Operating Segments (IFRS 8)

IFRS 8 applies to separate, individual financial and consolidated financial statements of entities whose securities are, or will be, traded in a public market (IFRS 8.2). When separate and consolidated financial statements are contained within one financial report, segment information is required only in the consolidated financial statements (IFRS 8.4).

An operating segment is a component of an entity (IFRS 8.5):

  1. that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity),
  2. whose operating results are regularly reviewed by the entity’s chief operating decision maker (‘CODM’) to make decisions about resources to be allocated to the segment and assess its performance, and
  3. for which discrete financial information is available.

Discussion on operating segment is contained in paragraphs IFRS 8.5-10.

In general, IFRS 8 has a management approach to identification of operating segments and its aim is to enable the users to see an entity through the eyes of management.

It is sometimes the case that CODM regularly reviews information on different product lines and geographical regions at the same time. When taken separately, products and geographical regions would meet the definition of operating segments. However, entities need to analyse deeper and decide on one basis for identifying operating segments – products or geographical regions.

IFRS 8 inserted a requirement to IAS 34 that requires disclosure of selected segment information in interim financial statements (see IAS 34.16A(g)).

The determination of operating segments by an entity has some implications for impairment tests. Namely, paragraph IAS 36.80(b) states that each cash generating unit (or group of units) to which the goodwill is so allocated cannot be larger than an operating segment before aggregation.

Entities are not required to report separate information for all operating segments identified. Instead, IFRS 8 introduces quantitative thresholds for each segment, but separate aggregation criteria should also be considered (IFRS 8.11). Additionally, paragraph IFRS 8.IG7 presents a useful diagram to assist in identifying reportable segments. It is reproduced below:

Diagram for identifying reportable segments (source: IFRS 8.IG7)
Diagram for identifying reportable segments (source: IFRS 8.IG7)

Separate information should be reported for each operating segment that meets any of the following quantitative thresholds (IFRS 8.13):

  1. Its reported revenue, including both sales to external customers and inter-segment sales or transfers, is 10 per cent or more of the combined revenue, internal and external, of all operating segments.
  2. The absolute amount of its reported profit or loss is 10 per cent 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.
  3. Its assets are 10 per cent or more of the combined assets of all operating segments.

If operating segments are granulated so that the revenue of reportable segments is below 75% of total revenue, additional segments should be separated until the 75% threshold is reached (IFRS 8.15).

See paragraphs IFRS 8.14-19 for more discussion on reportable segments.

Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the core principle of this IFRS, the segments have similar economic characteristics, and the segments are similar in each of the respects listed in paragraph IFRS 8.12.

The main principle of disclosure of segment information is to enable users of the financial statements to evaluate the nature and financial effects of the business activities in which the entity engages and the economic environments in which it operates (IFRS 8.20). IFRS 8 does not allow any exceptions to its disclosure requirements due to potential ‘competitive harm’ (IFRS 8.BC43-45).

The disclosure of segment information should include factors used to identify the entity’s reportable segments, including judgements made in the process (incl. in applying the aggregation criteria), and description of business activities of each reportable segment (IFRS 8.22).

Entities are required to disclose the following for each reportable segment (IFRS 8.23):

  • a measure of profit or loss,
  • measure of total assets and liabilities for each reportable segment only if such amounts are regularly provided to the CODM
  • items listed in IFRS 8.23 if they are included in the measure of segment profit or loss reviewed by the CODM, or are otherwise regularly provided to the CODM, even if not included in that measure of segment profit or loss
  • items listed in IFRS 8.24 if they are included in the measure of segment assets reviewed by the CODM or are otherwise regularly provided to them, even if not included in the measure of segment assets

Measures of segment performance that combine P/L, cash flow and balance sheet items are not required to be disclosed even if they are provided to the CODM, but in practice entities often disclose them, especially if they are included in other financial information provided to analysts. Examples of such disclosures are ROCE (return on capital employed), net debt/EBITDA, FCF (free cash flow).

The general rule is that the reported segment measures should the measures reported to CODM. It means that these measures may not directly correspond to items presented in primary financial statements (IFRS 8.25-26). As noted earlier, IFRS 8 has management approach to segment reporting and its aim is to enable the users to see an entity through the eyes of management. Therefore, entities need to provide an explanation and reconciliations of the measurements of segment profit or loss, segment assets and segment liabilities for each reportable segment. Paragraph IFRS 8.27 lists minimum information that should be provided in making explanations (reconciliations are discussed below).

Segment measures are often non-IFRS measures. This is the major reason for criticism of IFRS 8, i.e. that it does not predefine segment measures to be reported so that they are IFRS-defined and comparable between entities.

Most major regulators (e.g. SEC, ESMA) have issued separate regulations which cover the inclusion of non-IFRS (non-GAAP) measures in financial statements. Such measures are often described as alternative performance measures (APM) or management performance measures (MPM). Make sure to familiarise yourself with such a regulation applicable to a particular entity. Requirements relating to APM/MPM have often common features, such as:

  • APMs/MPMs should be clearly defined with basis of calculation explained
  • APMs/MPMs should be labelled in a way that is not misleading
  • APMs/MPMs should be reconciled to GAAP measures
  • APMs/MPMs should not be displayed with prominence greater than measures directly stemming from primary financial statements

Entities should provide reconciliation of segment measures to items presented in primary financial statements, as specified in paragraph IFRS 8.28. Note that the reconciliation is not needed at the level of an individual segment (IFRS 8.BC42). Example of such a reconciliation is given in paragraph IFRS 8.IG4.

IFRS 8 specifies also some entity-wide disclosures, as set out in paragraphs IFRS 8.31-34. They include information about products and services (which will often be met by providing a disaggregation of revenue), revenue earned in foreign countries and non-current assets held in foreign countries (see paragraph IFRS 8.IG5 for an illustrative example). Entities also need to provide information about the extent of their reliance on major customers, including customers under common control.

© 2018-2020 Marek Muc

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