Segment reporting – not so fast, aggregation fiends!

The IASB sheds more light on a key aspect of IFRS 8

Converting to IFRS didn’t create too many difficulties for most Canadian companies in the area of segment reporting, because the main points of IFRS 8 are much the same as those in old Canadian GAAP standard CICA 1701: they both build on the same premise of identifying operating segments based on the information provided internally to the “chief operating decision-maker”. As with anything though, it’s possible to think of areas where differences could have arisen. For example, IFRS 8 allows aggregating two or more operating segments into a single operating segment if aggregation is consistent with the standard’s core principle (which doesn’t say much in itself), if the segments have similar economic characteristics, and if the segments are similar in each of five respects: the nature of their products and services; the nature of their production processes; the type or class of customer for their products and services; the methods used to distribute their products or provide their services; and if applicable, the nature of their regulatory environments. CICA 1701 contained a similar stipulation: however, in the early days of putting that standard into practice, it became clear these words made it too easy for preparers to justify aggregating essentially dissimilar segments; in particular because of the vagueness of what might constitute “similar economic characteristics.”

Remembering old Canadian GAAP

The old Emerging Issues Committee consequently addressed this in EIC Abstract 115, reaching a consensus that two operating segments didn’t have similar economic characteristics unless they exhibited similar long-term financial performance, including similar long-term average gross margins and sales trends; alternatively, if two segments didn’t share a past history of similar long-term financial performance, EIC-115 required identifying a change in economic characteristics of one of the segments that led to similar gross margins and sales trends in the current year, along with evidence, including budgets supported by appropriate analyses, that this similarity would continue in the future. The EIC added that where gross margin wasn’t reported internally as a measure of financial performance, operating segments would be considered to exhibit similar long-term financial performance if long-term sales trends were similar and other key financial measurements (e.g., return on assets, levels of capital investments, operating cash flows) used by the chief operating decision maker didn’t present contrary evidence. All of this made it much more difficult to justify aggregation based merely on some broad assertion of two segments having similar economic characteristics.

More clarity about aggregation

IFRS doesn’t have an equivalent to EIC-115 though, allowing at least a possibility that some companies might have tried to revert back to a broader concept of what it takes to justify aggregation. Someone told me this happened with some companies, although I never came across any cases directly. Even if a particular entity reports fewer segments under IFRS than it did under Canadian GAAP, without any obvious change having taken place in the business, it’s always possible there’s another reason for it: maybe for instance the entity amended its internal reporting practices at the same time, so that the chief operating decision maker is now reviewing the organization at a higher level of detail (there’s always been some artificiality to this aspect of the standard).

The IASB’s recent Annual Improvements to IFRSs: 2010-2012 cycle, doesn’t go as far as EIC-115 did, but it does stir this up a bit by introducing a new requirement to disclose “the judgements made by management in applying the aggregation criteria in paragraph 12. This includes a brief description of the operating segments that have been aggregated in this way and the economic indicators that have been assessed in determining that the aggregated operating segments share similar economic characteristics.” The accompanying basis for conclusions doesn’t explain the rationale too much, beyond noting that the Board “thinks that including a disclosure requirement in paragraph 22 would provide users of financial statements with an understanding of the judgements made by management on how (and the reasons why) operating segments have been aggregated.” But even if investors gain some incrementally greater understanding of the other aggregated segments that lie beneath the surface, it’s hard to see what they could practically do with that information. It’s hard not to think the main beneficiaries might be regulators, using this new disclosure as a potential red flag for segments that maybe shouldn’t have been aggregated in the first place. In other words, if any Canadian companies did indeed do anything different in this area on adopting IFRS, the story may not necessarily be over yet.

More IFRS 8 tidying

By the way, the annual improvements also bring in another amendment to IFRS 8, to state that a reconciliation of the total of the reportable segments’ assets to the entity’s assets is only disclosed if a measure of segment assets is regularly provided to the chief operating decision maker, and not otherwise – that is, a preparer doesn’t need to create a measure of segment assets for disclosure purposes alone. This was already clear enough from other parts of the standard, but the amendment removes a slight inconsistency.

The opinions expressed are solely those of the author

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