to analysts. Common examples include return on capital employed (ROCE), net debt to EBITDA ratio, or free cash flow (FCF).
Measuring segment information
The fundamental rule for segment measurement is that the reported segment data should align with what is presented to the CODM. This may mean that these figures don’t always match the items in the primary financial statements (IFRS 8.25-26). Reflecting IFRS 8’s management approach to segment reporting, the objective is to present the entity from the management’s perspective to the users. Consequently, entities are required to explain and reconcile segment profit or loss, assets, and liabilities for each reportable segment, as detailed in IFRS 8.27, which outlines the essential information for these explanations.
Management-defined performance measures
Segment measures often differ from standard IFRS measures. This aspect has led to criticism of IFRS 8 for not mandating IFRS-defined and comparable segment measures across entities. Key regulators, like the SEC, ESMA, and the FRC, have established guidelines for the inclusion of non-IFRS measures in financial reports. These are typically referred to as non-GAAP measures, Alternative Performance Measures (APMs) or Management-defined Performance Measures (MPMs). It’s crucial to understand the regulations relevant to a specific entity. Common requirements for APMs/MPMs include:
- Clear definitions and explanations of the basis of calculation.
- Non-misleading labels.
- Reconciliation to IFRS measures.
- No greater prominence than measures from primary financial statements.
IFRS 18 (effective from 2027) mandates the reconciliation of non-GAAP measures with IFRS-specified subtotals, but this only applies to P/L measures such as adjusted profit. Other metrics like free/organic cash flow or net debt are not included.
Reconciliations
Entities must reconcile segment measures with the items in the primary financial statements (IFRS 8.28). It’s important to note that this reconciliation doesn’t need to be at the individual segment level (IFRS 8.BC42). An example of such reconciliation is provided in IFRS 8.IG4.
Entity-wide disclosures
IFRS 8 mandates certain entity-wide disclosures (IFRS 8.31-34), covering areas like products and services, revenue from foreign countries, and non-current assets held in foreign countries (illustrated in IFRS 8.IG5). Additionally, entities must disclose their dependence on major customers, including those under common control.
Scope of IFRS 8
Scope overview
IFRS 8 is applicable to both separate and consolidated financial statements of entities with securities traded or to be traded publicly (IFRS 8.2). When both types of statements are in a single financial report, segment information is only required in the consolidated financial statements (IFRS 8.4).
Interim financial statements
IFRS 8 introduced a requirement to IAS 34 for the disclosure of selected segment information in interim financial statements (see IAS 34.16A(g)).
Interaction with IAS 36
The identification of operating segments has implications for impairment testing. Specifically, IAS 36.80(b) states that each cash generating unit (or group of units) with allocated goodwill cannot exceed the size of an operating segment before aggregation.