Operating Segment Reporting - Essay Example

IFRS 8 Operating Segments Do the requirements of IFRS 8 Operating Segments enhance the quality of information available to financialstatement users? Introduction Operating segment reporting is the reporting involving separation of operating segments of a corporation or company as additional disclosures to its financial books. The process involves division of the company into different sectors and reporting non-financial or financial information for each of the sectors. IFRS 8 requires that the identification of operating segments to be on the basis of internal reports reviewed regularly by CODM with the intention of allocating resources to the segment thereby assessing its performance. There are various ways that an entity can segregate its operations, but the most common mode of segmentation is segmentation by business type or industry, by geographical area or a combination of both the industry and geographical area. IFRS 8 guides operating segment reporting. IFRS 8’s core principle requires that an entity must disclose all the information to enable all those who use the financial statements gain value from it. It helps to evaluate the financial effects and nature of the business activities that the company engages on and also the economic environment that the entity is operating (Media, 2011 pg. 213). As IFRS 8 requirement, all entities must disclose information that relate to all their operating segments that a function or an individual that is commonly referred to as the Chief Operating Decision Maker (CODM), utilizes internally in making its management decisions. Another requirement of this management approach is that all the operating segments to be identified only if they are based on internal reports regularly reviewed by the Chief Operating Decision Maker. The Chief Operating Decision Maker must be using segmental items that are internal, and it is not a must that the measures must be conforming to international accepted accounting practice (GAAP) disclosures. Why do accounting standard setters believe that the provision of segmental information is useful? IFRS 8 has a mandatory requirement for all those adopting IFRS as from January 2009. There has not been much research done in the field concerning the usefulness of the new regulation. Most of the users of the financial information agree that IFRS 8 has led to the provision of more useful segmental information when compared to IAS 14R. The findings from the few working papers and articles indicate that IFRS 8 has helped provide segmental information that has been proven to be useful for decision making. Investors are the primary users of operating segments information (Nobes, 2010, pg 359). The operational segmented data is very useful for decision making and more amongst investors. With the increased rules and principles under IFRS 8, the information provided under IFRS 8 is more useful in decision making than that of IAS 14R. Most of those who prepare and use financial information prefer IFRS 8 as opposed to IAS 14R. They have welcomed the management approach concept which is the core principle under IFRS 8 and have been positive about the introduction of the standard. Most of the users of financial information have over time been worried about the lack of comparability of operational disclosures of different entities. Some factions have thought that the identity of CODM should be better disclosed and also believed that the more explanations have been needed to expound on the purpose and the role of the entity-wise disclosures. Most of those preparing the financial information believe that the flexibility that IFRS 8 offers is allowing companies to provide more gainful information to the stakeholders and users of the financial information of the profits before unusual items. It has also provided insights on how the company was operating internally. What are the current requirements of IFRS 8 in relation to operating segments and how do they differ from other past and present accounting standards? IFRS 8 was adopted because International Accounting Standards Board and Financial Accounting Standards Board (FASB) were attempting to converge accounting standards between countries applying IFRS and the United States. It replaced the IAS 14R which was previously used. The main reason for replacing IAS14R with IFRS 8 by International Accounting Standards Board was to anticipate that under the new IFRS 8, more companies would engage in segment reporting. Under the new regulation, it was believed that the new guidelines will increase disclosures of segment information in those firms that were already using IAS 14R. The new change that the new IFRS 8 has introduced that was absent in IAS 14R is the introduction of the management approach. According to the management approach, entities are required to perform disclosure of their segmental information basing it on the companys parts that the management of the company is using to make decisions about the operating matters. It has become a must for the companies to report on their financial books the same operational segments that they utilize internally within the organization for making the decisions concerning allocation (Crawford, 2012, pg 65). The difference with IAS 14R was that IAS 14R required the disclosure of two different types of segments, geographical and business. It was based on the disaggregation of the information that was to be reported in financial books of the entity. According to the guidelines in IFRS 8, the amounts of operational segment assets and liabilities, loss or profit are to be disclosed for each segment calculated. It was not applicable in IAS 14R. The same measures were to be used by the Chief Operating Decision Maker in the decisions of resource distribution and performance assessment for each segment. On the other hand, the preparation of segment information according to IAS 14R was carried out basing on the usual accounting principles used in the preparation of the financial statements. IFRS 8 had other changes that were not in the old IAS 14R. They are the new requirements for qualitative disclosures like the identification determinants of operating segments (Bryois, 2009, pg 162). There were also the distribution interest expenses, product and services, revenues, major customers and geographical areas as a requirement. IFRS 8 addresses the financial statements users’ needs for increased disaggregation of information disclosures while also keeping the levels of consolidated information constant as opposed to IAS 14R. With the introduction of a new Chief Operating Decision Maker (CODM) concept by the new rules, the entities are not imposed with problems especially in the European Union IFRS has introduces relevant segment reporting guidelines and rules for all firms as opposed to IAS 14R which used to deal with only large companies. Given that all firms that are listed are obliged the same level of operational segmented information under the new regulations, there is no need under IFRS 8 for special rules to be applied by the small listed firms on segment reporting. The management approach was adopted by the IASB to help the investors have a better understanding of the procedures followed by the company’s management with a view to eliminating risk and making sound financial decisions. The approach would make financial statements preparation easier and less costly as oppose to IAS 14R as the information disclosed was already prepared for internal use in management accounting department. What evidence is there as to whether the current requirements increase the quality of information available to users of financial statements? Segment reporting has been proven to provide a powerful tool to analyse and provide risks and opportunities that diverse entities encounter. Understanding the risks and opportunities has been key in determining whether to extend credit or invest and how to price the credit or investment if the opportunity is taken. For a company that is diverse, users of information find it sufficient to project cash flows or earnings on a segmental basis rather than on an entity as a whole. When performing valuation of companies, users of financial often apply a different discount rate or multiple to a segments cash flows or earnings. It reflects the diverse risks and opportunities of each particular section. Data on segments will thus provide for a more precise valuation than otherwise would have been possible. Information on industry segments is necessary because the industry structure is an essential driver of risks and opportunities in nearly all business sectors. The industry structure is a crucial determinant of future cash flows and profitability. All the users of financial information do adopt an industry focus because of the insight the focus brings in the evaluation of companies in the industry. Users use the industry segmentation in multi-segment companies as a unit of analysis in the determination of the risks and the opportunities that a company phases. Financial information that is based on geographical segmentation and areas where an entity is carrying out its operations provides a valuable insight into an enterprises risks and opportunities resulting from those trends. Market locations affect the risks and opportunities for the revenues of an entity, and the operating locations of the entities affect the risks and the opportunities related to the assets of the company. Conclusion Overall, users of segmental information need more accurate information on the financial statements to help them make sound decisions. It will be worthwhile to have a continued review of the rules and principles on segmental reporting found in IFRS 8 to improve the credibility of financial statements. Segmental reporting helps in making economic and investment decisions and the information should thus be presented in an IFRS 8 format to assist in easier understanding. Entities should thus provide general information on how the reportable segments are identified. They should also disclose the types of services or products from which each reportable segment gets its revenue to help assist the users Reference List Bryois, F. (2009). IFRS 8 - operating segments: Management approach to segment reporting.Top of FormBottom of Form Crawford, L. (2012). Operating segments: The usefulness of IFRS 8. Edinburgh: ICAS.Top of FormBottom of Form IFRS 8, operating segments. (2006). London: International Accounting Standards Board. Top of Form Bottom of Form Media, B. (2011). CIMA F1 Financial Operations Study Text. (2011th ed.). London: BPP Learning Media. Top of Form Bottom of Form Nobes, C. (2010). Current debates in international accounting. Cheltenham: Edward Elgar. Read More