Utility as a Convergence Standard on Segment Reporting - Research Paper Example

IFRS 8: Utility as a Convergence Standard on Segment Reporting 0 Introduction: The purpose of International Financial Reporting Standard 8 (IFRS 8) 'Operating Segment' issued by the International Accounting Standards Board (IASB) is to eliminate major differences between IFRS and US Generally Accepted Accounting Principles (GAAP) and also to improve the financial reporting. The IFRS adopts the 'management approach' to report on different segments as set out in Statements of Financial Accounting Standards 131 (SFAS 131). In this way it becomes possible for the users of the financial statements to make an in-depth analysis of the statements and raise queries as to the ways in which the entity was controlled by its senior decision makers. The IFRS make the entities achieve this purpose by enabling them to provide segment wise information. However the entities do not incur any excessive cost for such reporting; they are able to make only at a little extra cost. IFRS 8 arises from the IASB's comparison of International Accounting Standard 14 (IAS 14) 'Segment Reporting' with the US standard SFAS 131 'Disclosures about segments of an Enterprise and Related Information'. IFRS 8 replaces IAS 14 and aligns Segment reporting with the requirement of SFAS 131. This paper envisages a critical analysis of the impact and usage of the introduction of IFRS 8 and the extent to which this standard aids in achieving the convergence between national accounting standards and IFRS to deliver high-quality solutions. 2.0 Scope of IFRS 8: IFRS 8 applies to the separate or individual financial statements of an entity (and to the consolidated financial statements of a group with a parent): whose debt or equity instruments are traded in a public market; or that files, or is in the process of filing, its (consolidated) financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market. However, when both separate and consolidated financial statements for the parent are presented in a single financial report, segment information need be presented only on the basis of the consolidated financial statements. (Deloitte Paper) 3.0 Reasons for Issuing IFRS 8 Operating Segments: International Accounting Standards Board (IASB) based in London represented and funded by major accounting firms, industrial companies, financial institutions, central banks and other international and professional organizations throughout the world is committed in developing, in the public interest, a single set of high quality global accounting standards that require transparent and comparable information in general purpose financial statements. According to the IASB Paper on IFRS 8 (2006), the prime objective of the IASB is to achieve the convergence of accounting standards in all the countries around the world. With this objective in view, the IASB and the Financial Accounting Standards Board (FASB) in the United States have undertaken a joint short term project with the objective of reducing the difference between the IFRSs and US GAAP that are capable of resolution in a relatively shorter period of time. The other consideration was that the differences to be addressed must be outside the major projects. With a view to adopting high quality financial reporting solutions, both the Boards considered the standards prescribed by them recently and evolved the new standard as the best combination of existing standards. In order to decide on the new IFRS 8 standard the IASB compared the IAS 14 Segment Reporting and SFAS 131 Disclosures about Segments of an Enterprise Related Information. It is worth noting that the IAS 14 was adopted substantially from the earlier standard issued by the International Accounting Standards Committee (IASC) in the year 1997. Hence the main reason for the issue of a revised standard in IFRS 8 is to increase the convergence of different standards as well as to present the best of the standards available in respect of Segment Reporting. 4.0 Rationale behind the Issue of IFRS 8: Generally on the information for the readers of the financial statements, the earlier standards required the entities to report on such information the management would have used internally for the evaluation of the performances of the different segments of the entity. However it was observed that such information is different from the ones used by the entities to draw up the income statements and Balance Sheets. Such disclosures usually helped the users to understand the firm's operations in general but did not provide enough information to assess the performance of its segments. It greatly hampered the user's ability to make a meaningful analysis of the performance of the segments vis--vis that of the entity. Now the IFRS requires the entity to adopt the 'management approach' to reporting on the financial performance of its operating segments. Such requirement from the IFRS necessitates reporting the explanations of the basis on which the segment information is prepared and reconciliations to the amounts recognized in the income statement and balance sheet. 5.0 Purpose of Adopting 'Management Approach': According to IASB adopting the 'management approach' will improve the financial reporting in the following ways: By making available to the user, the explanation on the basis on which the segment information is prepared the user is enabled to view and read the financial statements from the angle of and through the eyes of the management. This provides a meaningful base for the segment reporting instead of being a mere formality. Secondly, since the information to be reported additionally are already available and are being used by the management, there will be very little extra time and cost involved in preparing these information and they can be made available on a timely basis. This means that the existing reporting on segment information can be easily extended to meet the new requirement under IFRS 8. 6.0 Main Features of IFRS 8: The IASB paper states that "the IFRS requires an entity to report financial and descriptive information about its reportable segments." By 'reportable segments' IFRS 8 means the 'operating segments' or an 'aggregation of operating segments'. In order to become a reportable segment the operating segment(s) should certain specified criteria. The criteria relate to the internal and external revenue of the entity, profitability of the segments and the combined asset values of the segments. An operating segment is one 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 The term 'Operating Segments' covers those components of the entity about which the entity can make discrete financial information available Moreover the financial information should have been evaluated regularly by the Chief Operating Decision Maker. Such evaluation comprises of the decisions relating to the allocation of resources as well as assessing the performance of the components. For the purpose of IFRS 8 the financial information is required to be reported on the basis that it is used internally for evaluating the performance of the operating segment and deciding on the ways of allocation of resources to operating segments. 7.0 Disclosure Requirements: According to Deloitte Paper IFRS 8 demands the following disclosure requirements: general information about how the entity identified its operating segments and the types of products and services from which each operating segment derives its revenues; information about the reported segment profit or loss, including certain specified revenues and expenses included in segment profit or loss, segment assets and segment liabilities and the basis of measurement; and reconciliations of the totals of segment revenues, reported segment profit or loss, segment assets, segment liabilities and other material items to corresponding items in the entity's financial statements. some entity-wide disclosures that are required even when an entity has only one reportable segment, including information about each product and service or groups of products and services. Analyses of revenues and certain non-current assets by geographical area - with an expanded requirement to disclose revenues/assets by individual foreign country (if material), irrespective of the identification of operating segments. information about transactions with major customers. considerable segment information at interim reporting dates. 8.0 Key Implications of IFRS 8: The emphasis of segment reporting has completely been changed by IFRS 8. Now the segment reporting is to be based on drivers like the ways in which the businesses are run as well as the information used the chief operating decision makers. The focus has been made less on issues like products, geographies and GAAP measures unless they form part of and used in internal assessment and reporting. While the changes may have very little in respect of certain companies, others will have to make radical changes in the way they identify reportable segments and present the segment information in the financial statements. As opposed to the reporting requirements under IAS 14 which was seemed to be somewhat rigid, IFRS 8 provides diversity in reporting on the basis of the information that the management believes important. Because of this phenomenon IFRS should provide a more meaningful segment reporting. "For example, some companies might report a combination of business and geographical segments; others that were previously a matrix organisation will identify a single set of segments" (Price Waterhouse Coopers 2007) According to the IFRS Newsletter of Price Waterhouse Cooper introduction IFRS 8 will result in the simplification of the financial reporting for the companies which are presently reporting different segment information for internal and external purposes. Now it is enough one set of information is prepared and reported. Similarly Foreign Private Issuers may not have to maintain two sets of records for segment reporting to provide information required by IAS 14 and SFAS 131. Further IFRS 8 is expected to reduce the volume of segment information. This is so because the disclosures under IFRS 8 are required only in respect of one set of segments. However there are conflicting views on this aspect in that a company that reports information about segment interest and taxes to the CODM will make more disclosures and a company that reports a non-GAAP performance measure will have to reconcile to the GAAP measures reported in the income statement. It may so happen that some of the companies might not find any change or find only little change between the disclosure requirements as given under IAS 14 or SFAS 131 and those required under IFRS 8. However this does imply that the new standard has no impact. For example, operating segments sometimes determine the level at which goodwill is tested for impairment under IAS 36. This may necessitate some companies to reconsider the approach to the impairment test. 9.0 Improvements Envisaged under IFRS 8 as compared to IAS 14: IFRS 8 is issued by the IASB in replacement of IAS 14 and is expected to provide an improved reporting environment as far as the segment reporting is concerned. In replacing IAS 14 IFRS: Extends the scope of the segment reporting by including entities that hold assets in a fiduciary capacity for a broad group of outsiders. IFRS 8 also covers the segment reporting in respect of entities whose equity or debt securities are publicly traded and entities that are in the process of issuing equity or debt securities in public securities markets. This is a very important deviation from the old requirement under IAS 14 as this reporting will enable the financial institutions and other investing public to know more about the operations of the company in whose securities investments are proposed to be made. Requires identification of operating segments based on internal reports that are regularly reviewed by the entity's chief operating decision maker in order to allocate resources to the segment and assess its performance. This is because the requirements of the Exposure Draft are based on the information about the components of the entity that management uses to make decisions about operating matters. (Deloitte Paper) This requirement broadens the scope of segment reporting than the earlier way of reporting. In this way the segment reporting has been made to provide meaningful information to the user instead of merely reporting on the overall positions of the segments instead of detailing their performances and the resulting revenues and losses and the reasons for such results. Includes a component of an entity that sell primarily or exclusively to other operating segments of the entity in the definition of an operating segment if the entity is managed in that way (Deloitte Paper) This again is advantageous from the user point of view as the financial statement in this case have to reveal the transfer pricing policies of the entities concerned. Usually the inter divisional transfer pricing is a gray area in which anomalies will set in and this way the efficiencies and inefficiencies of the different operating segments will be brought to light. Requires the amount of each operating segment item reported to be the measure reported to the chief operating decision maker for the purposes of allocating resources to the segment and assessing its performance. (Deloitte Paper). This requirement of the IFRS 8 provides a 'management approach' to the disclosures under segment reporting. This will completely changed the outlook of the segment reporting as being done under IAS 14. Hitherto the reporting under IAS 14 was considered as a mere formality which is of no interest either to the provider of the information or the user of the financial statements as the reporting was very superfluous without any back up information to make the report meaningful. The segment reporting under IFRS 8 will make the segment reporting with such back ground information and details to make the user look at the report from the eyes of the management. This implies that the segment reporting can be done in a critical manner to find out any weaknesses affecting the performances of the different segments of the entity. Requires reconciliations of total reportable segment revenues, total profit or loss, total assets, and other amounts disclosed for reportable segments to corresponding amounts in the entity's financial statements (Deloitte Paper) It may be observed that this particular reporting requirement of IFRS 8 that enables the user to have a meaningful interpretation of the financial statement with respect to reporting on the segments. The provision under the Standard to report segment revenues and reconcile the same with the figures as reported in the entity's financial statements helps the user to make a comparative study of the performances of the different segments representing different departments by way of studying the relative profitability of the individual segments. This also enables the user to arrive at his own conclusions on the effectiveness of the segments in contributing to the overall profitability of the entity. requires an explanation of how segment profit or loss and segment assets are measured for each reportable segment (Deloitte Paper) This is yet another significant deviation from the old requirement and provides a concise view of the report to make the financial statements become the basis of forming opinions on the financial strengths of the business in which the entity is in. This is possible by analyzing how the entity has performed in its main activity vis--vis the other segments in terms of profitability. requires an entity to report information about the revenues derived from its products or services (or groups of similar products and services), about the countries in which it earns revenues and holds assets, and about major customers, regardless of whether that information is used by management in making operating decisions.(Deloitte Paper) This reporting requirement broadens the scope of the segment reporting to the maximum extent possible by requiring the entities to include as much info as possible with respect to the different segments the entity is operating upon. A complete segment wise overview of the entity's business is facilitated by this disclosure requirement. The user will be provided with more than adequate information to know the segment wise performance as well as the other details relating to asset holding by each segment and the details about the Customer base which enables the user to read the financial statement of the entity in-toto. requires an entity to give descriptive information about the way that the operating segments were determined, the products and services provided by the segments, differences between the measurements used in reporting segment information and those used in the entity's financial statements, and changes in the measurement of segment amounts from period to period (Deloitte Paper). This change in the reporting on the segments places an obligation on the part of the entity to provide the user with incremental profits from period to period so that the performance of the segment concerned can be effectively measured over a period of time and the resultant efficiency of the segment in contributing to the overall profitability of the entity on a period wise comparative basis. 10.0 Conclusion: In the case of the merged MCI Worldcom, the segment wise reporting under SFAS 131 has not provided the most essential information on the segment wise profitability which of course is in compliance with the reporting requirements under SFAS 131. However this reporting requirement was not meaningful since the financial statement was not explicit in reporting either the segment wise profitability or the reconciliation of the total revenue with those of the segments. These kinds of inadequacies will be eradicated with the introduction of reporting as per IFRS 8. This new segment reporting is to take effect from 1st January 2009, unless the entities on their own decide to adopt it earlier. Hence much remains to be seen how the entities take up this requirement and how far the changed reporting is really useful for those who read the financial statements. However it needs to be mentioned that in the background of the foregoing discussions, it appears that the segment reporting requirements envisaged under IFRS 8 encompass a wider compliance on the part of the entities than that was necessary under either SFAS 131 or IAS 14, in that IFRS 8 can be regarded as smarter in requiring the entities to come out with more than adequate information for the users of the financial statements of the entities concerned.. References: 1. IASB Paper on IFRS 8, (2006)IASB issues convergence standard on segment reporting IASB Paper dated 30 November 2006 http://www.iasb.org/News/Press+Releases/IASB+issues+convergence+standard+on+segment+reporting.htm 2. Deloitte Paper Standards: IFRS 8 IAS Plus Newsletter IFRS 8 http://www.iasplus.com/standard/ifrs08.htm 3. Price Waterhouse Coopers (2007) IFRS 8 - now's the time to consider the implications IFRS News Issue 48 January 2007 http://www.pwc.com/extweb/pwcpublications.nsf/docid/6B2150E47CD6D4218025711800473281/$file/pwcBelgium_IFRSNewsJan2007.pdf Read More