ABOUT ACCOUNTING CLUBS
Discover who we are and what we do
Expert Q&A’s
Read about various complex accounting concepts
PODCASTS
See the podcasts we offer to help in your respective areas
Chapter 1: Introduction
The core principle (and objective) of IFRS 8 is to require an entity to disclose information that enables 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. This principle makes it clear that the standard is primarily a disclosure standard. The standard does not prescribe the way in which management should measure segment information. Instead, it requires the disclosure to be based on information reported to the chief operating decision maker (CODM).
Scope
IFRS 8 applies to:
- The separate or individual financial statements of an entity:
- whose debt or equity securities are traded in a public market (that is, a domestic or foreign stock exchange or an over-thecounter market, including local or regional markets); or
- that files, or is in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market.
- The consolidated financial statements of a group with a parent:
- whose debt or equity securities are traded in a public market (that is, a domestic or foreign stock exchange or an over-thecounter market, including local or regional markets); or
- that files, or is in the process of filing, the consolidated financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market.
Public markets: For this purpose, a ‘public market’ is any domestic or foreign stock exchange, or an over-the-counter market, including local and regional markets.
Subsidiary entity whose debt or equity securities are traded in a public market or that is in the process of filing its financial statements
A subsidiary entity whose debt or equity securities are traded in a public market, or that is in the process of filing its financial statements with a securities commission or regulatory authority for the purpose of issuing its securities in a public market, is required to present segment information.
The subsidiary would need to analyse its segments separately from the parent’s analysis. This would include identifying its own CODM, determining its own operating segments based on its CODM’s review, and disclosure of its reportable segments in accordance with IFRS 8. The separate subsidiary’s reportable segments will not necessarily be the same as the parent entity’s disclosures of the activities of the listed subsidiary. It would not be uncommon for the subsidiary’s reportable segments to be more detailed than the corresponding segment disclosures in the parent entity’s financial statements.
Subsidiary has listed Securities, but parent does not
Where a subsidiary has listed securities but the parent does not, whether the parent’s consolidated financial statements are required to comply with IFRS 8 will depend on whether the consolidated financial statements need to be filed with a regulator. Where the consolidated financial statements are required to be filed with a regulator, the consolidated financial statements should comply with IFRS 8, irrespective of the subsidiary’s disclosure or filing requirements.
Entities that issue puttable instruments on a public market
IFRS 8 might apply to entities that issue instruments on a public market where those instruments can only be redeemed by ‘putting them back’ to the issuer.
For example, an entity that is a fund issues a public prospectus, whereby members of the public can subscribe for units. Investors can only redeem their units by selling them back to the fund. Since the entity was required to file its financial statements as part of the public prospectus, IFRS 8 would apply for the purpose of issuing the instruments (and subsequently issued instruments) to members of the public.
Regulatory requirement to file financial instruments
A regulatory requirement to file financial statements is not always linked to the process of issuing instruments to a public market. Therefore, entities that file financial statements will not always be within IFRS 8’s scope. Where an entity does not file financial statements for issuing instruments (for example, a mutual fund has to file financial statements, but not for the purpose of issuing instruments to the public), it would not be required to comply with IFRS 8. However, if a regulator nevertheless requires segment information or an entity voluntarily provides segment disclosure, this information should comply with IFRS 8.
Consolidated financial statements of an intermediate holding company when the ultimate parent has debt or equity instruments traded in a public market – example
Entity B is an intermediate holding company within a group headed by Entity A. Entity A’s equity shares are traded in a public market; Entity B has no debt or equity instruments traded in a public market and is not in the process of issuing any class of instruments in a public market.
Under the requirements of local law, Entity B prepares consolidated financial statements.
The requirements of IFRS 8 do not apply to the consolidated financial statements of Entity B. IFRS 8 states that IFRS 8 applies to “the consolidated financial statements of a group with a parent whose debt or equity instruments are traded in a public market or that is in the process of issuing any class of instruments in a public market”.
In this context, the ‘parent’ for the purposes of IFRS 8 Entity B (i.e. the entity which controls the other entities within the consolidated financial statements under preparation). Entity A is not part of the reporting entity and the fact that its shares are publicly traded is not relevant to the consideration of the applicability of IFRS 8 for the purposes of Entity B’s consolidated financial statements.
Consolidated financial statements published together with separate financial statements When a single financial report includes both consolidated financial statements and the separate financial statements of a parent falling within the scope of IFRS 8, segment information need be presented on a consolidated basis only.
If an entity that is not required to apply IFRS 8 voluntarily discloses information about segments, but that information does not comply with IFRS, the entity should not describe the information as segment information.
Entity voluntarily discloses information about segments
If an entity voluntarily discloses information about segments, but that information was not the information reported to the CODM, it should not be described as segment information. Similarly, if the entity voluntarily disclosed only part of the information required by the standard, such as sales information for segments, but did not disclose segment profit or loss or the other information required by the standard, it should not describe the sales information as segment information.
Where a parent’s separate financial statements that are required to comply with IFRS 8 are included in a financial report with the consolidated financial statements of the parent and its subsidiaries, segment information need only be given for the consolidated financial statements.
An entity that is not within IFRS 8’s scope might still be required to identify its operating segments in accordance with IFRS 8. IAS 36 states that a cash generating unit, to which goodwill acquired in a business combination is allocated for the purpose of impairment testing, cannot be larger than an operating segment. Therefore, although the entity does not need to comply with the disclosure requirements of IFRS 8, it will still need to comply with IFRS for the purpose of determining its operating segments.
Approach to segmental reporting
IFRS 8 requires an entity to first identify its ‘operating segments’. Once an entity has done that, it is required to determine its ‘reportable segments’. Reportable segments might comprise single operating segments, or an aggregation of operating segments. Reportable segments are the basis for disclosure of segment information in the financial statements.
Additional information presented to supplement IFRS 8 operating segments information
Although IFRS 8 requires a decision to be made as to what the operating segments are (applying, if necessary, the core principle), there is nothing in the standard to prevent an entity from reporting additional information, to supplement the information required for operating segments.
An entity could give such information in the form of a matrix presentation so that, for example, if operating segments were based on products, the additional information would also give geographical information. Although not required by the standard, a matrix presentation can be very useful to users of the financial statements.
Operating segments
An operating segment is defined as a component of an entity:
- that engages in business activities from which it could earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity);
- whose operating results are regularly reviewed by the entity’s CODM to make decisions about resources to be allocated to the segment and assess its performance; and
- for which discrete financial information is available.
Start-up operations could be operating segments, because operating segments might engage in business activities from which they have yet to earn revenues.
Entity that has yet to earn revenue is operating segmentAn entity whose sole activity is the development of a new product might only be incurring research and development expenses and administration expenses, without any revenue yet being earned from the product, but it might still need to treat those activities as an operating segment. |
Research and development function are operating segment
A research and development function can be an operating segment, provided that discrete information is regularly reviewed by the CODM. Although the function does not earn revenues, it differs from a corporate overhead department, in that its activities are not incidental activities; rather, its activities serve as an integral component of the entity’s business. The research and development business unit are essentially a vertically integrated operation of the entity.
CODM reviews revenue information only
The definition of an operating segment requires discrete financial information to be available. Where discrete financial information is not available, a business activity is not an operating segment.
Where the CODM reviews revenue information only, for a particular area of business, in most cases this will not meet the definition of an operating segment. For most entities, the review of revenue-only data is not sufficient for decision-making related to resource allocation or performance evaluation of a segment.
However, where product sales or service provisions involve minimal costs, the revenue-only data could be representative of the operating results. In this case, the review of the revenue-only data by the CODM might be sufficient to conclude that the business activity falls within the definition of an operating segment.
Is a segment balance sheet required for discrete financial information to exist?
A segment balance sheet is not necessary to conclude that discrete financial information is available. The requirement for discrete financial information can be met with operating performance information only, such as gross profit by product line.
Vertically integrated operations
IFRS 8 defines an operating segment as a “component of an entity that engages in business activities from which it may earn revenues and incur expenses”.
This envisages that part of an entity that earns revenue and incurs expenses, relating to transactions with other components of the same entity, might still qualify as an operating segment, even if all of its revenue and expenses derive from such intra-group transactions.
Therefore, a vertically integrated operation of an entity, for which no revenues are allocated, can still meet the definition of an operating segment. Vertically integrated operations are structures that combine many or all of the production and selling processes within one entity.
For example, manufacturing entities that are managed by an operating cost centre might not have revenues allocated to each cost centre. Provided that discrete financial information is prepared and reviewed by the CODM, such components would be considered to be operating segments.
A further example is in the oil industry, where the activities of exploration and production (upstream activities) and refining and marketing (downstream activities) are carried out within one entity. Even though most, or all, of the upstream product (crude petroleum) is transferred internally to the entity’s refining operations, the standard’s requirements mean that the upstream activities could still qualify as an operating segment.
Discontinued operations and operations being wound Down
A discontinued operation can meet the IFRS 8 definition of an operating segment if it continues to engage in business activities, the operating results are regularly reviewed by the CODM, and there is discrete financial information available to facilitate the review.
This might be the case where an operation is being wound down, even if no strategic or long-term planning decisions are being made with respect to the operation. If the CODM continues to review the operation’s results for the purpose of short-term management, it could still meet the definition of an operating segment, as illustrated in the example below.
Example – Insurance entity disposing of its workers’ compensation business
An insurance entity discontinues its workers’ compensation business. The discontinuation meets the criteria for ‘discontinued operations’ treatment under IFRS 5. For internal purposes, separate financial results are maintained for this business, and they are reviewed by the CODM until the discontinuance is complete. The operation is still being managed by the CODM and would continue to meet the definition of an operating segment.
Conversely, if the CODM no longer reviews discrete financial information on the discontinuing operation, it would no longer fall within the definition of an operating segment. However, note that particular disclosures might still need to be presented in accordance with IFRS 5.
Joint ventures as operating segments
Joint venture operations can qualify as operating segments, provided that the entity manages these operations separately and that such operations meet the IFRS 8 definition of an operating segment. The financial information (as reported to the CODM) regarding the joint venture activities that comprise the segment would be disclosed.
If the results of the whole of the joint venture are reviewed by the CODM, such financial amounts should be disclosed and then reconciled to the corresponding amounts (for example, the investor’s 50% interest) reported in the consolidated financial statements.
In addition, appropriate eliminations would need to be reflected in the reconciliation column, for amounts reported in excess of those amounts reflected in the consolidated financial statements. For example, since the joint venture’s revenue information is not included in the revenue figure reported in the consolidated financial statements (if the joint venture is accounted for under the equity method), an elimination of the revenue amount disclosed for the joint ventures would need to be reflected as a reconciling item.
Some parts of an entity will not necessarily meet the definition of an operating segment, because they might not be in a position to earn revenues or they might earn revenues that are only incidental to the entity’s activities. An entity’s post-employment benefit plans are not operating segments.
Corporate headquarters support function that does not meet the definition of an operating segment
A corporate headquarters, carrying out support functions in the areas of accounting, treasury, information technology, legal, human resources, environmental and internal audit, would generally not be an operating segment; this is because the revenue earned and expenses incurred are only incidental to the entity’s business (since these activities only arise to support the main business). This applies even if discrete, internal financial information about the headquarters’ activities is reviewed by the CODM.
However, IFRS 8 does not preclude the additional disclosure of any information by management that is consistent with the core principle and that contributes to the understanding of the entity. An entity might therefore separate the corporate headquarters’ results from the ‘all other segments’ results, provided that it clearly identifies that the corporate headquarters information presented does not represent an operating segment.
Chief operating decision maker
The term ‘chief operating decision maker’ (CODM) is intended to mean a function rather than a manager with a specific title. The function is to allocate resources to operating segments and to assess their performance. This function will vary from entity by entity and might be carried out by the person who is the entity’s chief executive or chief operating officer, but it could also be, for example, a group of executive directors, senior management team, the management board or others. Deciding who the CODM is can be difficult, and judgement is needed to ensure that the right person or persons have been identified. The CODM is responsible for the allocation of resources and assessing the performance of the entity’s operating segments. The CODM’s identity will not always be clear and will depend on the entity’s structure.
Supervisory board or committee of non-executive directors as CODM?
In some jurisdictions, a supervisory board might have significant oversight responsibilities over the function of the board of directors. However, it is unlikely that a supervisory board is the CODM. The supervisory board would need to act in the same capacity as the typical chief executive officer, in order to be the CODM; this would include regular reviews and interaction with segment management. Veto rights or rights of approval alone would not constitute the function of allocating resources and assessing performance in the context of IFRS 8. A supervisory board function that simply approves management’s decisions would not constitute the CODM.
Additionally, a committee of non-executive directors is unlikely to be the CODM. Non-executive directors are not usually involved in resource allocation decisions, except at a very high level. Their role is a governance one, rather than a management role. Therefore, they would not meet the definition of the CODM. However, a function, such as a board of directors, might include non-executive directors whose sole responsibility is governance. Such a function would be a CODM if the most significant operating, as well as strategic, decisions are made by that function, even if those non-executive directors do not participate in implementing such decisions. So, care should be taken where non-executive directors are members of a committee that is deemed to be the CODM.
Management approach
A condition for identifying an operating segment is that it should be a component of the entity whose operating results are regularly reviewed by the entity’s CODM, to make decisions about resources to be allocated to the segment and to assess its performance.
The IASB chose to adopt the ‘management approach’ to identifying operating segments for several reasons, which include: It gives consistency between what is reported to users and what is reported internally to management – that is, it enables the user of the financial statements to review the operations ‘through the eyes of management’. Segment information is more consistent with information reported elsewhere in the financial report (for example, in a management commentary). The cost of producing segment information is reduced, because the information is the same as that generated internally for management, rather than having to be specially produced for the financial statements. The management approach in IFRS 8 is consistent with the US standard ASC 280, and so the adoption of this approach helps to converge IFRS and US GAAP. Adopting the same approach as in ASC 280 results in some entities reporting more segments, and more segment information, in interim financial reports.
Identifying operating segments
The CODM might receive and review reports, giving several different types of segment information, that makes it difficult to clearly identify operating segments. This might result in other factors, including the nature of the business activities, the existence of managers responsible for them and information presented to the board of directors, being taken into account to identify the operating segment.
Identification of operating segment where CODM receives reports by product and by geographical region
The CODM might receive reports on an entity’s sales and operating profit, both by product and by geographical region. On its own, this information might make it unclear as to whether the ‘management approach’ would result in operating segments based on the type of product (or business unit responsible for the product) or geographical criteria.
For the purposes of this example:
· The entity had managers responsible for each product area.
· The entity had just one sales manager.
· The CODM also received information regularly on development costs of new products and employee numbers in each product area. Information on each product area was regularly supplied to the whole board.
· The board only received information on total global sales figures.
The management approach would result in operating segments that were based on the type of product (or business unit responsible for the product), because there are individual managers for each of these business units (product areas), but not for each geographical region. The board receives information on each product area, but it does not receive sales figures on individual geographical regions.
Identification of operating segment where CODM reviews multiple levels of reports
The CODM might review multiple sets of information when assessing the entity’s overall performance and deciding how to allocate resources. This is an area that requires significant judgement.
For example, the CODM might review three levels of reports:
· level 1 is an aggregation of level 2, yielding three components;
· level 2 contains the level 3 components aggregated into 10 components; and
· level 3 is the more detailed component level and is represented by 25 individual components.
In order to determine the operating segments, the following factors should be considered:
· Understanding the regular process that the CODM uses to assess performance, what information is used, and with whom the CODM interacts. The presumption would be that any information provided to the CODM on a regular basis is used. An entity should consider whether the receipt of certain specific information (such as ratios) can logically be used to assess performance and allocate resources, or whether the CODM could practically perform the function at the low disaggregated level 3.
· Identifying the segment managers and what they are responsible for. Segment managers are usually compensated on the basis of the results of the segment as a whole. However, a segment manager can be in charge of more than one operating segment.
· The budgeting process, on the assumption that the operating and capital budget would be approved or modified by the CODM for the segment as a whole.
· The information sent to the board of directors. The board would not usually receive information at a level lower than the operating segments.
· Whether the level of the organisation viewed makes sense as operating segments in the context of the core principle (that is, whether the presentation of segments at a lower level contributes significantly to the understanding of the business activities).
The existence of segment managers is an important factor in determining operating segments. Segment managers are those who are directly accountable to the CODM and who regularly discuss the operating activities, financial results, forecasts or plans for the segment that they manage with the CODM. The term ‘segment manager’ relates to a function and need not be a single person but could, for example, be the executive committee of a subsidiary that constitutes an operating segment. The CODM might also have a dual role (that is, being both CODM and segment manager of one or more operating segments). A single manager might be the segment manager for more than one operating segment – for example, a regional manager might have responsibility for several segments within that region. Where several sets of components of an entity would meet the criteria for identifying operating segments, but segment managers are held responsible for only one set of those components, the function of segment manager is a key indicator. In that situation, only the component set for which they are held responsible constitutes the operating segment.
Role of segment manager as an indicator of operating segments
An entity manufactures and sells electronic components for the automotive and aerospace industries in three geographical markets: Europe, USA and Asia. There is discrete financial information available for each manufacturing location and for the selling activity for each product in each geographical region. This financial information is regularly reviewed by the CODM. There is a sales director, who is responsible for all worldwide sales, to whom each regional sales manager reports. There are also line managers responsible for each of the automotive and aerospace manufacturing activities worldwide. The line managers’ report directly to the CODM, which is the group chief executive officer.
In this situation, both the geographical sales areas and the product areas might meet the criteria for operating segments. However, it is likely that, because the automotive and aerospace line managers’ report directly to the CODM, they would be considered to be ‘segment managers. The regional sales managers do not report directly to the CODM, so they would probably not be regarded as ‘segment managers.
Therefore, it is likely that the entity’s operating segments would be identified as being the automotive and aerospace product areas.
A matrix form of organisation exists where managers are held responsible for overlapping components of an entity and the components are reported to the CODM. For example, some regional managers might be responsible for products and services worldwide, and others might be responsible for different geographical areas. The CODM regularly reviews the operating results of both sets of components, and financial information is available for both. Matrix forms of organisation might present challenges when identifying operating segments. The entity should determine which set of components are the operating segments, by reference to IFRS 8’s core principle. The entity should also assess whether the identified operating segments could realistically represent the level at which the CODM is assessing performance and allocating resources. The identified operating segments are expected to be consistent with other information that the entity produces, such as press releases, interviews with management, entity websites, management discussions and other public information about the entity.
Application of the core principle in a matrix organisation
An entity manufactures and sells electronic components for the automotive and aerospace industries in three geographical markets: Europe, USA and Asia. There is discrete financial information available for each manufacturing location and for the selling activity for each product in each geographical region. This financial information is regularly reviewed by the CODM. The regional sales managers are responsible for both product sales and the geographical markets, and they report to the CODM.
Because management assesses the business on both a product and a geographical basis, it is difficult to determine operating segments by reference to the way in which management assesses the business.
In this situation, application of the core principle might depend on the way in which the CODM assigns priorities in making decisions.
If, for example, the priority is to increase total sales, market share and geographical spread, application of the principle might mean that the most relevant information for shareholders should be based on geographical markets.
If, on the other hand, the priority is to improve the sales of individual products, and the CODM believes that improving and maintaining the product quality is the key to this, and that different geographical markets are likely to respond uniformly to such measures, application of the principle might mean that the most relevant information for shareholders should be based on products.