Issues in Accounting and Finance - Report Example

Current issues in Accounting and Finance. Segmental Reporting Table of Contents Executive Summary 2 Introduction 3 Features of IFRS 8 Segment Reporting 3 Distinction between IAS 14 and IFRS 8 4 Issues 5 Bruegel Institute’s Report 6 Impact on SMEs 6 Views of the E.U.Commission 7 Conclusion 11 References 12 Executive Summary This report dealing with Segmental reporting is essentially a commentary on IFRS 8 that introduces segmental reporting for all public-listed companies of the countries which have adopted IFRS as such. Embracing IFRS was a necessity on global scale in order to have a global standards in the wake of advent of transnational companies pursuant to globalisation. It has been observed that IFRS 8 is a merely an extension of US GAAP standards which has SFAS 131 similar to IFRS 8. The purpose seems mainly to achieve the convergence of US GAAP with IFRS. It has been reported that it is clearly a lost opportunity to address more issues on segmental reporting on which the existing IAS 14 itself deals with it even more comprehensively. However the EU commission in September 2007 in its report has decided to endorse IFRS 8 to be implemented from January 2009 as per the mandate of the IFRS. The commission states that the reservations in regard to the management approach for segmental reporting i.e as seen by the management though may appear outrageous it would certainly bring in an era of new culture of transparency which the user groups should adopt themselves to. The reporting entities should embrace IFRS 8 for its positive aspects of freedom of segmental reporting which the user groups should view it in the right perspective Introduction Publicly traded companies’ businesses may comprise of different product groups or different types of services or both in one region or in different geographical regions. As they would have different segments of business, product wise, service wise and region wise, investors must know how efficiently different segments operate in a business. Hence public companies are required to report results of operations of each such segment stated above so that the investors and other stake holders can know which segments are earning profits and which are not. Or if all earn profits, which earn more. This process known as segmental reporting has been made mandatory by the International Accounting Standards Board for all the listed companies and those who are qualified and in the process of making such reporting. This is a disclosure requirement set by the standard setting authority of International Accounting Standards.(IAS) Companies not listed are also free to make such segmental reporting but they must fully comply with the requirements of the IAS14 3,5 since governed by International Financial Reporting Standards.(IFRS). IFRS prescribes two formats, one for business segment and the other for geographical segment. Formats for reporting (Segment Reporting) Segmental reporting is not new. IFRS ED8 has now been made mandatory for all listed companies from January 2009. Entities can voluntarily report on segment basis even earlier. Features of IFRS 8 Segment Reporting The management approach adopted in IFRS 8 operating segments is the underlying idea which renders segment reporting to external agencies the same as are used for internal management reporting. Though it does not look at the profit or loss angle having a bearing upon the treatment of income, expenses, assets, liabilities or equity, segmental reporting serves as a source for financial analysts and other users to gain better appreciation through a global view of the over all performance of an entity. There is guidance on thresholds generally 10% for a segment to be a reportable one. The segments must make up at least 75 % of the total revenue of the entity. There are no definitions for the components of a segment such as revenue, expense, assets and liabilities of the segment or the segment result. If an entity has only one reportable segment, the disclosures should encompass the entire entity such as information on each product and service or group of products and services. Geographical analysis of these sub segments is also required. If there are transactions with external customers for value of 10% or more of the entity’s revenue for the period reported, it should be a segmental reporting for each such customer. Distinction between IAS 14 and IFRS 8 IFRS 8 adopts ‘as viewed by the management’ approach which means it should be in the same style as are prepared for the internal management for its day to day or routine decisions. Though entities have adopted IAS 14 reporting formats almost akin to IFRS 8 formats, both differ in several respects. The analysis in a geographical segmentation as per IAS 14 can be limited as to secondary segmental reporting while IFRS 8 aims at operating segment for a geographical analysis. In its absence, IFRS 8 needs data on entity-wide level on revenue and selected non-current assets. In IAS 14, primary segmental information should disclose revenue, result, assets, and cost of new PPE (property, plant or equipment) and intangible assets. But under IFRS 8, more details are required but restricted to what are given to internal management. As a result of changes made to IAS 34, interim reporting under IFRS 8 require more information than before. Issues Survey conducted by IASB elicited the following views. Those supporting the IFRS 8 are preparers, due to advantages of availability of information. But investors, users and audit firms feel that quality of disclosures will be reduced under IFRS 8 formats than it is under IAS14. About 80 % of the respondents to the survey want the scope of IFRS 8 to be so extended as to give country wide analysis. Similar survey made by and EFRAG (European Financial Reporting Advisory Group) gives the following results. That the IFRS 8 meets with the requirements of conceptual frame work of IASB and that it would result in improved accounting and also would meet the criteria for EU endorsement albeit some of the members of the group voice concerns with the issues of non-GAAP requirements for segment information. EFRAG however has decided that recommending to the European commission would be in the interest of the persons and entities entrusted with the responsibility of financial reporting. To go into individual issues, analysts and user groups say that IFRS 8 has not provided sufficient certainty in the definition of segments giving too much leeway for the management to define them which might result in less objective information. It can not assure stable nature of segments thus susceptible to vary from year to year, harming comparability. Second, The true and fair view of the affairs of the entity could be weakened by giving too much leverage to managers for maximising their own utility thus reducing the value of firm value to the shareholder. Third, IFRS 8 based on management information and allowing non-GAAP items without having to reconcile to IFRS on segment basis can lead to management hiding non-profitable activities and also affecting comparability. Fourth, The management view likened to Chief Operating Decision Maker is a US practice conflicting with the concept of unitary boards, the main feature of governance structure in many EU countries. Bruegel Institute’s Report The research report of the institute says that IFRS 8 does not have the quality fit for adoption in the EU and that IASB has issued the IFRS 8 mainly for convergence purposes. It argues that the IFRS 8 will reduce quality of information otherwise available to investors as IFRS 8 does not envisage consistent operating segment format by not allowing geographical information on segment basis. Further, IFRS 8 was issued without consultation process with the user groups. Companies following the concept Corporate Social Responsibility (CSR), have been keenly following the new accounting standards but IFRS 8 does not envisage country by country analysis for each segment reported as demanded by the members of “publish what you pay” coalition as such disclosures would only show the fiduciary relationship of companies with outside countries especially of third world jurisdiction and their tax liabilities which would have a direct bearing on the investors’ decisions to invest in trans-national entities. Impact on SMEs Listed companies of smaller size feel that IFRS would result in adverse and unexpected consequences as per the deliberations of their association ‘Quoted Companies Alliance’ (QCA) in the U.K. The remarks are significant in that they come from an organisation representing smaller companies with a market capitalisation of lesser than € 500 million. The main reason for their concern is the consequence of disclosing commercially sensitive information that has a direct baring their competitiveness especially in the E.U.region. Besides, the European Union Commissioner for internal markets Charley McCreevy himself in September 2007 rejected IFRS 8 for SMEs since the standards were too complicated running to 260 pages as reported by Lewis (2007) of AccountingWEB. Richard Murphy, IFRS Project Director, Tax Justice Network, UK, has informed the commission that IFRS 8 is not in agreement with article 43, subsection 8 of the 4th Directive on Company Accounts. Article 43(8) says that the net turnover should be segregated activity wise to be further subdivided by geographical markets to which IFRS 8 is not consistent with. IFRS merely says that geographic disclosure should be split between the country where the entity is incorporated and the rest of the world. Hence if IFRS 8 is followed, it will be in violation of Article 43(8) of the 4th Directive. Besides 7th Directive dealing with consolidated accounts has no such requirement as social environment reporting. (Tax Research UK) Views of the E.U.Commission As for the management approach, based on the consultations conducted, the Commission feels that the adoption of management approach would only result in better quality of segment information and increased utility and that there is no evidence to show that such disclosures would harm the financial function of entities. About the freedom of flexibility in segmenting available to entities which might result in information distortion to the detriment of investors and other users, the Commission states that it is quite far fetched and any such comparability problems would however be outweighed by the advantages from segment information based on management approach. That the geographical information requirement is more specific under IAS14 than IFRS 8, is also not sustainable due to the fact IFRS 8 would serve the general purpose of the users and there is no evidence to show that IFRS 8 would only give limited information on geographical segments. The Commission feels that in fact it would eventually give more information. The provision in the US, SFAS 14 identical to IAS 14 concerning geographical information, treat it as a secondary segment which will be of only limited value where as the IFRS 8 can give extensive information on geographical basis once the Chief Operating Decision Maker (CODM) decides to give geographically segmented information. For Corporate Social Reporting, country wise segmental reporting is highly essential. Though IFRS doe not contemplate, such arrangement could still be arranged through listing agreement. Another contentious issue of the possibility negative results of a segment being covered up by other segments with positive results has also been addressed by the commission stating that IFRS 8 does not hinder corporate governance in the EU by the mere introduction of the US concept “Chief Operating Decision Maker” as against the widely prevalent unitary board model in Europe. US experience shows that it was only under SFAS 14 similar to IAS 14, covering up a segment by single segment reporting had been in practice. At present the U.S‘SFAS 131 akin to IFRS 8 such a disclosure is not possible. The commission has noted that the model CODM should be seen as a function rather than as an individual. The issue that smaller listed companies are disadvantaged having to disclose commercially sensitive information is not viewed by the commission as a genuine one since no evidence of any such adverse result has surfaced. Besides, the aspiring companies wanting more capital through listing are not justified in holding such a view since investors’ expectations from smaller listed companies are the same as from large companies. The cost benefit analysis of the IFRS 8 implementation is also viewed by the commission in a positive light. The commission holds this view by relying on consultations held. It has been found that cost of preparing will be lower than what is incurred under the IAS 14 scheme. Non adoption of IFRS would result in competitive disadvantage for the EU entities. Many companies have evinced interest on earlier adoption of the IFRS 8. It should be noted that IFRS 8 is similar to US SFAS 131 dealing with disclosures about Segments of an Enterprise and related information and in effect it is mere convergence of IFRS with US GAAP with very insignificant differences. The IFRS 8 also meets with the requirements of EC Regulation No 1606/2002 dealing with International Accounting Standards. The IFRS 8 has not been contrary to true and fair principle envisaged in Article 16(3) the Council Directive 83/349/EEC and article 2(3) of Council Directive 78/660/ EEC (Enevoldsen 2007) Véron (2007) a research fellow at Bruegel Institute which is a European think tank on international economics, states that IFRS (not IFRS 8)has been adopted in European Union, Australia, China and soon Canada, South Korea, Japan would follow suit by requiring IFRS from listed companies. The US is also contemplating on IFRS to replace it GAAP in the interest of Global Accounting Standards though it was US GAAP that inspired IFRS. The notable reservations were of Jon Browne, ex-Chief Executive of BP who said that IFRS made the results more difficult to understand. Although it is for the benefit of investors, some the group of investors such as UK’s Investment Management Association and National Management of Pension Funds were not happy with the rash adoption of IFRS. Since IFRS 8 is dependant up on companies’ judgement, comparability can not be ensured. Enforcement also would be difficult especially in jurisdictions like China. In his presentation on EU adoption of IFRS, Véron (2007) argues that current version of IFRS 8 should not be endorsed by EU for the reason that it does not ensure sufficient safeguards due to several methodological flaws. The fact that the US will recognise IFRS is not convincing enough for global its adoption. He adds that the management approach envisaged by the IFRS 8 does provide safeguards to reflect economic reality in segments to be reported. There is also no guarantee to ensure segment information to be consistent with consolidated information. He also testifies as he was once a chief financial officer of a publicly listed company during 2000-2002 which had been reporting under French accounting standards in addition US GAAP and as a free lance consultant since 2002. He says that due to inherent difficulties, segment reporting can not be standardised to be a common format for all the listed companies all over the world. Though there was no consensus for adoption of IFRS 8, IASB decided in November 2007 to adopt the IFRS. On 24 April 2007, AccountingWEB.co.uk reported that main concerns against the IFRS 8 adoption is the Chief Operating Decision Maker, absence of requirement of segment wise reporting on cash flow and liability analysis and the simple adoption of U.S. standards thrust up on European member states who are under different frame work from that of the U.S. (Financial Reporting News 2007) Conclusion From the above discussion, it would be clear that there are apparent advantages stemming from the adoption of IFRS 8. The management approach though may be new, it will emerge as the best practice once markets have learnt to use the additional information arising from segmental reporting. Therefore the increased utility of segmental reporting will outweigh the comparability issues. Similarly the limited geographical segmentation on which IFRS 8 has been said to be soft, will also not adversely affect the volume of information in comparison with that of IAS 14. The European Commission is of the belief that endorsement and application of IFRS 8 would result in positive cost-benefit results and that the delayed adoption would only seriously cause disadvantage to the EU companies and it will also entail them more costs. Where as IAS 14 is meant for only external reporting purposes, IFRS 8 as seen inside the companies will result in more confidence building among the investors and would give the a sense of participation in the management of the companies in which they are interested. The need of the hour is the quick decision on the adoption since the first adopters would otherwise have to first apply IAS 14 and quickly move on to IFRS 8 which will have undesirable effects on their economy and result in wasteful exercise telling upon profits. The commission also believes that companies should be prepared for changes in IFRS 8 in 2010 or 2011 in the interest of development of overall global standards References Enevoldsen Stig, 16 January 2007, European Financial Reporting Advisory Group “Adoption of IFRS 8 Operating Segments” Financial Reporting News 2007 “Brussels have second doubts over IFRS 8” 24 April 2007 Accessed 8 March 2008 Lewis Rob 2007 Financial Reporting News “EU rejects IFRS for SMEs “17 September 2007, Accessed 8 March 2008 Segment Reporting, Price Waterhouse coopers, accessed 27 February 2008http://www.pwc.com/Extweb/service.nsf/docid/FE161F5660F398EC8025713E0045BBE6 Tax Research UK, Richard Murphy on Tax and Corporate accountability, “IFRS 8-TJN makes a further submission to the European Commission” accessed 8 Marc 2008 < Vèron Nicolas, 2007 “called to account” Financial World May 2007 Vèron Nicolas, 2007 “EU Adoption of the IFRS 8 Standard on Operating Segments” Presentation to the Economic and Monetary Affairs Committee of the European Parliament “19 September 2007 Read More