In an organization, various products are manufactures or services are offered. In a big entity, operations are performed in various locations, cities, and states and even overseas in various countries. Some of the locations are identified as profit centers because they incur expenses and make revenues. In order to assess the performance of each profit center, decision-makers call these centers operating segments. The purpose of doing so is to keep separate underperforming and overperforming products and services in order to make the right decisions.
For an operating segment, separate financial information and records are maintained in order to assess its performance from top management.
Who is required to Disclose Operating Segment?
Not every company is required to disclose the performance of its operating segment. Companies who are involved in equity and debt instrument trading in the public stock exchanges or in the process of doing so are required to prepare their financial statements using segment reporting.
Criteria for segment Reporting?
In order to qualify as a reportable segment, a segment must be:
- Making at least 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} profit of the combined profit of all reporting segments, or
- Making at least 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} loss of the combined losses of all reporting segments, or
- Making at least 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} revenue of the combined revenue of all reporting segments, or
- Having at least 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} asset of the combined asset of all reporting segments.
It should be made possible that the reportable segment must cover at least 75 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} revenue of the entity. If the total segment revenue is less than 75 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}, then the entity needs to identify further segments to ensure revenues reach at least 75 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}.
Example
The alpha industry is engaged in the production of plastic furniture in various parts of the USA. It has the following data available for its various locations. Being a management accountant, advise the directors of the Alpha industry whether they should be treated as segments or not.
| NY | DC | AK | AL | AZ | TX | Total | |
| Revenues | 44 | 20 | 48 | 64 | 20 | 8 | 204 |
| Assets | 69 | 25 | 60 | 80 | 40 | 26 | 300 |
| Profits | 6 | 1 | 8 | 14 | -3 | -1 | 25 |
Solution
We will calculate portion of revenues, assets and profits of each state tomake any decision about the segment reporting:
| NY | DC | AK | AL | AZ | TX | Total | |
| Revenues {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} | 21.6 | 9.8 | 23.5 | 31.4 | 9.8 | 3.9 | 100 |
| Assets {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} | 23 | 8.33 | 20 | 26.7 | 13.3 | 8.7 | 100 |
| Profit {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} | 24 | 4 | 33.3 | 56 | -12 | -4 | 100 |
NY, AK and AL are meeting the criteria of at least 10{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} for revenues, assets, and profits. However, AZ is meetng just the asset criteria. As, the criteria require the meeting of any one factor. Over this basis, the Alpha industry can make NY, AK, AL and AZ as its segments for reporting purposes.
The IFRS (International Financial Reporting Standard) and US GAAP provide exactly the same procedure for the reporting of the segments. Mostly, the segment reporting is performed for public entities because they have public interest involved in their operations. However, it is not a hard and fast rule as any entity who thinks that it is in its best interest to prepare its financial statements over the product line or geographical segment basis, it can do so.
Now, the question arises whether different accounting policies can be followed for segment reporting than that of group. The answer is no as the entity has to consolidate all its segments into one consolidated financial statements and as such accounting policies ahs to be uniform in all segments.
Disclosure
As the purpose of the financial statements are to give true and fair view of the financial position and performance of the entity. It is necessary to follow the same rule for segment reporting. An entity has to disclose following information while reporting for primary segments:
- Sales revenue – this include sale to outside customers as well as sales to another segment in the group. The value of transfers between segments can be measured using the methods deployed by the entity,
- Liabilities – for each of the segment, liabilities should be disclosed into current and non-current liabilities so that informed decisions can be done with reliability,
- Assets – Like liabilities, assets of the segments should be disclosed into non-current assets and current assets.
- Depreciation & amortization – these should be calculated by following the accounting policies of the group and should be charged into the profit & loss of the relevant segment.
- Equity method income – the segment income should also be disclosed via the equity method. This is to ease out the process of understanding for the users of the financial statements.
However, for secondary segments, the requirements are not that much detailed as that of primary segments. An entity has to disclose following information for the secondary segments:
- Revenues – this also involve sales to other segments,
- Assets – the assets should be categorized into current assets and non-current assets,
- Capital additions – Whatever additions are made into the capital of the secondary segments, these should be properly disclosed either on the face or notes to the financial statements.
Reconciliation
In order to present the information as clear as possible, it is required to reconcile the following items:
- A reconciliation of segment assets with consolidated assets of the group – this ensures completeness of the information in the financial statements,
- A reconciliation of the segment liabilities with that of the group as a whole, this ensures not only completeness but also helps in knowing the detailed liability structure and helps greatly in managing the working capital cycle,
- A reconciliation of segment revenue and segment expenses with that of the group as a whole is also essential in knowing the group performance and how each segment is responsible for the success or failure of the group as a whole.